From Electrical Engineering to Macroeconomics

0:00Okay. My talk today, the title is From Electrical Engineering to Macroeconomics. Now, it seems an unlikely even strange metamorphosis. That was my career path, though, as I'll explain. But my talk today is not intended strictly as autobiographical in nature. You don't need to know that much about me and so I plan to hang some ideas on it about methodology, about the nature of Austrian economics, something we can learn about the relationship between mathematics and economics and even a few recommendations along the way.

0:46Given the twists and turns in my career, we can even say something about the graphical Analysis of Macroeconomics. That's probably what I'm known best for, and I'll present that as an effective pedagogy, for one thing, and as a check on the logical consistency of theories that we may develop. Now, with that much said, I have to admit that my talk The talk today is a bit reflective. It's, well, it's very reflective. And I realize that any speaker, to give a reflective talk, has to meet two qualifications. And one is, you have to be old, okay? Sorry. Okay, I got that one. I've got that one. And secondly, You have to have clear, objective evidence that you've actually achieved some degree of success during your career.

1:48You have to have that too. Well, I've got that too. I've got my graphics on the back of a Mises Institute t-shirt, so my career is whole. Now as Joe mentioned, those graphs and that pamphlet was first published in 1978. He showed the new version. There's the old version. It's published by the Institute for Humane Studies. And the new version then that he's shown you came out just last year in 2010. And they got very different reactions from fellow Austrians and others.

2:38So I'm getting ahead of my story, so back to that part later. So let me give you a little chronology to show you how I got from electrical engineering to Austrian macroeconomics. That when I first went to college, I simply followed my nose from mathematics, which seemed like that came natural for me, and into engineering, okay? And that was at a little college in my hometown of Joplin, Missouri, which I'm happy to say is mostly still there, including the college where I went, that's where Obama spoke.

3:25And later I went to Missouri's engineering school, which then was called the Missouri School of Mines and Metallurgy. I mean, that's hardcore engineering. Started out as a mining college and developed from there. During this time, I avoided even looking down on any courses in the social studies or in the humanities. My idea was just, it's a bunch of mush, okay? Social studies, a bunch of mush. You can't get your teeth into it. And if I dug a little more deeply, I would discover you can't apply math to it, okay? So the heck with it. Stay away from it. Stay in engineering.

4:12After college, I dodged the military draft by ducking into the Air Force, where I spent 4 years, and I spent it in an electronics development lab in the Mohawk Valley. Now, for those of you not in this country, the Mohawk Valley lies between the Catskill Mountains and the Adirondacks in upstate New York, which turned out to be a pretty good place to be during the Vietnam War. I'm happy about it. But since the Vietnam War was a limited war, I had plenty of time to read and was influenced by my brother who sent me copies of Rand's books, Atlas Shrugged, The Novels, Fountainhead, and importantly Capitalism, The Unknown Ideal.

5:07And there, with Rand, you had philosophy without the mush, okay, it was hardcore stuff. And so, I relished it, I read it, it was great, but I gravitated towards the economics. And the book on capitalism, The Unknown Ideal, contained a bibliography at the end, which Which was a virtual reading list to anybody who wanted to study Austrian economics. I checked this morning just to see what's in there, eight books by Mises, four by Hazlitt, one by Benjamin Anderson. So that was what I read for starters.

5:52In my foggy memory, I thought Hayek was in that list too, and Rothbard, they weren't it turns out, but if you start reading Mises and Hayek and related materials you soon find your way to Hayek and Rothbard, which I did. Now, my formal transition from electrical engineering to economics involves both some pushing out of electrical engineering and some pulling into economics. Being pushed out of electrical engineering came from the And the fact that I spent four years figuring out how to jam antique Soviet radar.

6:39Not a saleable skill as the Vietnam War is winding down. Those are the radar that they gave to North Vietnam, of course. And so it was practical at the time to figure out how to jam the things. So my options were either to go with a defense contractor as an engineer or get out of engineering. So I was pushed out in that sense. I was pulled into economics, of course, by my fascination with Rand and then subsequently with Mises, Hayek, and Rothbard, and even before I left the Air Force, I had read some of Hayek and some of Rothbard, including Man Economy and State. So my graduate work began at University of Missouri, Kansas City, and you might think, given my background, that I would just go headlong into mathematical economics, but it wasn't so.

