I have been and am still eager to engage Austrians generally and Hayekians in particular in debates over macroeconomic fluctuations.
This is not because I believe – as many have suggested – that Real Business Cycle Theory over even the Chicago emphasis on micro-foundations are Hayekian. They don’t seem to be to me.
Its because in my mind Hayek’s explanation of the business cycle is a beautiful example of a theory whose only vice is that happens not to be true. Its brilliant. Its elegant. Its parsimonious. It possess boundless fecundity. It’s the kind of thing we expect from brilliant minds. It just happens to be wrong.
And, this is a crucial, crucial, crucial point.
The world is not something that makes sense to us. The world is something that is. Its entirely possible for very beautiful sensible things to just be wrong.
For me, I will say, the first instance of this was reading as a child the debate between the Steady State Universe and the Expanding Universe. Obviously, the Steady State Universe is far more beautiful, far more sensible. It lays to rest dozens of meta-physical questions and produces a model of the world in harmony with our spirit as human beings.
Its also wrong.
I remember so badly wanting it to be true and when I grew up wanting to discover that the expansionist had been wrong. That this theory – the theory that deserved to be true – was true.
But, its not true.
This is painful but its real. And, we have to decide at some point whether we want to bask in the joy intellectually fulfilling views of the world, or whether we wish to see the world as it is, warts and all.
Coming back to Hayek let me take these line from his elegant Nobel Prize lecture on the Pretense of Knowledge
The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate. What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity. The fact is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing; not because, as this view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to occur as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.
What he is saying in our modern terms is that mass unemployment is the result of frictional unemployment which in turn result from a distortion of the price system.
This makes a lot sense and in many ways it should be true. But, its not true.
And, we know its not true because when we run the process in reverse we get the reverse result, but Hayek’s frictional analysis would not allow for that. Any distortion in prices should produce frictional unemployment as the economy readjusts.
Yet, in the early 1980s the US Federal Reserve crushed down on the inflation rate, producing immediate unemployment. This is somewhat anomalous from Hayek’s prescription because the initial phase of distortion doesn’t produce contraction. However, let that be.
What really makes the difference is that when the Fed decided to stop, without telling anyone by the way, the economy boomed. Naturally, after such a harsh period of dislocation resources were away from their long run best uses. It should take time to readjust.
However, it took no time. In months the economy was accelerating rapidly and what’s more the inflation did not come back.
Perhaps ironically, I don’t know, we can see why if we sit and pick a part business cycle fluctuations on an industry by industry, even job type by job type level. Resources don’t shift around. New modes of production or ways of satisfying consumer demand are not created at an unusual rate.
Indeed, the rate of creative destruction actually falls during a recession. Fewer jobs are destroyed. Fewer new firms are created.
Most importantly, specific types of production go into hibernation – the building of transportation equipment and the construction of structures. Those workers for the most part move very slowly into other industries, if at all.
And, amazingly when the recession is over they go right back to doing what they were doing before. No change at all. Same cranes, same hammers, same assembly lines. Often the same model lines for the cars and the same blueprints for the buildings.
Its not a shift, it’s a hibernation.
A shift would be more elegant. It would make sense. It should be true.
It just not true, in this world.