Austrian Business Cycle Theory

EconBuff Podcast #29 with Bob Murphy

Dr. Robert P. Murphy talks with me about what causes business cycles. Dr. Murphy walks us through the two major theories of business cycles, Real Business Cycle theory and Keynesian Business Cycle theory. We discuss Dr. Murphy’s major critiques of each and he explains how these models fail to match the observed behavior of the economy. Dr. Murphy argues that Austrian Business Cycle theory takes the best of both models while avoiding their major problems. Finally, Dr. Murphy addresses the critiques of Austrian Business Cycle theory, and we explore what the implications of this theory are for government policy when facing recessions.

For more from Dr. Murphy be sure to check out his podcast at The Bob Murphy Show.

He also writes at the Mises Institute on topics like Austrian Business Cycle Theory and much more.

Photo by Luis on Unsplash

Transcript

Stitzel: Hello and welcome to the econ buff podcast. I'm your host, Lee Stitzel. With me today is Dr. Robert P. Murphy. He is a senior fellow at the Mises Institute. He is the author of many books. His latest is Contra Krugman: Smashing The Errors of America's Most Famous Keynesian. His other works include Chaos Theory: Lessons For The Young Economist, and Choice Cooperation Enterprise and Human Action which is modern distillation of the essentials. For the layperson, he's also host of The Bob Murphy Show. Bob, welcome.

Murphy: Thanks for having me Lee. Glad to be here.

Stiztel: So I'm honored to have you on, and the reason that I asked you to come on is to talk about business cycles and what causes them. So I find that when I teach a principles of macro class, a lot of textbooks…the treatment of this is sort of like…business cycles happen….and here's a really stylized graph of sort of ups and downs here. So it's one of those things that I would really love to fill in for the economic education of a lot of people. You're going to be bringing an interesting perspective, but just start us out with telling us what business cycles are.

Murphy: Sure so you're right in terms of you ask professional economists and what they mean. Like the the NBER (The National Bureau of Economic Research), they're the ones in the U.S that are officially in charge of documenting when business cycles, you know the expansion and the contractions. begin. You can go and look up the dates, and typically (it's not a hard and fast rule) they say if real GDP growth is negative for two quarters in a row that's when they say oh we're in recession, right? But for the layperson, you know, first of all, that's like a very technical thing. I think what the average person, you know what they mean by what's the business cycle, is there's periods when it seems like the economy is doing well, and workers’ wages are rising, and if you don't like your job you can quit, and there's lots of opportunities elsewhere. And then for some reason it seems, like there's these periods where everything is just kind of bad, and businesses are laying off workers, and the unemployment rate goes way up. And so that's not just in people's heads. Like there really is this cyclical rhythmic flow in market economies that has been around at least since the 1900s where it just does seem like it's not just, you know, economic growth continues over longer stretches. But it does seem like it's not just smooth and steady uptrend, that there's these cycles where there's periods where there's above average growth and then it falls, and then there's above average growth, and then it falls. And so the question is why does that keep happening? Like well you know why. These are cyclical ups and downs.

Stizel: So I always kind of make the point there's a trend in modern economies, right? But there's this general growth. There's deviation sort of above and below it over time. A lot of times I’ll show them a picture of the type of graphs, from like the St. Louis Fred that show this kind of jagged picture of ups and downs you know. And usually the sharp falls and then sort of longer periods of growth. But you always end up teaching kind of out of a stylized, you know, nice smooth curves of up and down. So what I guess what we're here to ask today is: what is it that causes that? And i kind of want to start out, because I want to take an approach to get the several different ideas out there. So what's the current mainstream story about what causes business cycles?

