Yes, A Thought That Would Make Neither Group Happy

Daniel Kuehn draws on a similarity between Austrian Business Cycle Theory (ABCT) and Minsky’s Financial Instability Hypothesis (FIH) theory. What is funny is that he is implying that neither group would be happy of the similarity which Daniel raised, and the two direct blog responses of Daniel’s post have the title of  “X vs Y”.

Jon Catalan’s post, “Minsky v. Mises–Hayek“, tries to make the case that ABCT is superior to Minsky’s theory and ends up concluding that Minsky’s theory “just doesn’t seem necessary”.  Lord Keynes responds in his post,” Minsky versus ABCT“, and defends Minsky’s theory and attacks ABCT on three points: 1) that it is hard (possibly impossible) to classify capital goods into higher and lower orders and capital can have “a significant degree of durability and substitutability” and 2) that ABCT is dependent on equilibrium theory, and 3) “the ABCT has little concern with financial crises or asset bubbles, the real world economic phenomena associated with credit booms in poorly regulated financial systems”. I want to concentrate on the third criticism.

Jon does have a response to this over at his comments section, saying, “I agree that early literature on Austrian business cycle theory doesn’t focus on the financial aspect of bubbles, and instead focuses on malinvestment. But, in my opinion, it’s just a problem of extension and application. I’ve certainly applied it myself, and I think quite successfully.”

Both are right, to a certain extent. Jon is basically saying that over the years, Austrians have focused on the financial sector aspect of the economy using ABCT over time. This is fair to say, but I do not think it adequately answers the criticism raised by Lord Keynes.

For example, Post Keynesians have stressed the flaws of the loanable funds theory, especially when putting subjective expectations into the picture. In essence, the introduction of subjective expectations ruins the nice pretty picture of loanable funds theory.

Thus, to Post Keynesian, this is a huge problem with ABCT when trying to explain the financial sector of capitalistic economies because ABCT wholly needs loanable funds theory to be valid in order for ABCT to be valid. As Greg Hill tried to point out in his debate with Steve Horwitz, you must first prove loanable funds theory as correctly explaining real world economies before trying to say anything else of the financial sector. For a quick summary on this part of the debate, see here.

Thus, putting the last two paragraphs into consideration, Jon’s response doesn’t dent Lord Keynes’ third criticism.

An Austro-Keynesian?

I received an e-mail a couple days ago, which I will reproduce some of it here. It is part of an email conversation I have been having for a while now with a PhD student that thinks of himself/herself as an Austrian. He/She has requested to remain anonymous:

Isaac, I have come to the conclusion that you are the combination of Austrian and Keynesian thought. You’ve said before that you approve of Keynesian stimulus in slumps, you question the validity of Say’s law, you don’t agree with loanable funds theory, etc. And your justifications for not believing in these primarily come from Keynesian resources. Nevertheless, you still defend the basic core of Austrian economics, which deals with the emphasis of human action. To a certain extent, you agree with praxeology, you claim that economic theory as a whole must be described through acknowledging the actions of people. In other words, “microfoundations play a key role” as you have stated before in our email conversation…

Your radical subjectivist idol seems to be [Ludwig] Lachmann, and you assume that everything you approve of, Lachmann would too, but I dont think this is quite right. If anything, you are more of the Shackleian radical subjectivist, who is seen as a person who uses ‘austrian’ premises to keynesian conclusions. In other words, you are setting up to be the modern day Austro-Keynesian.

I think the PhD student has some fair points. I do agree that I partially assume that Lachmann would approve what I advocate. I would state this differently though, rather, I assume to be consistent with a Lachmannian framework to where I draw my conclusions. For example, my advocacy of endogenous money did not really come from reading Keynesian resources, it came from reading Lachmann’s (1937) “Uncertainty and Liquidity Preferences,” in which the article considers money’s function as one that has ‘debt discharging’ which is the main difference of money and a commodity in modern capitalistic systems (Lachmann 1937: 305). Lachmann also goes on to say that money is also legal tender and can explain the process through logical deduction by making the reader aware of “what money does and what only money can do” (Lachmann 1937: 307). Lachmann seems to be the only Austrian to endorse this claim on money, thus when I do try to justify endogenous money and legal tender, I have to by default use Keynesian articles, for they have expanded this concept, while the modern Austrians still hold on to a commodity-money relationship, who oppose legal tender laws. So yes, while I use Keynesian articles to justify my point, I still think it is consistent with the Lachmannian framework.

