The Austrian School Flunks (Jerusalem Post, Nov 29, 2003): “There is nothing new in Campan’s analysis – it is a rehashing of the basic ideas of what economists call the Austrian School, a group of economists whose leading thinkers include Friedrich Hayek, Carl Menger and Ludwig van Mises. I value the originality reflected in the Austrian work, but like all mainstream economists, I utterly reject their macroeconomic ideas. Consider Campan’s theoretical explanation for Israel’s recession.
He argues that excessive monetary expansion triggered a boom in high-tech that led to excessive investment. As those investments came to fruition, consumers were unable to absorb the new output, inventories ballooned, and the result was a wave of bankruptcies and unemployment. All this is classic Austrian economics. To understand what is theoretically wrong with this story, it is important to consider the “time discount rate.” The idea behind the discount rate is that consumers value present consumption more than future consumption. The discount rate measures by how much this is this case.Say, for example, a consumer would feel equally happy knowing that he will consume 10 beers this year or 11 beers next year. Then the discount rate is 10%.
Now, the Austrian argument is that when governments pursue easy monetary policies, short-term interest rates are artificially pushed below the time discount rate. This supposedly leads investors to mistakenly believe that the discount rate itself has declined, which implies that the public will be increasing its consumption in the future. Investors build new factories based on this belief. The result is over-capacity and an inevitable bust, since the true discount rate has not declined and the consumption increase doesn’t materialize.
THE FIRST problem with this is that investors supposedly make this mistake again and again and never learn that easy monetary policies lower the rate of interest below the time discount rate. The second problem is that investors are also consumers. As such, they must know that the rate of interest is below their own private time discount rate for consumption, yet choose to ignore that fact. It is as if they have a split personality. The investor and the consumer inhabit the same brain, but never exchange information (or even pleasantries).
So Campan, for all his supposed respect for market economies, actually is arguing that capitalists are a bunch of idiots who suffer from mass psychotic episodes when real interest rates are low. This simply isn’t true, but if it were, it would be compelling evidence that central planning is superior to market economics as a means of allocating capital.
