Testing Austrian Business Cycle Theory? A Rejoinder to Andrew Young By Robert P. Murphy Adjunct Scholar Mises Institute 518 West Magnolia Auburn AL 36832-4528 rmurphy@pacificresearch.org William Barnett II Professor of Economics and Chase Bank Distinguished Professor of International Business Joseph A. Butt, S.J., College of Business Loyola University New Orleans 6363 St. Charles Ave. New Orleans, LA 70118 (504) 864-7950 wbarnett@loyno.edu http://www.business.loyno.edu/faculty/wbarnett and Walter Block Harold E. Wirth Eminent Scholar Endowed Chair and Professor of Economics College of Business Administration Loyola University New Orleans 6363 St. Charles Avenue, Box 15, Miller 318 New Orleans, LA 70118 c.v.: http://www.cba.loyno.edu/faculty.html office: (504) 864-7934 dept: (504) 864-7944 fax: (504) 864-7970 wblock@loyno.edu wblock70118@yahoo.com 1 Testing Austrian Business Cycle Theory? A Rejoinder to Andrew Young Abstract: Young (2005) attempts to test Austrian Business Cycle Theory (ABCT). The present paper is devoted to an examination of this test. Our conclusion is that Young’s paper fails on several grounds. In the first place, Young’s model fails on its own terms. In particular, we come up with significantly different parameter estimates using the same data. Beyond these serious objections, there is the more fundamental difficulty that Young’s approach, even if conducted flawlessly, would still be an improper “test” of ABCT. Key Words Austrian Business Cycle Theory; testing economic theories; illustrating economic theories JEL Category E32 2 Testing Austrian Business Cycle Theory? A Rejoinder to Andrew Young1 I. Introduction Young (2005)2 sets out to test Austrian Business Cycle Theory (ABCT).3 This is a very welcome development, in that this theory has been around for a long time (Mises, 1912) and has suffered unwarranted neglect at the hands of the economics profession, even though one of their number had won the Nobel Prize in Economics (Hayek, 1931).4 Although we shall find some errors in Young (2005) we enthusiastically welcome this publication to the economic literature. In section II we provide a quick review of ABCT. In section III we provide a summary of Young’s model, accompanied by an immanent critique, taking Young’s approach at face value and demonstrating its internal problems. In section IV we broaden our critique, by arguing that even if all of the problems in section III were corrected, Young (2005) nonetheless provides no serious difficulty for the Austrian macroeconomist. This is because Young has misconstrued the empirical claims of ABCT; even if we agreed with his parameter estimates (which we do not) they would be entirely consistent with Hayekian cycle theory.5 In short, we argue in section III that Young mishandles his own model, while in section IV we argue that he chose the wrong model to begin with! We conclude in section V. II. A Review of Austrian Business Cycle Theory In this section we offer a very brief review of ABCT, in order that the reader may fully understand Young’s critique—and our own dissatisfaction with his “test.” Naturally this description will not provide a comprehensive exposition; the interested reader is referred to the citations in footnote 3. 1 We would like to thank NYU graduate student Paul Dower for his helpful comments, but especially for independently running a regression that confirms our own results. 2 All references to Young are to his 2005 paper. 3 For an explication of ABCT, see Barnett and Block, 2005, 2006B; Block, 2001; Block and Garschina, 1996; Carilli and Dempster, 2001; Callahan and Garrison, 2003; Cochran, Call, and Glahe, 2003; Cwik, 1998; Garrison, 1994, 2001, 2004; Garrison and Bellante, 1988; Hayek, 1931; Mises, 1998; Powell, 2002; Rothbard, 1993, Sechrest, 2001. 4 Co-Nobel Prize winner in 1974. See http://nobelprize.org/economics/laureates/ 5 We sometimes refer to ABCT as the Hayekian cycle theory since it is often referred to in that way in the literature. There is some justification for this nomenclature since Hayek (1931) was the first to use the triangle. But Mises (1912) should perhaps be given priority in this regard since he published on this topic earlier, albeit without utilizing the triangle to illustrate the theory. Garrison (2001) also deserves mention in this regard since he was the first to “tilt” the triangle on its side, placing time on the horizontal axis, and value on the vertical. Young (2005) follows the practice of Garrison, not Hayek. 