WEBVTT NOTE Are People Really Fooled? Rational Behavior, Misleading Signals, and the ATBC 1 00:00:00.000 --> 00:00:03.960 When I talk about the rational expectations, I think it's more of, I think, kind of in 2 00:00:03.960 --> 00:00:10.000 line with Bob Higgs when he talks about vulgar Keynesianism. And I think this is sort of 3 00:00:10.000 --> 00:00:14.920 really more vulgar rational expectation, a very simplistic view. I mean, I haven't gone 4 00:00:14.920 --> 00:00:22.040 into Muth and I haven't gone really into Sargent or Lucas and that. I'd actually like to do 5 00:00:22.040 --> 00:00:27.800 more of it down the road because they do try to do things like bring in shocks and all 6 00:00:27.800 --> 00:00:30.800 and all that to the system. 7 00:00:30.800 --> 00:00:37.800 But nonetheless, as you can see, this is the famous proverb, 8 00:00:37.800 --> 00:00:42.800 every October we would get this, right, that Lucy would promise Charlie Brown 9 00:00:42.800 --> 00:00:46.800 that she would hold the football for him and he could go kick it. 10 00:00:46.800 --> 00:00:50.800 And, of course, every year Lucy would pull up the football. 11 00:00:50.800 --> 00:00:53.800 And so every year she would rationalize it somehow, 12 00:00:53.800 --> 00:01:02.720 I know that in the end, Charlie would believe her, this time he would trust her, and he would run down to kick the football, and boom, losing it, always picking it up, and there goes Charlie Brown. 13 00:01:02.720 --> 00:01:08.380 Ah, no, I did not get the copyright on that, so I hope nobody turns me in. 14 00:01:08.380 --> 00:01:20.620 Ah, I'm sure that's probably a Federal crime worth at least 30 years in prison, but nonetheless, you know, answers, you know, and so what I do is I first remember Gordon Tullock's article, 15 00:01:20.620 --> 00:01:50.620 Walter hadn't answered to it years and years ago, and I've not used that in this, but I should have, I know Walter, but I know it just, but nonetheless, I'm aware of it, I just kind of ran out of time, but anyway, he says that Rothbard's apparent belief that business people never learn, okay, in other words, this is the Charlie Brown problem, that the business people would be, they would have been misled maybe the first time, maybe even the second time, okay, but third time, they're not going to let Lucy pull up the football, and because they're going to say, 16 00:01:50.620 --> 00:01:58.320 They're going to tell Lucy where to go because they're going to look at this, you know, the Fed has lowered interest rates and they're going to say, 17 00:01:58.320 --> 00:02:04.320 ah, we know what's going on here, no problem, all right, so we're not going to take the bait, okay? 18 00:02:04.320 --> 00:02:12.320 And in fact, that would also be, to a certain extent, in the rational, remember, if you understand the rational expectations literature, 19 00:02:12.320 --> 00:02:26.320 It'd be like, I think that Hunter talked about earlier today, where the Fed would, they run deficits, but that did not lead to more savings. 20 00:02:26.320 --> 00:02:39.320 Remember in the whole rational expectations idea that, okay, the government runs up, now people are going to, in order to pick up aggregate demand, but people are going to save more in order to avoid all that. 21 00:02:39.320 --> 00:02:50.320 So, I think that this is kind of in line with that. Again, it's more of a vulgar, it's not the sophisticated technical stuff that you get from Lucas and Sargent and others. 22 00:02:50.320 --> 00:03:01.320 This is now Brian Kaplan. You know, you got to go to Brian's website, you know, and this is from, you know, why I'm not an Austrian economist. 23 00:03:01.320 --> 00:03:12.320 But he says, you know, what I deny is that artificially stimulated investments have any tendency to become malinvestments. 24 00:03:12.320 --> 00:03:25.320 That supposedly, since it cannot continue indefinitely, it's eventually necessary to let interest rates rise back to the natural level, which then reveals profit, which is what we Austrians believe. 25 00:03:25.320 --> 00:03:33.820 Okay, why would any businessman make his profitability calculations based on the assumption that low interest rates will prevail indefinitely? 