Murphy: Well I don't know that there's actually one. So I'll give two different theories that are attributable to, you know, economists that are/would be considered in the mainstream. So there's the Chicago. It's associated with the Chicago School. But it's beyond that, and it's called Real Business Cycle Theory, or RBC for short. So these are people that they think markets clear. You know people are generally rational, and whenever you try to, like, see some anomaly or a parent anomaly, you just try to explain it through rational, like oh, once you realize what people are doing, it all makes sense. And so the reason it's called Real Business Cycle Theory is they're saying there are shocks to the real economy. And so real in this context means not monetary. And so they're, you know, they'll just say that for whatever reasons. This system was in a nice equilibrium, and then there was some unexpected shock. And then the way the system responds to that it's optimal or rational for a certain poor part of the labor force, to just, you know, pull back for a while until the economy retools. And so it's very elegant. And you can draw up nice sophisticated models where all the people in the model know what's going on. And they use calculus so they optimize. And it is quote “a rational response” in certain periods for ten percent of the labor force to just, you know, enjoy and consume their leisure; because their product productivity at that moment, while the economy is (while stuff's) getting moved around, you know, it doesn't justify them going into work…and so the problem. And also people are trying to, like, how could that be rational? Because it throws in realistic things like workers and firms need to find each other, right? There's search costs, right? So once you start making your model more realistic, about how the real world is, it can make sense, you know? In a certain setting, that oh yeah, we didn't know what was coming. We thought labor was going to be more productive than it is, or we thought, you know, farmland was going to be more productive. What, hey, where there's this innovation from China that we weren't expecting? And given the way we sort of locked ourselves in this thing took us by surprise. And then while re-equilibrating there are pocket periods where certain things, you know, need to.

And what a quick one, and then I'll move on to a different example of a mainstream explanation. Lee, you could imagine how, like, if a hardware store thought some product was gonna take off, and they ordered a bunch of it, and it was sitting on the shelves, and it was overflowing in the stock room, and then the customers just turned out they didn't like it. You know they thought it was gonna be the hot new thing this Christmas season, and it turned out kids didn't like it because the noise was a bit too loud or something. And then you could imagine the store having this overhang, and they're reluctant to slice slash prices, but so they leave the prices up for a little bit just to see. Oh doesn't anybody want these? Let's wait till after Christmas and we'll cut it ten percent. And then finally they slash prices just to get rid of it. Ah, we screwed up! And so there would be a period where, like, the product would be just sitting on the shelves and nobody would be buying it as the stores, like, experimented. So that's kind of, like, what happens to the labor market in a recession. In these models where people didn't quite forecast correctly, and then, you know, they're reluctant to just cut wages right away to the market. You know, the thing that would clear supply and demand quantities. And so there's a brief overhang, you know, workers are like hoping. Wait, can I get a job? What if I'm willing to move? Wait, let me stay unemployed while I keep looking. And finally ah, I cut my wage demands, and I go and take a job somewhere, and then unemployment. So that's kind of the model there.

So the more Keynesian approach of people who don't think markets are always quote “rational,” and that things can get screwed up for long periods of time. But, by the way, so far, that last theory, if that's basically true, there's nothing for the government to do, right? Because the government can't let people forecast better. And once it is what it is, you just gotta let it ride it out. The Keynesians, in contrast, or those just more broadly who believe it's a demand side problem, not just like a supply side shock to the system, you know, real factor, they would say that it could be from various things. It could be because monetary policy is poor, or just there's some kind of shock. But what they're saying the specific cause is it's not something on the real side. It's not physical or technological like, oh farmland is less productive than we thought, or something like that it's consumers got spooked that they're not spending like we thought they would. And then that's what causes the system to seize up. And so in that framework where there's just inadequate demand, again, you have the same impact on the macro variables. All of a sudden, businesses aren't selling as much. They lay off workers and everything. But if that's what the ultimate cause is, the fix is really easy: oh just have the government come in and run a budget deficit, and then that will, you know, replace the spending that the private sector is seizing up on, and then you can restore employment that way. So those are two of the main competing narratives right now I would say in terms of economists who are not Austrians not, from top schools.

