Austrian Macro I

1. Austrian Macro I Intermediate Macroeconomics ECON-305 Fall 2013 Professor Dalton Boise State University

2. Post KeynesiansandAustrians

3. Shared Criticisms Austrians and Post-Keynesians share four criticisms of orthodox macroeconomics: (1) Equilibrium approach overlooks processes of adjustment; (2) Rational expectations framework minimizes fundamental uncertainty regarding the future; (3) Equilibrium theorizing minimizes attention to how historical past influences historical future; and (4) Treatment of economy as if barter with a numeraire overlooks the effects of money on economic relationships.

4. AustrianMacroeconomics

5. What is the nature of Capital? • Austrian macro distinguished by its view of capital and interest • Nature of capital • Heterogeneous structure of goods or homogeneous fund? • Nature of interest • What is interest a payment for? • How do we conceive of the economic process? • Circular Flow or Means-End Framework

6. Austrian Capital Theory • Capital is the set of heterogeneous, specific intermediate goods that assist in the production process – they are produced but are not ultimate sources of consumer satisfaction • Interest originates in the universal preference for current goods over future goods; it is a payment for waiting and is central to all time-consuming processes (production!)

7. Time and Money • Time is the medium of action in all markets. • Money is the medium of exchange in all markets • In “macroeconomics,” focus is upon growth and deviations in production. • Production takes time – as capital goods are turned into consumer goods.

8. Time and Money Macroeconomics has to concern itself with capital structure. Money is a “loose joint” that binds the supply of capital goods and the subsequent demand for the corresponding consumer goods. Monetarist tight joint Keynesian broken joint

9. Time and Money “…capital gives money time to cause trouble.” - Garrison, Time and Money, p. 8

10. Austrian Business Cycle Theory Historical Time Heterogenoeus Capital Capital Structure Non-neutral money Coordination failure Integration of growth theory and theory of fluctuations

11. Cantillon Effects Where money enters into the economy matters Monetary injections and leakages alter the distribution of wealth and thereby alter relative prices and the allocation of resources Money can never be neutral in its effects on production and consumption Money is always non-neutral

12. Cantillon Effects Monetary injections in a modern financial system are through the banking system Money is “lent into existence” not “spent into existence” Monetary growth alters the interest rate and affects the intertemporal allocation of resources

13. Capital and Saving Financial capital is the available fund that arises from decisions of individuals businesses to neither consume nor hoard (=Saving) Saving is the source of the payment of factors of production in time-consuming production processes The demand for and supply of loanable funds determines the equilibrium interest rate

14. Capital Goods Key factors of production are the heterogeneous capital goods that go into making a product Every consumer product has an “ancestral lineage” of previously applied factors of production, including heterogeneous labor and capital goods

15. Capital Goods At every stage of the lineage from original factors of production to finished consumer product, entrepreneurs are making a decision between current expenditures and expected future discounted revenues When the production process is in intertemporal equilibrium, the discount rate will be the equilibrium or natural interest rate

16. Capital Goods In order to maintain the “ancestral lineage” necessary to continue the current production of a given consumer good, prices paid and received at each stage of production must continue to reflect normal profitability (the discount rate) Changes in the interest rate change the discount rate and therefore change the relative profitability of different stages of the production process

17. The ABCT Story Changes in credit can come from either changes in real saving or changes in the money supply Changes in credit change the interest rate Changes in the interest rate change the profitability of different stages in production processes, altering the intertemporal allocation of resources

18. The ABCT Story • Changes in the intertemporal allocation of resources that arise from changes in real saving are sustainable and lead to greater economic growth • No divergence of the actual from the natural rate of interest

19. The ABCT Story • Changes in the intertemproal allocation of resources that arise from changes in the money supply are unsustainable and lead to a “boom and bust” cycle • The actual interest rate diverges from the natural rate of interest • The bust can be particularly painful if a secondary deflation is allowed to occur and price and wages are rigid downwards

20. Common Confusions An unsustainable boom is initiated by an actual interest rate below the natural interest rate. During an investment boom initiated by changes in technology, one would expect the demand for loanable funds to rise relative to the supply of savings. This should cause the interest rate to rise. If the central bank steps in to moderate interest rates, the interest rate might stay the same or rise but still be below the natural rate, making the resulting boom unsustainable.

21. Policy Implications • Recessions are the cure for the misallocation of resources occasioned by unsustainable booms • Control of MV (not just M) matters • Gold-standard • Free banking and competitive monies • Denationalization of money and credit • Removal of price and wage rigidities can accelerate adjustment processes

22. Criticisms of ABCT No real world analog to natural rate of interest Capital aggregation problems Dependent upon expectational lags (not consistent with rational expectations) Overemphasis on interest rate miscoordination Unpopular policy prescriptions

23. Strengths of ABCT • Austrians claim that theirs is the only theory that predicted the Great Depression (Lakatosian novel fact) • (not true of the “Great Recession”) • Rational individual behavioral adjustments to changed relative prices • Importance of knowledge and expectations in a complex world

24. Distinguishing Beliefs Expectations are forward-looking but each individual agent possesses unique, diverse and partial knowledge-information sets; coordination failures are possible Economy has a tendency towards intertemporal equilibrium output and employment through entrepreneurial adjustments to relative prices

25. Distinguishing Beliefs Cantillon effects assures non-neutrality of money in short and long run Discretionary fiscal and monetary policy increase uncertainty and increase likelihood of coordination problems; rules are preferable to discretion and automatic institutions are preferable to rules.