3 Contrary to those who believe that the boom-bust cycle is natural to a market economy, Ludwig von Mises (1912) argued that government intervention was the ultimate cause of business cycles. Specifically, the government would attempt to curry popularity with the voters by an easy money policy that kept interest rates below their “natural” levels. In the Austrian view, interest rates are crucial market phenomenon that helps coordinate the intertemporal structure of production. Free-market rates of interest indicate the tradeoffs, on the margin, between the enhanced output that would be possible if more “roundabout” methods of production were chosen, versus the loss in utility (time preference) that would result from a further delay in consumption. Within this context, Mises (and later Hayek, 1931) argued that artificially low interest rates give false signals to entrepreneurs. Acting on the basis of faulty information, firm owners behave as if more savings are available in the economy (since an increase in genuine savings would also push down free-market interest rates). Consequently firms would hire more workers and expand production capacity due to the lower rates. A period of prosperity would ensue. Unfortunately, this growth is illusory, according to Mises. Since the supply of savings really hadn’t increased, there are insufficient capital goods and natural resources to complete all of the new projects initiated by the overly optimistic business owners. When they realize their errors, the bust ensues, with workers being laid off and intermediate goods being sold off to other lines of production. In the long-run, the only way to avoid the bust, according to the Austrians, is to avoid the preceding (artificial) boom period. In this context, Young’s critique analyzes the sensitivity of employment to changes in the interest rate. Because he believes his data support a low estimate, Young concludes that the Austrian story cannot be the major cause of business cycles in the real world. III. A Summary of Young’s Model, and Its Internal Difficulties In Young’s model, a firm’s desired amount of job reallocation in any period t is given by: Ri*,t F[| rt 1 rt 2 |, Wi ,t ], (1) where r is the Federal Funds (FF) rate and W is a set of unobservable variables relevant to the decision. (All equation numbers are consistent with Young’s paper.) We note that the firm’s optimal decision in time t is based on the lag of the change in the fed funds rate. Because adjustments take time, actual adjustment need not equal desired adjustment. The actual reallocation at any time t is given by: Ri ,t Ri ,t 1 Ri ,t ( Ri*,t Ri ,t 1 ). (2) 4 Young assumes that 0< λ<1, where λ is a speed of adjustment parameter. This author then approximates F as linear and combines his equations (1) and (2) to yield, after rearrangement: Ri ,t (1 ) Ri ,t 1 a (| rt 1 |) b (Wi ,t ). (4) Next Young assumes that changes in W are white noise, allowing him to write: Ri ,t 1 Ri ,t 1 2 (| rt 1 |) i vi ,t , (6) where δi=bλ(W0), vi,t=bλ(εi,t), β1=(1-λ), and β2=aλ. Finally, Young aggregates each such equation for the individual firm into an industry equation: R j ,t 1 R j ,t 1 2 (| rt 1 |) j v j ,t , (7) where every j variable is the summation of i=1, 2, 3, …, I, where I is the number of firms in industry j. With data for j=1, 2, 3,…, N such industries, equation (7) “represents a dynamic panel data model of reallocation” (Young p. 278). Even at this early stage of the analysis, we have objections. First, why is the lag in the change in the fed funds rate taken to be “the latest signal available to firms”? Under Young’s assumption, at any time t a firm can only observe the FF rate through rt-1. This seems odd, especially since the data Young uses are quarterly. Moreover, this isn’t simply an ad hoc way to capture the time needed for desired reallocation to take place; Young explicitly models this as the speed of adjustment parameter, λ. In other words, Young’s model explicitly takes into account the distinction between desired reallocation and actual reallocation. Presumably desired reallocation in any quarter could depend on interest rates in that quarter itself, and so we cannot see how Young can justify a lag in this particular independent variable. Our second objection concerns the aggregation process, from individual firms to industries. When Young moves from his equation (6) to (7), he carries through the β2 term without changing it. This is a mistake: Because the lag in (the absolute value of) the difference in fed funds rates is the same for all firms and in the industry-wide regression, the coefficient on this term in the industry-wide regression is being inflated by a factor of I (the number of firms in the industry). For example, if a given shift in interest rates coincides with (on average) a reallocation