Archives for posts with tag: Austrian Economics

For an Institute for Humane Studies program I wanted to participate in you had to write a short essay on how a famous article or book is misguided and inimical to liberty. I wrote the essay below for the occasion, and I’m pretty happy of how it turned out, so I’m sharing it here. Some readers will instantly recognize the heavy influence of chapter 6 of Lawrence H. White’s Theory of Monetary Institutions—get this book.

The seminal paper by Diamond & Dybvig (1983) on bank runs is misguided and inimical to liberty. It suggests that banks are inherently unstable, always on the verge of suffering a “redemption run” at any unrelated ‘sunspot,’ and that it is absolutely necessary that bank runs be suppressed, and that deposit insurance is the most effective way to do it. In their model, if banks ought to survive it has to be through intervention into the financial system. The basic features of this model are still present in most publications on financial stability to this day.

First, unlike the model would suggest, bank runs are generally not responsible for the initial shock. Gorton (1988) studies the National Banking Era in the US, and finds that for each of the 7 crisis he identifies, bank runs were rather the result of a previous event announcing a possible depreciation of banking assets. Likewise, Calomiris (1991) finds that over 1875–1913 all banking panics (generalized run on all banks) happened within the quarter following an abrupt increase in business failures. Mishkin (1991) studies bank panics from 1857 to 1988, and finds that for all but that of 1873, panics occur well after the recession has started.

Secondly, banks that do go bankrupt because of a bank run are those that are pre-run insolvent. Banks that are solvent can generally borrow from other banks and other institutions, historically clearinghouses, have a large repertoire of possible solutions to help banks is crisis. While bank runs and associated liquidity problems can be aggravating factors, even in the worst bank panic episodes they are causes of bank failure only in exceptional circumstances (Kaufman 1987, 1988). Even in the most fruitful historical era in terms of banking panics and runs, the American National Banking Era, runs were a primary cause of failure in only one case out of 594 bank bankruptcies (Calomiris 1991, 154). Calomiris & Mason (1997) study the banking panic of June 1932 in Chicago and find that no pre-run solvent banks failed. Reviewing this literature, Benston & Kaufman (1995, 225) conclude that “the policy implications of the Diamond & Dybvig (1983) model are not very useful for understanding the workings of the extant banking and payments system.”

A third reason is that most runs have in fact been partial “verification” runs. Depositors eventually figure out that the bank will likely survive the crisis, and runs stop. This is impossible in the Diamond & Dybvig (1983) framework; once initiated the run must always go through and make the bank fail. Ó Gráda & White (2003) study a single bank from the 1850s. They investigate depositor behavior through individual account data, and particularly through the panics of 1854 and 1857. The bank survived both. They find that runs are not sudden, but involve a learning mechanism where random beliefs are progressively dropped, while behavior motivated by legitimate signals become more important over time. Panic does not displace learning in the market processes of bank runs.

Finally, if Diamond & Dybvig (1983) is correct, it should apply to all fractional-reserve banking systems without deposit insurance. But, as evidenced by the US-centric literature cited, bank runs are much more common in U.S. history than elsewhere, and bank panics are specific to the American National Banking Era and attributable to bank regulation of that era, such as the ban on branch banking that made mergers with insolvent banks impossible, and the bond deposit system that limited emission at a critical time (Smith 1991). Bordo (1990, 24) compares bank panics internationally and comments that “the difference in the incidence of panics is striking.” While over the 1870–1933 the US had four panics, there were none in Britain, France, Germany, Sweden, and Canada despite the fact that “in all four countries, the quantitative variables move similarly during severe recessions to those displayed here for the U.S.” Table 2-1 in Schwartz (1988, 38–39) report that from 1790 to 1927 the U.S. experienced 14 panics, while the Britain, the only other country with as many observation, experienced 8, all of them before 1867.

Not only does Diamond & Dybvig (1983) suggest bank runs have much higher costs than evidence does, but it also shrouds its benefits. My research suggests that bank runs could play an important role in initiating insolvency procedures earlier, before the bank can enlarge its losses, and therefore limit systemic externalities.


