Sunday, March 28, 2010

The ABC You Never Learned in Kindergarten

If ever you meet an economist who claims that their latest model can accurately describe the ebb and flow of the business cycle do not be alarmed should you start to hear a high pitched alarm in the back of your head or see flashing lights appear before your eyes. This is merely your finely honed bullshit detector, and it has been triggered. Economist Joan Robinson once remarked that one of the best reasons to study economics is simply to avoid being deceived by economists. Sounder advice is rare. An economist with a model to predict the future is like a traveling salesman with a tonic to cure erectile dysfunction. Don't buy it.

Economists are not, nor have ever been, particularly renowned for their skill in predicting fluctuations in the business cycle. For good reason, we're not very good at it. Most recognize the limitations of our highly stylized macroeconomic models and the dangers of naively applying them to the dynamic complexities of the real world. The Austrians should know this better than most, being one of the best and most devastating critics of mainstream economics in general and macroeconomics in particular.

This is why I'm sorely disapointed with the poor choice of title Mark Thornton  selected for his podcast, promising readers that the secret to predicting the next economic crisis lay a mere podcast away. An Austrian should know better.

Andrew Lawrence's "Skyscraper Index" and other research documenting the correlation between construction and the business cycle is well established. I don't doubt that a strong correlation between high-rise construction projects and economic booms exists. But that is not really the argument Thornton is trying to make here (which is a much easier read than it is a listen, I'd recommend just reading the article his lecture is based off instead of the sitting through the podcast.).

Thornton goes beyond correlation by trying to argue that the Fed plays a causal factor in this relationship and that this validates the Austrian theory of the Business Cycle. For those unfamiliar with the ABC, well, there's a reason. It doesn't held up very well to empirical scrutiny. The literature on the ABC and its failures is vast, technical, complicated and beyond summary in this short post. Suffice it to say that I think it's mostly wrong and Thornton, like other ABC theorists, fails to establish a causal relationship between government manipulation of the interest rate, economic expansion or the subsequent busts.

He even seems to contradict his own thesis that the Skyscraper Index/Business Cycle correlation is a validation of the ABC when he admits that the relationship holds during periods in American history when the Fed didn't even exist. How a central bank can trigger malinvestments through artificially low interest rates before it exists is beyond me.

Of course the Austrians have never been ones to let contradictory evidence stand in the way of their theories.

No comments:

Post a Comment