7:38I didn't. And for reasons I only came to understand later. The key, I don't need to save my punchline to the end, the key is that I learned math quite separately from economics. I learned math and its obvious applicability to the hard sciences, including certainly electrical engineering, and then economics separately from that. So my math and my economics are stored on separate brain cells. It helps, it turns out. It helps. It keeps math from getting in your way when you're doing economics. And to show you how that works, in my double Double E days, electrical engineering is always called double E. In my double E days, I learned how to get the maximum gain out of an amplifier, subject to some bandwidth constraint. Alright?

8:41And you do that with a little bit of calculus, using Lagrangian multipliers. Those of you You've taken math, econ, know what that is. Now when I got to economics at the graduate level, I learned how to maximize utility subject to an income constraint. It's a little bit of calculus, okay, with use of the Lagrangian multipliers. And so all of a sudden I was way ahead of my fellow students because I already knew I knew the technique and all I had to remember was to report my answer in terms of utils rather than decibels. And that was one of my tip-offs that economics really isn't about the math.

9:28The math is just a very formalized way of doing that sort of thing. So what is it about? Well it's about the nature of the so-called utility or the utils that we're supposedly and to get insights into that I end up going back to Menger, Menger's principles, the subjectivist revolution, the reckoning of utilities in an ordinal sense rather than a cardinal sense and one that you can't quantify in terms of utils. For the budget constraint, rather than simply drawing a line that goes from one axis to To the next, learn something about the basic concept of scarcity and the calculation debate, the business of determining what resources can be used and at what cost and so on, and Hayek's use of knowledge.

10:24It's the market process that grapples with that problem that causes the budget constraint to take on a certain reality in the economy. So my focus was very different. I got past the math of it very quickly, and I noticed at the same time that I was sort of having this advantage over other students by knowing the math already, I noticed that some of my fellow students couldn't quite tell the economics from the math. They were learning them at the same time and storing them evidently on the same brain cell. And so it was easy to conflate one with the other. I remember, in fact, one classmate who thought that Joseph Lagrange was an economist. No, no, no, no. Eighteenth century French mathematician, okay, and nothing about economics. So if I want to issue my first recommendation, many of you I know are graduate students or beyond and past this point, but for those For those of you thinking about studying economics at the graduate level, get a degree in electrical

11:34engineering first, okay? Or if you want to tone that down a little bit, at least learn the math separately from the economics and make sure you can tell one from the other, never getting them confused. I was particularly drawn into macroeconomics, where what counts is the interconnectedness of all the different aspects of the economy. We find the most general statement to that effect in Leon Volra's work, where he says essentially everything depends upon everything else. That's Volra's. In macroeconomics, you sort of boil it down to a relatively small number of magnitudes that depend interrelatedly one on the other.

12:28The trick is choosing the magnitudes wisely so that you can actually capture the workings of the market economy. So my first exposure to these interconnected relationships that supposedly depict the macroeconomy Money, is something called ISLM analysis. Let me just take a poll. How many have gone through that, ISLM? In some curriculums now, it's just viewed as old hat and nobody deals with it. ISLM is the interpretation of Keynes offered by Hicks and elaborated by Hansen Back in the early part of the Keynesian Revolution, and at a time, at one time, it was affectionately known as the Islamic art, ISLM, although that term, I'm told, has become politically unpopular.

13:26Okay? So we don't use Islamic art anymore. The IS, of course, stands for the equality between investment and saving, and the LM for the Equality Between the Demand for Money, that's liquidity, L, and the Money Supply, that's M. So those are the things that are juggled in ISLM analysis. But it's a fixed price, fixed wage Keynesian model. Okay, so you model the economy on the assumption that wages don't change and prices don't change. It seems like such an economy would be doomed from the beginning. If you can't change prices and wages, then it's going to perform very And certainly, ISLM didn't square with what I'd learned from Mises, Hayek and Rothbard.

14:17They seem to be worlds apart. But there needs to be some way of bringing them together to get a one-to-one comparison. In fact, that's what I was doing and trying to do in my first little pamphlet there on Austrian macroeconomics. So one of my objectives was to figure out how best to demonstrate ISLM's wrongheadedness, okay? And by the way, that term wrongheaded comes from Haslett. He uses it a lot, wrongheaded. And I've read Hayek and reread and gone back to Haslett. And I certainly get the impression that wrongheaded is different from just plain being wrong. I can't tell you just what the difference is except wrong-headed is much worse, okay, is much worse.