Stitzel: I was actually introduced to real business cycle theory on the way through my undergraduate education. And so when I asked what what's the current mainstream story, I could just, I kind of always think mainstream equals Keynesian. So you know that's the consumer confidence story. I think it is what people see on the news, right? And so that's kind of, that was kind of my thought process there. But let's go back to the Real Business Cycle Theory for a moment. There, you said a couple things that I thought were interesting. One is, you know, the shocks that are coming to the system are sort of from outside the system. Economists call that exogenous shocks, right? And so there's not much the government can do. Course, I would also interject at that point and say: except not to make policies that are unexpected for people, and therefore cause their own kind of shock, right? So can you comment a little bit on that, because you mentioned some examples of, like, what might cause the shocks. And it is that classic market idea of things that will equilibrate and how would you integrate some of these ideas about the labor market. I think people think of the labor market as unique, as different from some of the other markets. Like, we don't really mind cutting the prices on,(the example that you gave, children's toys or something like this, but there are quite a few economic theories out there that say there are reasons that we're much more hesitant to cut wages. Can you talk about that a little bit?

Murphy: Sure. If you don't mind, let me just real quickly say what I think the big problem with the RBC approach is, just so we don't get lost in the shuffle and then I'll answer your question. So to me, it works. It's internally consistent, It's very elegant mathematically. Conceptually it's great, and it grew out of the (we're getting a little technical, but I gather your podcast gets into some technical stuff for your listeners) the Lucas Critique. Like, The Rational Expectations Critique of old-school Keynesian analysis, where, like, the Keynesians in the 50s and 60s and 70s, they kind of assumed workers were stupid and, like, oh the union got me a big wage. So I'm going to work more, even though prices are rising too. Like, so Lucas said no. Really a good theory should have everybody in the model, know how the world works. And so that's these RBC models that kind of developed in, like, I think like the late 70s and 80s when they really got pinned down. It survives that critique, right? In other words, they live up to their own thing. It's a neat little internally consistent story. It's like if you're watching some sci-fi movie and there's no obvious plot holes, even though their physics is different, like, but still the reason I think it just doesn't fit the facts well. And so I think this is one where the Keynesians, I think, have a good put down.

They say in the real business cycle approach in the 1930s, that the reason unemployment went up to 25 percent was because workers just rationally said no. Given the situation, I would rather consume more leisure than I did in the 1920s. And so they call it, they say, oh so for the real business cycle people it's not the great depression, it's the great vacation, which just doesn't seem to, you know, that doesn't ring true. It's like no workers were desperate to find work, and nobody was willing to hide, you know. So to me, I do agree with that. Also to come up with what was the shock, you know, it wasn't like there was, you know, to there was like the dust bowl and stuff. That doesn't explain why the economy was on the ropes for a decade! And then like in the 80s or the housing bubble it's not clear there wasn't some innovation in building houses that all of a sudden threw everything off, right? So even like I said, you can do these little internally consistent models that are elegant. To me they don't explain in the real world why did this happen. Okay, so to answer your question, yes there are people who argue that the labor market is different, and that wages are what they could say are sticky downward. Meaning, if firms wanna, you know, in a boom period workers are very fluid, they're moving back and forth, because, yeah, as the firm expands, it's profitable. It can bid workers away from their existing jobs by offering them raises, and that's, you know, workers are quite happy to switch jobs if they're getting a pay hike. The problem is: if all of a sudden it's a downtime down period, and a bunch of businesses realize we can't continue to pay workers what we were paying them last year, or at least to carry this many workers, and so we either got to lay people off or reduce wages. So the kind of the puzzle this is: why does unemployment go up so much during recessions if business is just not as profitable? Why don't they just reduce how much they're paying their workers, and they cut their costs and keep things even? And so, yeah, workers get paid less, but then unemployment doesn't go up. And so there's some theories as to why that is. One being that, you know, it would hurt morale, right? Like, you'd rather know if the firm's carrying 100 workers and they're unprofitable at that amount, then why don't you just lay off the least productive five workers, right? And then a given thing you know you can tell, yeah, I got Jim down there, and he's always on the coffee machine, you know, he's a pain. And so rather than cut everybody's pay, just get rid of the worst five people, and ask the other 95 to do a little more until things improve. And that, yeah, people might feel bad for a bit, but they'll forget about those five people a month later and go back to work; whereas, if everybody's pay gets cut, they're all going to be grumbling for the next year, and that's just not good. So there's that kind of a theory and things like that to explain. But, you know, what is clear cut is that firms, in that situation, nowadays tend to lay off workers and not just cut wages across the board. And so that has implications, like you say Lee, that. you know. why other things, like, oh commodities and stuff, if people are carrying soybeans or pork bellies and (blah blah) oil crude prices move pretty rapidly in response to new news, whereas, the labor market that doesn't happen. And one reason too is workers sign long-term contracts, like, for their mortgage payments (assuming their salary or wage rates are such and such) and so workers would be reluctant to take a job where the employer could renegotiate their hourly pay every week, right? Why would you take a job like that? Some jobs are like that. They're like piece rate and stuff. But in general, workers feel much better locking in so they can have some certainty at least for the near term.

