Transcript Austrian Macro – II - Boise State University

Garrison’s Model of
Austrian
Macroeconomics
Intermediate Macroeconomics
ECON-305 Fall 2013
Professor Dalton
Boise State University
Distinguishing Beliefs
1.
2.
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
Distinguishing Beliefs
3.
4.
Cantillon effects assures nonneutrality 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.
Capital-Based
Macroeconomics
Based on the Business
Cycle Theory of Ludwig von
Mises and F. A. Hayek
With acknowledgment to Professor Roger W. Garrison, Auburn University
“Loanable funds” is the generic term that refers both to lending
(which constitutes the supply side of the market) and to borrowing
(which constitutes the demand side).
Each side of the market for loanable funds is governed by the rate
of interest.
Saving, broadly conceived, underlies the supply of loanable funds.
Consumer borrowing is
netted out on the supply
side. That is, the focus is
on the funds lent collectively
by income-earners/savers to
the business community.
The demand for loanable
funds represents demand by
businesses for investment.
The Market for Loanable Funds
Capital-based macro features
consumption and investment as
alternative ways to use
resources.
The alternative uses are
depicted as a Production
Possibilities Frontier (PPF).
The PPF shows the maximum
sustainable level of output as
a locus of points representing
all possible combinations of
consumption and investment
for a fully employed economy.
Production Possibilities Frontier
Consider a particular point on
the frontier.
This point represents an
economy that is fully employed
(with the unemployment rate in
the 5%-6% range). Hence,
output is being produced at a
sustainable rate.
Production Possibilities Frontier
Now consider a disequilibrium
point inside the PPF.
This point represents an
economy in recession,
producing fewer consumption
goods and/or fewer investment
goods than it could.
The distance below the frontier
Production Possibilities Frontier
reflects the idleness of labor and
other resources. The
unemployment rate is higher than
6%, suggesting significant cyclical
unemployment.
Now consider a disequilibrium
point beyond the PPF.
This point represents an
overheated economy. The
unemployment rate is below
5%. The level of output is
unsustainable. (Points very far
beyond the PPF are, of
course, literally impossible.)
Production Possibilities Frontier
Increased saving moves the
economy along the PPF in the
direction of more investment;
decreased saving moves the
economy along the PPF in the
direction of consumption.
Investment in this framework
is measured in gross terms.
Suppose an investment of
$600 billion is needed just to
offset depreciation.
As long as gross investment is
greater than depreciation, the
economy will grow, as will be
represented by an outward
shift in the PPF itself.
DEPRECIATION = $600
CONSUMABLE OUTPUT
PRODUCTION TIME
Beyond the two-way division
of resource usage captured by
the PPF, capital-based macro
tracks the intertemporal
allocation of investable
resources.
Production time is measured
along the horizontal axis.
The vertical axis tracks the
value dimension—with value at
the end of the production
process representing
consumable output.
CONSUMABLE OUTPUT
RETAILING
DISTRIBUTIING
MANUFACTURING
REFINING
MINING
STAGES OF
PRODUCTION
At a given point in time, an
ongoing production process is
characterized by activities in
all the separate stages.
Identifying the stages as
“mining” through “retailing” is
only suggestive. The actual
intertemporal structure of
capital, of course, entails a
complexity of interconnected
production activities.
C The resulting figure is known as
the Hayekian triangle.
PRODUCTION TIME
For analytical purposes, the
economy’s production process is
conceived as a continuum of
stages and is represented as
goods in the making that gain
value as they near completion.
First, it depicts the production
process that plays itself out over
time.
Second, it depicts the full
complement of stages that exist
at a given point in time; the
second interpretation suggests
that resources can be
reallocated in either direction
from one stage to another.
The market for loanablefunds—a.k.a. investable
resources—shows that the
market-clearing rate of
interest is 5%, at which
saving and investment are in
equilibrium at $800 billion.
The PPF shows that with
$800 billion committed to
investment activities, $2200
billion are available for
current consumption.
The market for loanablefunds—a.k.a. investable
resources—shows that the
market-clearing rate of
interest is 5%, at which
saving and investment are in
equilibrium at $800 billion.
The Hayekian triangle depicts
current consumption as the
output of the economy’s multistage production process. The
rate of interest governs the
allocation of resources among
the stages.
The slope of the hypotenuse of
the Hayekian triangle reflects a
rate of interest consistent with
the rate that prevails in the
loanable- funds market.
An initial full-employment
equilibrium is defined by:
the Loanable-Funds Market,
the PPF,
the Hayekian Triangle,...
…plus the representative
stage-specific labor markets.
