I enjoy reading your posts. I wanted to add a personal story from my real estate investing career over the past 4 years. Interest rates have risen quickly and I am not sure how you can view this within the context above. Flippers took significant losses due to this. Some didn't because they did solid deals, others lost their shirt! I do think outside of economics, there is something to be said about some people are just better at calculating risk than others and this skill is less a skill and more a trait (meaning it cannot be taught). Keep it up and thanks for always being entertaining and informative.
> I now believe the best explanation for the 2007-9 housing crisis is that even very smart insiders irrationally believed that high housing price increases would continue indefinitely.
Per Scott Sumner, price increases DID continue after the recession. Thus the assumption wasn't irrational, but the Federal Reserve was.
> you could say that I’ve moved toward an Austrian view of entrepreneurial progress
Schumpeter was from Austria, but in terms of economic schools wasn't he a follower of Walras instead of Menger?
Came to point out the same thing. What is Bryan’s response to Sumner’s view on the causes of the Great Recession? He must be aware of it considering they were co-bloggers for so many years.
Schumpeter was not a member of the Austrian school of economics but he was a fellow traveller. He has a really interesting life story, which is told wonderfully in the introduction to Capitalism, Socialism and Democracy by Richard Swedberg that you can find at the below link
I've got a question. Do you disagree with David Friedman about anything? I like both of your blogs a lot, and you're both very prominent anarcho-capitalists. Do you know if you have different visions about anarcho-capitalism or anything else?
I think you're right to criticize rational expectations theory but I think it's more accurate to criticize it because of imperfect information than irrationality.
It is difficulty to suss out what is real increased demand versus demand coming from new money entering the economy. To the extent that its duration can be predicted, new money directs real resources to flow to certain areas. For example, if you forsee it as real demand that will last long term you will be more likely to invest in longer term projects and capital. If you guessed wrong then when monetary policy tightens you're left with your pants down.
This should only result in a sectoral contraction offset by other sectoral expansions, but because of wage and price stickiness you historically see recessions due to overtightening, like in 2008.
Under a stable spending regime you can still have sectoral expansions and contractions due to changes in real economic conditions, but I think the Austrian story is that expansionary and then contractionary monetary policy is more volatile and thus more likely to cause business cycles.
Isn’t the discussion of rational expectations based on a misleading if not mistaken interpretation of a modeling hypothesis? Is the hypothesis that agents are irrational, or that the error term in an expectations variable is symmetrically distributed with mean zero? If it is a hypothesis about the distribution of the error term, then agent irrationality is a possible but not necessary explanation.
This would not let the Austrians completely off the hook. Their model either has no term for expectations, or indeed assumes an estimate that the mean error is not zero. While they might have an explanation for this, it definitely needs one. Either errors in expectations are not even part of the story (implausible and inconsistent with other Austrian and neoclassical assumptions), or you need an estimate. The estimate is either zero (“rational expectations”) or something else. The strength of the RE hypothesis is not so much why we think it is right, but what we have to know to come up with an alternative that doesn’t contradict agency. That is, it seems innocuous to assume that people are as likely to overestimate than to underestimate when making their plans. But if you're going to say they systematically err in a particular direction, and these errors, which will probably create profit opportunities, are not eliminated by arbitrage, then you need a very good explanation. Some modelers have managed to do that using asymmetric info, etc.
It isn’t clear that those explanations are really satisfactory. The governors of the fed have asymmetric info, but they try to be predictable and even if they didn't they might still be somewhat predictable.
My own quibble: Some who call themselves Austrian think of economics as the ring in which policy fights are held, rather than a subject to be understood. Example: use of statistics in economics is opposed by some who think that this will enable central planning. That's the wrong criterion. The question should be, "are statistics helpful in understanding the economy?" I've done quantitative work my whole career as a business economist; rational business leaders paid me for insights that I gained from analyzing data. Hayek thought that no substantial economics principles had ever been discovered through statistics. But for business applications, we need to understand magnitudes. Often two opposing forces will be at work on something like a price or quantity. Statistics are needed to estimate (although imperfectly) which force will be greater.