of 100 jobs in each firm, and if there are 50 firms in the industry, then the same interest rate change will coincide with an increase of 5,000 jobs at the industry level. It is true that in this particular application the problem is minor, since Young only works with industry data and uses the firm-level equations 5 only to motivate his later specification.6 However, we raise the point in case Young (or others) pursues this line of research and in particular tries to tie macro events with individual firm decisions. The thorny issue of aggregation leads to yet another concern with Young’s modeling approach. Specifically, by dealing only with the absolute value of changes in labor allocation—that is, failing to distinguish between job growth versus decline—Young opens himself up to a form of “double counting.”7 For example, suppose that one firm in an industry gains market share at the expense of another; perhaps the former adds 500 jobs while the latter sheds 500. In Young’s first regression, the dependent variable is R (total reallocation), which is “[j]ob creation plus job destruction” (p. 279). It seems then that Young’s regression would attempt to relate the interest rate to this “change” of 1,000 jobs in the industry in question, even though these particular reallocations (by themselves) wouldn’t affect total industry employment. Since what Young is ultimately testing is Hayek’s theory of interindustry employment shifts, we feel he should have explicitly addressed this potential concern. (For example, if some industries have higher intraindustry job movement—for whatever reason—then this could distort a test of the Hayekian theory.) Unfortunately, Young makes no mention of this possible danger. We finally come to the most serious objection in our immanent critique. Simply put, we believe Young has reported parameter estimates that are significantly erroneous! With total reallocation R as the dependent variable, and with the first lag of R and the first lag of (the absolute value of) the change in fed funds as the two independent variables, Young reports parameter estimates of 0.819 and 0.391, respectively. This leads him to conclude that “a standard deviation change in the federal funds (positive or negative) is associated with a change in desired reallocation of about 11% of its standard deviation” (p. 280). This is presumably a blow against the Mises-Hayek cycle theory, because “the contribution of monetary policy [on job reallocation] is modest” (p. 281). In this context, it is clear that Young believes large estimates for the coefficient on the lag of R, and low estimates for the coefficient on the lag in fed funds changes, undermine the Misesian-Hayekian theory (ABCT). It is with some irony then that we report our own estimates of 0.156 and 0.544, respectively!8 Thus, putting aside all of the other immanent objections, this one alone demonstrably reverses Young’s pessimism regarding the Austrian story. This is because, using our own estimates, it appears that the previous period’s reallocation has far less influence than changes in the interest rate. Thus, if anything Young’s model bolsters ABCT (assuming that our parameter estimates are correct and Young’s are wrong, and that it is logically coherent to test economic theories). 6 In private correspondence (July 23, 2006) Young has admitted that this is a mistake but considers it akin to a “typo,” since writing a different label for β2 would eliminate the problem. 7 We are grateful to Paul Dower for originally voicing this concern. 8 We ran a LSDV fixed effects panel data regression on the Excel data provided by Young himself (via email, dated June 7, 2006). Thanks again are due to Paul Dower, who independently ran the same data using a different software program, and achieved point estimates identical to ours. 6 IV. Even if Done Properly, Young’s Model a Poor Test of ABCT In light of the fact that our own parameter estimates, given Young’s framework, if anything seem to support Hayekian cycle theory, we are tempted to end our critique at this point and declare ABCT vindicated by the data. However, that would be a strategically risky move, because a different econometric test in the future might yield the opposite result. Therefore in this section we discuss broader difficulties with Young’s approach, and argue that even if we disregarded the serious problems discussed in section III, Young’s model wasn’t a very good “test” of ABCT in the first place. For the Austrian economist, the most fundamental problem we encounter is that apodictic economic theories cannot be empirically tested at all. Rather, they are aspects of praxeology,9 and, as