Here’s an interesting CfP that might not have been distributed as widely as it deserves. My understanding is that the initiative is from Prof François Facchini.

The controversies between Hayek and Keynes began in 1929 when Hayek, then a Privatdozent at the University of Vienna, gave lectures at the LSE. The opposition appeared in their respective books Prices and Production, Monetary Theory and the Trade Cycle, A Treatise on Money and their comments on these books published in journals. Keynes was in favour of an active monetary and fiscal policy, while Hayek thought that money has to be neutralised in order to respect the natural rate of interest and the structure of capital. The controversies continued about the ways to finance the war and the financial system to be established after the war, but both men agreed about the free enterprise. After Keynes’ death, there was an alliance between neoclassical theory and bastard keynesianism, that has eclipsed the economic thinking of Hayek. But in recent decades the decline of keynesianism has awoken hayekienism.

The object of the conference is the controversies between Hayek and Hayekians on one side and Keynes and Keynesians on the other side. These controversies are numerous and various since the ideas of Keynes and Hayek have varied. E.g. the money of the Treatise is not the money of the chapter 13 of the General Theory and the money of Prices and Production or Monetary Theory and the Trade Cycle is not the money of Denationalisation of Money and that the ideas of Keynesians and Hayekians are even more numerous.

Therefore the scope of the conference is a priori very large. The scientific committee will study every proposition that may refer to the debate Hayek-Keynes: these propositions may refer to theory and methodology, to history, to economic policies, to the 30’s, to the problems of the present crisis…

The committee includes Post-Keynenesian and Hayekian colleagues. It will select 12 propositions coming from Keynesians and 12 coming from Hayekians and will group them by subject in order to organize debates between the two schools. We remind that Keynes and Hayek, albeit very opposite in ideas, had very cordial relationships. We hope it will be the same for Keynesians and Hayekians during the conference.

Paper submission deadline: July 31, 2014
Communication of Acceptance: August 31, 2014
Final papers due by: October 15, 2014

Download the pdf for more details.

The Online Library of Liberty’s Liberty Matters debate forum just hosted a very interesting discussion on Ludwig von Mises’ Theory of Money and Credit (1912). The lead essay is by Lawrence H. White, with comments by Jörg Guido Hülsmann, Jeffrey Hummel, and George Selgin, and a final reply by White.

It contains, among other things, an enlightening reply by White on Mises’ purported disapproval of free banking, and free banking’s supposed procyclicality. Other topics includes a reassessment of the original contributions of Mises’ book and how his “regression theorem” holds up with the emergence of bitcoins.

This passage in Hummel’s comment was of particular interest to me;

[W]e must carefully distinguish between favoring free banking as a legal regime and predicting how it would operate in practice. I think Larry goes too far when he seems to imply that Mises had in mind the kind of free banking that he (1999) and George (1988) predict would emerge without regulation: that is, a system in which reserve ratios are extremely low and banks adjust the money supply to demand in a way that stabilizes velocity. As much as I may agree with their prediction, I can assure them that Sennholz repeatedly affirmed his belief that unregulated competition among banks would drive reserve ratios up very high and possibly close to 100 percent, and he left the impression that such was Mises’s opinion as well.

Of course Hummel knows that both White’s and Sennholz are equally predictions, and admits his own support for the idea that reserve ratios would be extremely low. But what I want to get to is that Sennholz’s predictions are much less supported than White’s are. They are not equal predictions. This is important because elsewhere one-hundred-percenteers have suggested that the market would favor 100% reserves anyway.  White replies to this passage;

Mises in Human Action (p. 446) does quote Cernuschi to the effect that free banking would have narrowed the use of banknotes considerably, and in other ways suggests that reserve ratios under free banking would be, as Hummel puts it, “up very high and possibly close to 100 percent.” If that is Mises’s prediction, then on this point I do depart from Mises. In my 1992 essay that Hummel cites, I criticized Mises for suggesting that free banking would produce reserve ratios close to 100 percent. The best historical evidence we have, from the Scottish free-banking system and other mature systems, shows reserve ratios below 10 percent.