So that's why then when these shocks happen whether they're from the demand or supply side. Depending on what school of thought you come from, that’s what seems to happen. The way the immediate adjustment occurs is by laying off workers rather than just cutting wage rates. So the last thing I'll mention that is this: is this isn't so much a feature of capitalism. This is more of a recent thing. So in the work I’ve done on The Great Depression, that was one of the explanations about how awful the gold standard was. Because in the 1930s, once prices fell (like the stuff businesses could sell for -- oh well -- you can't cut workers’ wages), and then unemployment went 25%. In the Depression (of which a lot of people don't even know is a thing, but, you know that is a thing) wages fell much faster in a 12-month period than they had at any point in the 1920s, okay. And so there was something institutional that changed from the early 1920s to the early 1930s that to help explain why wages all of a sudden became sticky downward. They didn't used to be as sticky. And so even though that does seem to be a thing nowadays, I'm saying it's not just a feature of capitalism. I think it has to do with, like, unions and government policies and not workers. Oh there's unemployment benefits, you know what I mean? So there's lots of changes that occurred. And you can even see it in just the passage of 10 years historically that wages, all of a sudden, became a lot more rigid. And so it's not a feature of capitalism, per se.

Stitzel: I hadn't heard that. So it's very interesting. So what I'd like to do now…do you want to mention a critique that you would make of the Keynesian theory? And then that kind of set us up for introducing Austrian business cycle theory, and the explanation that you would favor for what would cause business cycles.

Murphy: Sure. So I guess, probably, my big problem with the Keynesian approach is that they're really just treating the symptoms. They don't step back and say: why is it all of a sudden that you have these big, you know, collapses in demand? And then also (and the reason that's important) is we're about to get into presumably, if you know what the Austrian theory is, what causes the business cycle. If the Austrians are correct, or at least if that's part of the story, you know, maybe there's other stuff going on too. But if they put their finger on one important contributing factor, then what the Keynesian’s recommended solution is. Actually, the thing that keeps setting up these recurring boom bust cycles (and so it's s actually not just that the Keynesians aren't helping), it's that what they're recommending is actually the thing that causes the, you know, the next wave of this stuff. And so that's to me, that and also too with the Keynesian approach, is it's very macro in the sense. Like, it's just looking at big picture numbers like total spending and things. Like, that it's not looking at more granular micro phenomenon or phenomena. That's the plural of, like, if mistakes were made and certain investments went in particular lines and they shouldn't have. Then that's a real thing. And just to have more spending is not necessarily going to fit that.

And the last thing I’ll mention too is even on its own terms, like the Keynesian idea, is, oh we can have the government (so normally what they'll say is like something like Paul Krugman will admit that oh yeah in general in a healthy economy) run a budget deficit to spend money on bridges or something. There's an opportunity cost that real resources, including labor hours go into producing the bridge, where the politicians point to those resources, including labor hours that could have been allocated elsewhere. So we shouldn't just look at the bridge or the stadium or whatever and say, oh, that's brand new wealth that we got for free. You have to contrast it with, well what don't we have now because those resources went there. And typically you would expect the market economy to allocate resources to where consumers want better than the political process. So that makes us poor. So the Keynesians say you're right. That's true in general, but not during a bad recession. In particular that is what they would call a liquidity trap, right? And they say, there it's free, that when the government runs a deficit, it's taking idle resources including workers who are sitting around watching The View and not doing anything productive. And they go back to work now, and so there's no opportunity cost. And so I think that's a bit too glib, because in general it's, you know, it's never going to be that. Even the majority, you know, there's some bridge being built, if you went and surveyed all the workers and stuff, and all the resources, it's not that literally every resource that goes into that bridge was previously totally unemployed and would have been unemployed forever. You know I mean? So if they had stepped back, you know, things would have gone back to normal. And so, at best, it's you're mobilizing these resources earlier than would have happened under the market process. And so if you think there is a sense in which during a recession things really are getting retooled to be more efficiently or sustainably deployed, then the Keynesian alleged solution interrupts that okay. And so you could argue there's a trade-off between relief and long-run sustainability. But even on its own terms, I think when you push it, it's clear that it's almost like a knife edge case. Like what they're having to argue; whereas, when they talk about it to the public and explain what they're doing, glibly I think they way oversell or way under acknowledge that the harms of what they're doing.

