The Ludwig von Mises Institute welcomes its new Executive Director, and inaugural Carl Menger Research Fellow, Peter G. Klein!

Lew Rockwell announced the appointment at the Manhattan Mises Circle.

Click here for audio, or read the transcript:

Peter is a professor of Economics at the University of Missouri. He also taught at the University of Georgia, teaches in Copenhagen, is the author or the editor of five books.  But I want to mention one new thing about Peter, if I may make an announcement. He’s going to be joining the Institute as our Executive Director.  I’m looking forward to having him come to Auburn.

I’ll just tell a couple of stories. I’ll always remember this one. It was in 1988; Peter was leaving Chapel Hill and going to get his PhD at Berkeley. He wrote to the Institute for some help. I read his letter, and Judy Thommesen, who is our publications editor, reminded me the other day of just how agog I was when I saw this letter. I immediately called Murray Rothbard, and I said, “Murray, I’ve just gotten the most extraordinary letter from a student that I’ve ever seen. May I fax it to you?  And if you’d read it, and if you agree with me, would you talk to Peter?” So Murray was very excited and did indeed talk to Peter. Peter was very close to Murray, and to the late Burt Blumert, who was our chairman at that time. I can tell many other stories about Peter; I’ll just mention one other.

As a post-doc he spent a year internship on Bill Clinton’s council of Economic Advisors. So about four or five months after he finished his year in Washington, I get a visit from a local FBI agent. He’s wanting to check out Peter’s bona-fides and see if he’s a security risk, because he’s going to have this internship. I said, “But, he’s already had his internship. It’s already over.” And the guy said “You know the government.” And so I said, “Yes, I do know the government.”

Regime Uncertainty and Slow Recovery

Robert Higgs at the Beacon again reminds us that “anemic investment recovery evinces, at least in part, the prevailing regime uncertainty brought about by the Fed’s and the Bush and Obama administrations’ massive, ill-advised, and counter-productive interventions in the economy during the past five years.”

Higgs provides the chart on RGDI, but private non-farm employment closely follows RGDI up and down over the relevant period and remains anemic as well.

Some non-Austrian economists have also made similar arguments relative to anemic growth and slow recovery. For details see John Taylor’s blog post from May, “More Evidence on What Is Holding the Economy Back.”   Here, using a Freidman Plucking Model as the basis that recovery from a severe recession or pluck should be strong, he argues, “Of course something is now interfering with the usual economic response, because our current recovery is certainly not springing back to normal. I have argued that economic policy is holding the economy back, and I think recent research by Ellen McGrattan and Ed Prescott (on increased regulations) and by Scott Baker, Nick Bloom, and Steve Davis (on policy uncertainty) supports this view. Their work is part of a forthcoming [now out] book (Government Policy and the Delayed Economic Recovery) edited by Lee Ohanian, Ian Wright and me.”

Critics of regime uncertainty; in reality a real threat of regime worsening relative to property rights, return on investment, and economic freedom, as a significant contributor to the slow growth have argued that significant recessions accompanied by financial crisis are followed by slow, not rapid recoveries. However, this argument is not supported by economic history as recently shown by Michael Bordo, in a Wall Street Journal, editorial contribution, “Financial Recessions Don’t lead to A Weak Recovery. He concludes, “The evidence since 1880 shows a faster pace of recovery, The [Bush] Obama years are the exception.”

More reasons and more evidence that QE infinity will be just as ineffective as QEI and QE II.

I share now as I have in the past, Dr. Higgs’s pessimism, “Policy makers have cost the U.S. economy a decade or more of normal economic growth. How long will people in their capacities as political and financial actors continue to tolerate this foolish, destructive policy making? I do not know, but I believe I know what the result of these misguided ongoing experiments will be—economic stagnation at best, relapse or another bust at worst.”

“The theorems of economics, say the historicists, are void because they are the product of a priori reasoning. Only historical experience can lead to realistic economics. They fail to see that historical experience is always the experience of complex phenomena, of the joint effects brought about by the operation of a multiplicity of elements. Such historical experience does not give the observer facts in the sense in which the natural sciences apply this term to the results obtained in laboratory experiments. Historical facts need to be interpreted on the ground of previously available theorems. They do not comment upon themselves. The antagonism between economics and historicism does not concern the historical facts. It concerns the interpretation of the facts.”

–Ludwig von Mises. Theory and History: An Interpretation of Social and Economic Evolution

A wonderful video tribute to a life-changing week by Amanda BillyRock.

Ludwig von Mises, the most important social philosopher in history, was born 131 years ago today. To learn about this heroic figure, check out Tom Woods’ excellent resource page on Mises.

A recent comment by Bryan Caplan provides a good opportunity to discuss differences between Austrian and neoclassical concepts of marginal utility. In response to Steve Horwitz, who claimed that the law of diminishing marginal utility and the downward-sloping demand curve can be known a prior, Bryan asks:

Mainstream micro textbooks often have counterintuitive examples with increasing marginal utility. Are you really saying that the premise of these problems is somehow logically impossible? Or are you using a heterodox conception of marginal utility?

As Chesterton said, heterodoxy is your doxy and orthodoxy is my doxy, but I think I know what he means. Indeed, the modern, neoclassical concept of marginal utility is quite different from the causal-realist version offered by Menger and developed by Menger, Böhm-Bawerk, Fetter, Rothbard, and others.

