It was about 30 years ago that Fred Glahey at the University of Colorado handed me about a page and a half of notes
that he'd give as commentary on the Hayek-Keynes debate at the Mount Pilaran Society and told me turn this into a dissertation.
At that time, I had read Little Hayek, even less of Mises, and even less of Rothbard.
So it was turned into a five-year process of essentially redoing a graduate program on my own out in Boulder, Colorado before all these amazing resources are available on the web that give you access to this stuff.
So it's really good to be back in terms of this.
And I'd also just like to take a moment and dedicate this presentation to a dearly missed colleague, Larry Seacrest, who I would love to have him still around here to be listening to his insights in this.
So I'm also a PowerPoint virgin.
So this is the first time I have been told this.
And I think I've got some creative slides.
But if you were here earlier, I have none
that were as creative as Bob Milligan's second slide.
If you remember the screen, it was really
a slide of all the propositions from Keynesian theory
that were both true and relevant.
let's see now I guess I need to be able to move forward okay first slide came to
me from my twin brother about the time of the last recession so you can see
There are some people that may have a different view of Hayek's relevance.
If you can't read that, it shows the two characters.
And one of them says, Frederick Hayek and John Keynes argued incessantly,
their ideas shaped modern economic thought.
Even today, the struggle between the Keynesians and Austrians rages on.
And the other one says, that's good.
I can whistle the Seinfeld theme through my nose.
So, OK, for some of us that have been writing on the Austrian business cycle theory through
the last 15 to 20 years, I think particularly by the second one we felt very much this is
a quote from Hayek in the mid 70s.
The publication was a Cato publication in 79, but I think it reprints some lectures
in the mid-70s, and a couple things in here, he says, I've been preaching for 40 years
that this over-expansion of the money supply misdirects production, creates temporary unemployment
that will often lead to even greater unemployment in the future.
And now we're in that, Major and I think too often overlooked in this discussion, catastrophe
of the 1970s and early 1980s, where we really had double-digit unemployment, double-digit
inflation, and while the slowdown didn't last near as long as this one, it was certainly
much deeper and we should take that into account.
And he's kind of, now you ask me, what do we do when we're in the cycle, and you still
hear some of that right now about the Austrians in here, your policy's too harsh, I've addressed
I'm going to focus more on the boom and the bust relevance here at an earlier paper in QJE last fall where I try to go the other way and what's the relevance for these Austrian policy for the recession and the recovery and I think there's a lot more there that's been under-appreciated and under-pushed in there.
Another thing I kind of want to go back to is that is overlooked particularly by the people pushing just general stimulus on the economy. Going back, and this is a quote from Hayek's monetary theory in the trade cycle, which was really his earlier work in German in 1929 was translated into English in 1933. But he's talking about what's the task as we try to
separate out good business cycles from bad business cycle theory and I've got some citations
in there that I think it's even clear that Keynes accepted this fundamental that the
task is made easier on at least one point. Then when we look at fluctuations, we not
only have the up and down in GDP, but what we tend to see is the relatively greater instability
in the component that we would call business or future-oriented spending relative to consumption.
The second point that I think we need to be much, much clearer on is that, as we're talking
about these things, is the relevant discussion in this point is not the absolute fluctuations
up and down, but the relative magnitudes.
And in a boom, the investment components are expanding not only in absolute terms, but
relative to their overall size in the economy.
So investment is increasing.
I've got some other comments in the paper, and there's a few copies up here if anybody
is interested, that we also kind of face the problem on the relative magnitude of investment
to consumption is that the way we measure in the product of income accounts greatly
understates the amount of current economic activity that's really being undertaken right
now, not to produce goods now, but to produce them in a future stream, so we'll stylize
facts.
As far as the relevance to the cycle, and these are just some simple things in here,
is that we should see two things going on.
One is the first cycle, and I think that we really need to be looking at these two periods
as really a single phenomena, that we probably did have a productivity-driven expansion,
and that shows up in the period in the early 90s where you actually see the blue line is
real gross domestic product is being produced at a level higher than what people were estimating
is the trend potential or full employment GDP.
That was the first phase of the cycle, which to me was an Austrian cycle that was piggybacked
on a productivity cycle.
That the increased investment demand was driving the demand for credit and a Federal Reserve
banking system that was targeting interest rates just accommodated the expansion of credit
that led to this over-expansion in the, at this time, we saw a lot of it in the dot-com
boom, that type of segment in there.
We got a correction, temporary recession that also, like this one, the press beat up as
a jobless recovery for a long period of time.
And what we saw in this one is an attempt, the active part of the policy of the Federal
The Federal Reserve or even John Taylor has some pretty good work on this that the Fed kept interest rates far too low for far too long and if they were too low for a Taylor rule you can imagine how low they were relative to a natural rate in here and this one's kind of interesting because it created what looks like a quasi-recovery we got a very shallow recession and GDP recovers back to the trend
The facts, I think, still show up, and if you want another look at this in broader terms is there's a...