Stitzel: So I like the way that you put this, because one of the things that I would say about Real Business Cycle Theory is the recession is a way to fix some of the misallocations that have happened in the economy, right? It's resetting that resource allocation. That's kind of the paradigm that I think about macro through a lot of the time. So having set both of those up, I think we're now really nicely set up for you to kind of lay out for us what your preferred explanation for business cycle theories.

Murphy: Sure thing. What's interesting about the Austrian Approach is to me, is it takes what's true from both camps. And it's not that the Austrians sat back and it was sort of a thesis antithesis synthesis thing. And so it's Ludwig Von Mises, one of the giants in the Austrian School developed this originally in 1912. And then he elaborated, and his follower Friedrich Hayek continued his work, and then ultimately won The Nobel Prize in 1974, largely for his work on business cycles. So this was developed before the Keynes. You know, Keynes's famous thing came out in the real business cycle. Like I said, really wasn't until the late 70s-80s, but it's interesting. That it's sort of, it anticipates the mission theory, the elements of truth in both camps. So in the Austrian story, there's both real factors going on, but also demand set or monetary ones too. And so, I'm gonna not get the exact phrasing right, but Fritz Mocklup said something like, in the Austrian approach the business cycle has real effects that are driven by monetary causes, or something like that. So that's why, you know, the problems I identified for you Lee earlier, and the RBC and the Keynesian camp, I think the Austrian overcomes both of them. So in the Austrian vision, what you need to realize is the market economy tends to work well. Prices help allocate, you know, resources. They're not perfect, but that's the best, you know, human institution. Certainly having politicians come in and second guess speculators who have their own money on the line, you know, skin in the game to say, oh no resources should go here or here. That's goofy! Why would you think the political process, that those people would have any more wisdom than, you know, the experts with their own money on the line? And in particular one of the prices that's very important is the interest rate (or in practice there's multiple interest rates), but just, you know, for our purposes here, just think of it as the interest rate. And in the Austrian view that helps allocate resources over time. And so, in particular, if the people in a society are very patient, and they're willing to defer consumption so they save a lot of their income, that tends to push down interest rates. And so the businesses see a low interest rate and they realize, oh I can borrow funds that are like a low penalty, as it were, and invest in longer projects, so long as you know they're going to yield something down the road. And so that's the way, you know, the interest rate helps coordinate the use of resources into steering them into things that the consumers want. Whereas, if the society is very impatient, and the consumers kind of want, you know, immediate gratification, they don't save much of their income. And so then how do market prices adjust? Well the interest rate tends to be high, right? Because, like, there's not many loanable funds available. And so then businesses know, oh, if you're going to tie up resources for a long time it better be in a really productive thing; because you're having that high interest rate dinging you over time until you can, you know, sell the product for the revenue and pay off the loan, right? And so that's obviously (I'm speaking loosely here Lee), but that's the idea that interest rates serve a function in a market economy, just like a high price of oil means something. And you need to pay attention to it. And it would be bad if the politicians somehow masked that, and made people buy gasoline as if oil were twenty dollars a barrel when really it was two hundred dollars a barrel. You wouldn't be doing anybody any favors by hiding those signals that the prices are giving people.

