Human action, not data sets, is the starting point for economic theory

Not data sets that are prone to change, but logical deductions based on what we know about human behaviour are the starting point for Austrian economics.

Our understanding of the economy, according to popular belief, is elusive. As a result, the best we can do is use various statistical tools on so-called macro data to try to determine some facts about economic reality.

An economist, for example, believes that consumer spending on products and services is driven by personal disposable income and interest rates. (Personal disposable income and interest rates are the driving determinants of consumer expenditures, according to economists.)

The economist then translates this viewpoint into an equation using a statistical method. The created equation is then used to forecast the future direction of consumer spending. If the equation produces correct forecasts, it is considered a useful instrument for determining reality's facts. It is no longer useful in establishing the truths of reality if it fails to make accurate projections. The theory must be abandoned or amended in this scenario. The popularizer of this way of thinking Milton Friedman wrote,

The ultimate goal of a positive science is the development of a theory or hypothesis that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed.

In this mode of thinking, as long as a theory "works," it is considered an acceptable framework for evaluating economic situations. It doesn't matter what a theory's fundamental assumptions are, according to Friedman, because it's impossible to determine "how things truly function." (It makes little difference whether consumer spending is influenced solely by disposable income and interest rates, or by a variety of other factors.) In fact, everything goes as long as the theory is capable of producing accurate predictions.

Friedman writes:

The relevant question to ask about the assumptions of a theory is not whether they are descriptively realistic, for they never are, but whether they are sufficiently good approximation for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.

Thinkers such as Ludwig von Mises held a different view. As he wrote,

It is vain to search for coefficients of correlation if one does not start from a theoretical insight acquired beforehand.

According to Mises, an economist must use a theory that is not based on historical data in order to judge the facts of reality. The hypothesis must be able to "stand on its own" in the absence of historical evidence. Individuals have a certain amount of knowledge about themselves, which can aid in the development of such a theory. Individuals can be seen participating in a range of activities, for example. They could be doing manual labor, driving automobiles, strolling down the street, or eating in restaurants. The fact that these behaviors are aware and purposeful distinguishes them from others.

We can determine the significance of an individual's behavior by using the understanding that human action is deliberate and purposeful. As a result, manual labor may be a way for certain people to earn money, allowing them to attain various goals such as purchasing food or clothing. Dining in a restaurant can be a good way to meet new people and start a business relationship. Driving a car might be a convenient way to go to a specific location. Individuals act within a framework of means and objectives, employing a variety of methods to achieve their goals.

Knowing that people take purposeful activities means that economic reasons come from people, not from outside forces. Individual expenditures on products and services, for example, are not caused by income as such, contrary to popular belief. Every individual selects how much of a given income will be spent on consumption and how much will be invested in his or her own unique circumstances.

While it is true that people are more inclined to respond to improvements in their income, this is not always the case. Every person weighs the rise in income against the specific set of objectives he wishes to achieve. He may determine that increasing his investment in financial assets is more beneficial than increasing his consumption of goods and services.

It is certain, not speculative, that human conduct is conscious and purposeful. Anyone who objects to this is contradicting himself since he is engaging in an intentional and conscious action to claim that human activities are not purposeful and conscious.

Applying the Means-End Framework in the World of Economics

Furthermore, the knowledge that individuals’ action is conscious and purposeful implies that it emanates from reality. Various conclusions that are derived from this knowledge of conscious and purposeful conduct are valid as well. According to Murray Rothbard:

Beginning with the certain knowledge of the basic explanatory axiom A, he deduces the implications of A: B, C, and D. From these he deduces further implications, and so on. If he knows that A is true, and if A implies B, C, and D, then he knows with certainty that B, C, and D are true as well.

He adds:

We do not know, and may never know with certainty, the ultimate equation that will explain all electromagnetic and gravitational phenomena; but we do know that people act to achieve goals. And this knowledge is enough to elaborate the body of economic theory.

It also means that this knowledge could aid economists in deciphering observed individual activities. For example, a person may wish to purchase products and services in order to achieve a goal of preserving his life and well-being. The individual uses money to exchange for goods and services in order to achieve the aim.

We can also deduce that money is a general means of exchange because it was created from the most marketable commodity. As a result, the individual trades products for money, then trades money for goods that he feels will help him live a better life. We can also deduce that the individual uses money to exchange something for something.

