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Austrian Economics and Predictions.

Had a chat over at mises.org about what we can know about the future, in particular if inflation lies ahead. Since I got complimented on my post there, I decided you loyal readers deserve to see it as well.

Someone wrote:
 Human action theory reveals that  no one [not even the banks] can reliably, consistently predict future economic events, [therefore further future deflation is still a distinct possibility].

Here’s my reply:

What I don’t get is, if we assume you are correct here, then why bother studying economics at all? If the bottom line is “you can’t predict anything” doesn’t that mean “close the books and turn on the basketball games”?

Here is my take: Human action theory teaches that…
1. …there is a cause and effect relationship between economic events. There is a Law of Supply and Demand. There is a Theory of the Business Cycle. There is a Law of Diminishing Returns. And so forth. And although all the laws assume ceteris parebis [=all other things remaining unchanged], and in the real world everything changes, yet …

2…some causes are way more powerful than others. As an extreme example, Obama deciding to invade Iran influences the economy more than me buying a dozen eggs.

Of course, Economics per se limits itself to if-then statements. If the Fed prints more money, then all other things being equal, prices will go up. An economist, while wearing his economist hat, will not consider it his job to predict whether the Fed will indeed print more money or not. All he discusses is the consequences of what happens if they do or they don’t.

Thus a whole new field of knowledge is introduced when trying to predict economic events, what we may call psychology. What kind of people run the Fed? What have they done in the past, what are the likely reasons they acted the way they did, and is there reason to think they will act that way in the future? Obviously, this whole area is more an art than a science, though the theory of human action gives us a bit of a hint. They will probably do what they percieve as best for them.

All of the above leads me to conclude that…
3… though nobody is likely to be perfect, some people will be far better at predicting future economic events than others.

Summing up. The uncertainty we all have is in predicting what people will do. And there is uncertainty as to how much influence their action will have on the future. But…
4… there is no uncertainty about the direction of the influence of past actions on the future. 

For example. We do not know for sure if the Fed will print money tomorrow [though shrewd people can make excellent guesses]. We do not even know for sure if the money printing that causes prices to rise, ceteris parebis, will be offset by other factors, leaving prices the same or even lower. But we do know for sure that yesterday’s money printing by the Fed will introduce a force which will push in the direction of higher prices. We also know that the more money printed, the stronger this force will be. 

Now let’s look at what is before our very eyes. Fifty years ago, politicians and economists all agreed that inflation was bad. It was even considered a given that printing money caused inflation [See Keynes remark about debauching the currency].

Nowadays, things have changed. Every single politician with power anywhere in the world, and every single economist with access to the media or with any other power, lets it be known that inflation is a good thing, and that besides, printing money doesn’t cause prices to rise, and that besides, the central banks do not really print money, and that besides we never did have inflation, really, ever. In other words, they are announcing for all the world to see that they intend to print money till prices go up. And they have done it in the past.

One doesn’t have to be an Albert Einstein to make the following argument. They have printed money in the past. The have the power to print more, and announced their intention to do so, telling everyone how wonderful it is. Ergo…

5…the probability of their printing more, so much that prices will keep on rising like they announced is their intention, is enormous. Protect yourself.

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