Another key article of Lachmann’s (2005) article “Speculative Markets and Economic Complexity,” in which it shows the instability that capitalistic market systems has. He urges to make the distinction between ‘ordinary markets’ (which is a generalized form of the typical supply-demand market analysis, ie. the discovery process) and financial markets (specifically speculative markets), which are different since expectations seems to make this market more acceptable to instability (Lachmann 2005: 264; 267). Indeed talking about speculation and financial markets makes stability theories like Say’s Law and loanable funds questionable. Certainty, (Post) Keynesians see it this way and have furthered the literature on it, which Austrians have not really done so, since they faithfully hold onto the loanable funds theory, probably in fear that if they reject loanable funds, their Austrian Business Cycle (ABCT)  is also worth throwing out

I admit that Lachmann was not too clear on his thoughts on the Austrian Business cycle. It is generally known though that he thought the theory lacked a role of expectations and, according to Lewin in one of our email conversations, it was “too mechanical.” Also with conversation with Lewin, we discussed whether Lachmann would approve of the loanable funds theory, Lewin said he probably would have while I took the opposing view. But after our online talk, I realized if Lachmann himself did not agree with me of his position (assuming that he supported loanable funds theory of course. As Lewin said at the end of the discussion, this is something that we will never know), who cares? I am only concerned with using the Lachmannian framework and expanding on it. So a better discussion would have been if my positions are consistent with the Lachmannian framework. In order to conclude from my interpretation of the Lachmannian framework that ABCT is questionable, I must show a connection how the lack of expectations might lead to at least being skeptical of the ABCT (and at most, completely rejecting it). And I could do this very easily by pointing to Lachmann’s (2005) article “John Maynard Keynes: A view from the Austrian Window” in which he makes that controversial statement that Keynes was more committed to subjectivism that the Austrians (Lachmann 2005: 187)! Keynes’s psychological law to his view of expectations (thus making markets instable) all contribute to Keynes as a subjectivist. But the simple fact of expectations making markets unstable is something that the ABCT lacks due to its appeal on loanable funds (Ertürk 2006). Also, it not like the Austrians haven’t heard of this reasoning, they just refuse to accept it. I would look at the G. Hill (1996a; 1996b; 1998) and the S. Horwitz (1996; 1998) debate for an example.

So am I am Austro-Keynesian, I don’t know, I guess it depends how one defines it. I obviously have a lot of Austrian influence and a lot of Keynesian influence, but it is all consistent to the Lachmannian framework, which is the radical subjectivist Austrian view. Instead of creating new labels like Austro-Keynesian, I would just much rather be label a radical subjectivist.


Ertürk, Korkut A. 2006. Speculation, Liquidity Preferences, and Monetary Circulation. The Levy Economics Institute, Annandale-on-Hudson, NY. Online.

Hill, Greg. 1996a. The Moral Economy: Keynes’s Critique of Capitalist Justice. Critical Review 10: 411-34.

—. 1996b. Capitalism, Coordination, and Keynes: Rejoinder to Horwitz. Critical Review 10: 373-87.

—. 1998. An ultra-Keynesian strikes back: Rejoinder to Horwitz. Critical Review 12: 113-26.

Horwitz, Steve. 1996. Keynes on Capitalism:  Reply to Hill. Critical Review 10 (Summer): 353-72.

—. 1998. Keynes and Capitalism One More Time:  A Further Reply to Hill. Critical Review 12 (Winter-Spring): 95-111.

Lachmann, L.M. 1937. Uncertainty and Liquidity Preferences. Economica 4 (August): 295-308.

—. 2005. John Maynard Keynes: A view from the Austrian Window. In Expectations and the Meaning of Institutions: essays in economics by Ludwig Lachmann, edited by Don Lavoie. London and New York: Routledge.

—. 2005. Speculative Markets and Economic Complexity. In Expectations and the Meaning of Institutions: essays in economics by Ludwig Lachmann, edited by Don Lavoie. London and New York: Routledge.