So likewise, if the interest rate's supposed to be eight percent, and somehow the political process pushes it down to two percent, then that's going to screw things up. You're not helping people by having low interest rates that stimulate spending, right? And so then, when the Austrians get more particular and specific about, well what does it screw up if the interest rate's artificially low, it in a sense gives the wrong signal to entrepreneurs that, oh, it's okay to tie up resources in long-term projects, because the penalty, you know, per year of this stuff rolling over is low. And so it gives us a false greenlight so entrepreneurs start these long projects that might have been justified in an alternate universe; where there was more savings and the interest rate really should have been low, but not in the current universe when the interest rate is supposed to be higher, but yet it was pushed down because of the central bank let's say. So that's the Austrian story. Then the boom period is the problem, right? So it's the boom/bust cycle. It's not just, oh, recessions happen. It's for every recession that in the Austrian view there's a prior artificial boom where mistakes were made, where mal investments were made and businesses invested in things that they shouldn't have. They were giddy, they were overly optimistic, and then that ultimately leads to a bust. And so that's the Austrian story. And so in the recession period, even though it's painful that's fine. In the recession period, even though it's painful. ironically that's almost like the cleansing period where the economy shakes off those mal investments. And that's why certain resources, including labor hours, (temporarily some of them are unemployed) because the economy (I'm speaking loosely here) collectively realizes, oh, wait a minute, what we were doing was unsustainable during that boom period. We were investing in longer term projects than the people were willing to save and fund. And so we were going to hit a wall physically. This could not have continued. It was literally impossible to keep up the pace of what we were do doing. And it's better to acknowledge the error sooner rather than later. And then once you do what you do, you stop if to say, the economy as a whole was on an unsustainable trajectory. This means there were some workers every day getting up and going into work that were going to the wrong places. And so in a market decentralized economy, where there's not a dictator who just orders people around, how do you coax people to stop going to the wrong factory every day? They have to get laid off, and that's painful for the worker, but that's in a decentralized system where everybody chooses their own employment. That's the way the system gives that feedback. And then and so they gotta search. And the reason it's painful is because we were not as rich as we thought we were. The new jobs those people take, the ones who had been going to the wrong places of work during the unsustainable boom, their job, at least for a while, is not going to be as lucrative, right? Because we were poorer than we thought. And so nobody wants, you know, like I say, it's easy to go to a better job. It's tough to get laid off and then realize I gotta take a job that's not paying as much, or that's not as fun or whatever. And so that's why there's this overhang of workers who search to see -- is there something better? And then, yeah, unemployment benefits can extend. So that's the gist of the Austrian story. So what they say is during a recession, the worst thing to do is for the central bank to slash interest rates and pump in cheap credit to try to, you know, boost spending, especially investment spending; because that's what sets up, you know, sows the seeds for the next boom bust cycle. So you're just you're causing the very thing that you think you're helping. And so, like, I said that's why if the Austrians are right, or at least that's part of the story, the Keynesian solution which entails slashing interest rates, and then if that still isn't enough, having the government deficit spend ---that's the worst thing to do.

Stitzel: I have my students in my graduate classes read Arnold Clings. Not what they had in mind. And one of his principle points in there is to say, every time we have a recession, the policy responses so the seeds for the next crisis is akin to what you're saying. But you're saying it's really just the general response that the federal reserve is taking?

Murphy: So if I could, so all of Arnold's stuff on, like, what he called like a recalculation story or something like that, yeah I agree with everything he said. It's just, I think the Austrian story gives more explanation as to why did we find ourselves in this situation where recalculation was necessary.

Stitzel: Right. So yeah, that's a good point, because I think Kling's story is to say we just have bad policy responses to these. It's not even necessarily giving a type of explanation that you're giving for each sort of bust that's actually caused by resources being misallocated because interest rates are a price. And you have a price distortion that's causing people to make choices that don't actually reflect. And

now you framed this specifically in the preferences of the individuals that are in the economy, is that right? Or is there more to that?

