Archive for March, 2022

Hayek Refutes Banana Republican Followers of Scalia Declaring War on Unenumerated Rights

Published March 27, 2022 Antonin Scalia , enumerated rights , Hayek , Ninth Amendment , originalism 5 Comments
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Though overshadowed by the towering obnoxiousness of their questioning of Judge Katanji Brown Jackson in her confirmation hearings last week, the Banana Republicans on the Senate Judiciary Committee signaled that their goals for remaking American Constitutional Jurisprudence extend far beyond overturning the Roe v. Wade; they will be satisfied with nothing less than the evisceration of all unenumerated Constitutional rights that the Courts have found over the past two centuries. The idea that rights exist only insofar as they are explicitly recognized and granted by written legislative or Constitutional enactment, as understood at the moment of enactment, is the bedrock on which Justice Scalia founded his jurisprudential doctrine.

The idea was clearly rejected by the signatories of the Declaration of Independence, which in its second sentence declared:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness.

Clearly the Declaration believed that individual rights exist independently of any legislative or Constitutional enactment. Moreover the three rights listed by the Declaration: rights to life, liberty and the pursuit of happiness are not exhaustive, but are only among a longer list of unenumerated rights endowed to individuals by their Creator. Rejecting the idea, of natural or moral rights to which individuals are entitled by virtue of their humanity, Scalia adopted the positivist position that all law is an expression of the will of the sovereign, which, in the United States, is in some abstract sense “the people” as expressed through the Constitution (including its Amendments), and through legislation by Congress and state legislatures.

Treating Scalia’s doctrine as controlling, the Banana Republicans regard all judicial decisions that invalidate legislative enactments based on the existence of individual rights not explicitly enumerated in the Constitution as fundamentally illegitimate and worthy of being overruled by suitably right-thinking judges.

Not only is Scalia’s doctrine fundamentally at odds with the Declaration of Independence, which has limited legal force, it is directly contradicted by the Ninth Amendment to the Constitution which states:

The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people.

So, the Ninth Amendment explicitly negates the Scalian doctrine that the only rights to which individuals have a legal claim are those explicitly enumerated by the Constitution. Scalia’s jurisprudential predecessor, Robert Bork, whose originalist philosophy Scalia revised and restated in a more palatable form, dismissed the Ninth Amendment as unintelligible, and, therefore, essentially a nullity. Scalia, himself, was unwilling to call it unintelligible, but came up with the following, hardly less incoherent, rationale, reeking of bad faith, for relegating the Ninth Amendment to the ash heap of history:

He should apply the Ninth Amendment as it is written. And I apply it rigorously; I do not deny or disparage the existence of other rights in the sense of natural rights. That’s what the framers meant by that. Just because we’ve listed some rights of the people here doesn’t mean that we don’t believe that people have other rights. And if you try to take them away, we will revolt. And a revolt will be justified. It was the framers’ expression of their belief in natural law. But they did not put it in the charge of the courts to enforce.

https://lareviewofbooks.org/article/reading-the-text-an-interview-with-justice-antonin-scalia-of-the-u-s-supreme-court/

If Scalia had been honest, he would have said “He cannot apply the Ninth Amendment as it is written. And I rigorously do not apply it.” I mean what could Scalia, or any judge in thrall to Scalian jurisprudence, possibly do with the Ninth Amendment after saying: “But [the framers] did not put [the Ninth Amendment] in the charge of the courts to enforce”? After all, according to the estimable [sarcasm alert] Mr. Justice Scalia, the Ninth Amendment was added to the Constitution to grant the citizenry — presumably exercising their Second Amendment rights and implementing Second Amendment remedies — a right to overthrow the government that the framers were, at that very moment, ordaining and establishing.

