Keynesians -v- Austrians: The Battle of the Better Neoclassical Theory

Now obviously what I mean by Keynesians and Austrians, in the title, are the orthodoxy strands of both schools. It is actually quite funny, I find close similarities between orthodoxy Austrianism and orthodoxy Keynesianism, and I find close similarities between the heterodoxy strands of both schools. Of course I am mainly talking about the theories of the schools and not their general political stance, whether left or right.  I hope people do see this insight because it would decrease the tensions between the schools. Maybe if the schools acknowledge this insight, we could give respectable critiques of one another, cough cough Paul Davidson.

But anyway, the top paragraph is more of a side note than what I want to talk about in this post.

Anyway, Murray Rothbard stated this about mainstream Keynesian in his Chaos Theory article:

Here the chaos theorists have directly challenged orthodox neoclassical theory of the stock market, which assumes that the expectations of the market are “rational,” that is, are omniscient about the future. If all stock or commodity market prices perfectly discount and incorporate perfect knowledge of the future, then the patterns of stock market prices must be purely accidental, meaningless, and random (“random walk”), since all the underlying basic knowledge is already known and incorporated into the price. [I]f rational expectations theory violates the real world, then so too does general equilibrium, the use of the calculus in assuming infinitesimally small steps, perfect knowledge, and all the rest of the elaborate neo-classical apparatus.

What I want to show here is not the theory of Chaos Theory, but just know that they have similar critiques on mainstream economics as the heterodoxy, more specifically, the Austrians. Here Rothbard made a strong case that the rational expectation assumption in mainstream economics was absurd because it assumed that people were ‘omniscient about the future.’ Furthermore, a rejection of this flawed assumption also implied a rejection of general equilibrium, perfect knowledge and ‘the rest of the elaborate neoclassical apparatus.’  On the whole I agree with Rothbard, but does Rothbard actually believe this? Keep this question in mind.

Roger Garrison is known for his interpretation of the Austrian Theory of the Business Cycle and of Capital Theory. In the early 70’s, Garrison wrote a paper, Austrian Macroeconomics: A Diagrammatical Exposition, merging the ideas of the structure of capital with  models, which had neoclassical assumptions, a key assumption was the general equilibrium. Now one would assume that Rothbard would have been against this, considering that the Rothbard passage above rejected the assumptions that Garrison made in his models. But Rothbard liked this concept, hell, Garrison said that the reason Rothbard invited him over to his house for the first time was because of his paper, and as Garrison said, the reviews were generally positive. And ‘Rothbard was clearly enthused about the diagrammatical exposition; he saw it as beating the Keynesians at their own game.‘*

Beating Keynesians at their own game? To me, that is probably one of the worst quotes ever by an Austrian Economist. Yes, lets beat X by using X’s flawed theories, what kind of logic is that? This quote basically implies that the Austrian movement saw this neoclassical synthesis has a positive, but yet I thought Austrian Economics opposed neoclassical theory.

So now back to our question: Does Rothbard actually believe his criticisms towards neoclassical theory?  Does he only reject neoclassical theory whenever Keynesians use it and praise it whenever Austrians use it?

* Garrison on Rothbard

-Isaac Marmolejo

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6 responses to “Keynesians -v- Austrians: The Battle of the Better Neoclassical Theory

  1. I think you’ve got an interesting post here. However, I must say that Rothbard was referring to
    “perfect knowledge of all “probability distributions” of the future”

    This is in contrast to what you state,
    “assumed that people were ‘omniscient about the future.”

    If you consider that he was referencing the stock market, it becomes clear that he is more or less talking about the efficient market hypothesis. Do you agree? Not sure anyone would legitimately argue that people can really tell the future.

    • “If you consider that he was referencing the stock market, it becomes clear that he is more or less talking about the efficient market hypothesis. Do you agree?”

      Yes, but it is irrelevant here, his criticism for, say rational expectations, extends beyond the stock market, and applies to the whole field of economics. I was merely using Rothbard’s words, he is critiquing that view and I praise him for doing so. But the point of the post was to show that the same neoclassical assumptions that he criticizes are the same assumptions put in the Garrison’s version of the ABCT. So, Rothbard, in a sense, contradicts himself, it seems that he only criticizes the neoclassical assumptions when others, not Austrians, use them.

