The Slow Vindication of the Austrians Every once in a while, I notice a truth, revealed long ago through reason by the Austrians, peeking through when a modern Keynesian happens to write about real-world effects that seemed to him counter-intuitive. by Benjamin J. Thompson

Followers of the Austrian economists (if you are at all sincere about understanding political economy, you should at least get familiar with their arguments) frequently lament that the Keynesian social-democrat mainstream not only disagrees with them but also never even bothers to argue against them, treating them instead as if they were invisible, or worse, attacking idiotic strawmen instead.

A Keynesian Catches On

But every once in a while, I notice a truth, revealed long ago through reason by the Austrians, peeking through when a modern Keynesian happens to write about real-world effects that seemed to him counter-intuitive. Several times in the past year or two, I’ve seen Austrian conclusions pop through the cracks of post-2008 Keynesianism, but they are justified on different grounds and expressed in different language.

The truth is making itself known, for truth can never be suppressed forever, but the mainstream of economics is still having a hard time shedding their faux empiricism and obsession with complicated-but-meaningless mathematical models. So when they notice it, they have to notice it in terms of economic history throwing them a curveball that warrants more study.

Earlier this month in The New York Times, Neil Irwin noticed with some consternation that low interest rates have a strange way of favoring the biggest players in a market. The revelation came from a chance encounter with on-the-ground experiences of actual entrepreneurs:

Atif Mian, an economist at Princeton, was recently having dinner with a colleague whose parents owned a small hotel in Spain. The parents had complained vociferously, Mr. Mian recalled the friend saying, about the European Central Bank’s[ECB] low interest rate policies.

That didn’t make sense, Mr. Mian thought. After all, low interest rates should make it easier for small business owners to invest and expand; that’s one of the reasons central banks use them to combat economic weakness.

The owners of the small hotel didn’t see it that way. They thought that big hotel chains were the real beneficiaries of low interest rate policies, not a mom-and-pop operation.

Empirical Validation

The gee-golly head-scratching about this one strikes me as pretty funny since the Austrians have argued for the last half-century or more that artificially low interest rates bias the market in favor of the Large. Interest rates are the price of access to future money today subject to the same supply-and-demand pressures as anything else that has a price. Depending on how much stored capital is sitting in the banks to lend and how many demands there are to borrow, a natural market interest rate would emerge. The ECB, just like the Federal Reserve, takes it upon itself to press a finger on the scale and push that price down.

Since prices carry information, wrong prices carry wrong information. In the case of interest rates fixed to be too low, it sends the message that the economy is ready and waiting for very large capital projects. Production shifts to larger, more time-intensive projects at the cost of smaller ones. If this goes on long enough, it becomes the poison boom that creates a bust later, as it turns out consumers weren’t actually waiting to buy the ambitious finished product. The top-heavy house of cards, built on an illusion of rich-and-waiting customers, topples over.

So as Atif Mian and his colleague Ernest Liu started thinking this through, what did they find?

Imagine a town in which two hotels are competing for business, one part of a giant chain and one that is independent… When interest rates fall to very low levels, though, the payoff for being the industry leader rises, under the logic that a business generating a given flow of cash is more valuable when rates are low than when they are high. (This is why low interest rates typically cause the stock market to rise.)

A market leader has more to gain from investing and becoming bigger, and it becomes less likely that the laggards will ever catch up.

“At low interest rates, the valuation of market leaders rises relative to the rest,” Mr. Mian said. “Amazon becomes a lot more valuable as interest rates fall relative to a smaller player in the same industry, and that gives a huge advantage to Amazon.”

Got there by a slightly different route, but you still got there.

The best part comes next:

The researchers tested the theory against historical stock market data since 1962, and found that falling interest rates indeed correlated with market leaders that outperformed the laggards.

That’s right. This empirical validation of the Austrian view had been sitting there waiting to be acknowledged for decades:

“There’s a view that we can solve all of our problems by just making interest rates low enough,” Mr. Mian said. “We’re questioning that notion and believe there is something else going on.”

Indeed.