In The Constitution of Liberty, F. A. Hayek provided an extended analysis of the U. S. Constitution and why a Bill of Rights was added as a condition of its ratification in 1788. His discussion of the Ninth Amendment demolishes Scalia’s nullification of the Ninth Amendment. Here is an extended quotation:

Hayek The Constitution of Liberty, pp. 185-86

Eight Recurring Ideas in My Studies in the History of Monetary Theory

Published March 17, 2022 Uncategorized 3 Comments

In the introductory chapter of my book Studies in the History of Monetary Theory: Controversies and Clarifications, I list eight main ideas to which I often come back in the sixteen subsequent chapters. Here they are:

  1. The standard neoclassical models of economics textbooks typically assume full information and perfect competition. But these assumptions are, or ought to be, just the starting point, not the end, of analysis. Recognizing when and why these assumptions need to be relaxed and what empirical implications follow from relaxing those assumptions is how economists gain practical insight into, and understanding of, complex economic phenomena.
  2. Since the late eighteenth or early nineteenth century, much, if not most, of the financial instruments actually used as media of exchange (money) have been produced by private financial institutions (usually commercial banks); the amount of money that is privately produced is governed by the revenue generated and the cost incurred by creating money.
  3. The standard textbook model of international monetary adjustment under the gold standard (or any fixed-exchange rate system), the price-specie-flow mechanism, introduced by David Hume mischaracterized the adjustment mechanism by overlooking that the prices of tradable goods in any country are constrained by the prices of those tradable goods in other countries. That arbitrage constraint on the prices of tradable goods in any country prevents price levels in different currency areas from deviating, regardless of local changes in the quantity of money, from a common international level.
  4. The Great Depression was caused by a rapid appreciation of gold resulting from the increasing monetary demand for gold occasioned by the restoration of the international gold standard in the 1920s after the demonetization of gold in World War I.
  5. If the expected rate of deflation exceeds the real rate of interest, real-asset prices crash and economies collapse.
  6. The primary concern of macroeconomics as a field of economics is to explain systemic failures of coordination that lead to significant lapses from full employment.
  7. Lapses from full employment result from substantial and widespread disappointment of agents’ expectations of future prices.
  8. The only – or at least the best — systematic analytical approach to the study of such lapses is the temporary-equilibrium approach introduced by Hicks in Value and Capital.

Here is a list of the chapter titles

1. Introduction

Part One: Classical Monetary Theory

2. A Reinterpretation of Classical Monetary Theory

3. On Some Classical Monetary Controversies

4. The Real Bills Doctrine in the Light of the Law of Reflux

5. Classical Monetary Theory and the Quantity Theory

6. Monetary Disequilibrium and the Demand for Money in Ricardo and Thornton

7. The Humean and Smithian Traditions in Monetary Theory

8. Rules versus Discretion in Monetary Policy Historically Contemplated

9. Say’s Law and the Classical Theory of Depressions

Part Two: Hawtrey, Keynes, and Hayek

10. Hawtrey’s Good and Bad Trade: A Centenary Retrospective

11. Hawtrey and Keynes

12. Where Keynes Went Wrong

13. Debt, Deflation, the Gold Standard and the Great Depression

14. Pre-Keynesian Monetary Theories of the Great Depression: Whatever Happened to Hawtrey and Cassel? (with Ronald Batchelder)

15. The Sraffa-Hayek Debate on the Natural Rate of Interest (with Paul Zimmerman)

16. Hayek, Deflation, Gold and Nihilism

17. Hayek, Hicks, Radner and Four Equilibrium Concepts: Intertemporal, Sequential, Temporary and Rational Expectations

Wherein I Try to Calm Professor Blanchard’s Nerves

Published March 15, 2022 expectations , Federal Reserve , Milton Friedman , Monetarism , nominal GDP targeting , Olivier Blanchard , Paul Volcker 10 Comments
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Olivier Blanchard is rightly counted among the most eminent macroeconomists of our time, and his pronouncements on macroeconomic matters should not be dismissed casually. So his commentary yesterday for the Peterson Institute of International Economics, responding to a previous policy brief, by David Reifschneider and David Wilcox, arguing that the recent burst of inflation is likely to recede, bears close attention.

Blanchard does not reject the analysis of Reifschneider and Wilcox outright, but he argues that they overlook factors that could cause inflation to remain high unless policy makers take more aggressive action to bring inflation down than is recommended by Reifschneider and Wilcox. Rather than go through the details of Blanchard’s argument, I address the two primary concerns he identifies: (1) the potential for inflation expectations to become unanchored, as they were in the 1970s and early 1980s, by persistent high inflation, and (2) the potential inflationary implications of wage catchup after the erosion of real wages by the recent burst of inflation.