People by definition cannot act irrationally. Action by definition is rational, and by rational I mean 'using reason'. Action is when you think about an end you want to bring about, devise a plan to bring about that ends, and then carry out your plan. This necessarily entails the use of reason.
So I guess the problem is that we are using different meanings of the word irrationality. Like you mean it to say they are not calculating properly, or they are pursuing ends they shouldn't pursue, or something like that.
Here is what google tells me about 'irrational'
Not based on reason
When describing a person's feelings or behavior as irrational, it means they are not based on logical reasons or clear thinking. For example, you might describe arguments as irrational. Synonyms of irrational include illogical, crazy, silly, and absurd
So they sort of split the baby in half, using what i would consider my definition as the heading, and the definition which Brylan is using in the post. "not based on clear thinking". But someone can be "not thinking clearly" and still be using reason. Indeed, even a schizophrenic in the middle of a break is still using reason, even if their reasoning seems absurd to a normal person. Like they think "I need to throw out this shirt or the demons will get me" and they throw out the shirt. This is still involving reason and is hence rational. We just consider their thinking to be faulty or crazy. Not based in reality.
Anyway, could you please clarify on what you mean by "people not acting rationally"? Because this is a common criticism about economics that I hear frequently and I'd like to understand the argument better.
There must be some people who are relatively immune to the systematic irrationalities that afflict participants in the financial markets, and these people will become fabulously rich. Are they hiding their superior grasp of rationality from the rest of us? Is there a conspiracy of the clever rich to keep us muggles in irrationality, through ignorance of our systematic errors?
Smearing those who raise methodological objections to neoclassicism as "amateur philosophers" is an _ad hominem_ fallacy that does nothing to justify the misapplication of quantitative probability theory, arbitrary assumptions of indifference, or the misuse of psychology in formulating and validating universally-valid laws of economics.
By the way, the perspectives of Mises, Rothbard, and Hayek regarding the foundations of economics all diverged from each other and from that of the founder of the Austrian school (Carl Menger) with respect to the precise philosophical details. It is not the case that anyone, even if one is inclined towards a monolithic authoritarian mindset, can cite them chapter-and-verse to arrive at "The Answers" because each of them offers a somewhat different answer. Reading them obliges any honest intellectual to think more deeply about their own philosophical perspective.
What Austrians all agree on though is that economic reasoning employs its own distinctive method that shouldn't be confused with what natural scientists do or with what historians do. It is folly for economists to give up what has worked so well for them over the past three centuries, just as it is intellectual malpractice for any serious economist (amateur or professional) to evade the interesting epistemological questions raised by the distinctive means by which they arrive at universally-valid theories.
Alas, I am not a very good Austrian School economic historian. The picture shows Mises, Hayek, Menger, Rothbard, Schumpeter, and…who are the others? One of them must be Bohm-Bawerk, and another would be Kirzner. (If there are still misspellings, blame autocorrect. I had to insist twice that “Mises” was not actually ‘Moisés’. I turned off autocorrect on my phone, and if this keeps up then I will have to use two devices to type anything, but I feel a little apprehensive about inscribing things on two tablets.)
It seems to me that Austrian economists have no problem with behavioral economics. Nothing in Austrian economic thinking posits that humans are able to choose rationally and without mistakes, only that humans try to choose rationally and act with purpose.
We humans are subject to all the cognitive biases so ably researched and cataloged by Kahneman and Tversky, of course. I think Austrians have embraced behavioral economics well ahead of mainstream economists. For sure, this Austrian has.
I like math for many purposes in economics, but I don't like math for superficial purposes in economics; good to see that my conclusions here match up well with yours, given that I frequently admire your conclusions and reasoning about lots of stuff economic and otherwise.
I am wondering why you don't heap praise on Austrian economists who have noted that econometric modelling and estimation is pretty much useless in economics, which it most certainly seems to be. The reason is well known; we have no constants to estimate in populations of people that have anything to do with human choice and actions. What say you about this proposition?