Murphy: I don't know this is answering your question, so what is true is what people's subjective preferences, over, you know, how much do I, of my income, do I want to consume now versus deferring for the future? Yep, you know, that that's a subjective thing, just like if you look at one society where people really like to smoke cigarettes. Well then, it would make sense for more farmland to be devoted to tobacco; whereas, in a place where everyone doesn't like cigarettes, that none of the farmland should be devoted to tobacco. So likewise, looking at the economy, it might be correct for most of the productive resources every year to go into building more factories, and 18-wheelers, and drill presses as opposed to movie theaters, and milkshakes, and, you know, designer jeans. So that's just a matter of subjective taste as to what the consumers want. The problem occurs when it's people who want the milkshakes, and movie theaters, and jeans. And yet because the central bank pushes down interest rates, the entrepreneurs who are building long-term factories, and drill presses, and things -- they're able to start plants and hire workers right because they think, oh, we have enough savings to justify this when we really don't.

Stitzel: So the reason that I like the combination of what you said up there, and this idea of prices is one of the first places that I came across Austrian business cycle was actually brought up by Tyler Cowan in a critical way. And his argument is: even if there's easy money out there and interest rates are wrong, that doesn't mean necessarily you have mal investment. This is his analogy that just because bananas are very common you don't have to put them on your roof. That strikes me as not a particularly good argument. In the sense that in almost any other situation I would imagine an economist like Cowan probably would say. But prices, when they're distorted in every other market, we would say that is going to cause some kind of problem: whether it's misallocation, or just a mix of goods and services that don't match what people want, which is why you're bringing up the preferences I thought was so important. Would you like to comment on those type of, I hesitate to even call them critiques of what you've laid out?

Murphy: Yes, you know, it's good. That's, I think, the single strongest objection to Austrian business cycle theory. So people might call it the rational expectations objection. And so, yeah, the complaint goes just to flesh it out a little bit, says okay, according to Mises and Murray Rothbard, and, you know now this guy Bob Murphy who's just parroting what they say. It's like, oh, businesses are just chugging along, and then the fed comes and cuts interest rates, and businesses (oh look at interest rates are lower it's because people save more there must be more you know tractors available and things like that and more pro programmers who have who know all kinds of software skills) go ahead and start building this 10-year factory, and then oops when the fed tightens two years down the road because CPI starts getting a little hot. Then those factory owners slap their heads and say, oh wow, I didn't see this coming. I didn't know that the interest rates could rise. Now I'm dead and I gotta let everybody off. And so the maybe back in the 1920s they didn't know this, but by this point you got FED watchers. Everybody's watching m1 and m2. They're reading FED minutes. They know what the FED’s objectives are in terms of, you know, unemployment and inflation. And so they have, you have, long-term futures markets and interest rates and things, you know, bonds, what have you treasuries. So how can it be that the business people just keep getting surprised by what the FED does? Don't they take this into account? So if interest rates really are artificially low, don't the businesses all know that? And don't they, you know, act appropriately? And not so that there's certainly an element there.

I think part of the problem is just the standard way Austrians tell the story glibly. You could fix it up a little bit. And it's not the businesses are just like, oh wow, I had no idea. Like you say Lee, everybody agrees, that in this conversation, that outright central planning doesn't work and that market prices serve a function in general. You wouldn't just say, oh well, why isn't the socialist planner just, you know, if everybody knows where shirts are supposed to go, what do we need prices for, you know? What, are all of a sudden the shirt distributors stupid, and they don't they think that nobody needs shirts, or they think everyone needs 16 t-shirts at once? No they don't! You wouldn't talk like that. You would say, yeah, but there's a lot of specifics, and you do need exact market prices to help decide on the margin, you know. Does this town need more shirts or not? You know, that kind of stuff. And so likewise, yes, if the FED pushes interest rates down from 700 percent to one percent, we can all know that that one percent is artificially low. But we don't know how low it is. We can't just be central planners and say, oh, in the absence of FED action, here's what the interest rate really would have been. Because then that, you know, then socialism would work if we could talk like that. You need actual market prices to guide things. The other thing too with what this is, during, like let's take like a real example, like during the housing bubble mania, there were plenty of, you know, financial institutions that were sort of on the sidelines. They were saying these mortgage-backed securities we don't understand how these things work. This is crazy! We're not getting involved! And their competitors made a bunch of money on the way up.