Unanchored Inflation Expectations and the Added Cost of a Delayed Response to Inflation

Blanchard cites a forthcoming book by Alan Blinder on soft and hard landings from inflation in which Blinder examines nine Fed tightening episodes in which tightening was the primary cause of a slowdown or a recession. Based on the historical record, Blinder is optimistic that the Fed can manage a soft landing if it needs to reduce inflation. Blanchard doesn’t share Blinder’s confidence.

[I]n most of the episodes Blinder has identified, the movements in inflation to which the Fed reacted were too small to be of direct relevance to the current situation, and the only comparable episode to today, if any, is the episode that ended with the Volcker disinflation of the early 1980s.

I find that a scary comparison. . . .

[I]t shows what happened when the Fed got seriously “behind the curve” in 1974–75. . . . It then took 8 years, from 1975 to 1983, to reduce inflation to 4 percent.

And I find Blanchard’s comparison of the 1975-1983 period with the current situation problematic. First, he ignores the fact that the 1975-1983 episode did not display a steady rate of inflation or a uniform increase in inflation from 1975 until Volcker finally tamed it by way of the brutal 1981-82 recession. As I’ve explained previously in posts on the 1970s and 1980s (here, here, and here), and in chapters 7 and 8 of my book Studies in the History of Monetary Theory the 1970s inflation was the product of a series of inflationary demand-side and supply-shocks and misguided policy responses by the Fed, guided by politically motivated misconceptions, with little comprehension of the consequences of its actions.

It would be unwise to assume that the Fed will never embark on a similar march of folly, but it would be at least as unwise to adopt a proposed policy on the assumption that the alternative to that policy would be a repetition of the earlier march. What commentary on the 1970s largely overlooks is that there was an enormous expansion of the US labor force in that period as baby boomers came of age and as women began seeking and finding employment in steadily increasing numbers. The labor-force participation rate in the 1950s and 1960s fluctuated between about 58% to about 60%, mirroring fluctuations in the unemployment rate. Between 1970 and 1980 the labor force participation rate rose from just over 60% to just over 64% even as the unemployment rate rose from about 5% to over 7%. The 1970s were not, for the most part, a period of stagflation, but a period of inflation and strong growth interrupted by one deep recession (1974-75) and bookended by two minor recessions (1969-70) and (1979-80). But the rising trend of unemployment during the decade was largely attributable not to stagnation but to a rapidly expanding labor force and a rising labor participation rate.

The rapid increase in inflation in 1973 was largely a policy-driven error of the Nixon/Burns collaboration to ensure Nixon’s reelection in 1972 without bothering to taper the stimulus in 1973 after full employment was restored just in time for Nixon’s 1972 re-election. The oil shock of 1973-74 would have justified allowing a transitory period of increased inflation to cushion the negative effect of the increase in energy prices and to dilute the real magnitude of the nominal increase in oil prices. But the combined effect of excess aggregate demand and a negative supply shock led to an exaggerated compensatory tightening of monetary policy that led to the unnecessarily deep and prolonged recession in 1974-75.

A strong recovery ensued after the recession which, not surprisingly, was associated with declining inflation that fell below 5% in 1976. However, owing to the historically high rate of unemployment, only partially attributable to the previous recession, the incoming Carter administration promoted expansionary fiscal and monetary policies, which Arthur Burns, hoping to be reappointed by Carter to another term as Fed Chairman, willingly implemented. Rather than continue on the downward inflationary trend inherited from the previous administration, inflation resumed its upward trend in 1977.

Burns’s hopes to be reappointed by Carter were disappointed, but his replacement G. William Miller made no effort to tighten monetary policy to reverse the upward trend in inflation. A second oil shock in 1979 associated with the Iranian Revolution and the taking of US hostages in Iran caused crude oil prices over the course in 1979 to more than double. Again, the appropriate monetary-policy response was not to tighten monetary policy but to accommodate the price increase without causing a recession.

