Table of Contents

Journal Article

Software Simulation

Directory of Names

Fiction and Poetry

Contact Victor

Return to Home

Back to Home Page

The Austrian Rebuttal

"Never be concerned about harsh criticism of your position, but always fear the weakest defense of it." - Peter Boettke

A Reply to Aguilar by Robert Murphy

A Rejoinder to Mr. Murphy by Victor Aguilar

Comparison of Garrison's and Aguilar's Capital Structure

Comparison of Austrian and Axiomatic Foundations

Ode to an Economics Troll - Poetry

I would like to thank Robert Murphy for taking up the challenge to write a rebuttal to my 2004 paper, Critique of Austrian Economics from 1930 to 1990. As I state on the home page of this website, "critiques and rebuttals are how science advances." I firmly believe this and, after only three years of searching, I have found someone in the Austrian camp who also believes it.

For those who are not familiar with Robert P. Murphy, he has a regular online column (click here to view) and has written a study guide (2006) for Murray Rothbard’s treatise (1970), Man, Economy and State, both of which are available from the Mises Institute. Robert Murphy's most recent book is The Politically Incorrect Guide to Capitalism (2007), the first book that I know of by any Austrian to be sold in public bookstores.

Murphy writes, "Most Austrians are familiar with Victor Aguilar’s Critique of Austrian Economics From 1930 to 1990. He has long since thrown down the gauntlet, by publicly offering to pay $1000 for the best response to his critique" I decided that I would be an appropriate person to write just such a reply." Because of Murphy’s following among young Austrians, particularly those studying Man, Economy and State, which is the standard approach to Austrian theory, I also feel that he is an appropriate person to rebut my Critique and I have paid him $1000 to do so.


Click here to read Robert Murphy's capitulation.

The Chicago Rebuttal

’The essence of the Chicago state of mind: Challenge everything, particularly people’s most dearly held beliefs. No true Chicagoan ever says, "How can you think that?" in response to a provocative statement. He will, instead, ask, "Why do you think that?" If the answer offered in reply does not have a logical and empirical basis, only then will it be rejected."

William R. Dougan (What is the Chicago School? 2004)

What brave words! A thousand dollars says Dougan is a liar. I want to see him write a refutation of my most dearly held belief, Axiomatic Economics. Also, I want his comments on what I have written about Milton "Assumptions Don’t Matter" Friedman.


The Keynesian Rebuttal

I hereby offer Paul Davidson, the editor of The Journal of Post-Keynesian Economics, $1000 to write a rebuttal to Axiomatic Economics. As he has attempted to capitalize on the discontent of economists with Debreu's increasingly numerous and unrealistic assumptions, claiming that this should somehow lead them back to Keynes' 1936 General Theory, I want to learn what he finds wrong with my three concise axioms.

Hark! Is that Paul Krugman, the famous Keynesian, writing about Austrian Economics? Yes, on 4 Dec 1998 at 0330 hours, Professor Krugman of Princeton University posted a paper titled "The Hangover Theory" at

Krugman's paper was posted at three-thirty in the morning and has all the hallmarks of a project that was conceived at one-thirty that same morning. Frankly, if Dr. Krugman could not sleep, he should have watched a dirty movie or something, because this is not his best work. The Austrians may hate me with a passion, but they cannot deny that, unlike Krugman, I at least took their theory seriously.

So simplistic is Krugman's paper (motto: Print more money!) that I do not even have to write a rebuttal to it. I will just post it here in its entirety, annotated with links to the relevant passages of my own Critique of Austrian Economics.

A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle’a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking’not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.

The hangover theory is perversely seductive’not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love. Powerful as these seductions may be, they must be resisted’for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality’with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression’with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.

The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity’of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes’investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.

