Due to the wealth of post crisis material present and the polarised nature of the Hayekian / Keynesian Debate, a similar literature gathering tool as used in Chapter 2 is used to generate
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reliable and valid data for this section. The results of various search terms in appropriate databases are shown below:
Table 5: Literature Search Results: Is Hayekian Thought compatible with empirical testing?
Research Objective:
Is Hayekian Thought compatible with empirical testing?
Databases Searched Econ.
Academics of the Austrian School of Economic Thought tend toward a firm belief in the explanations and understanding that Austrian Business Cycles can offer to past economic cycles. For instance Mulligan (2006) considers that Hayek’s theory of the trade cycle is
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unmatched in offering persuasive qualitative explanations for economic cycles. It is here that the considerable conflict between Neo-Classical economics with its standard econometric empirical testing approach and the Austrian School with its rejection of scientism is highlighted. For the traditional Austrians a qualitative examination based in logic is
paramount, any empirical examination is subject to a fundamental epistemological problem, there is little value in direct proof from past observation as human action is not measurable or constant (Mises 1966) and as such conclusions based on past observation of human behaviour alone are non-repeatable and only valid in terms of the understanding they can provide.
It is within this philosophical stance that this thesis is required to justify the empirical
approach taken. The Austrian Econometric literature reviewed in this section presents various arguments for the support of this approach.
There are select cases of empirical examination, and these cases are growing with the influence of the New School of Austrian Thought. The long contested Austrian Keynesian sparring ground of the Great Depression44 provides a starting point for a consideration of previous research. As per the Austrian methodological constraint limiting the empirical testing of hypotheses, Mises (1966) explains the Austrian view of the epistemological problems of Human Action. Burns and Mitchell (1946) consider both short and long term interest rates and find support that long term bond yields are pro-cyclical and have a lag factor, furthermore with a larger sample the long term rates are relatively stable in the boom period and vary considerably in the contraction, as per Hayek’s theory of the trade cycle. Rothbard (1962) for instance argues that the considerable expansion of the artificial monetary supply determined
44 Although Grant (2014) considers that the 1920-21 US Recession provides insight as this was the last recession before widespread government stimulus action.
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by the rise of the monetary base above its natural rate resulted in an uncontrollable boom in the 1920s leading to the Great Depression. Furthermore for Rothbard government
intervention prevented the natural correction mechanism of the market and resulted in the Hayekian secondary economic contraction. Using a measure similar to the standard MZM monetary aggregate, “MZM is a measure of money that includes assets redeemable at par on demand” (Carlson & Keen 1996), Rothbard (1978) demonstrates that artificial monetary expansion occurred into the 1930s, continuing to prevent the natural market correction required by Hayek’s theory of the trade cycle in this scenario and continuing the misallocation of resources and malinvestment predicted by the theory. This was, for Rothbard, further worsened by ineffective and damaging government intervention designed to maintain the artificial price level and prevent the liquidation of malinvested resources. O’Driscoll et al.
(1976) consider the economic conditions (stagflation) of the 1970s through an Austrian Business Cycle Theory framework with a conclusion that an increase in the artificial money supply can create extra demand at consumption altering the price structure of the economy and thus the allocation of resources, in accordance with Hayek’s theory of the trade cycle.
Mishkin (1981) rejects the idea of real interest rates being stable over relatively long periods (1953-1979), finding that technological development or alterations in the time preference of the economy would alter the real rate of interest, as well as a negative relationship between short term nominal interest rates and inflation indicative of a liquidity effect. Wainhouse (1984) provides probably the first econometric analysis of Hayek’s theory of the trade cycle using hypothesis testing, now applauded by the New School of Austrian Economic Thought.
Wainhouse identifies a series of hypotheses and empirically tests them via Granger Causality tests, he identifies a pattern in accordance with Hayek’s theory of the trade cycle starting with monetary shocks and leading to changes in both the interest rate and output levels.
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Wainhouse (1984) using econometric techniques concluded finding considerable supporting evidence for Austrian Theory. Le Roux and Levin (1998) use the Wainhouse approach to the South African Economy (1980-1996) with comparable supporting results. Zarnowitz (1992) once again notes the change in the real interest rate over time.
4.3.1 Hayekian Thought and an ACE approach?
In this section, recent developments in computational modelling are discussed as vehicles for the analysis of Hayekian Theory. Agent Based Approaches, in particular Agent Based
Computational Economics (ACE) can be seen to link with Hayekian Thought. When considering an ACE approach there are a number of factors which highlight the appropriateness of the technique for this research over a (solely) statistical analysis, these predominantly lie within the aforementioned Hayekian45 views of economics being an understanding of the process rather than mathematical formalism and prediction. For instance an Agent Based
Computational Economic (ACE) approach when compared to statistical analysis can provide a two way interpretation of the process, that is the interaction between micro and macro and vice versa. An ACE approach provides a bottom-up perspective, whereas statistical modelling predominantly provides a top-down viewpoint from aggregated data. A simplifying
assumption in much statistical modelling within economics is the homogeneity of individuals, as within representative agent modelling. Within an ACE approach agents can be
heterogeneous in all their characteristics if needed (Fagiolo & Roventini 2008), formal models are often dynamic and evolve over time whereas statistical modelling tends toward a static form unsuitable for modelling human action (Mises 1977), statistical modelling is perhaps more appropriate for ceteris paribus situations than for mutatis mutandis ones (Freeman 1998 p.19). Furthermore statistical modelling is clearly appropriate for a linear system, whereas the