However, by the time of the second oil shock in 1979, inflation was already in the high single digits. The second oil shock, combined with the disastrous effects of the controls on petroleum prices carried over from the Nixon administration, created a crisis atmosphere that allowed the Reagan administration, with the cooperation of Paul Volcker, to implement a radical Monetarist anti-inflation policy. The policy was based on the misguided presumption that keeping the rate of growth of some measure of the money stock below a 5% annual rate would cure inflation with little effect on the overall economy if it were credibly implemented.

Volcker’s reputation was such that it was thought by supporters of the policy that his commitment would be relied upon by the public, so that a smooth transition to a lower rate of inflation would follow, and any downturn would be mild and short-lived. But the result was an unexpectedly deep and long-lasting recession.

The recession was needlessly prolonged by the grave misunderstanding of the causal relationship between the monetary aggregates and macroeconomic performance that had been perpetrated by Milton Friedman’s anti-Keynesian Monetarist counterrevolution. After triggering the sharpest downturn of the postwar era, the Monetarist anti-inflation strategy adopted by Volcker was, in the summer of 1982, on the verge of causing a financial crisis before Volcker announced that the Fed would no longer try to target any of the monetary aggregates, an announcement that triggered an immediate stock-market boom and, within a few months, the start of an economic recovery.

Thus, Blanchard is wrong to compare our current situation to the entire 1975-1983 period. The current situation, rather, is similar to the situation in 1973, when an economy, in the late stages of a recovery with rising inflation, was subjected to a severe supply shock. The appropriate response to that supply shock was not to tighten monetary policy, but merely to draw down the monetary stimulus of the previous two years. However, the Fed, perhaps shamed by the excessive, and politically motivated, monetary expansion of the previous two years, overcompensated by tightening monetary policy to counter the combined inflationary impact of its own previous policy and the recent oil price increase, immediately triggering the sharpest downturn of the postwar era. That is the lesson to draw from the 1970s, and it’s a mistake that the Fed ought not repeat now.

The Catch-Up Problem: Are Rapidly Rising Wages a Ticking Time-Bomb

Blanchard is worried that, because price increases exceeded wage increases in 2021, causing real wages to fall in 2021, workers will rationally assume, and demand, that their nominal wages will rise in 2022 to compensate for the decline in real wages, thereby fueling a further increase in inflation. This is a familiar argument based on the famous short-run Phillips-Curve trade-off between inflation and unemployment. Reduced unemployment resulting from the real-wage reduction associated with inflation will cause inflation to increase.

This argument is problematic on at least two levels. First, it presumes that the Phillips Curve represents a structural relationship, when it is merely a reduced form, just as an observed relationship between the price of a commodity and sales of that commodity is a reduced form, not a demand curve. Inferences cannot be made from a reduced form about the effect of a price change, nor can inferences about the effect of inflation be made from the Phillips Curve.

But one needn’t resort to a somewhat sophisticated argument to see why Blanchard’s fears that wage catchup will lead to a further round of inflation are not well-grounded. Blanchard argues that business firms, having pocketed windfall profits from rising prices that have outpaced wage increases, will grant workers compensatory wage increases to restore workers’ real wages, while also increasing prices to compensate themselves for the increased wages that they have agreed to pay their workers.

I’m sorry, but with all due respect to Professor Blanchard, that argument makes no sense. Evidently, firms have generally enjoyed a windfall when market conditions allowed them to raise prices without raising wages. Why, if wages finally catch up to prices, will they raise prices again? Either firms can choose, at will, how much profit to make when they set prices or their prices are constrained by market forces. If Professor Blanchard believes that firms can simply choose how much profit they make when they set prices, then he seems to be subscribing to Senator Warren’s theory of inflation: that inflation is caused by corporate greed. If he believes that, in setting prices, firms are constrained by market forces, then the mere fact that market conditions allowed them to increase prices faster than wages rose in 2021 does not mean that, if market conditions cause wages to rise at a faster rate than they did in 2022, firms, after absorbing those wage increases, will automatically be able to maintain their elevated profit margins in 2022 by raising prices in 2022 correspondingly.

