What the Austrians Say about Prediction

0:00When I was asked to speak about what the Austrians say about prediction, I first thought that I would just say that the Austrians say you can't do it and then just sit down, but I predicted that that wouldn't have altogether good consequences for me if I did that, and in any case, it wouldn't be altogether true. The Austrians don't say there's absolutely nothing at all you can say about the future, nothing that you can predict. However, there are, in the Austrian view, severe limitations to what one can predict about the economy and what one can say about the future. And I want to go into some of the reasons for this.

0:45Now, the Austrian method of economics, made most clear by Mises in his great book of 1949, Human Action, is a deductive method, what he calls a praxeological method, he talks about the science of praxeology. I find people who read Human Action always find the section which Mises discusses these issues, the part about praxeology, which is about the first 140 or so pages of the book, the most difficult part of the book, and they always assign this, when we have Mises University, they always assign this part to me to lecture about.

1:35I think they're trying to tell me something, but I'm not going to try to figure out what it is. So what does Mises in the human action say? What is it that the economist is doing? Well, according to Mises, the economist is starting from the axiom that human beings act. The economist is considering what is the nature of action. How can we tell about what any action is, no matter what kind of action it is, just by thinking about the concept of action. Imagine any particular action you want, say my lecturing or you're listening to me, anything you like. We say, what is involved in the structure of the action, just in the action as such?

2:25What does any action have? If those of you familiar with the way Mises develops, the notion will remember that he gets a whole lot of things about action just from the concept, like any action involves the use of means to achieve ends, and in each action a person is trying to achieve his most highly valued goal. So, what he's doing is to elaborate deductively various consequences of the notion of action. Now, when he's doing this, remember I just said he's considering the form of any action, whatever it is. He's not considering particular actions. So he's not considering, say, how much, say, someone demands oranges, what the person's demand for oranges or apples is, or how much someone values money.

3:24He's considering what is involved in any action at all, and he won't be coming up with any laws in economics about specific quantities that people want. One, you won't be having any laws such as that if you increase the supply of money by three percent, prices will go up by such and such an amount. There won't be just from the notion of action, we won't be able to come up with any relationships of that kind, because we're just considering, as I say, just the structure of action won't be coming up with quantitative estimates. Estimates. Now, you might say, well, this doesn't show that you can't come up with such estimates. All that shows is that you can't come up with them by praxeology. You can't come up with them by the deductive process of reasoning that Mises has elaborated and carried out in his own economics.

4:30But, Mises, as you know, those of you who read him know, always has, anticipates, objects, and has an answer for them. He says, not only is it the case that the deductive method won't come up with quantitative laws of economics, he doesn't think there's any other way of doing it either. He says, in economics, in matters dealing with human action, unlike the physical sciences, There are just too many variables involved for us to be able to come up with quantitative laws. These quantitative laws would be ones, obviously not deductive consequences of action, but just empirical laws, say the kind we had in physics, that we can't come up with them because there are too many variables and we can't do controlled experiments as we can in the physical sciences.

5:21So he said, really, you can't get quantitative predictions in economics. You can't say, have any such predictions, either by praxeology or any other method. Now, so as if this weren't bad enough for the notion of prediction, there's another element that must be considered in bearing on this topic. That is to say, as Mises developed the notion of economy, various matters, economic matters, such as inflation or the business cycle, he always, Austrian economist, he always started from, built up the total thing he was, the topic he was concerned with, from individual's actions.

6:14He was concerned, say, let's take an example of this. Suppose we have the government increases the supply of money. What will be the effect on prices? Well, we've already said we can't give quantitative estimates, but what can we say about the increase of supply of money on prices? Well, as the Austrian Mises analyzes, what we don't do is say, we try to consider the economy as a whole. We don't try to come up with some relationship, say the supply of money has gone up by a certain amount, therefore prices, all prices will rise by a certain amount.

