Ludwig von Mises Institute of Canada

I will here outline some very basic mistakes in Steve Keens book “Debunking Economics” where he assess shortly the Austrian School and particularly his attempt to address Austrian Business Cycle Theory.

Steve Keen claims that the Austrian business cycle theory is one that attempts to explain the business cycle by the fact that the central bank lowers interest rates. This is a mistake, as the ABCT is a theory that explains the business cycle as a consequence of an expansion money and credit affecting relative prices and leading to capital and resource misallocation. The discernible difference between monetary and credit expansion that must lead to capital misallocation and what must not, is dependent upon the amount of savings that can counteract or allow for the expansion. There is no clear macro-aggregate or measureable aggregate statistical number that can be computed to necessarily reveal this, but it can and often is reflected in the amount of savings not increasing (or decreasing) while money and credit is expanding.

If the ABCT was simply a theory of how central banks can create booms-and-busts, then it would not be a theory that could explain why business cycle occurs before central banking. But that was precisely what it was and the reason it was thought out. This is why Mises(1949) places business fluctuations under the analysis of a market economy and not an interventionist regime.Lets now quote Steve Keen in his first reference to ABCT:“and the latter[the Austrian School economists] because of their familiarity with Hayek`s argument about the impact of interest rates being held too low by government policy.” (p. 326)The ABCT in fact lays the casual factor again on artificial increases of credit or rather increases not corresponding to an relative increase in voluntary savings.

Had Steve Keen consulted one or more of the dozens of articles by Austrians scholars in the run up to the financial crisis predicting the crisis, the focus is expressly on money, credit growth and the interest rate policy that encouraged it. Indeed this is why for example Jesus Huerta de Soto locates the start of the boom in 1992 and the expansionary monetary policy that did not end until 2007, and not with Greenspan interest rate cuts in 2001 although that was an extension of the policy.

This can be produced both in a free fractional reserve banking system and in a highly regulated central banking system such as today. It can also be produced by financial participants that engage in maturity mismatching. What the central bank can do, even without actively inflating is to guarantee that the banks can themselves inflate by extending loans and being backstopped by the central bank. That is the raison d’être of the central banks and the reasons almost all Austrians would cherish its demise in an attempt to avoid/limit business cycles and other ill-effects of inflation.

The fact though is that the central banks actively target goals to accomplish a certain amount of inflation that is to be achieved through credit growth and often actively encourage credit expansion.If one read the listed material of Austrian authors on the business cycle by Steve Keen such as Murray Rothbard(Americas Great Depression) this would be absolutely clear and the comments above almost completely unnecessary, I only bring them up because all these considerations are ignored and certain arguments against ABCT is formed that are wrong in the light of these considerations.

They are:

“they argue that the current system of state money means that the money supply is entirely exogenous, and under the control of the state authorities” (p.447)

If the monetary supply is completely “endogenous” as the Post Keynesians like to hold, the current monetary easing should not be expected to be able increase prices at all, as deleveraging and deflation is the goal either way. If the Austrians are right the monetary expansion that has taken place if continued will again lead either to higher price-inflation or credit growth.
Furthermore this presumes that Austrians hold that monetary growth under the current system can only take place via an increase in base money, or reserves. This is far from the case, but the ability, willingness and in fact expansion of base money of the central bank encourages the commercial banks to extend further credit with their legal granted monopolies and guarantees of being saved by the central bank should they find themselves in need of money. This is then a false accusation and indicates yet again that Keen seems to be unaware or unlearned of the position he is critiquing.