The market conditions facing firms in 2022 will be determined by, among other things, the monetary policy of the Fed. Whether firms are able to raise prices in 2022 as fast as wages rise in 2022 will depend on the monetary policy adopted by the Fed. If the Fed’s monetary policy aims at gradually slowing down the rate of increase in nominal GDP in 2022 from the 2021 rate of increase, firms overall will not easily be able to raise prices as fast as wages rise in 2022. But why should anyone expect that firms that enjoyed windfall profits from inflation in 2021 will be able to continue enjoying those elevated profits in perpetuity?

Professor Blanchard posits simple sectoral equations for the determination of the rate of wage increases and for the rate of price increases given the rate of wage increases. This sort of one-way causality is much too simplified and ignores the fundamental fact all prices and wages and expectations of future prices and wages are mutually determined in a simultaneous system. One can’t reason from a change in a single variable and extrapolate from that change how the rest of the system will adjust.

Robert Lucas and the Pretense of Science

Published March 9, 2022 Abraham Wald , Alfred Marshall , Arrow-Debrew-McKenzie model , common knowledge , expectations , general equilibrium , Hayek , intertemporal equilibrium , Kenneth Arrow , Leon Walras , Lucas Critique , macroeconomics , microfoundations , New Classical macroeconomics , partial equilibrium , rational expectations , rational expectations equilibrium , representative agent , Uncategorized , Walrasian equilibrium 21 Comments

F. A. Hayek entitled his 1974 Nobel Lecture whose principal theme was to attack the simple notion that the long-observed correlation between aggregate demand and employment was a reliable basis for conducting macroeconomic policy, “The Pretence of Knowledge.” Reiterating an argument that he had made over 40 years earlier about the transitory stimulus provided to profits and production by monetary expansion, Hayek was informally anticipating the argument that Robert Lucas famously repackaged two years later in his famous critique of econometric policy evaluation. Hayek’s argument hinged on a distinction between “phenomena of unorganized complexity” and phenomena of organized complexity.” Statistical relationships or correlations between phenomena of disorganized complexity may be relied upon to persist, but observed statistical correlations displayed by phenomena of organized complexity cannot be relied upon without detailed knowledge of the individual elements that constitute the system. It was the facile assumption that observed statistical correlations in systems of organized complexity can be uncritically relied upon in making policy decisions that Hayek dismissed as merely the pretense of knowledge.

Adopting many of Hayek’s complaints about macroeconomic theory, Lucas founded his New Classical approach to macroeconomics on a methodological principle that all macroeconomic models be grounded in the axioms of neoclassical economic theory as articulated in the canonical Arrow-Debreu-McKenzie models of general equilibrium models. Without such grounding in neoclassical axioms and explicit formal derivations of theorems from those axioms, Lucas maintained that macroeconomics could not be considered truly scientific. Forty years of Keynesian macroeconomics were, in Lucas’s view, largely pre-scientific or pseudo-scientific, because they lacked satisfactory microfoundations.

Lucas’s methodological program for macroeconomics was thus based on two basic principles: reductionism and formalism. First, all macroeconomic models not only had to be consistent with rational individual decisions, they had to be reduced to those choices. Second, all the propositions of macroeconomic models had to be explicitly derived from the formal definitions and axioms of neoclassical theory. Lucas demanded nothing less than the explicit assumption individual rationality in every macroeconomic model and that all decisions by agents in a macroeconomic model be individually rational.

In practice, implementing Lucasian methodological principles required that in any macroeconomic model all agents’ decisions be derived within an explicit optimization problem. However, as Hayek had himself shown in his early studies of business cycles and intertemporal equilibrium, individual optimization in the standard Walrasian framework, within which Lucas wished to embed macroeconomic theory, is possible only if all agents are optimizing simultaneously, all individual decisions being conditional on the decisions of other agents. Individual optimization can only be solved simultaneously for all agents, not individually in isolation.

The difficulty of solving a macroeconomic equilibrium model for the simultaneous optimal decisions of all the agents in the model led Lucas and his associates and followers to a strategic simplification: reducing the entire model to a representative agent. The optimal choices of a single agent would then embody the consumption and production decisions of all agents in the model.