The historical evidence is one way of answering this. In my own research with Antoine Gentier (unpublished) we found that New England’s freest banking systems in terms of both freedom of entry and banking regulation (ie not in the “Free Banking Laws” sense) had similarly low reserve ratios. But there are also theoretical reasons.

Competition over bank’s financial stability does not only occur over reserve ratios. In our study, for example, banks competed over capitalization levels to prove their resilience. But they could also be competing over the liquidity of their assets, their demand debt to total debt ratio, or a variety of  “living will” arrangements (liability regime of shareholders, option clauses, clearinghouse memberships, etc.) just to name a few. I’m going to conjecture (and derogate from Selgin’s comment on the use of statistics), and say that given the prevalence of banknote circulation as a source of banking profit in free banking systems relative to the costs of these other ways banks can prove their financial stability, it is not at all a blind prediction, or one merely supported by historical anecdotes, to say that reserve ratios would be closer to 1% than they would to 100% under free banking. In fact, it would take a particularly unfree institutional environment for competition between banks to lead to 100% reserve ratios.

Yesterday I had the honor of participating in the Charles Street Symposium organized by the Legatum Institute in London, under the topic of “What Would Hayek Say Today (Really)?” . The essay I presented is titled “A Hayekian Critique of the New Financial Institutions Insolvency Policies.” Also check out the other essays, they are all exceptional. My coups de coeur are those of Zachary Caceres and Wolf von Laer.

The word zombie is sometimes used to refer to firms that are virtually insolvent, in a state where they can merely afford to service their debt, or to refer to government sponsored vehicles where bad assets are stashed to clear banks’ balance sheets from underperforming loans. The zombies I’m concerned with here, however, are actual flesh eating undeads. I think zombie fiction is especially interesting to economists because it mirrors a lot of debates going on within the profession.

A lot of people do not understand what zombies are all about and miss out on some great fiction. While it is true that zombies are the most brainless horror flick monsters around, it does not mean that zombie movies are senseless gore films. In fact, there’s a long tradition of using zombies in media as a plot device to push a social commentary and reflect on human behavior. Because zombies are clumsy, mindless, and generally easy to trick or avoid, zombie stories are not so much about the zombies, but about the survivors and how they cooperate. Zombie fiction allow us to witness miscooperation leading to dire consequences without having to experience these situations, just like economists use economic models (in the very loose sense) to reflect upon economic miscooperation because they don’t have the luxury of experimenting.

Because zombies are so easy to overcome, storylines have relied on other threats, which you could call zombie survival market failures. From an economist’s point of view, a lot of zombie stories involve variants of close-ended non-cooperative games, where egos and foul play get in the way of happy Pareto optimal endings. The model for human behavior is generally one where humans would have perfect chances of surviving if they could execute their plan, but where adverse selection and moral hazard make it so that they cannot spontaneously coordinate themselves. That is, humans have good expectations about what needs to be done to survive the post-apocalyptic world, but plan conflicts, absence of a consensus, betrayal and unenforceable contracts ultimately always lead to some of the most tragic possible outcome.

Think of George A. Romero’s Night of the Living Dead, the movie to which we owe modern zombies. It’s a huis clos movie where the survivors take shelter in a farm surrounded by flesh eating ghouls. Leaving aside the rather clumsy class struggle theme, the demise of the group is not so much due to the living dead trying to break in, but rather to the failure of survivors to cooperate and agree on a plan. The group on the ground level has a plan to resist zombie attacks that requires the unanimous cooperation of the group taking refuge in the cellar. The group in the cellar needs the collaboration of the other one for their radio, apparently a precious asset during zombie invasions. The zombies ultimately feed on their failure to agree. Other zombie movies by Romero explored similar themes, where safe havens that could have been shared are ultimately invaded and destroyed, leaving everyone worse off. This is the dominating theme in what I would call first generation zombie fiction, with more recent entries such as Zombieland also touching on it.

