When a presidential candidate declares, as Ron Paul has,

“We’re all Austrians now,”  it’s inevitable that his
critics would try to discredit him—whether they understand what
he’s talking about or not. That’s what Matthew Yglesias does in his
Slate piece “What Is ‘Austrian Economics’?”

I recommend the piece because it’s highly informative—about what
Austrian economics is not.

We’re off to a rocky start with this: “The Austrian school
originally referred to a set of classical liberal thinkers with
diverse interests who came out of the Austro-Hungarian Empire.”

The earliest Austrian economists did not make their mark by
advocating free markets and other classical-liberal ideas. They did
so by proffering a revolutionary positive (not normative)
theoretical approach to understanding how markets work, focusing on
value, price, and capital, theory. What
Wikipedia says is consistent with my understanding of the
matter: “When Carl Menger, Eugen von Böhm-Bawerk, and
[Friedrich von] Wieser began their careers in science, they were
not focused on economic policy issues, much less in the rejection
of intervention promoted by classical
liberalism. Their common vocation was to develop an economic
theory on a firm basis.”

Economics vs. Politics

Yglesias thus conflates Austrian economic theory
with libertarian political theory. In fairness, he is not alone in
committing this error. Many libertarians do the same, which is
unfortunate. Austrian economic theory describes how purposive
action by fallible human beings unintentionally generates a grand,
complex, and orderly market process. An additional ethical step is
required to pronounce the market process good. Economic theory per
se cannot recommend but only explain markets. This is what Ludwig
von Mises meant when he insisted that Austrian economics is
value-free. Anyone of any persuasion ought to be able to
acknowledge that economic logic indicates that imposing a price
ceiling on milk will, other things equal, create a shortage of
milk. But that in itself is not an argument against the policy.
Mises assumed the policymaker would have thought that result bad,
but the economist qua economist cannot declare it such. As Israel
Kirzner likes to say, the economist’s job in the policy realm is
merely to point out that you cannot catch a northbound train from
the southbound platform.

Yglesias writes: “Austrians reject the idea that there is
anything at all the government can do to stabilize macroeconomic
fluctuations.” It’s odd to say this without also pointing out that
Austrians believe that government causes the instability
of inflationary booms, recessions, and depressions. In light of
that point, the suggestion that government is capable of
stabilizing the economy may be seen in its proper light.

That said, Yglesias’s statement is not quite right. Some
prominent Austrian macroeconomists think that in a second-best
world, the central bank (which of course wouldn’t exist in a
first-best world) should counteract a sudden and substantial
monetary contraction. In other words, deflation is not necessarily
a cure for inflation. Mises made the point metaphorically
in 1938: “If a man has been hurt by being run over by an
automobile, it is no remedy to let the car go back over him in the
[opposite] direction.” (See Steven Horwitz’s “Deflation:
The Good, the Bad, and the Ugly.” )

Distorts Markets

“In the view of the Austrians,” Yglesias goes on, “practically
every economic policy pursued by the federal government and Federal
Reserve is a mistake that distorts markets. Rather than curing
recessions, claim Austrians, stimulative policies cause them by
producing unsustainable bubbles.” Well, yeah, and it’s amply
demonstrated by George Selgin, William D. Lastrapes, and Lawrence
H. White in “Has the Fed
Been a Failure?” (See my summary, “‘F’ as
in Fed.” ) As they put it:

Drawing on a wide range of recent empirical research, we find
the following: (1) The Fed’s full history (1914 to present) has
been characterized by more rather than fewer symptoms of monetary
and macroeconomic instability than the decades leading to the Fed’s
establishment. (2) While the Fed’s performance has undoubtedly
improved since World War II, even its postwar performance has not
clearly surpassed that of its undoubtedly flawed predecessor, the
National Banking system, before World War I. (3) Some proposed
alternative arrangements might plausibly do better than the Fed as
presently constituted. We conclude that the need for a systematic
exploration of alternatives to the established monetary system is
as pressing today as it was a century ago.

Yglesias understands that the
Austrian theory of the business cycle has something to do with
artificially low interest rates breeding malinvestment, but he
thinks it can’t be right because “it’s hard to understand why
business people would be so easily duped in this way. If Ron Paul
and Ludwig von Mises know that cheap money can’t last forever, why
don’t private investors? Why wouldn’t firms avoid making the
supposedly dumb investments?”

Gerald P. O’Driscoll and Mario Rizzo addressed this long ago in

The Economics of Time and Ignorance:

[T]here are profits to be made from exploiting temporary
situations. . . . Though entrepreneurs understand [the
macro-aspects of a cycle] they cannot predict the exact features of
the next cyclical expansion and contraction. . . . They lack the
ability to make micro-predictions, even though they can predict the
general sequence of events that will occur. These entrepreneurs
have no reason to foreswear the temporary profits to be garnered in
an inflationary episode. . . . From an individual perspective,
then, an entrepreneur fully informed of the Austrian theory of
economic cycles will face essentially the same uncertain world he
always faced. Not theoretical or abstract knowledge, but knowledge
of the circumstances of time and place is the source of
profits.

Spending Shifts