What do you think of the Austrian proposition from ABCT that the only thing that can really account for the business cycle is misinformation, misplaced incentives, and destructive policy brought on by government operatives in their mostly misguided attempts to manipulate the macro economy. Without any desire to allude to his ideas incorrectly, which I might do unintentionally, I think I got a lot of this idea from the work of Pete Boettke. Forgive me, Pete, if I misstated.
Do you really think that very smart insiders inside and outside government believed that high housing price increases would continue indefinitely? Wouldn't a simpler explanation be the problem of moral hazard?
As for Austrian emphasis on bad central banking policies, isn't it true that the housing bubble could not have happened without aid and comfort from the Fed and Congress?
Great to see that you have come to appreciate the emphasis of Austrians on the source of profit and the role that entrepreneurship plays in creative destruction.
Incidentally, not all Austrian economists who read and think about philosophy along with economics are amateurs, do you think?
Your injunction that Austrians should philosophize less and psychologize more (yes, I know) is interesting, given what philosophy is; I personally think Austrians are the best friends of wisdom. I will admit to considerable bias (which is itself an Austrian idea).
Thank you for your most excellent response to Matthew Gagnon's questions. 😊 Your work is always worth our time.
I really like how Austrians place an emphasis on the philosophy of economics. That is, they are willing to ask fundamental questions about the nature of economic analysis. Whereas, many graduate-level economists that I’ve interacted with couldn’t care less.
However, Austrians seem to fall into exactly the same trap as normal philosophers. Namely, it’s all too tempting to make appeals to radical skepticism in order to derail an argument.
Just like a stereotypical philosopher might question whether or not anyone can know anything. An Australian economist might use similar reasoning to question whether or not externalities exist.
I am unaware of any Austrian economist who question whether or not externalities exist. can you send me a link; I would like to read whatever you've seen on this.
I enjoy reading your posts. I wanted to add a personal story from my real estate investing career over the past 4 years. Interest rates have risen quickly and I am not sure how you can view this within the context above. Flippers took significant losses due to this. Some didn't because they did solid deals, others lost their shirt! I do think outside of economics, there is something to be said about some people are just better at calculating risk than others and this skill is less a skill and more a trait (meaning it cannot be taught). Keep it up and thanks for always being entertaining and informative.
> I now believe the best explanation for the 2007-9 housing crisis is that even very smart insiders irrationally believed that high housing price increases would continue indefinitely.
Per Scott Sumner, price increases DID continue after the recession. Thus the assumption wasn't irrational, but the Federal Reserve was.
> you could say that I’ve moved toward an Austrian view of entrepreneurial progress
Schumpeter was from Austria, but in terms of economic schools wasn't he a follower of Walras instead of Menger?
Came to point out the same thing. What is Bryan’s response to Sumner’s view on the causes of the Great Recession? He must be aware of it considering they were co-bloggers for so many years.
Schumpeter was not a member of the Austrian school of economics but he was a fellow traveller. He has a really interesting life story, which is told wonderfully in the introduction to Capitalism, Socialism and Democracy by Richard Swedberg that you can find at the below link
https://periferiaactiva.wordpress.com/wp-content/uploads/2015/08/joseph-schumpeter-capitalism-socialism-and-democracy-2006.pdf
I've got a question. Do you disagree with David Friedman about anything? I like both of your blogs a lot, and you're both very prominent anarcho-capitalists. Do you know if you have different visions about anarcho-capitalism or anything else?
Related: https://www.betonit.ai/p/what_economic_thtml, https://www.betonit.ai/p/the_wise_pluralhtml, https://x.com/bryan_caplan/status/1478033846201421824.
I think you're right to criticize rational expectations theory but I think it's more accurate to criticize it because of imperfect information than irrationality.
It is difficulty to suss out what is real increased demand versus demand coming from new money entering the economy. To the extent that its duration can be predicted, new money directs real resources to flow to certain areas. For example, if you forsee it as real demand that will last long term you will be more likely to invest in longer term projects and capital. If you guessed wrong then when monetary policy tightens you're left with your pants down.
This should only result in a sectoral contraction offset by other sectoral expansions, but because of wage and price stickiness you historically see recessions due to overtightening, like in 2008.