15:08And so I thought the ISLM analysis was definitely wrong-headed. Now here's another instance where you actually can use the math, sort of in a defensive mode so to speak. Every once in a while someone shoves a model in my face, sometimes strictly a mathematical Model and wants a comment on it or what's wrong with this or is this right or is this Austrian or is this Keynesian or something else. Well, it turns out there's an acid test, the Keynesian, I call it the Keynesian acid test and if it's a graph, it's a bunch of interlocking graphs, you can write equations for each of the graphs and you've got a set of simultaneous equations.

15:55You can even solve, and this is the key, you solve those equations for consumption as it relates to investment, all right? And then you take a derivative of consumption with respect to investment and you look at the sign. Now, if the sign turns out to be positive, which means they both move up and down together, And that right sign is positive, they both move up and down together. Then that means that the chances of the market working are simply ruled out because the market has to have some way of trading off how you use your resources, partly for investment, partly for consumption.

16:42There ought to be a way for the market to shuffle resources out of consumption into investment or out of investment into consumption, in which case CNI would have to move opposite. as well as the business of one another. That's an integral part of the Austrian theory, but in the Keynesian theory, it doesn't work that way. They always move up and down together. Now, let me qualify that. In the simplest Keynesian theory, certainly in the ISLM analysis, then they simply move up and down together, which precludes a healthy functioning market from the get-go. All right. If you get into some of the more complex Keynesian theories, then they move up and down together with the exception of a set of imagined parametric values that are decidedly un-Keynesian, okay? You have to really find some odd numbers for the parameters to get consumption and investment to move against one another. So there's an application of Math as an Acid Test to see if at root a particular model is Keynesian and doesn't

17:56have a chance of capturing the Austrian insights. Now, one of my objectives in the early Austrian

18:07macroeconomics and also in Time and Money, written much later, it was published in 2001, is to show how those market mechanisms work. What are the market mechanisms that allow resources to be removed from consumption and into investment? In fact, that's how economy grows. People save. The savings are borrowed by the investment community. They take command of resources that weren't consumed and use them to expand the productive capacity of The economy, that's what causes economic growth. Saving comes first. And so I was devising a model that would do that.

18:53Now, some people didn't like my model because it involved some aggregation, right? And it did, but all models involve aggregation. It's a question of what are your aggregates? Do you choose your aggregates where you can actually get alternative movements in consumption and Investment, or choose them such that you can't, okay? So in the Austrian spirit, I chose them so that you can and showed what market mechanisms do the job. Now to show, in fact, how those alternatives get traded off with people's changing time preference, in other words, if people decide to consume less now in order to be able to Consume More in the Future, then those resources that they didn't consume now get employed in industry, in the business world, to produce at a profit consumption goods available in the future.

19:59Now back to my two publications of this, again side by side, 78 and 2010, 32 years apart, You know, they get separated, and the reaction was different from the one time versus the first time. The first time I did it, I actually got hate mail, hate mail, saying that this is a sacrilege to Mises. You know, I've drawn a graph and claimed that it captures a Misesian idea. Even people who wanted to like the Austrian macro were critical of the graphical model.

20:55Now, one critic who will remain nameless, it was Richard Ebeling. This is recorded, too, and he suggested strongly, and with support from Mises, that graphs are not an appropriate tool for economics. Now, Richard is a dear friend of mine. He's a brilliant economist, and he is a bottomless source of knowledge about the history of economic thought. He's a virtual walking encyclopedia of economic thought, and at the time though that he made this suggestion, he was an undergraduate.

21:47He was an undergraduate at, I think it was Sacramento State, and isn't that where he was? in California. So he was an undergraduate. At the time, I was at Menlo Park Institute for Humane Studies, so was Jerry O'Driscoll, Suda Shanoi and a few others. And Evelyn had made that charge. Now O'Driscoll, Jerry O'Driscoll, pioneer in the early resurgence of Austrian macro at the time, decided to look through Mises and find, if he could find Mises actually saying And the passage said, and I have to paraphrase because I don't actually have the exact quote, The passage was, in economics, graphs are inappropriate, except for undergraduates.