$600
If gross investment needed to
offset capital depreciation is
$600 billion, the economy is
experiencing net investment of
$200 billion.
$600
The increase in productive
capacity and hence in output is
depicted by a shifting outward
of the PPF and by a
corresponding shifting of the
supply and demand for
loanable funds.
$600
This additional capital is
distributed among the stages
of production in accordance
with an unchanged rate of
interest.
Watch the economy grow!
The supply of loanable funds registers people’s current saving
preferences.
Changes in saving behavior for the economy as a whole can stem
from a change in demographics or from a change in attitudes
toward saving.
Suppose that, for whatever reason, people decide to save more.
The loanable funds market
strikes a new equilibrium.
Both saving and investment
increase to $1,000 billion.
The PPF shows how the
increased saving affects the
mix of consumption and
investment.
For a given income, saving
more means consuming less.
The economy moves along the
frontier, as current
consumption is reduced from
$2,200 billion to $1,780
billion.
Resources are shifted away
from production activities aimed
at the present and near-future
and toward production activities
aimed at the more remote
future.
A reshaping of the Hayekian
triangle mirrors the movement along the PPF in the
direction of investment and
depicts the change in the
time dimension in the
production process.
With reduced consumption
demand, the derived demand
for labor and other factors
of production in the late
stages is reduced as well.
In the early stages, demand
for labor and other factors
of production is increased, as
the interest-rate effect
more-than-offsets the
derived-demand effect .
A wage-rate differential during the capital restructuring
encourages workers to move from late stages to early stages.
A wage-rate differential during the capital restructuring
encourages workers to move from late stages to early stages.
Watch the economy respond to an increase in saving.
Watch the economy respond to an increase in saving.
A saving-induced reallocation
of resources among the
stages of production skews
the pattern of consumable
output toward the future.
Early-stage investments
during this transition allow
the increased future demands
for consumption goods to be
accommodated. The economy
grows more rapidly than
before.
People don’t just save; they
save-up-for-something.
Consumption is down only
temporarily—during the
transition to new growth
path.
Now watch
the economy grow!
Now watch
the economy grow!
Now watch
the economy grow!
Accelerated growth driven by an increase in saving entails a
market process in which the interest rate falls and investment
increases.
Policymakers may misunderstand the nature of the process and
believe that low interest rates (rather than increased saving) is
the cause of the increased growth rate.
With this understanding in mind, Congress might enact an
interest-rate ceiling, prohibiting a yield of more than, say,
2.3% on financial assets.
Accelerated growth driven by an increase in saving entails a
market process in which the interest rate falls and investment
increases.
Policymakers may misunderstand the nature of the process and
believe that low interest rates (rather than increased saving) is
the cause of the increased growth rate.
With this understanding in mind, Congress might enact an
interest-rate ceiling, prohibiting a yield of more than, say,
2.3% on financial assets.
The result would be a credit
shortage, which would be
apparent as soon as the
legislation went into effect.
Accelerated growth driven by an increase in saving entails a
market process in which the interest rate falls and investment
increases.
Policymakers may misunderstand the nature of the process and
believe that low interest rates (rather than increased saving) is
the cause of the increased growth rate.
With this understanding in mind, Congress might enact an
interest-rate ceiling, prohibiting a yield of more than, say,
2.3% on financial assets.
The result would be a credit
shortage, which would be
apparent as soon as the
legislation went into effect.
Accelerated growth driven by an increase in saving entails a
market process in which the interest rate falls and investment
increases.
Policymakers may misunderstand the nature of the process and
believe that low interest rates (rather than increased saving) is
the cause of the increased growth rate.
With this understanding in mind, Congress might enact an
interest-rate ceiling, prohibiting a yield of more than, say,
2.3% on financial assets.
With the yield on financial
assets held to 2.3%, the
yield on real assets would rise
to 7.7%, as indicated by the
demand price.
Accelerated growth driven by an increase in saving entails a
market process in which the interest rate falls and investment
increases.
Policymakers may misunderstand the nature of the process and
believe that low interest rates (rather than increased saving) is
the cause of the increased growth rate.
With this understanding in mind, Congress might enact an
interest-rate ceiling, prohibiting a yield of more than, say,
2.3% on financial assets.
With the yield on financial
assets held to 2.3%, the
yield on real assets would rise
to 7.7%, as indicated by the
demand price.
In the face of diminished
incentives to save, people begin
consuming more.
Foiled by the interest-rate
ceiling, people increase their
consumption to $2,480 billion,
moving the economy
counterclockwise along the PPF.
In the face of diminished
incentives to save, people begin
consuming more.