“…private banks and other credit-generating institutions largely force the state`s hand. Thus the money supply is largely endogenously determined by the market economy, rather than imposed upon it exogenously by the state.”(p. 447)

“empirical…supports post-Keynesians rather than Austrians on this point. Statistical evidence about the leads and lags between state-determined component of money supply and broad credit shows that the latter “leads” the former” (p. 447)

“If the Austrians were correct, state money creation would instead precede private credit creation.” (p. 447)

There is also the strange notion of statistically “proving” this by appealing to what follows of the these two aggregates, focusing on these two aggregates misses the whole institutional set up and ignores the fundamental aggression against private property and its natural restrictions on bank credit expansion that have been detailed in the works of Austrian economists since Mises and by classical authors before him.
None of these elements are discussed, thus leaving an important economic and legal aspect of banking practices out of the analysis. To claim that private banks “force” the state hands is simply presuming his conclusion and assuming away any guilt on the central bank for constantly expanding the supply of money. Lobbying, demanding and appealing for the monetary policy which benefits them the banks certainly do. But that does not warrant Keens label of it “forcing the state hands”. A follow-up question to that statement then is, what would the banks do if the state did not have a monopoly over money? There would be no hands to force, and they would have to go bankrupt as they should. And they would also be aware of this.

Furthermore if all banks are compelled by government edict to be a member of the state bank, and all deposits with them insured to what extent are they private?
This would at least not meet the definition of private in any other field and this seems to mere rhetoric by followers of the socialistic “Post-Keynesian” school.
If it has any importance at all, it seems to be more of the debate between the various current mainstream schools of thought and not the Austrian theory of money and banking. Austrians do not claim that all expansion of money is actively engineered by the central bank, as I have stated it can simply backstop their members and leave it to them, the problem is of course the only way any trust is placed in that backstopping is because of the monopoly over the supply of cash or “base money”.
This claim is seems even more ridiculous and thinly based once one recognises the fact that in the financial crisis of 2007-08, if the government edict interest rates were removed and market rates were allowed to form or by simply keeping the interest rates up the market participants would have deflated severely the broad money and credit aggregates thar Keen focuses on. It was in fact the actions of the central bank in the US and around the world which kept this from happening and thus illustrates the erroneous nature of his claims.

“monetarism also provides an evocative counter-example.” (p. 447)

To envoke monetarism as a counter-example also seems to be completely missing the point and misleading. No Austrian has only fought against an expansion of base money, but an expansion of broad money. The fact that Austrians all are against an expansion of the supply of base money, does not equate them to monetarists who also want to limit the supply of base money. Secondly, the fact that the current central banking system failed to keep credit growth from growing is no surprise.
It is precisely the reason why Austrians focuses on getting rid of central banking, and advocate 100 % market commodity money. The classical Austrian position that Keen completely ignores in his argument against them and the only true form of endogenous market money would be the money chosen under freedom of contract.

Some last comments
“a non evolutionary attitude towards both the existence of the state…the state was simply imposed from outside as an alien artifact”
“This is certainly one way to consider to the growth of the welfare state….an equally tenable argument…evolved as a response to the failure of the pure market system during the Great Depression”

These comments appear as a weakness of the Austrians, but it is more of a weakness and misleading description by Steve Keen. The existence of the state is seen as evolutionary by rothbardians, as state rulers and the nature of their justifications and the choice of state leaders, and the peoples convictions and interactions has changed. But if by evolutionary it means that the state will or must naturally arise, then this is of course an anathema to the Rothbardian view of the state.
Secondly, it is weak because it confuses the state as an institution with the welfare state. As if the growth of state argued against is only in the form of the welfare state.
Thirdly, it is downright dishonest to label the period before or during the Great Depression as a pure market economy. Especially to a group of scholars who locate the problem of business cycles with fractional-reserve banking, government meddling with money and credit, in its worse form central banking and fiat money. As central banking in America was established in late 1913, the history of events is more fitting with the Austrian detest of central planning in money, banking and finance simply broadening out the business cycle and exacerbating it. It is in fact the Post-Keynesians and in general the economic professions admiration for central planning in this arena which is an anathema both in the historical examples and the basic theory of a dynamic/equilibrium market economy. To say that they are equally tenable is just a statement, and in contradiction with the historical facts around government intervention in the early 20^th century.

I get the sense that Steve Keen has simply attempted to fill his “Alternative schools of thought”-chapter on the Austrians with something, while actually not investigating the literature. Anyhow, the above comments are only certain observations and a more general critique of the Minsky approach to business cycles and other concepts in Keens “Keynesian” economics will be investigated and discussed in the future.