Notes
Toward a Theory of the Business Cycle
Note: this is merely an excerpt taken from a rough draft of an essay that will appear in my forthcoming book, Visions of Reality. —Greg Nyquist
Mainstream economics —
by
which I mean, the sort of economics that is taught in universities and
promulgated in the mainstream press — is clearly in a grievous
state
and
has been so for many decades now. One of the most serious deficiencies
of academic economists is their incorrigible obtuseness concerning the
business cycle. Despite all their theories about how business cycles
come about and all the statistical evidence they have compiled
detailing what happens when an economy goes into its inevitable
malaise, they are still at sea when it comes to prognostication. Nor is
it simply a matter of not being able to say precisely when an economy
will rise or fall. Exact predictions in economics are impossible. But
at least one would expect economists to have a rough idea of where the
economy is likely to go. Even in respect to this very modest goal,
mainstream economists fail more often than not. In June 1990, to take
one example, 88% of economists polled predicted a continued economic
expansion. [Prechter, The Crest of the Wave, 19] A month later,
the economy promptly nose-dived into the worst recession in a decade.
Economists really ought to do better if they expect any intelligent man
to take them seriously.
Their grasp of the financial
side of things is little better. Mainstream economists were just as
clueless about the nineties' stock market as they were about the
economy as a whole. "Economists are as perplexed as anyone by the
behavior of the stock market," Stanford economics professor Robert Hall
confessed. To the question, "Is the Stock Market too high?" Berkeley
economics professor J. Bradford De Long answered, "No one knows." Is
this not incredible? What good are all their graduate and postgraduate
degrees, all their mathematical and empirical training, all their
models and analysis, if they cannot explain something so simple as the
behavior of the stock market?
Now as long as the economy
is humming along at a good pace and most people are doing just fine,
the fact that the overwhelming majority of professional economists are
clueless about business cycles provokes little interest. Why should any
of us care, as long as the paychecks keep flowing into our bank
accounts and our credit card debt is manageable? But as soon the
economy begins to flounder and we find ourselves facing unemployment
and crushing debts, we are likely to take a different attitude towards
the intellectual malfeasance of mainstream economists. Their ignorance
now seems to be implicated in our misfortune. Perhaps if they knew
something more about business cycles than do palmists and tarot card
readers, we could turn to them for guidance in time of crisis. But
given their track record, this would clearly not be a very wise thing
to do.
Who, then, in a time of
economic crisis, should we turn to? Is there anyone at all who
understands these mysterious fluctuations in economic activity that
lead so inevitably to booms and busts? Or is the science of economics,
and especially of business cycle research, one vast and perpetual
morass of unintelligibility?
To know nothing is to be in
a lamentable to state. But even worse is to think one knows when one is
actually quite ignorant. Mainstream economists may appear ignorant to
those who observe them from the outside and can hardly fail to notice
how often they are wrong concerning the direction of the economy. But
this is not how they perceive the matter. In their own eyes, they are
great interpreters of economic fact, men whose understanding and wisdom
soars well above the common herd. Icarus had his wings, all wax and
feathers, and economics its "science," all mathematics and intellectual
pretense; yet neither, I fear, can hold fast under the bright warm
glare of truth. Economists have compiled all sorts of theories to try
to explain the business cycle, none of which, alas, are all that
convincing or can be counted on in the practical matter of guiding
fiscal and monetary policy. Consider, as one example, perhaps the most
influential business cycle theory within the economics profession
today, the Keynesian theory, as expounded by the pundit-master of
liberal economics himself, Paul Krugman. "As is so often the case in
economics (or for that matter in any intellectual endeavor), the
explanation of how recessions can happen, though arrived at only after
an epic intellectual journey, turns out to be extremely simple,"
Krugman smugly assures us. "A recession happens when, for whatever
reason, a large part of the private sector tries to increase its cash
reserves at the same time." [Slate, 12-3-98]
This explanation, like so
many propagated by Lord Keynes and his followers, raises more questions
than it answers. Business cycles, we are told, happen when, for some
inexplicable reason, a whole lot of people suddenly decide to increase
their cash holdings. But why should such a thing ever occur in the
first place? Why would so many people, at the very same time, decide to
start stuffing their mattresses with cash? How can we explain so
singular an occurrence? Is it mere coincidence? A malignant conjunction
of the planets? Or is it perhaps a wave of temporary hoarding insanity
that spreads through the population like a vulgar fashion or a bad
cold? It is very odd that a man of Krugman's stamp, who is so sure that
he alone is right and that everyone who disagrees with him is a
complete dunce, should offer up so ridiculous a theory. For it should
be clear that Krugman's Keynesian theory of recessions suffers from an
egregious superficiality. Imagine if some medical researcher had
written an editorial in the New York Times insisting that the
common cold is caused by a sore throat! Yet Krugman's statement is no
more credible. Increased cash reserves is merely a symptom of a
recession, not its cause. If you cannot provide a coherent explanation
of why a large part of the private sector increases its cash reserves
at the commencement of an economic crisis, you will never explain why
recessions happen.
If mainstream economics
cannot provide us with an adequate explanation of the business cycle,
who on earth can? Has any progress at all been made in explicating this
great mystery? Well, yes, some progress has been made. Not in
mainstream economics, but on fringes, a few economists can give you at
least a rough idea of the how and why of recessions. The best theories
are those that arose at the turn of the century out of Austria. Two men
in particular deserve mention: Ludwig von Mises and Joseph Schumpeter.
In 1911, they each published a book introducing a new theory of the
business cycle. Mises' theory, introduced in his classic The Theory
of Money and Credit, is known as the Austrian theory of the trade
cycle, because it relies heavily on the work of the two great founders
of the so-called "Austrian school" of economics, Carl Menger and Eugen
Böhm-Bawerk. Schumpeter's theory, which, due to its unique and
heterodox nature, has no special name of its own and belongs to know
particular school (though it dovetails nicely with certain aspects of
the Austrian theory), was first introduced to the world in the
pathbreaking The Theory of Economic Development. While neither
of these theories is fully adequate, they both provide the essential
groundwork for grasping the inner workings of the business cycle.
[This concludes the excerpt of the essay "Notes Toward a Theory of the Business Cycle"]