such, can only be illustrated, not tested. For praxeologists, economic theories are equivalent to mathematical or geometrical claims, such as the Pythagorean Theorem, or to the assertion that the three angles of a triangle sum to 180 degrees. One can indeed illustrate such declarations, but it would be meaningless to even attempt to test them. Young (p. 2) in this regard points to the “unwillingness of the ‘Austrian school’ to pursue econometrics.” But Austrians10 are by no means “unwilling” to pursue econometrics; there are numerous praxeological publications that utilize such statistical techniques. All of them, however, illustrate, but do not purport to test, economic law.11 Moreover, ABCT takes seriously the complexity and heterogeneity of real world. Thus it is a mistake to think that one can illustrate, much less “test,” ABCT with a model, such as Young’s, that attempts to capture resource (specifically, labor) reallocations with a single-equation for each industry; this is simply inadequate to the task. That is, when all is said and done, after his simple, algebraic manipulations, Young ends up estimating a single equation regression model (Young, 278). And, that equation takes the form of a dependent variable being regressed against the dependent variable, i.e., itself, lagged one period, the difference between the FF rate lagged one period and the FF rate lagged two periods, and a dummy variable representing: “a set of unobservables relevant to the firm’s decisions.” (We did not see a constant term in the model.) At best this is a very simplistic model. This inadequacy is magnified by the fact that Young uses one, single, proxy variable – the FF rate − to capture [the essence of] the Federal Reserve’s “monetary policy’s stance.” Austrian economists do not accept models based on “the” interest rate, or “the” 9 Block, 1973; Batemarco, 1985; Fox, 1992; Hoppe, date, 1989, 1992, 1995; Mises, 1969, 1998; Rizzo, 1979; Rothbard, 1951, 1957, 1971, 1973, 1976, 1997a, 1997b, 1997c, 1997d, 1993; Selgin, 1988. We are puzzled by the quote marks around “Austrian school.” It would appear to imply that there is no such school of thought as the Austrian. But this is surely mistaken. See on this Rockwell, 1995. 10 11 See on this Callahan and Garrison, 2003; Carilli and Dempster, unpublished; Gallaway and Vedder, 1992; Keeler, 2001; Mulligan, 2002, 2005, 2006; Powell, 2002. 7 real wage, etc. Also, monetary policy is reflected not only in interest rates, but also in other terms and conditions of credit.12 Even to capture the interest rate part more accurately would require some sort of measure of the term structure that would take into account not only “the” level, however measured, but also the intertemporal and risk spreads. Furthermore, even if the stance of monetary policy could be captured by one proxy variable, this one indicator would not be the Fed Funds rate – an overnight, virtually-riskless rate available only to depository institutions. The rates that affect realworld allocations of resources are those that include premiums for default risk and inflation premiums, and involve many different terms-to-maturity. Such rates are notinfrequently quoted as (varying) spreads over a riskless (US Treasury) rate, but also over the three-month dollar LIBOR rate. Additionally, there is no basis in anything other than mathematics and statistics for assuming the validity of a single variable W, said to be “a set of unobservable variables relevant to ‘the’ firm’s decision” (Young, 277). Moreover, he (Young, 278) later assumes: “This requires assuming that W0 to be the same set of variables for all firms in an industry.” It is true that he allows the magnitude of W to differ among firms in the same industry by an error term - εit, but his assumption is that every firm; i.e., each decision maker, bases his decision on the same set of (unobservable) variables. (He does not say so, but we presume that Young assumes the error term is a random variable, distributed N(0, σ2).) Entrepreneurship is central to Austrian Economics, including ABCT, and this assumption of his effectively removes any entrepreneurial decision making from the process. That is, save for a random variation, captured by the error term, all firms in an industry make the same decisions. In effect, we have a “representative firm,” which renders the mathematics and statistics tractable, but finesses the truly intractable problems of aggregation.13 Again, there is no basis in anything other than mathematics and statistics for: “Approximating F as linear…” (Young, 278). Nor, yet again, is there any basis in anything other than mathematics and statistics