26 00:03:33.820 --> 00:03:42.320 And no, that would happen. Entrepreneurs would realize that interest rates are only temporarily low and take this into account. 27 00:03:42.320 --> 00:03:50.320 Again, it's an RE point. In other words, in short, the Austrians are assuming that entrepreneurs have strange, irrational expectations. 28 00:03:50.320 --> 00:04:20.320 So, in other words, that the ATBC is actually an irrational thing, but you know, we, and even though I don't have it up here, I looked for it on YouTube, but if you remember that, you know, one of the greatest movies ever made, Animal House, and that important scene there at the end where the band is trying to walk through the wall, and the, and I forget the name of the character leads him into the wall, the only thing I think he said the entire movie was, 29 00:04:20.320 --> 00:04:26.960 He called Blutarsky a moron, but his only line. 30 00:04:26.960 --> 00:04:33.720 But nonetheless, again, this is this whole view that what we believe is that the band 31 00:04:33.720 --> 00:04:37.520 can really walk through the wall. 32 00:04:37.520 --> 00:04:44.520 But then also Richard Wagner, and I actually got this from Walter's article. 33 00:04:44.520 --> 00:04:56.880 But again, it ignores elementary requirements of rationality, in other words, it's an irrational 34 00:04:56.880 --> 00:04:57.880 thing. 35 00:04:57.880 --> 00:04:59.680 But here's what I think is important. 36 00:04:59.680 --> 00:05:05.160 The situation might have had plausibility when the Austrian cycle theory was initially 37 00:05:05.160 --> 00:05:06.160 formulated. 38 00:05:06.160 --> 00:05:10.500 The collection of economic statistics was primitive, central banks were committed to 39 00:05:10.500 --> 00:05:15.300 to exchange in their notes for specie, there was no developed community of financial observers 40 00:05:15.300 --> 00:05:16.600 and fed watchers. 41 00:05:16.600 --> 00:05:22.420 Now this is, I think this is really interesting as well because what he's saying is that everybody 42 00:05:22.420 --> 00:05:25.400 else is going to look towards the same statistics that we do. 43 00:05:25.400 --> 00:05:30.900 Of course, notice that not a lot of economists figured out that we were in a housing bubble 44 00:05:30.900 --> 00:05:32.800 even though they're looking at the same things. 45 00:05:32.800 --> 00:05:37.100 But again, what I want to try to do as much as possible is keep this in a systematic way 46 00:05:37.100 --> 00:05:44.680 as opposed to stating the obvious, that they're saying that malinvestments can't happen and 47 00:05:44.680 --> 00:05:45.680 they happen. 48 00:05:45.680 --> 00:05:51.740 And the reason I want to do that is because people often write about Say's Law, a couple 49 00:05:51.740 --> 00:05:56.860 years ago I did a presentation on Say's Law and one of the assumptions was that the Say's 50 00:05:56.860 --> 00:06:00.860 Law claims that recession never can happen, which isn't true. 51 00:06:00.860 --> 00:06:04.300 And if you read that chapter you can see that that's not true. 52 00:06:04.300 --> 00:06:08.560 But nonetheless, I want to avoid that particular prob, but nonetheless, I think what Wagner 53 00:06:08.560 --> 00:06:11.980 is saying is very, very important. 54 00:06:11.980 --> 00:06:19.960 Now, okay, then go on, he talks about, we've been coming, looked about statistics, observers 55 00:06:19.960 --> 00:06:21.900 and pundits are everywhere. 56 00:06:21.900 --> 00:06:26.060 Cycle theory that depends on the inability of people to distinguish in the aggregate 57 00:06:26.060 --> 00:06:31.420 between increase in personal saving and increase in central bank holdings of government debt 58 00:06:31.420 --> 00:06:35.780 must be dismissed on the ground that it fails to incorporate any reasonable requirement of 59 00:06:35.780 --> 00:06:38.900 individual rationality and economic action. 60 00:06:38.900 --> 00:06:42.940 Okay, all right, and so again, that 61 00:06:42.940 --> 00:06:46.980 he's saying, well look, this stuff is available and we can all interpret 62 00:06:46.980 --> 00:06:51.740 these things, except for the small fact, of course, that people interpret 63 00:06:51.740 --> 00:06:53.300 these things very differently. 