The staggering simplification involved in reducing a purported macroeconomic model to a representative agent is obvious on its face, but the sleight of hand being performed deserves explicit attention. The existence of an equilibrium solution to the neoclassical system of equations was assumed, based on faulty reasoning by Walras, Fisher and Pareto who simply counted equations and unknowns. A rigorous proof of existence was only provided by Abraham Wald in 1936 and subsequently in more general form by Arrow, Debreu and McKenzie, working independently, in the 1950s. But proving the existence of a solution to the system of equations does not establish that an actual neoclassical economy would, in fact, converge on such an equilibrium.

Neoclassical theory was and remains silent about the process whereby equilibrium is, or could be, reached. The Marshallian branch of neoclassical theory, focusing on equilibrium in individual markets rather than the systemic equilibrium, is often thought to provide an account of how equilibrium is arrived at, but the Marshallian partial-equilibrium analysis presumes that all markets and prices except the price in the single market under analysis, are in a state of equilibrium. So the Marshallian approach provides no more explanation of a process by which a set of equilibrium prices for an entire economy is, or could be, reached than the Walrasian approach.

Lucasian methodology has thus led to substituting a single-agent model for an actual macroeconomic model. It does so on the premise that an economic system operates as if it were in a state of general equilibrium. The factual basis for this premise apparently that it is possible, using versions of a suitable model with calibrated coefficients, to account for observed aggregate time series of consumption, investment, national income, and employment. But the time series derived from these models are derived by attributing all observed variations in national income to unexplained shocks in productivity, so that the explanation provided is in fact an ex-post rationalization of the observed variations not an explanation of those variations.

Nor did Lucasian methodology have a theoretical basis in received neoclassical theory. In a famous 1960 paper “Towards a Theory of Price Adjustment,” Kenneth Arrow identified the explanatory gap in neoclassical theory: the absence of a theory of price change in competitive markets in which every agent is a price taker. The existence of an equilibrium does not entail that the equilibrium will be, or is even likely to be, found. The notion that price flexibility is somehow a guarantee that market adjustments reliably lead to an equilibrium outcome is a presumption or a preconception, not the result of rigorous analysis.

However, Lucas used the concept of rational expectations, which originally meant no more than that agents try to use all available information to anticipate future prices, to make the concept of equilibrium, notwithstanding its inherent implausibility, a methodological necessity. A rational-expectations equilibrium was methodologically necessary and ruthlessly enforced on researchers, because it was presumed to be entailed by the neoclassical assumption of rationality. Lucasian methodology transformed rational expectations into the proposition that all agents form identical, and correct, expectations of future prices based on the same available information (common knowledge). Because all agents reach the same, correct expectations of future prices, general equilibrium is continuously achieved, except at intermittent moments when new information arrives and is used by agents to revise their expectations.

In his Nobel Lecture, Hayek decried a pretense of knowledge about correlations between macroeconomic time series that lack a foundation in the deeper structural relationships between those related time series. Without an understanding of the deeper structural relationships between those time series, observed correlations cannot be relied on when formulating economic policies. Lucas’s own famous critique echoed the message of Hayek’s lecture.

The search for microfoundations was always a natural and commendable endeavor. Scientists naturally try to reduce higher-level theories to deeper and more fundamental principles. But the endeavor ought to be conducted as a theoretical and empirical endeavor. If successful, the reduction of the higher-level theory to a deeper theory will provide insight and disclose new empirical implications to both the higher-level and the deeper theories. But reduction by methodological fiat accomplishes neither and discourages the research that might actually achieve a theoretical reduction of a higher-level theory to a deeper one. Similarly, formalism can provide important insights into the structure of theories and disclose gaps or mistakes the reasoning underlying the theories. But most important theories, even in pure mathematics, start out as informal theories that only gradually become axiomatized as logical gaps and ambiguities in the theories are discovered and filled or refined.

The resort to the reductionist and formalist methodological imperatives with which Lucas and his followers have justified their pretentions to scientific prestige and authority, and have used that authority to compel compliance with those imperatives, only belie their pretensions.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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