for the assumption: “Changes in W are assumed to be white noise…” (Young, 278). Austrian economics, as all good economics should be, is forward looking. True we may learn from the past, but all decisions must necessarily be forward looking. Unless entrepreneurs consider the future to be a pure extrapolation from the past, they will not base their decisions entirely on past data, save as it informs their expectations as to the future. Thus Young’s model is problematical in the same sense that Friedman’s laggedexpectations model14 was. Moreover, although it is true that, as noted in this present As we write, there is much talk of “quantitative easing,” by the Federal Reserve in an attempt to increase the quantity of credit. 12 13 This constitutes further mainstream avoidance of the complexity and heterogeneity of the real world. For more on this theme, see Anderson, 2001, 2002; Barnett, 2003A, 2003B, 2004; Callahan, 2001; Herbener, 1996; Jablecki, 2007; Leoni and Frola, 1977; Mises, 1977, 1998; Murphy, 2008; Rizzo, 1979; Rothbard, 1988, 1993; Shostak, 2002 14 See, for example, Friedman (1970), eq. 35 and accompanying text, p.228. 8 rejoinder, Young’s model implies that decisions in period (quarter) t are made based on FF rates from period t-1 and earlier, and that more current FF rates are available to the entrepreneur, nevertheless, even that is insufficient as, as noted above, for several reasons: the market for FF, and thus the FF rate, is not available to non-depository institutions; entrepreneurs are not concerned normally with overnight rates, riskless or risky; and, current rates, FF or others, are historical, and only future rates are relevant. Beyond these major methodological difficulties, Young’s attempt to empirically test ABCT fails on several grounds. First, all of Young’s chosen industries come from the manufacturing sector. Yet this is the single worst sector to pick. As Young’s own Hayekian diagrams15 indicate (p. 277), central bank-induced expansions have the smallest effect in the middle of the triangle. Thus, Friedrich Hayek himself might have hoped for Young’s reported results, so long as he supplemented them with similar studies in, say, mining and retail sectors that showed a larger impact of the Federal Funds (FF) rate on reallocation. A second problem is that Young’s empirical data is limited to that concerning job reallocations subject to Fed oriented changes in the interest rate. He thus in his figure 2 implicitly makes an assumption concerning size of the labor force in the various stages of production; to wit, his assumption is that there would be a perfect correlation between size of the labor force in each of the various stages of production, and the value, or contribution to GDP, of any given stage of production. To say the least, this need not be the case. If it is not, Young’s calculations are to that extent rendered inaccurate. Let us put this into other words. Young is “testing” for number of workers. His observations are numbers of jobs. If the number of employees was proportional to the stages in his two sets of diagrams, well and good, at least insofar as this present point is concerned. For, then, if a given stage gained (lost) job slots, we could unambiguously infer that that stage had increased (decreased) in size. But this does not at all apply if the number of workers in a given stage is not proportional to the value it contributes. And, there is simply no reason to suppose that this is correct. For example, in the earlier stages, heavy industry, there are fewer workers per value created and more capital equipment. In the later stages, think retail, there are more employees, and less valued capital. To put this in yet other words, the vertical axis in his diagrams represents value of product at any given stage. Value of product, not number of laborers involved. But his statistical work is couched in terms of number of employees, not value of product. Thus there is a disconnect. The loss of signs (both in job reallocation and interest rate changes) through taking absolute values is another defect of the Young test. It would have been far more appropriate—and perfectly tractable with the data available—to examine whether interest rate increases were positively correlated with job creation in late stages (wholesale, retail) and with job destruction in early stages (mining). 15 Young (2005) quite properly utilizes the Hayekian triangle to illustrate ABCT. This has been the well established practice since 1931 within the Austrian tradition. However, Barnett and Block (2006B) have severely criticized this procedure. 