64 00:06:53.300 --> 00:06:57.580 And even in hindsight, I remember once David Henderson 65 00:06:57.580 --> 00:07:01.780 and somebody else had that paper a while back that claimed that the Fed really 66 00:07:01.780 --> 00:07:05.620 hadn't done any artificial lowering of interest rates at all. 67 00:07:05.620 --> 00:07:10.460 And so, I mean, and there's always, and then there's always Paul Krugman. 68 00:07:10.460 --> 00:07:14.660 But, alright, and so in other words that 69 00:07:14.660 --> 00:07:19.620 what you have is a syllogism, alright. Entrepreneurs, and if you want to 70 00:07:19.620 --> 00:07:24.140 put the major premise, entrepreneurs make rational decisions and 71 00:07:24.140 --> 00:07:29.860 Generally are correct about business conditions, some random errors are committed, and because 72 00:07:29.860 --> 00:07:35.620 business information is readily available, entrepreneurs are able to make rational decisions. 73 00:07:35.620 --> 00:07:40.540 Furthermore, business decision makers are fully aware of the theory of rational expectations, 74 00:07:40.540 --> 00:07:42.820 or at least act as though they're aware of it. 75 00:07:42.820 --> 00:07:47.540 Even if they don't know the formal theory, their actions would imply that they're aware 76 00:07:47.540 --> 00:07:48.540 of it. 77 00:07:48.540 --> 00:07:56.140 Second, the minor premise, the ATBC requires entrepreneurs to be systematically fooled by economic conditions. 78 00:07:56.140 --> 00:08:05.140 Therefore, all right, the conclusion, therefore the ATBC requires irrational behavior by rational decision makers, 79 00:08:05.140 --> 00:08:08.740 which invalidates the Austrian theory of the business cycle. 80 00:08:08.740 --> 00:08:14.740 That's the, you know, okay, and I want to answer it, I mean, there's lots of ways to answer it. 81 00:08:14.740 --> 00:08:44.740 What I've done is, and I've tried not to plow the same ground, I think that Walter, that Dempster and Carilli did back about ten years ago, I think Bob Murphy did a paper, counter paper on that, and I actually have all those in my files, and I think when I want to expand this paper, do some work on it, I want to bring all that in, this was much more of a hurried type job. 82 00:08:44.740 --> 00:08:54.740 But nonetheless, you've got to keep in mind though, what they're saying first is that errors are irrational. 83 00:08:54.740 --> 00:09:10.740 What they want to do is operate on the perfect information hypothesis when in fact, even that hypothesis was counteracted by the mainstreamers 50 years ago with George Stigler in 61. 84 00:09:10.740 --> 00:09:25.140 They have to admit that obviously entrepreneurs do make errors about the future, but what 85 00:09:25.140 --> 00:09:31.740 they deny is that they can make a cluster of errors, except of course, what do we see 86 00:09:31.740 --> 00:09:34.720 at the end of the boom and beginning of the crisis? 87 00:09:34.720 --> 00:09:39.720 be in essence the evidence for this cluster of errors, okay? 88 00:09:40.560 --> 00:09:45.560 And now the question is why, okay, I make a point here 89 00:09:46.320 --> 00:09:51.040 that entrepreneurs are not responding to economic theories. 90 00:09:51.040 --> 00:09:54.680 I mean, I might guess that typically an entrepreneur 91 00:09:54.680 --> 00:09:56.400 doesn't know who the heck Gordon Tulloch 92 00:09:56.400 --> 00:10:00.480 or they might know who George Lucas is, 93 00:10:00.480 --> 00:10:03.360 but they don't know who Robert Lucas is. 94 00:10:03.360 --> 00:10:08.360 but they respond to relative prices, all right? 95 00:10:08.720 --> 00:10:12.640 The other thing is that, and I bring this in, 96 00:10:12.640 --> 00:10:15.240 in my second called time is of the essence 97 00:10:15.240 --> 00:10:20.320 that errors occur over time and in fact what's going on 98 00:10:20.320 --> 00:10:25.320 is that in fact the, in the system 99 00:10:25.340 --> 00:10:30.340 that you can't tell the difference as an entrepreneur. 100 00:10:30.340 --> 00:10:38.780 Sure, you're looking at relative prices and present factors of production and what you 101 00:10:38.780 --> 00:10:44.600 would estimate to be future prices for consumer goods or those final goods that would be the 102 00:10:44.600 --> 00:10:46.400 lower order goods. 103 00:10:46.400 --> 00:10:50.380 And in the early stages, there's no way entrepreneurs can tell the difference. 