7:08Irving Fisher had a famous of the equation of exchange which is his follower in that he said this respect, Milton Friedman has the notion that just by plugging in the amount of increase into this equation of exchange you can come up with an amount that prices will rise as a whole. Fisher and Friedman and their followers would admit that not all prices rise exactly the same amount But they think just from some information about how the supply of money is increasing the economy, we can come up with some general statement from this equation of exchange of how prices rise.

7:53Now the Misesian, the Austrian way is different. What we would say is that supposing money is injected into the economy, well, the people who get this money first will find they have a lot of money that they didn't have before to spend on various things, so they'll have an increase in their income. And then the things they'll find first, since they're the ones who have the money, we have by Hypothesis. The other people haven't gotten money yet. Price, they find the prices won't rise for them. They'll, they will rise to a certain extent on goods they spend their money on, but they'll be doing very well because the prices won't get arisen while they're spending the money. Now the people who get the money from them will also be in a fairly good position because they'll get, have more money and they'll be able to spend it on various Most goods, the prices of which haven't risen yet. But as the money spreads more and more,

9:01people who have the money, the new money will find that most goods have risen in price already. So as the people later on in the chain of circulation, as money is going on, will find that for them the prices have risen, the goods they want to buy, so they won't be benefiting very much, if at all, from any increase in money. So you see the basic difference between the Misesian way of analyzing the increase in supply of money and this method that I've mentioned, say that Irving Fisher and Milton Friedman have, the Austrian Misesian way is considering what the effects are on particular people. So you see, you can see how this makes prediction much more difficult and also makes more difficult trying to use Austrian theory to try to use it in particular financial decisions.

10:04Supposing somebody were to say, well, I think it's very likely the government is going to continue inflating money, so what I'm going to do is borrow some money and then I'll make a lot of money money because I'll be able to invest it, make some money in my business and then when I pay back the loan if I'm right that inflation has gone up more by what I predicted and so I predicted more it would rise by more than other people would. I'll be able to pay it back in money of less value so I'll make a big profit on the deal. Now on the Austrian way this would be much more difficult to to carry off because whether the person made the profit would depend on where he is in the chain of circulations of money. Is he someone who's gotten the money right away or in one of the first to get the new injections of money that he might do very well but if he gets it only one of the

11:08later people to get it then he won't get, he won't benefit as much, he won't be be able to do this sort of calculation of the kind I've just imagined. Now, let's take another example of how the Austrian stress on individual action limits predictability. Now, several of the other speakers have mentioned the Austrian theory of business cycle in which the government increases the supply of bank credit which drives the money rate of interest below the natural rate of interest and this induces people to invest in higher stages is a production they otherwise would have and when the expansion stops then it comes about that these investments and people return to the natural rate of interest based on their rate of time preference, it'll turn out these investments in the higher stages were unproductive, that there's been over investment, these will have to be liquidated.

12:27Now, some economists have objected to this account. They say, well, what happens when people find out about the Austrian business cycle theory? Then they'll just, when the government increases the money supply, they just won't invest. So the people will be able to anticipate that these investments won't work out. So the Austrian business cycle theory won't operate at all. People just anticipate what the government is going to do. So the argument there is that people can, by knowing about the effects of the government measures, they can anticipate, they can predict what's going to happen, and then they won't follow the overexpansion.

13:16expansion, we can make this more general, the rational expectations theory of Robert Lucas at the University of Chicago and his followers tends to say that government monetary policy designed to change the economy is always ineffective because people will be able to anticipate the consequences of it. So you see, now from the Austrian point of view, the problem with this way of looking at things is that it's assuming that people can, it's taking people as acting together in a way. in a way, as if everybody acted in the same way, everyone is successful in anticipating the government's action.

14:04It doesn't consider that from how certain individuals might react in this way and then if they not invest, others would. What the Austrian view is that one can't take sort of an aggregate of all investors, all businessmen and say, Everyone will react in this way, so everyone will rationally anticipate what the government is going to do, and by doing so, cancel the effect, and we'll just have to, in the Austrian view, just take effects of individuals, just say, well, certain individuals will act in one way, others will do it in a different way, and one can't predict that all individuals will react in a certain way to the same government policy.