Both the Austrian and neoclassical approaches to demand begin with an ordinal preference ranking. But the understandings of marginal and total utility are completely different. For Menger, marginal utility applies only to discrete units of a homogenous stock of a good. The fourth apple is allocated to a lower-valued use than the third apple, and so on. The law of demand follows from the fact that additional units of a homogenous good are used to satisfy lower-ranked ends.Note that for the Austrians, the term “marginal” applies to the units, not the utilities. “Marginal utility” is the total utility of the marginal unit, not the marginal utility of a unit. There is no larger concept of “total utility,” of which marginal utility is a little slice. Note also that if an agent possesses a set of unique goods—one apple, a piece of candy, a dollar bill, an iPod, etc.—he can rank them ordinally, but cannot assign marginal utilities to specific goods, since there are no “supplies”—multiple, homogeneous units—of apples, candy, money, and iPods.

The neoclassical approach begins with consumers who rank not discrete units of goods, but n-tuples or “bundles” of all goods in existence. Bundle A represents one apple, one piece of candy, and one iPod. Bundle B represents two apples, one piece of candy, and one iPod. Bundle C includes one apple, two pieces of candy, and one iPod, and so on. For all possible bundles i and j (and the set of feasible bundles depends on assumptions about divisibility) the consumer is assumed to prefer i to j, to prefer j to i, or to prefer neither i nor j. Hence the concept of indifference: if Bundle D is neither preferred nor dis-preferred to Bundle E, then the consumer is indifferent between D and E (and, if we assume a continuous space of bundles, they lie on the same indifference curve).

In this model, prices are expressed as exchange ratios between elements of the bundles. Given an amount of “income,” which when combined with a given ratio of relative prices gives a set of bundles that the consumer can afford, we can identify which bundle or bundles yield the greatest benefit (i.e., no other bundle is both affordable and preferred to the optimal bundle). This notion of ranking bundles is necessary to decompose the effects of relative-price changes into the familiar substitution and income effects. The notion of a substitution effect assumes that relative-prices changes combined with Hicksian income transfers can be represented by a movement along an indifference curve.

Note that if the consumer is ranking bundles, not individual units of goods, and the bundles are heterogeneous, then Menger’s concept of marginal utility does not apply. The consumer attaches a total utility to each ranked good— i.e., to each bundle—but there are no marginal utilities of individual units of goods, because we have no ordinal rankings of individual goods, only bundles. Hicks of course abandoned the concept of marginal utility altogether in favor of the marginal rate of substitution (the rate at which the consumer would substitute i for good j or the slope of the indifference curve). But Mengerian analysis concerns preferences that can be demonstrated in action. Because indifference among ranked goods (bundles) cannot be demonstrated in action, there is no place for a marginal rate of substitution, and no such thing as a substitution effect that can be analyzed independently of an income effect.

In short, in causal-realist analysis we go from an ordinal preference ranking among homogenous goods (gallons of water, bushels of wheat, whatever) to the law of diminishing marginal utility to the individual’s downward-sloping demand curve to the downward-sloping market demand curve to the conclusion that an increase in the supply of a good on the market leads to a reduction in price and an increase in quantity demanded. The neoclassical approach starts with rankings of heterogeneous bundles of goods, leading to an indifference map in which marginal rates of substitution could be increasing, decreasing, constant, or undefined (as with L-shaped indifference curves) and a conditional law of demand in which a decrease in price may or may not lead to an increase in the quantity demanded, depending on the sign of the income effect and the relative magnitudes of the income and substitution effect.

For Mises, the law of diminishing marginal utility is not only knowable a priori but “apodictically certain,” not conjectural, historically contingent, or subject to validation in a clever (freaky?) laboratory experiment.

“The drive for a $10,000,000,000 International Bank for Reconstruction and Development illustrates once more the fetish of machinery that possesses the minds of the governmental delegates at Bretton Woods. Like the proposed $8,800,000,000 International Monetary Fund, it rests on the assumption that nothing will be done right unless a grandiose formal intergovernmental institution is set up to do it. It assumes that nothing will be run well unless Governments run it. One institution is to be piled upon another, even though their functions duplicate each other. Thus the proposed Fund is clearly a lending institution, by whatever name it may be called; its purpose is to bolster weak currencies by loans of strong currencies.”

–Henry Hazlitt, From Bretton Woods to World Inflation: A Study of Causes and Consequences

Roger Garrison reviews Tyler Beck Goodspeed’s Rethinking the Keynesian Revolution: Keynes, Hayek, and the Wicksell Connection (Oxford, 2012) for EH.Net. Writes Roger:

The most recent episodes of unsustainable booms (centered on digital technology in the 1990s and housing in the 2000s) have rekindled interest in the clash between Keynes and Hayek. Which one had it straight about business cycles? In Goodspeed’s view, “the Wicksell connection” – a phrase drawn from the title of a 1981 article by Axel Leijonhufvud – turns the Keynes-Hayek dissonance (as perceived during the 1930s by the principals – and by everyone else) into consonance. Owing to the Wicksell connection, there was, in the author’s view, “a fundamental convergence of Keynes’s and Hayek’s respective theories of money, capital, and the business cycle during the course of the 1930s” (emphasis in the original, p. 3). This claim stands in stark contrast to the more common understanding that by the end of that decade, Hayek’s views were buried under the Keynesian Avalanche (McCormick, 1992).

Read the whole thing here. (Bonus: My review of McCormick’s Hayek and the Keynesian Avalanche).