45 Please see Ekelund & Hebert 1990, Chapter 21 – Austrian Economics.
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economy treated as a complex system (Liu 1960, Chan & Steiglitz 2008) is decidedly non-linear with the additional possibility of non-linear feedback loops between the micro and macro elements (Fagiolo & Roventini 2008). Goldspink (2002) suggests that an ACE approach is far more appropriate for modelling non-linear scenarios and Richiardi (2003) considers non-linear scenarios resistant to mathematical analysis. However an ACE approach should not be
considered a deus ex machina in that it like any method is not without its faults. Richardson (2002) considers the problem of equifinality, that is an infinite number of different models of complexity each validated by the data could be constructed to provide a solution to a problem however notes that rigorous caution can allow for the selection of appropriate model choices.
Richiardi (2003) considers overfitting to be a further problem of an ACE approach, that is where a too complicated model does not only fit the patterns and trends of the data but the general noise of the data too. Unlike a statistical approach however, the agents in an ACE method can interact directly, the simplifying assumption of rationality can be relaxed in the computational model, the agents can learn from experience and the system can evolve.
Statistical modelling has been widely criticised for being too far removed from reality (Stiglitz 2010, Lawson 2009) and the ability to study economic phenomena from the agent level begins to address this (Tesfatsion & Sun, 2005). The ACE approach is criticised within orthodox economics as failing to provide the proof of statistical analysis as it relies on artificial data produced by the simulation itself (Richiardi 2003). Furthermore the estimation of the
parameters and structure of the ACE model may create significant difficulty when comparing with real world empirical data. However the arguments describing the advantages of the ACE approach presented in this work, in particular those supporting the ACE movement toward reality and away from the simplifying assumptions of statistical analysis, could make an ACE approach a viable consideration for economic research within the paradigm of the Austrian School of Economic Thought and are worthy of further consideration outside this thesis.
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Though the fact remains that ACE is an output measure of economic analysis creating
simulated data, the ‘New Generation Austrians’ are perhaps more accepting of empirics than the traditional Misean adherents, however the philosophical justification of forecast data built on simulation is outside the set methodological constraints of this thesis46.
However, Austrians have tended to avoid empirical research, based on Mises (1966, pg 351):
“It is true the empiricists reject [a priori] theory; they pretend that they aim to learn only from historical experience. However, they contradict their own principles as soon as they pass beyond the unadulterated recording of individual single prices and begin to construct series and to compute averages. A datum of experience and a statistical fact is only a price paid at a definite time and a definite place for a definite quantity of a certain commodity. The arrangement of various price data in groups and the
computation of averages are guided by theoretical deliberations which are logically and temporally antecedent. The extent to which certain attending features and circumstantial contingencies of the price data concerned are taken or not taken into consideration depends on theoretical reasoning of the same kind. Nobody is so bold as to maintain that a rise of a per cent in the supply of any commodity must always – in every country and at any time – result in a fall of b per cent in its price. But as no quantitative economist ever ventured to define precisely on the ground of statistical experience the special conditions producing a definite deviation from the ratio a:b, the futility of his endeavours is manifest”
However, from the current perspective, this Misean view can appear naïve (Subrick and Beaulier (2010), as previously, noted modern econometricians do not search for exact
magnitudes, looking instead for correct signs of coefficients. Modern econometrics recognises measurement error, problems of causation and issues of data, variables and increasingly of autonomous interpretation (Colander et al 2009). Subrick and Beaulier (2010) note the example of the recent research regarding common law on economic outcomes. Hayek (1960) first postulated the basic idea discussing the emergence of the rule of law in Great Britain rather than France, however no Austrian adhering to the above Misean view sought to
46 For further insight into this argument, see Whittle, R. (2011). The Philosophy of The Austrian School of Economic Thought and an Agent Based Computational Method? EDAMBA 20th Annual Summer Academy, Soreze France.
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examine this empirically, turning the prepositions into testable hypotheses and collecting data. The idea failed to get traction and was abandoned outside the Austrian School, however Andrei Shleifer and various co-authors (Shleifer et al 1998, 2002) performed an empirical examination turning the obscure Austrian idea into a mainstream research project, published in the Journal of Political Economy and the Quarterly Journal of Economics. Empirical
examination of Austrian Theory can allow for mainstream acceptance, here Austrian ideas penetrated the mainstream, as their evaluation was empirical and allowed direct comparison with competing theories.
The research presented in this thesis seeks to develop this tradition of empirical examination of Hayekian Theory, namely the evaluation of a testable model of Hayek’s theory of the trade cycle.
4.4 What methodologies, methods and findings are present in the literature for the