Consider the situation of a counterfeiter who has created money out of "thin air." The money was secured by the counterfeiter trading nothing for it. The money is subsequently exchanged for products and services. This indicates that the counterfeiter has received nothing in exchange for nothing. What we have here is a counterfeiter diverting wealth from wealth generators to himself by creating money out of "thin air." As a result, wealth creators' ability to generate wealth is harmed. As a result, the wealth-creation process is jeopardized. Furthermore, we may deduce from this that any organization or individual that provides a platform for the exchange of nothing for something hinders the process of wealth creation.

Furthermore, we understand that the price of an item is the amount of money paid for it. We also know that, all other things being equal, a rise in the money supply must result in more money being paid for a unit of the good—an increase in the price of products.

As a result, without an increase in the money supply, all other factors being equal, general price increases are impossible. We can therefore deduce that increases in the pace of creation of money created "out of thin air" give rise to activities that would not be supported by a free and unrestricted market. It's worth noting that as long as the rate of growth in "thin air" money continues to rise, numerous activities that arose as a result of the money out of "thin air" could thrive by diverting cash away from wealth generators.

When the rate of money out of "thin air" growth slows, many activities that arose as a result of the earlier increase in money out of "thin air" will struggle. With the rate of money growth slowing, these activities are receiving less support—less real wealth is being moved from wealth generators to them. We're in the midst of a boom-bust cycle. Furthermore, anytime money is pumped, it begins with one market before moving on to others. There is a lag in time. This, in turn, could give us insight into future occurrences, such as boom-bust cycles and price inflation.

Applying the Means-End Framework to Interest Rates

The ultimate goal for most people is to maintain their life and well-being. We all know that in order to keep alive, one must consume items in the present. This implies that the individual should prefer to consume a similar basket of products now rather than later. This also implies that the individual places a higher value on the basket of things in the present than on the identical basket of goods in the future. A person who only has enough things to keep him alive is reluctant to invest or lend some of his limited resources. In this case, he is expressing an unrestricted preference for spending commodities now over consuming goods later. This indicates that he has stated a preference for an endless amount of time.

All other things being equal, when the pool of wealth grows, the person is likely to contemplate investing and lending some of his fortune. This suggests that the individual's time preference can be lowered as a result of the increased pool of commodities. We may also remark that the individual has reduced the premium he places on current consumption against future consumption. It's all about the premium when it comes to interest. It's worth noting that fluctuations in interest rates send messages to firms about their future requirements. An agency that tampers with these signals, such as the central bank, produces turmoil in the economy because it forces firms to disregard individuals' instructions about future consumption.

Consider a scenario in which several experts advise the central bank to raise interest rates to counter the upward trend in the price of goods and services. We believe that raising interest rates is not the best way to counteract rising price momentum. We believe that this will harm people's well-being since rising interest rates is equivalent to meddling with market signals. To stop the upward price trend, all that is required is to shut the loopholes that allow money to be created "out of thin air." The central bank's purchase of assets is a major loophole for money creation out of "thin air" in this regard. Similarly, decreasing interest rates is not an effective way to kickstart economic growth. What is needed is for the economy to be freed up and for firms to focus on creating wealth.

Also, keep in mind that being alive necessitates a good interest rate. This is due to the fact that persons must consume in order to stay alive at the present moment (i.e., to have a positive time preference). Now, just because there is a negative market interest rate does not indicate the positive time preference theory is invalid. The observed inconsistency is most likely due to central bank intervention in financial markets, which led the market interest rate to go below zero. Note that this inconsistency is handled by a theory that states that the temporal preference interest rate must be positive in order to stay alive.

Remember that the theoretical framework, not the observed data, is the final arbiter here. The evidence can only be explained with a theory. In this respect, the observed data does not provide the facts of reality on its own. When commentators offer observations about the facts, they do it in the context of a specific theory. As a result, a logical evaluation of the theories utilised by commenters is required to prove the legitimacy of their views. Let's pretend the central bank is pursuing a monetary strategy of expansion. Many analysts believe that this is vital to foster economic progress and improve people's lives. However, a close examination reveals that, all other things being equal, an expansionary monetary policy must imply a weakening of the wealth-generation process and a weakening of the economy.

Conclusion

Various mathematical and statistical methods cannot assist an analyst in discovering causes in the field of economics without a theory that "stands on its own feet." All these methods could do was explain the situation. A logically worked out theory is required to determine the fundamental reasons. An analyst could discover the core reason that drives the economic variable of concern using such a framework. The analyst should stick to the key component once it has been identified. Various noncore effects should be evaluated in terms of their potential impact on the core components.

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