14:50Mises, I should say, was well aware of the effect that people can react in a way to counter government policy. In fact, he was one of the first to point out that government inflationary policy can be failed to achieve the ends that the government wants by it because of people's anticipation. He rejected any kind of rigid or mechanical view in which everyone at the same time responds in the same way to the government policy. Now, I should say that if Mises did consider the case where just people wouldn't altogether respond to government increase in money supply, Money Supply, and he said, well in that case there wouldn't be a business cycle. This is just not a problem for his theory. He's trying to explain the business cycles that do happen, not the ones that don't.

15:52He had a very good article on this in the British journal, Economica, which came called Elastic Expectations and the Business Cycle. This came out in, I think, 1943. Now, let me give you one last illustration of how the Austrian view of individual that one has to, in economics, one has to deal only with individuals in their action, one isn't dealing in aggregates of how everyone reacts at the same time, is crucial. As many of you know, Mises developed a criticism of government intervention into the economy of this kind.

16:39He said, well, let's suppose the government imposes some measures such as price control. It'll say the government thinks people aren't getting certain goods. He gives one of his essays. He wants poor people to be able to get milk at low cost, so the government imposes price control, maximum prices on milk. The result will be we will have a shortage of milk. The policy will fail from the point of view of the people who wanted it. so then he said well what will happen then either we the government will have to repeal the price control or have further price controls designed to make the try to remedy the first situation and the same thing will happen again those will fail the government will face with either going on further or going back to the free market now there's an objection that I think Paul Samuelson and put to a similar argument by Hayek and he said well look this isn't what happened according to this argument we should be either have a complete free market or a total regulated system we don't have that we have some kind of intermediate state that Mises seems to be arguing that the measures will fail in effect and they'll have to push on either to full regulation or abolish regulation we don't have that we

18:11have some kind of intermediate system. You see, this objection is completely to misunderstand the Austrian argument. It isn't saying that the government will react in this kind of mechanical way that either having to push forward or go back, you'll just say that these are the decisions, this is the structure of a situation will confront the government either to have to, if the governmental powers are unsatisfied with the situation, they'll either have to try to remedy it by having more controls or move back. It isn't saying that people will react in this mechanical way. That depends on the particular people involved, and it's altogether conceivable that people, People, the government will just decide to flounder around indefinitely in this kind of condition of partial regulation.

19:10So you see, the objection there to the Misesian view is one that totally ignores the individualistic basis of the whole theory. So you see, I think in these three ways I've tried with the fact of inflation, the business cycle, and the interventionism I've tried to show how the Austrian view of that economics is based on consideration of individual action limits what very much what we can say about prediction as opposed to views of economics that view matter more, view the economy as a whole or an aggregate. Now, I'll just say in conclusion, we have to avoid moving to the opposite extreme and saying that we can't know anything at all about the future.

20:06Well, we can obviously know some things if Austrian economics is right, such as the way the laws discovered by Austrian economics hold in the future. The other view, this radical uncertainty of the future, was adopted by Ludwig Lockmann, who said, well, we just don't know anything at all about the future, but it's not clear why he held this. It seemed to be part of some kind of general philosophical view of his, but I've never been able to figure out what the arguments are for it or supposed to be. The view was also held by G.L.S. Shackle. I remember one time when I was talking to Lachman, he said to me, oh, the great book on economics, really the masterpiece, is Shackle's book, Epistemics and Economics.

21:00So I went and had a look at that and I turned to the first page and I see it's dedicated to Lachman. So I guess I can see why Lachman recommended it. but I so but you see this view that sort of sets we don't know anything about the future at all if that were we take that seriously that would end economic theory altogether so the Austrian view that because we're limited to the action of individuals we have we our ability to predict is very limited has to be very are very sharply distinguished from the infinite emptiness of the view held by Professor Lottmann.