A recent proposal out of Iceland has been making the waves around economics blogosphere. In it, Frosti Sigurjonsson critiques the current fractional-reserve banking system and proposes instead a system he calls “Sovereign Money”. But what is “sovereign money”, how is it different from the current system, and how will it work? In this post I’ll first explain how the current system works and the problems it has from an Austrian perspective, then go through the sovereign money proposal to see how it solves any of the short-comings of the current system.
How is money created in the current system?
Before we can analyze the sovereign money proposal, we need to understand how the current system operates. This can be demonstrated in a 4 step process. But first understand that a central bank (like the Bank of Canada or the Federal Reserve) is a lot like any other bank: it offers deposit accounts and loans to clients. The difference is that you can only become a customer of the central bank by invitation only.
Mainstream economists have long derided the Austrian School as a “cult”. Professor Walter Block recounts stories from Nobelists Gary Becker and James Buchanan off-handedly referring to the cultish Austrians. When pressed by Professor Block, Becker said, “By a cult I mean a small number of dedicated followers who speak mainly to each other, and interact little with let us call them mainstream economists.”
Nobelist Paul Krugman just last week gloated over Noah Smith’s attacks on the “hermetic system that is Austrians”. And onMonday, Krugman once again lambasted the Austrians as “as the floating crap game — the same 30 or 40 people meeting in conferences all over the world, reading and citing each others’ work”.
Famed Chicago economist John Cochrane gives a report from a recent meeting at the National Bureau of Economic Research (NBER, the US government institution which is tasked with determining whether or not the economy is in a recession, and where Ludwig von Mises was first employed upon moving to the United States). He reports that a recurring theme throughout the discussions was about “just how we do economics”. Certainly a topical conversation. Unfortunately, just how Professor Cochrane frames the discussion proves that gross methodological misunderstandings are still pervasive in the profession.
Firstly, Cochrane frames the methodological debate as “math vs. literature”. While the current orthodoxy in economics is to have quantifiable theories that can be “proved” or falsified by empirical evidence, and though there may be some who hold that the proper way to ascertain economic truths is through “imaginative and creative writing, especially recognized artistic value”, this dichotomy is not comprehensive of the Austrian view.
I’ve got a confession to make: my favourite economics blog name is Noah Smith’s “Noahpinion”. It’s a really great blog name.
With the niceties out of the way, let’s address Smith’s latest screed: “How the New Classicals drank the Austrians’ milkshake”. In it, Smith tries to make the case that the reason that the Austrian school is “dead” as a serious scholarship program isn’t because the Austrians have too many different ideas from the “New Classical” mainstream, but rather because all the best Austrian ideas have been incorporated into the New Classical tradition.
Smith does this using cutting edge blogging techniques: a list. First he lists three similarities between central Austrian and New Classical claims, and then lists two “big differences”. Let’s see what Smith gets right, and wrong, in his comparative analysis of Austrian and New Classical economics.
Smith Claim #1: “Rational Expectations” is a refinement of the Action Axiom
Smith starts out his characterization of the Austrian school by quoting Mises from Human Action, which is good. He goes on to describe Mises’ writing as “pre-WW2 European literary style”, which is somewhat funny, given that Human Action was written after the Second World War, and in the United States. But I get what he’s saying.
Much fuss is made in macroeconomic circles over so-called “microfoundations”: microeconomic justifications for macroeconomic models, as opposed to macro models that make ad hoc assumptions about utility, preferences, and price setting. People like to bring up the “Calvo pricing model”, where (supposedly) a magical fairy selects a firm at random to change its price, as both an example of a solid microfoundation and a brazenly nonsensical one.
Of course, when the even foundations of mainstream microeconomics are shaky at best—assuming such silly things such as perfect competition, farmers who solve calculus equations, perfect information, infinitely lived households, and infinitely divisible tractors—many macroeconomists are rightly skeptical of blanket calls by microeconomists to cite their papers and books when macro guys are constructing a new model for inflation targeting or growth modeling. Some have even gone to deny any strong linkages between microeconomics and macroeconomics.
It’s that time of year again: when Austriansspontaneously organize to collectively commit to disparaging the work and reputations of highly esteemed professional economists. For a sampling of what others have had to say, see here and here. This is my humble contribution to this storied tradition.
The Committee of the Swedish Riksbank Prize in Economic Sciences in Memory of Alfred Nobel decided this year to honour the works of three American economists: Robert Shiller of Yale, Eugene Fama of Chicago and Lars Peter Hansen of Chicago. All three are very well respected in the mainstream of the profession. And while there are many places that have summarized their contributions and beliefs, I present them here in their own words. (With my own quirky interpretation in parantheses.)