104 00:10:50.380 --> 00:10:53.780 I mean, they're not going, you know, the number one, the typical entrepreneur is not a Fed 105 00:10:53.780 --> 00:10:54.780 watcher. 106 00:10:54.780 --> 00:10:57.220 Number two, the typical Fed watcher can't tell either. 107 00:10:57.220 --> 00:11:03.540 It's not something that the Fed watchers pick up automatically. It's not like the Fed hoist 108 00:11:03.540 --> 00:11:12.660 something out. And in fact, people are not even aware of the concept of a natural rate 109 00:11:12.660 --> 00:11:19.780 of interest. They can't tell the difference. And they assume, here's another thing. In 110 00:11:19.780 --> 00:11:26.380 typical neoclassical economics, the use of time is such that it's compressed. If you 111 00:11:26.380 --> 00:11:32.740 If you look at a typical neoclassical model of the firm, whether it's a firm in imperfect 112 00:11:32.740 --> 00:11:35.180 competition or perfect competition, what do you assume? 113 00:11:35.180 --> 00:11:42.580 You assume that the process is instantaneous from when you dig the first spade of whatever 114 00:11:42.580 --> 00:11:45.500 minerals out of the ground to selling the final product. 115 00:11:45.500 --> 00:11:49.460 That everything is compressed into that one amount of time. 116 00:11:49.460 --> 00:11:55.500 And I dealt with that, Murray dealt with that in looking at the whole issue of profit maximization 117 00:11:55.500 --> 00:11:58.940 because, again, that you have to look at the issue of time. 118 00:11:58.940 --> 00:12:00.260 And I had a paper a couple of years, 119 00:12:00.260 --> 00:12:02.380 about, no, gosh, eight years ago, 120 00:12:02.380 --> 00:12:05.500 I guess, in the QJAE dealing with that. 121 00:12:05.500 --> 00:12:09.780 And when you bring real time into the model, however, 122 00:12:09.780 --> 00:12:13.780 that what you, which is not done 123 00:12:13.780 --> 00:12:16.580 in your typical neoclassical model, you're going to, 124 00:12:16.580 --> 00:12:19.740 what you're going to see are sets of relative prices 125 00:12:19.740 --> 00:12:23.460 that change over time, all right? 126 00:12:23.460 --> 00:12:24.780 Well, I call them the vulgar, 127 00:12:24.780 --> 00:12:54.780 The other thing is that they also look into the issue of, they're looking to think of risk, and this is what, you know, I think Peter, and he's done a real service by really kind of resurrecting Frank Knight and his whole view of risk and uncertainty, and the other thing is that they're making the assumption that entrepreneurs face risks, and risks have real live numerical possibilities, and this way you can put them 128 00:12:54.780 --> 00:12:59.780 in Mathematical Form, and have your nice symbols there. 129 00:13:01.220 --> 00:13:05.340 Okay, but Mises and others point out that, in fact, 130 00:13:05.340 --> 00:13:08.100 what entrepreneurs face is uncertainty. 131 00:13:08.100 --> 00:13:10.900 And this is important too, because you not only 132 00:13:10.900 --> 00:13:13.180 have real time, but the issue of uncertainty 133 00:13:13.180 --> 00:13:15.540 is that you don't know what the outcomes are going to be. 134 00:13:15.540 --> 00:13:18.980 It's not, I have a whole set of outcomes, 135 00:13:18.980 --> 00:13:22.100 and here are the probabilities that if this is repeated 136 00:13:22.100 --> 00:13:24.900 over and over again, this is what would happen. 137 00:13:24.900 --> 00:13:28.700 That instead what we have is uncertainty, all right, 138 00:13:28.700 --> 00:13:33.700 and but in the relative prices play out in real time. 139 00:13:34.420 --> 00:13:39.420 And so you have, as I point out, 140 00:13:40.580 --> 00:13:44.860 that I think that what we have to keep in mind in this 141 00:13:44.860 --> 00:13:49.860 is that the criticisms, 142 00:13:49.860 --> 00:14:19.860 Not only are they based on unreal assumptions, and a lot of neoclassical is very comfortable, of course, unreal assumptions, but the problem is that by ignoring both the issue of uncertainty and also the role of real time, that what the end, also for that, and really not understanding what entrepreneurs do regarding relative prices, that in fact that these critics actually get it wrong, that the ATBC 143 00:14:19.860 --> 00:14:26.800 can actually stand up against a view that entrepreneurs are making rational decisions.