Sunday, March 27, 2011

Cowen and Fink on the ERE

I finally got around to reading Cowen and Fink's great article on the "Inconsistent Equilibrium Construct" of Mises and Rothbard's Evenly Rotating Economy (ERE). This short piece is really great, and, in my view, strikes a death blow to the Austrian model of equilibrium.

Cowen and Fink describe the model accurately: (1) it is used to predict the direction of change; (2) it freezes all the data so that it can be used as a first step toward an analysis of complex change; and (3) it is used as a foil.

The paper makes three important criticisms of this model. First, Cowen and Fink claim that there is no tendency for a market to move toward equilibrium because "sequential transactions are not consistent with the notion of an intertemporal general equilibrium." In other words, for a tendency toward equilibrium to prevail, the equilibrium system must already be pre-ordained.

Second, and perhaps most important, is the idea that there can be no prices in equilibrium because "prices are institutions that have evolved over time in order to help coordinate the plans of market participants. [Therefore,] in a world in which all plans are already coordinated, and actors possess all relevant information, prices would not serve any function." This is an excellent point, and illustrates the absurdity of the Austrian ERE model. Technical general equilibrium theorists (for example, Frank Hahn) have recognized that money cannot exist in equilibrium, and have rightly excluded it from their analyses of equilibria.

And third, the ERE cannot be used as a foil because in equilibrium there is no human action. "If, as Mises claims, the ERE has no human action, then we cannot claim there is a tendency towards equilibrium, since this would imply the nonsensical conclusion that there is a tendency for human action (and human institutions) to disappear."

I thought this short article was really great. For anyone familiar with this literature, has there been any Austrian responses to this piece? Have Austrians accepted these criticisms, or simply ignored them? My impression is that Austrians have still retained the ERE as a model for analyzing change, although they are quick to admit its real world inapplicability. I would be very interested in reading any Austrian responses to this article.

Reference: Tyler Cowen and Richard Fink "Inconsistent Equilibrium Constructs: The Evenly Rotating Economy of Mises and Rothbard" The American Economic Review, vol. 75, no. 4 (September 1985), pp. 866-869.

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