22:53Well, that was ambling, you know what I mean? Okay, Richard, we won't do it, but you know, you go right ahead. And he hasn't lived that one down yet. Now, as Joe indicated, I did get some positive response from the monograph. and one from Rothbard because in fact the story is that when I finished this paper while I was at Kansas City, University of Missouri, Kansas City, I was invited to present at a professional meeting in Chicago and in fact my professor of macro had arranged for that for me but I hadn't really gotten feedback from an Austrian economist There were no Austrian economists at Kansas City, and so I hardly wanted to go to Chicago without getting some feedback from some Austrian economists.

23:53And so I just sent it on a hope to Murray Rothbard, hoping to get something back in time for me to feel more confident in going or possibly to cancel my reservation, depending on what he said. and a few days later I got a phone call and actually it was Joey Rothbard and said Murray liked your paper and then she brought Murray to the phone and I was expecting him of course to hear this very scholarly voice I heard all this cackling cackling that went on and on and he loved the paper but mainly in the defensive mode in other words he just he's what he was cackling about is that it was the Austrians beating Keynes at his own gas of Money and Credit, The Theory of Money and Credit, The Theory of Money and Credit, The

25:10and the Future. And so I said, yeah, I'll be there spring break. And that worked out. So I went up there spring break and met with Murray and he brought in other economists, including Walter and Walter Grinder. Bill Stewart. You remember him? Was there one more? Can't remember, but brought in a bunch of people who discussed this paper. It was about a 32-page paper. And we didn't start the discussion until after dinner, which is, say, about 10 o'clock. And by about 3.30 or 4, it seemed to me to be getting late. I didn't want to wear out my welcome.

25:56And so I started inching towards the front door, you know, and it was time to go. And not realizing that Murray was getting a little insulted, you know, what, you're leaving? We just got started. I didn't know at the time that he was a complete night owl, okay, and didn't plan to go to bed anytime soon, so I stayed and went, walked back to my hotel in the daylight without any trouble. So anyhow, that was quite an experience, but it sort of energized me to get going all the more on Austrian economics.

26:38Now, what I'd like to do in finishing up here is extend Mises' pronouncement and say that the graphical technique has its advantages and over and above undergraduates, okay? Although it is good for pedagogy, in fact that's one of my points, but for pedagogical reasons to instruct students and to get them to see the difference between the Keynesian in the Austrian view. It works charms. And let me just remind you that if you look at the development of Keynesianism, what you see is it went through pedagogical evolution that has no counterpart in the Austrian school. In other words, you have Keynes's own general theory, which only has one graph, single graph, and it's not a Keynesian graph. It's a supply

28:07And that went through an evolution of pedagogy. You got Samuelson and his Keynesian Cross by 1948 or so, simple stuff. You got Hicks and then later Hanson, about 49, who did the ISLM analysis. Then you got the so-called Keynesian neoclassical synthesis where for the first time they let wages and prices change, although they always change in the same direction.

29:02And then you've got what's called, let's see if I can, oh, you get new Keynesianism. And then you get something called the stochastic dynamic general equilibrium models, which have new Keynesianism embedded in it, okay? So you have this evolution. You don't have that kind of evolution pedagogically in the Austrian School. You've got refinements and developments and articles for journals and so on. But you don't have the pedagogy building. One of my objectives in doing the graphical stuff is to build a pedagogy that can go head to head with the Keynesians. And I have to say that I found it very heartening that the students, despite the fact that the The Austrian view, it's a little more complex because simply because it allows for this variation in opposite directions of consumption and investment.

30:05But nonetheless, it's easier to learn because it makes sense, it's straightforward, okay? So my students struggle learning Keynesian stuff with the spirits and the fetish and all that. And then when they get to the Austrian stuff, it almost teaches itself. They learn it very easy. is just the easiest kind of macroeconomics. In fact, in my principal's class, I've been calling it Easy Mac, which is a brand reserved for macaroni, I know, but it works. I'm not trying to get a copyright on it. Easy Mac. Now, beyond pedagogy, it helps you reconcile about different Austrian's views of the business cycle.

30:53And the one example I'll give here is that if you read Hayek, he talks about forced saving as it being an integral part of the cycle, forced saving. If you read Mises, you read about the boom consisting of malinvestment and overconsumption. So supposedly there's forced saving and overconsumption, what, going on at the same time? How can this be? It seems to be a contradiction, there's got to be some reconciliation. And I use the graphical model to show how each played a role as soon as you correctly understood what forced savings actually means. And in fact, I'll end with saying that will be a big issue tomorrow with me when we look Chapter 20 in Human Action. Thank you.