Except for that last bit about the virtues of recessions, this is not a bad story about investment cycles. Anyone who has watched the ups and downs of, say, Boston's real estate market over the past 20 years can tell you that episodes in which overoptimism and overbuilding are followed by a bleary-eyed morning after are very much a part of real life. But let's ask a seemingly silly question: Why should the ups and downs of investment demand lead to ups and downs in the economy as a whole? Don't say that it's obvious’although investment cycles clearly are associated with economywide recessions and recoveries in practice, a theory is supposed to explain observed correlations, not just assume them. And in fact the key to the Keynesian revolution in economic thought’a revolution that made hangover theory in general and Austrian theory in particular as obsolete as epicycles’was John Maynard Keynes' realization that the crucial question was not why investment demand sometimes declines, but why such declines cause the whole economy to slump.

Here's the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods’implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?

Most modern hangover theorists probably don't even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem created as the economy transferred workers from a bloated investment goods sector back to the production of consumer goods. (Hence their opposition to any attempt to increase demand: This would leave "part of the work of depression undone," since mass unemployment was part of the process of "adapting the structure of production.") But in that case, why doesn't the investment boom’which presumably requires a transfer of workers in the opposite direction’also generate mass unemployment? And anyway, this story bears little resemblance to what actually happens in a recession, when
every industry’not just the investment sector’normally contracts.

As is so often the case in economics (or for that matter in any intellectual endeavor), the explanation of how recessions can happen, though arrived at only after an epic intellectual journey, turns out to be extremely simple. A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?

The hangover theory, then, turns out to be intellectually incoherent; nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present. Yet the theory has powerful emotional appeal. Usually that appeal is strongest for conservatives, who can't stand the thought that positive action by governments (let alone’horrors!’printing money) can ever be a good idea. Some libertarians extol the Austrian theory, not because they have really thought that theory through, but because they feel the need for some prestigious alternative to the perceived statist implications of Keynesianism. And some people probably are attracted to Austrianism because they imagine that it devalues the intellectual pretensions of economics professors. But moderates and liberals are not immune to the theory's seductive charms’especially when it gives them a chance to lecture others on their failings.

Few Western commentators have resisted the temptation to turn Asia's economic woes into an occasion for moralizing on the region's past sins. How many articles have you read blaming Japan's current malaise on the excesses of the "bubble economy" of the 1980s’even though that bubble burst almost a decade ago? How many editorials have you seen warning that credit expansion in Korea or Malaysia is a terrible idea, because after all it was excessive credit expansion that created the problem in the first place?

And the Asians’the Japanese in particular’take such strictures seriously. One often hears that Japan is adrift because its politicians refuse to make hard choices, to take on vested interests. The truth is that the Japanese have been remarkably willing to make hard choices, such as raising taxes sharply in 1997. Indeed, they are in trouble partly because they insist on making hard choices, when what the economy really needs is to take the easy way out. The Great Depression happened largely because policy-makers imagined that austerity was the way to fight a recession; the not-so-great depression that has enveloped much of Asia has been worsened by the same instinct. Keynes had it right: Often, if not always, "it is ideas, not vested interests, that are dangerous for good or evil."
Paul Krugman is a pretty good newspaper columnist, second only to Dave Barry in his trenchant wit and his vast knowledge of economic theory. However, if this is the best criticism he can muster against Austrian Economics, then I am not going to pay him a thousand dollars to critique Axiomatic Economics. Maybe he can use his influence to pressure Paul Davidson into accepting my $1000 challenge.

I wait for a worthy opponent.

Postscript: This call by Paul Krugman to print more money was published in 1998, before the dollar headed south. However, as recently as 14 July 2008, Mr. Krugman has come out strongly in favor of monetizing the bad debts of Fannie Mae and Freddie Mac, even after admitting that their "management bought off the political process, systematically hiring influential figures from both parties." Print more money! Print more money! Print more money! That is all we hear from Krugman. I discuss his latest call to print more money at my new website page, Socialism without Seizure is still Socialism.

Click here to read the last economics paper Krugman wrote which did NOT call for printing more money.