Under a stable spending regime you can still have sectoral expansions and contractions due to changes in real economic conditions, but I think the Austrian story is that expansionary and then contractionary monetary policy is more volatile and thus more likely to cause business cycles.
Suggested books for beginners looking to learn more about Austrian economics?
Isn’t the discussion of rational expectations based on a misleading if not mistaken interpretation of a modeling hypothesis? Is the hypothesis that agents are irrational, or that the error term in an expectations variable is symmetrically distributed with mean zero? If it is a hypothesis about the distribution of the error term, then agent irrationality is a possible but not necessary explanation.
This would not let the Austrians completely off the hook. Their model either has no term for expectations, or indeed assumes an estimate that the mean error is not zero. While they might have an explanation for this, it definitely needs one. Either errors in expectations are not even part of the story (implausible and inconsistent with other Austrian and neoclassical assumptions), or you need an estimate. The estimate is either zero (“rational expectations”) or something else. The strength of the RE hypothesis is not so much why we think it is right, but what we have to know to come up with an alternative that doesn’t contradict agency. That is, it seems innocuous to assume that people are as likely to overestimate than to underestimate when making their plans. But if you're going to say they systematically err in a particular direction, and these errors, which will probably create profit opportunities, are not eliminated by arbitrage, then you need a very good explanation. Some modelers have managed to do that using asymmetric info, etc.
It isn’t clear that those explanations are really satisfactory. The governors of the fed have asymmetric info, but they try to be predictable and even if they didn't they might still be somewhat predictable.
Good discussion.
My own quibble: Some who call themselves Austrian think of economics as the ring in which policy fights are held, rather than a subject to be understood. Example: use of statistics in economics is opposed by some who think that this will enable central planning. That's the wrong criterion. The question should be, "are statistics helpful in understanding the economy?" I've done quantitative work my whole career as a business economist; rational business leaders paid me for insights that I gained from analyzing data. Hayek thought that no substantial economics principles had ever been discovered through statistics. But for business applications, we need to understand magnitudes. Often two opposing forces will be at work on something like a price or quantity. Statistics are needed to estimate (although imperfectly) which force will be greater.
I don’t think I am sophisticated enough either to give or withhold a like. I’m going to break the tie by giving one because I like Cranston’s stuff.
People by definition cannot act irrationally. Action by definition is rational, and by rational I mean 'using reason'. Action is when you think about an end you want to bring about, devise a plan to bring about that ends, and then carry out your plan. This necessarily entails the use of reason.
So I guess the problem is that we are using different meanings of the word irrationality. Like you mean it to say they are not calculating properly, or they are pursuing ends they shouldn't pursue, or something like that.
Here is what google tells me about 'irrational'
Not based on reason
When describing a person's feelings or behavior as irrational, it means they are not based on logical reasons or clear thinking. For example, you might describe arguments as irrational. Synonyms of irrational include illogical, crazy, silly, and absurd
So they sort of split the baby in half, using what i would consider my definition as the heading, and the definition which Brylan is using in the post. "not based on clear thinking". But someone can be "not thinking clearly" and still be using reason. Indeed, even a schizophrenic in the middle of a break is still using reason, even if their reasoning seems absurd to a normal person. Like they think "I need to throw out this shirt or the demons will get me" and they throw out the shirt. This is still involving reason and is hence rational. We just consider their thinking to be faulty or crazy. Not based in reality.
Anyway, could you please clarify on what you mean by "people not acting rationally"? Because this is a common criticism about economics that I hear frequently and I'd like to understand the argument better.
There must be some people who are relatively immune to the systematic irrationalities that afflict participants in the financial markets, and these people will become fabulously rich. Are they hiding their superior grasp of rationality from the rest of us? Is there a conspiracy of the clever rich to keep us muggles in irrationality, through ignorance of our systematic errors?
Prof. Dr. Caplan kann deutsch! Wie oesterreichisch!
Smearing those who raise methodological objections to neoclassicism as "amateur philosophers" is an _ad hominem_ fallacy that does nothing to justify the misapplication of quantitative probability theory, arbitrary assumptions of indifference, or the misuse of psychology in formulating and validating universally-valid laws of economics.