I think David Romer has an advanced micro text, has a pretty good chapter on the real business cycle theory,
and look at those stylized facts, and they clearly show greater fluctuations in time-related activities,
including durable consumer goods.
This is a chart that, the first one, the blue line is just gross domestic investment, measured in real dollars, absolute terms, and again you can see the trend in here, during the boom phase in here, investment is increasing very significantly, steep rates, collapses during the recession, you get the following trend in here.
The red line is average weekly employment in the private sector, so the other thing I just wanted to show is that not only do we get this trend in here, but when you actually look at employment of labor resources during this period, the trend very, very closely follows the trend in investment, and then to reinforce kind of the impact, this one is essentially showing gross private domestic investment,
Relative to Total GDP and again you'll see during the boom phases very very
high levels relative to average of the percent of economic activity even in the
GDP product and income accounts that's being picked up in there. Mark Skousen
has been working on a measure he calls gross domestic investment that when he
bad news is is the data he uses as much of its based on tax data and it's most
The most recent is about two years old, but his kind of preliminary reports is that even in that measure of expenditures, consumption drops from the 60, it's almost 70% in the GDP account down to about 30% and investment spending measured in that becomes almost 70% or about double consumption rather than what looks like a small component of that.
This was for later. This is just kind of five minutes. Boy, we'll speed through this then.
That shows a decline in nominal GDP. We'll ignore that. I'll skip through.
First, Hayek's cycle theory, and just real quick, I want to emphasize that the way he designed the cycle theory and to some extent Mises is there's two key components.
Components. The first that I'll call the theoretical components that long run, essentially, and I think I prefer to put that essentially tastes and preferences and resource scarcity is what determines relative prices, not monetary phenomena. The second, I think, is very, very important, the Kantian effects that Mark Thornton's done a lot with, that monetary injections create distortions in flows of spending relative to flows of resource
So distort relative prices and cause temporary flows in resources, in direction, the monetary,
which will have to be reversed when the monetary injections don't accelerate.
And then there's two empirical foundations to the Austrian business cycle theory.
One, looking at the nature of the financial system, was a belief at that time with a fractional
reserve banking system, and I think reinforced if there's a central bank, that normally
The additional money balances enter the spending stream through loans made through the commercial
banking through the fractional reserve banking system in there.
And the second proposition then is that normally those loans go to businesses or entrepreneurs.
That is what leads you with the decline in there to see the relative expansion of investment
following a monetary decline.
Declined. I want to go through this. It's kind of an interesting thing. Two critics of Hayek listed 10 propositions that they saw in his theory. And Hayek kind of says, there's a minor scribble on that. It's a pretty good summary. And I think it still holds up pretty well in broad general terms on his Capital Theory framework. And I added a tenth point to my own
When money is created in an economy that is not fully employed, it may initially be stimulated.
It will show up in employment, but you still get the same distortions in the economy,
so what you are just doing is continually setting up these booms and busts in here.
Hayek in the 1970s, or during this 1930 period, the other thing I will emphasize is that
that he made some very, very strong arguments against price stabilization as a goal in monetary policy.
And that really would fit my first business cycle scenario, where you're kind of piggybacking on a productivity-driven growth.
Prices should actually be falling, so anything targeting stable prices would essentially be distorting the economy
In the 1970s, he's looking at 30 years of data in here, hadn't seen much of this going on, and he kind of backs off of this.
He emphasizes the Kantian effects, he emphasizes that distortions in the economy,
flow of money spending that's different from the flow of resources is a major cause of unemployment in there,
and that leads us really to a recession if you've got a misdirection of
unemployment relative prices are wrong if you want stable long-term full
employment you've got to allow prices and wages to adjust and get the spending
streams in line with the resource streams in there but he does two things
in there he argues that when you look at that monetary system may be targeting
Banking Price Stabilization is not so bad.
Doesn't look like that causes that bad a problem compared to other types of things.
And then on kind of empirical grounds, he kind of abandons the capital theory in there.
He's saying, you look at, we're now making loans to consumers, we're doing all this
type of thing, it's not clear to him that you can as clearly delineate these misdirections
in there.
The conclusion of the paper is I think he was wrong on both of these points, that we
can clearly see, and even Alex Leonhoff had cited in the paper, clearly calls this last
crisis Hayekian, not Keynesian, that it's a misdirection of production.
And the other was kind of a fight with Larry White, who in a 1999 paper maybe argued that
Hayek in the 70s abandoned his business cycle theory.
And I say, no, he made a couple of minor adjustments
in empirical and on those two things he was right.
But the foundation of his business cycle theory,
the two theoretical components, he never did abandon.
And he stayed pretty consistent to that
in some of the other deals.
So I am about to get shot by Bill.
But that's because he took my five minutes being late.
Thank you very much.