9 On a related note, it is not clear why Young places so much emphasis on the distinction between the amount of current reallocation due to the previous period’s adjustment, versus the previous period’s change in monetary policy. After all, the Austrian School is (in)famous for its insistence on the roundabout structure of production, and the fact that policy changes may take years to reap their undesirable consequences. For example, Austrian economist Murray Rothbard (1963) blames the Great Depression on the unsustainable credit expansion throughout the 1920s, and not—as a monetarist might— on particular Fed blunders during 1929 and the early 1930s.16 In this light, a Hayekian might look at Young’s reported results and ask, “So what?” If Young had found that job reallocation is influenced more by tax policy (say) than by interest rate policy, that would have constituted a more legitimate objection to the Hayekian story.17 But the fact that a given period’s job reallocation is due more to the previous period’s reallocation, versus the previous change in the fed funds rate, by itself is fairly neutral. Again, this is because the initial fed funds change—which may have occurred, say, years in the past—might take time to work its way through the capital structure. In a simple econometric test such as Young’s, where only the previous period’s interest rate change is included, this situation might very well generate parameter estimates similar to the ones that Young reports. The previous two objections concern timing and sign changes, and manifest themselves in yet another difficulty: Young uses the quarters 1972:2 to 1993:4; he does so apparently only because Davis (1996) did so. But this start and end point are irrelevant to ABCT, which focuses on a single boom-bust cycle. This time period chosen by Young includes several business cycles. His conclusions are to that extent problematic. Within the ABCT, the effect of a given change in interest rates may be different, depending on the stage of the business cycle. If unemployment is virtually absent, and an unsustainable boom has been underway for several years, reductions in the interest rate might have very little influence on the number of workers in a given sector. Rather than looking at consecutive years, Young would have done better to look at either a single boom (or bust) period, or several booms, or several busts. We also point out that the Hayekian theory is quite subtle, and admittedly does not lend itself to easy empirical tests. Although this may be regrettable, one should be aware of the fact when interpreting an analysis such as Young’s. Consider a concrete example of this difficulty. In the standard Hayekian analysis, if the interest rate is originally at the “natural” level, a Fed cut will cause an unsustainable expansion, an artificial boom period. Now even if the Fed continually pumps in additional credit to keep rates artificially low, this illusory prosperity cannot continue forever. At some point there will not be enough physical capital goods to complete all of the various projects underway, 16 On this see also Robbins (1934); Garrison (2001, 2004); Rothbard (1993) 17 This would be far from a fatal objection, however. ABCT merely asserts that its story is true; it would be improper to interpret it as claiming that the phenomena it discusses need always and ever be the most important explanations of a business downturn. War, for example, or a gigantic natural disaster, might well account more for a bust than a slight tinkering with interest rates. 10 and some firms will need to shut down and fire their workers. This ultimate reckoning would not necessarily be tied to a “policy innovation” on the part of the Federal Reserve, which indeed might be cutting rates even further in an attempt to postpone the bust. As this scenario—which is entirely consistent with ABCT—demonstrates, one might find massive reductions in employment without prior increases in the interest rate. In any case, this level of amalgamation, economy wide, is incompatible with ABCT. For there, there will always be some stages that gain employment even during the depression (the higher stages), and others that lose job slots even during the boom (again, the higher stages). Finally consider the 20 industries used in the study (see appendix). The first few, (20-23) may be categorized as consumer goods. Young speaks in terms of a focus on manufacturing, but then lists these four clearly non-manufacturing categories. These four (20-23) are represented most reasonably, in Young’s figure 1, as “retailing” or “later stages.” The remainder are almost certainly to be characterized as either producers’ goods, or consumer