These behaviors can seem a little wooden, and overly pessimistic about human nature. In the face of certain death people would know exactly what to do to survive, but wouldn’t be able to do it because they value coming out on top of an argument or being in charge more highly than being alive? Moreover, in a post-apocalyptic world where a broken leg or a simple cut that gets infected can be the end of you, why is it that it is always failure to cooperate that leads to death instead of tragic unforeseen events?

Of course, in real life people do figure out how to coordinate themselves, and they’re rather inventive in the ways they do. Just think of the diversity and plurality of answers to coordination challenges; how some resources are managed by private firms, some by non-profit organizations, some by something in-between. And just think of the inscrutable mix of a lot of types of organizations and institutions that have emerged from our cooperation efforts to guard and enforce these agreements. It is true however that in a situation of urgency there’s no reason the survival learning process would be quick enough, and survivors adapt timely – zombies are not very forgiving. Still, the overall message of classic zombie fiction seems both overly pessimistic about human collaboration, and overly optimistic about human expectations.

Fortunately, what could be called a second generation of zombie storytelling “models” human cooperation better. In Left 4 Dead, Mountain Man, or Day by Day Armageddon for example, zombie apocalypse survivors do collaborate toward a plan, and there is clearly less betrayal toward  one’s own certain death. In these narratives, survivors lose their peers not necessarily due to a failure to coordinate, but because of truly unforeseen events. There is a sense that danger is unpredictable and all around the survivors. They don’t need a final zombie attack to come before they’ve agreed on a course of action for zombies to feast on human sashimi.

Having imperfect survivors that are capable of learning and innovating, yet are radically ignorant (instead of “socially challenged” Judas) changes the whole dynamic of zombie invasions. It allows authors to explore other themes such as anti-militarism. An example of a common theme is that government response always worsens the problem because of the knowledge problem, ordering survivors to seek shelters in areas that have already fallen prey to zombies. The only time where the military actually improves the situation is through insubordination or desertion. Often in those stories the only path to survival is individual initiative and rugged survivalism, an admittedly caricatural version of entrepreneurship. Of course this is not true of all zombie fiction, the popular zombie novel World War Z is not much else than a glorification of the war economy and government crisis management.

But mostly, having more realistic ideal types allows authors in The Walking Dead graphic novels (it’s less obvious on the TV show) to have groups of survivors experiment with a host of governance structures as their context and goals evolve. These range from a state of spontaneous leaderless voluntary cooperation, to characters imposing their tyranny upon a small community, with varying levels of success at their survival efforts. For example, the Governor leads his group with an iron fist, ultimately suppressing the feedback that would have signaled the Governor that his plan was wasteful. In Rick’s group, on the other hand, projects are generally more bottom-up initiatives validated or rejected by peers, and are much more successful. The franchise often explores problems associated with welcoming new survivors and their effect on enforcement and guarding costs.

Since it is customary to finish with an unsolicited policy advice, an implication derived from zombie fiction that will make it sound way more serious than it was ever meant to be; in times of crisis the law of association is more important than ever to increase the division of labor and make each party’s efforts more productive. Funny how, for zombie apocalypses just like for real world problems, themes emanating from Austrian economics seem to capture the problem of human cooperation better than mainstream economics, huh?

« Law & Economics »?

A new Think tank I’ve been collaborating with, Droit & Croissance (or as they call it in English, Rules for Growth), asked me and Pierre Bentata to define just what is Law & Economics. We gave a pretty standard textbook definition (aka neo-classical), strongly inspired by Paul H. Rubin’s Concise Encyclopedia of Economics entry on law & economics, but it sticks to what it is that they do. It would have been out of place to venture into the emergence and origin of Law and more advanced topics, but we still managed to cite Hayek in there.

Le « Law & Economics », ou analyse économique du droit, est plus que la rencontre du droit et de l’économie, puisqu’il s’agit d’une forme d’analyse juridique. Il ne s’agit pas non plus du « Droit économique », mais bien d’une analyse juridique utilisant les outils de l’économiste. Elle cherche à expliciter un ordre sous-jacent au droit, une logique du droit en dehors du droit lui-même, qui nous permet de le comprendre et d’étendre ses concepts de façon cohérente à des situations jusque-là inédites.

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