By the way, the perspectives of Mises, Rothbard, and Hayek regarding the foundations of economics all diverged from each other and from that of the founder of the Austrian school (Carl Menger) with respect to the precise philosophical details. It is not the case that anyone, even if one is inclined towards a monolithic authoritarian mindset, can cite them chapter-and-verse to arrive at "The Answers" because each of them offers a somewhat different answer. Reading them obliges any honest intellectual to think more deeply about their own philosophical perspective.
What Austrians all agree on though is that economic reasoning employs its own distinctive method that shouldn't be confused with what natural scientists do or with what historians do. It is folly for economists to give up what has worked so well for them over the past three centuries, just as it is intellectual malpractice for any serious economist (amateur or professional) to evade the interesting epistemological questions raised by the distinctive means by which they arrive at universally-valid theories.
Alas, I am not a very good Austrian School economic historian. The picture shows Mises, Hayek, Menger, Rothbard, Schumpeter, and…who are the others? One of them must be Bohm-Bawerk, and another would be Kirzner. (If there are still misspellings, blame autocorrect. I had to insist twice that “Mises” was not actually ‘Moisés’. I turned off autocorrect on my phone, and if this keeps up then I will have to use two devices to type anything, but I feel a little apprehensive about inscribing things on two tablets.)
It seems to me that Austrian economists have no problem with behavioral economics. Nothing in Austrian economic thinking posits that humans are able to choose rationally and without mistakes, only that humans try to choose rationally and act with purpose.
We humans are subject to all the cognitive biases so ably researched and cataloged by Kahneman and Tversky, of course. I think Austrians have embraced behavioral economics well ahead of mainstream economists. For sure, this Austrian has.
I like math for many purposes in economics, but I don't like math for superficial purposes in economics; good to see that my conclusions here match up well with yours, given that I frequently admire your conclusions and reasoning about lots of stuff economic and otherwise.
I am wondering why you don't heap praise on Austrian economists who have noted that econometric modelling and estimation is pretty much useless in economics, which it most certainly seems to be. The reason is well known; we have no constants to estimate in populations of people that have anything to do with human choice and actions. What say you about this proposition?
What do you think of the Austrian proposition from ABCT that the only thing that can really account for the business cycle is misinformation, misplaced incentives, and destructive policy brought on by government operatives in their mostly misguided attempts to manipulate the macro economy. Without any desire to allude to his ideas incorrectly, which I might do unintentionally, I think I got a lot of this idea from the work of Pete Boettke. Forgive me, Pete, if I misstated.
Do you really think that very smart insiders inside and outside government believed that high housing price increases would continue indefinitely? Wouldn't a simpler explanation be the problem of moral hazard?
As for Austrian emphasis on bad central banking policies, isn't it true that the housing bubble could not have happened without aid and comfort from the Fed and Congress?
Great to see that you have come to appreciate the emphasis of Austrians on the source of profit and the role that entrepreneurship plays in creative destruction.
Incidentally, not all Austrian economists who read and think about philosophy along with economics are amateurs, do you think?
Your injunction that Austrians should philosophize less and psychologize more (yes, I know) is interesting, given what philosophy is; I personally think Austrians are the best friends of wisdom. I will admit to considerable bias (which is itself an Austrian idea).
Thank you for your most excellent response to Matthew Gagnon's questions. 😊 Your work is always worth our time.
I really like how Austrians place an emphasis on the philosophy of economics. That is, they are willing to ask fundamental questions about the nature of economic analysis. Whereas, many graduate-level economists that I’ve interacted with couldn’t care less.
However, Austrians seem to fall into exactly the same trap as normal philosophers. Namely, it’s all too tempting to make appeals to radical skepticism in order to derail an argument.
Just like a stereotypical philosopher might question whether or not anyone can know anything. An Australian economist might use similar reasoning to question whether or not externalities exist.
I am unaware of any Austrian economist who question whether or not externalities exist. can you send me a link; I would like to read whatever you've seen on this.