durables. Thus, they would most properly be placed in his “earlier stages.”18 While some of these 20 can possibly be associated, specifically, with various of the stages depicted in his figures, others of them clearly transcend two or more or even all of these stages. They cannot all be considered members of the “manufacturing” stages in his figure 1. There are grave problems here, insofar as ABCT is concerned. For this theory does not at all speak in terms of total employment. Rather, the Hayekian model emphasizes employment or value or capital at specific stages. The boom shifts resources of all types and varieties, certainly including labor, to the earlier stages. In terms of employment of labor, jobs during the initial phase of the business cycle increase in the earlier stages, but decrease in the later ones. In the bust, yes, job slots decline in the early stages, but they increase in the later ones. Young’s is a “test” of total employment. ABCT knows of no such aggregation. Thus, even if all of our other criticisms of Young were for some reason discounted, this one alone would be fatal to his thesis. Let us draw but one more implication from this point. Consider the two triangles in Young’s figure 2. Let us focus on that stage depicted in the triangle where the two hypotenuses cross. There, employment remains constant, regardless of whether we are moving from boom to bust or in the opposite direction. But this is the only section of the triangle for which this is true. The “job reallocation data” he used was based entirely on the manufacturing sector of the economy, in which employment was falling during the period of the study from about 26% to about 14% of the total employment. The following is the abstract of the paper Young (279) cites as describing the data. “We rely on a decomposition of employment changes into job creation and job destruction components - and a novel set of identifying restrictions that this 18 For ambiguities in representing consumer durables in the ABCT triangle, see Barnett and Block, 2006B. 11 decomposition permits - to develop new evidence about the driving forces behind aggregate fluctuations and the channels through which they operate. We implement our approach to identification using quarterly postwar U.S. data on oil shocks, monetary shocks, and manufacturing rates of job creation and destruction. Our analysis delivers many inferences: 1) The data favor a many- shock characterization of fluctuations in employment and job reallocation, 2) Theories of employment fluctuations that attribute a predominant role to aggregate shocks must in order to fit the data involve contemporaneous effects of such shocks on job destruction that are at least as large as the effects on job creation, 3) Theories in which aggregate shocks primarily affect the first moment of the cross-sectional density of employment growth imply that allocative shocks have bigger contemporaneous effects on destruction than on creation and, hence, that allocative shocks reduce aggregate employment, 4) Allocative shocks drive most fluctuations in the intensity of job reallocation, 5) Oil shocks drive employment fluctuations through a mixture of allocative and aggregate channels, 6) Monetary shocks trigger job creation and destruction dynamics that fit the profile of an aggregate shock.” Because (Young, 279) states: “Job reallocation data is quarterly…” we assume that the FF rate data is also. This raises the issue of whether the (St. Louis Federal Reserve Bank’s data base “Federal Reserve Economic Data” commonly referred to as FRED) data used was that for the target rate or that for the effective rate. As they differ, regularly, it would seem that the appropriate one is the actual (effective) rate. Moreover, as can be seen at this url: http://research.stlouisfed.org/fred2/categories/118, the target rate series goes back only to 9/27/1982 and is a daily series, whereas the effective-rate series, daily, weekly, and monthly, can be found as far back as July, 1954. Then the question arises which of these series did he use, daily, weekly, or monthly? Monthly seems the most logical, but, regardless, the actual data used must have been an average (no matter whether the Fed’s or Young’s) of daily figures. The FRED data comes from the Board of Governor’s Statisatical Release H.1519 and is “a weighted average of rates on brokered trades.”20 A quick look at the relevant FRED graphs or data show that the daily figures varied, sometimes considerably, during the various quarterly periods. What have such averages of historical data to do with entrepreneurial decisions? Nothing. Young does not discuss the dummy variable at