And also, I talked to like a the guy who built my house in Nashville. I had, you know, talked to him and this was in like 2006 or 2007. I think he was looking around at the mania, and he was like pointing at developments down the street. And he's like, yeah the guy's doing that, you know, building that house. Down there they're like all in their young 20s, like they've just been in this business for, like, a year. And so he was older and he had reduced his inventory. You know he was just doing houses on spec and then moving on. He was not working on 10 houses at once, because he knew a crash was coming. He didn't want to get caught carrying a big inventory; whereas, these people, like those kids building the house down the street, like, they couldn't even finish it, like, once everything crashed. So my point being, when if the banks are handing out cheap money, it could be that the seasoned people know not to take it. But you can't stop other people from coming in who have no wisdom from just go ahead and borrow the cheap rates. And so capital, still like real physical capital goods in this case, you know, lumber, and shingles, and everything, and, you know, worker hours do get allocated into projects where they shouldn't. Because the chief regulator is prices, right? In a market economy, the thing that puts the brakes on silly investments is a high interest rate, or the bank's having good credit standards. And so if those things get battered down for various reasons, then there's going to be mal investments.

Stitzel: And why doesn't the normal, like kayaking, and the role of prices, and the in for solving the information problem that seems to work perfectly? Well in interest rates and messing with those prices seems just as bad as anywhere else. I mean this this is why I had you on in order to talk about this kind of thing. That it just strikes me, as I want to say straightforward. But, like, this this is a thing that free market economists would all point to. So I think that's where Austrian Business Cycle Theory has a lot of appeal. So we're coming up on our on our time limit here, and I don't want to keep you over. But I know what my listeners are going to ask. I said, okay Dr. Murphy, he comes along and he lays out this great theory and these excellent critiques. And okay, we buy it. We're all Austrian Business Cycle theorist now. They're gonna want sort of a policy prescription. So can you lay that picture for us out to sort of sort of play out this episode?

Murphy: Sure. So unfortunately, if the Austrians are right, then there's no way once there's a bad bust underway, then there's no way to, you know, automatically just make it end, right? Because the problem is, like I say, that mal investments were made. Workers were going to the wrong jobs, and so the only way to fix that is some of them need to switch over. So certainly what you don't want to do is push down interest rates or have stimulus spending to make it so that the places that are laying off workers change their mind. If what it is workers were going the wrong spot, if that was unsustainable, you don't want to let the illusion persist to try to avoid the short-term pain. What you don't want to do is sow the seeds for the next boom/bust cycle. So you certainly don't want the central bank engaging in easy money policies. Now you could take steps like the federal government or, you know state law, they could do things to try to ease the pain, but not retard the process of reshuffling workers. So for example, if you want to provide relief payments then go ahead and do that. But don't make it that, oh, if you're unemployed then you get more checks. Just do a flat, you know, give people if they got laid off, you know, give them a flat payment just for the next six months. We'll give you such and such as a percentage of your previous salary or something like that, whether or not you take a job. So that, you know, that would slow the process somewhat. But at least if someone goes and finds a new job, they can you know, know that they're not going to have their unemployment run out. So you could do little tweaks like that to try to split the difference, where you're providing some relief for people that, you know, happen to be bearing the brunt of this readjustment. But yet, you're not slowing the incentives to switch over to get to a more sustainable trajectory. So ultimately, the only long-term solution is to take. and I know this is radical, but you're asking them this. The only real fix is to put money in banking, back in the private sector, right? Like, if there was a committee in charge of setting oil crude oil prices, and they met every once in a while, and then had, you know, the federal open crude oil committees announcements on here's our target for the price of crude for the next three months. We're watching the situation in the Middle East, and that and we want the price of crude oil to be between 98 and 107 dollars a barrel, and we're going to adjust. That would be crazy, you know! You’re central planning! What are you doing! That's what we do with interest rates and money! And even lots of free market economists think that's totally fine. And so I'm saying there's no right way to centrally plan the economy. Whether you're talking about crude oil prices, or cars, or interest rates. And so it's not that I'm giving, you know, there's different proposals for here's what the fed ought to do. I'm saying, no the only real solution is to get rid of the FED altogether and just have interest rates be set in a decentralized market process the way other prices are.