      “Not sure anyone would legitimately argue that people can really tell the future.”

      Of course, but in neoclassical theory, mainstream economic theory, you do make this very assumption by assuming rational expectations, equilibrium analysis, formalism, etc. This is especially clear if one assumes ‘rational expectations’ because this is basically an assumption assuming that all people know the exact correlation of other people’s action, so in a sense, everyone is rational. Therefore that is an assumption that one can tell the future using market forces or economic theory. If you accept that though, then you disregard the huge impact human action, subjectivism, and expectations has on the economy.

      Regards

      • Good response. I’ll have to read up on my Rothbard. I’m currently working my way through Man, Economy, and State. I’m not sure Rothbard thought anyone could prediction the future with absolute certainty. He’s main focus was human action and the use ‘means’ to satisfy ‘ends.’ He mentions the marginal utility of each actor (market participant) does not exist on one scale. Meaning that for every person the amount of satisfaction received for a given transaction is difference. Thus, despite people being rational they could make different choices. Furthermore, Rothbard never eliminates the possibly of erroneous or irrational decisions (at least in Man, Economy, and State).

        Let me ask you this. How could anyone make a theory based on the opposite- people are irrational? If you assume that market participants are irrational and their actions are essence random, then it would be impossible to draw any conclusion from it. Because given any economic problem any outcome would be specific to those specific random events. For this reason, I hold that any theory must be based on ‘rational expectations.’ What say you?

  2. How could anyone make a theory based on the opposite- people are irrational? If you assume that market participants are irrational and their actions are essence random, then it would be impossible to draw any conclusion from it. Because given any economic problem any outcome would be specific to those specific random events. For this reason, I hold that any theory must be based on ‘rational expectations.’ What say you?

    Your comment assumes that what Austrians mean by rationality is the same as what neoclassicals mean by ‘rational’ in their assumption of ‘rational expectations’ This premise is false though.

    There is a clear difference in Austrian visions of rationality and the neoclassical assumption of ‘rational expectations’. To the Austrians, rationality simply means that people do means to achieve some end, so in a sense, all actors in the marketplace cannot be irrational. Rational expectations is quite different from Austrian rationality because they have a different view of what rationality is. Rational expectations is the assumption that under a given economic theory, all people in the marketplace knows the consequences of their actions because everyone knows the given economic theory. So my critique on ‘rational expectations’ (as well as the majority of Austrian’s critique on it ) has nothing to do with Austrian rationality, they are two totally different things.

    I’ll have to read up on my Rothbard. I’m currently working my way through Man, Economy, and State. I’m not sure Rothbard thought anyone could prediction the future with absolute certainty. He’s main focus was human action and the use ‘means’ to satisfy ‘ends.’

    Yes, if you read Rothbard, your interpretation so far is quite correct. Austrian Economics has a whole explains economic situations using human action has its center point. BUT, my critique on Rothbard is on how far is he willing to accept this as true. If he considers Garrison’s work as pioneering to Austrian theory, then he is contradicting himself because (again) he is accepting neoclassical assumptions which he critiques when neoclassical uses them. And if you accept Garrison’s interpretation of ‘Austrian Macro’ then, in a sense, you are accepting that one can tell the future due to its assumption of equilibrium analysis, and thus, ignoring the center point of Austrian Economics (human action).

    See, this is the main difference between orthodox Austrians (Rothbard, Garrison, early Hayek etc) and heterodox Austrian (Lachmann, Vaughn). Orthodox Austrians wish to defeat Keynesians at their own game, while heterodox Austrians wish to defeat Keynesians (and other neoclassicals) using Austrian principles, keeping true to the center point of Austrian Economics, namely, human action, subjectivity, and expectations.

  3. It seems a little harsh on Garrison to me. My understanding is that he is saying – “Look – your whole approach is flawed for basic methodological reasons. It’s so flawed that you cannot even understand what we in the Austrian Business Cycle theory school are discussing from where you stand. But suppose that for the sake of argument, I sweep for a moment all these methodological objections to one side, and squish my beautiful theory into ugly neoclassical garb… well, this does capture the essence of part of what is going on in a way that you are better able to appreciate. Even within your own framework, you must admit that we have a point.” To say that much is hardly to concede that your opposition are correct. Nothing stops one from then resuming with the attacks on the other unsatisfactory aspects of their framework.

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