all; as W0 is the same for all firms in an industry (a truly heroic assumption when dealing with ABCT, as the role of the individual entrepreneur is central to all of Austrian economics), we must assume that it varies among industries. On what basis are the values of W0 assigned to each industry? The dependent variable, “job reallocation data” (Young, 279), is meant to capture the effect of reallocation of resources; i.e., changes in the structure of production, as per ABCT. As ABCT is a “capital based” theory, it would seem more appropriate to use data, if such exists, on “capital goods reallocation.” Moreover, it is quite possible that changes in the structure of production could occur without “job (or even capital goods) reallocation.” 19 See “Source(s),” http://research.stlouisfed.org/fred2/series/FF?cid=118. 20 See footnote one, http://www.federalreserve.gov/releases/h15/update/. 12 Finally, let us consider the matter of units/dimensions as is appropriate for any work using applied mathematics (Barnett, 2004). Young (279) says that the “jobs reallocation data” is “percents of total jobs.” That is, the dependent variable is a percentage or pure number; i.e., something such as 100 jobs/1,000 jobs = 0.1. (We assume that to be the form as we have not access to the NBER paper cited by Young as describing the data.) The first problem with such a percentage is it assumes that all jobs are homogeneous, an assumption that flies directly in the face of Austrian economics and, indeed, of all common sense. However, assuming arguendo, that such a percentage is meaningful, because the dependent variable is such a percentage, that necessarily means that the first regressor, the lagged dependent variable and the second regressor, the difference between the FF rate lagged one period and the FF period lagged two periods, present no problem re dimensions, as they are also in percentages, and thus require no nonsensical assumptions re the relevant parameters. However, this is not so: the dummy regressor is different. First, what, pray, is the dimension of W? Unless each of the “set of unobservables” that constitute W is measured in percentage terms and then aggregated in some way, e.g., a weighted average, to yield W as a percentage, or they are first aggregated and then the aggregation used to create a percentage, W must be dimensioned. (It is hard to imagine that the relevant data re each of the variables in the “set of unobservables relevant to the firm’s decisions” are percentages thereof. Moreover, it is most likely that some of these are subjective in nature and thus not grist for the mill of cardinal mathematics.) Moreover, what the dimension of a “set of unobservables” might be is an interesting question. Assuming some or all are dimensioned, but not all have the same dimension, how would they be meaningfully aggregated so that the dimension of W was consistent with the different dimensions of its various elements? However, again, assuming arguendo, that the elements of W could be meaningfully aggregated into W with its own dimension consistent with those of its elements, it would then be necessary to see what is required to insure that δ = bλ((W) a pure number. From Young’s eq. 2 we know λ is a pure number. Thus, for δ to be a pure number the dimension of b must be the inverse of that of W. Moreover, as there is a different W for each industry, there is no reason to think that the elements of the different Ws are the same from industry to industry. That would mean that as the dimension of W varied among industries, so, also would the dimensions of b have to vary. To conclude this point, we doubt that Young’s model would look sensible if it were to pass the test of dimensional analysis. V. Conclusion We welcome Young’s econometric test of the Austrian Business Cycle Theory, which in our view is one of Mises and Hayek’s tragically underappreciated contributions to the profession. Having said that, we unfortunately find that Young does a poor job in testing his own model. In particular, we find parameter estimates that would lead to the exact opposite conclusion from Young’s. Finally, we find that Young’s model was never a proper test of ABCT in the first place. Contrary to a widespread view, Austrian economists do not fear empirical illustrations of their theories. They merely insist that 13 they be fair and correct. For that matter, we have no objection to neoclassical economists “testing” Austrian theories either; such practices are compatible with their own methodology, if not ours. But, again, fairness and correctness should be the order of the day. 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