Foiled by the interest-rate
ceiling, people increase their
consumption to $2,480 billion,
moving the economy
counterclockwise along the PPF.
There is now a premium on
producing for the present.
Labor and other resources are
bid away from early stages of
production and into late
stages. The value added at
each stage reflects the yield
on real assets of 7.7%.
There is now a premium on
producing for the present.
Labor and other resources are
bid away from early stages of
production and into late
stages. The value added at
each stage reflects the yield
on real assets of 7.7%.
The market-clearing wage rate
for late-stage labor will be
higher than the marketclearing wage rate for earlystage labor during the period
that the intertemporal capital
structure is adjusting to the
credit ceiling.
Now, watch the economy react to a credit ceiling.
Now, watch the economy react to a credit ceiling.
A lower interest rate imposed
on the market by direct
legislation has a negative
effect—and one that becomes
apparent almost immediately.
A seemingly positive effect—
though only a temporary one—
can be achieved if the interest
rate is lowered not by an act
of Congress but rather by an
act of the central bank.
A lower interest rate imposed
on the market by direct
legislation has a negative
effect—and one that becomes
apparent almost immediately.
A seemingly positive effect—
though only a temporary one—
can be achieved if the interest
rate is lowered not by an act
of Congress but rather by an
act of the central bank.
A lower interest rate imposed
on the market by direct
legislation has a negative
effect—and one that becomes
apparent almost immediately.
A seemingly positive effect—
though only a temporary one—
can be achieved if the interest
rate is lowered not by an act
of Congress but rather by an
act of the central bank.
The Federal Reserve can
increase the money supply by
lending into existence an
additional quantity of money.
Injecting money so as to
drive the interest rate down
to 2.3% is equivalent—at
least in its initial effects—to
imposing an interest-rate
ceiling of 2.3% and then
“papering over the credit
shortage” with newly created
money.
The Federal Reserve can
increase the money supply by
lending into existence an
additional quantity of money.
Injecting money so as to
drive the interest rate down
to 2.3% is equivalent—at
least in its initial effects—to
imposing an interest-rate
ceiling of 2.3% and then
“papering over the credit
shortage” with newly created
money.
Padding the supply of loanable
funds with new money drives a
wedge between saving and
investment.
The easy-money policy obscures
the resulting reduction in saving
while it spurs on investment
activities with a ready supply of
credit at a low rate of interest.
Whereas the problems of an
interest-rate ceiling are
immediately apparent, the
problems of a credit expansion
are pushed into the future—and
are allowed to fester until they
eventually do become apparent.
The conflicting market forces
pit consumers against investors
in a tug-of-war.
The conflicting market forces
pit consumers against investors
in a tug-of-war.
With less saving and more
spending, the behavior of
consumers is consistent with a
counterclockwise movement
along the PPF. But with
production decisions governed
by a low interest rate, the
behavior of investors is
consistent with a clockwise
movement along the PPF.
The conflicting market forces
pit consumers against investors
in a tug-of-war.
Together, consumers and
investors push the economy
beyond its PPF.
The policy-induced combination
of consumption and investment
is unsustainable….
The conflicting market forces
pit consumers against investors
in a tug-of-war.
Together, consumers and
investors push the economy
beyond its PPF.
The policy-induced combination
of consumption and investment
is unsustainable….
…but politically popular,
…regardless of party.
The conflicting market forces
pit consumers against investors
in a tug-of-war.
Together, consumers and
investors push the economy
beyond its PPF.
The policy-induced combination
of consumption and investment
is unsustainable….
Excessively long-term projects
are initiated at the same time
that consumer demand is
unusually high.
The “wedge” and “tug-of-war”
translate into a distortion of
the structure of production.
The Hayekian triangle is being
pulled at both ends against the
middle. The market process is
set against itself as investors
and consumers respond in their
own way to a low rate of
interest.
The resources committed to
the early stages of production
constitute “malinvestment.”
At the same time, other
resources are allocated to the
late stages in response to the
“overconsumption.”
For a time, increased
consumption and increased
investment have their separate
effects. The economy moves
beyond the PPF, producing an
unsustainable level of output.
The tug-of-war between
consumption and investment is
partially won by the
investment, if only because it
has more “pull”—the new money
being lent predominantly to
businesses.
There is an investment bias in
the allocation of resources,
however—as the business
community tries to take
advantage of the artificially
low rate of interest and at the
same time satisfy increased
consumer demand.
The initial movement of the
economy beyond the PPF
constitutes overconsumption
(the upward movement) and
overinvestment (the rightward
movement).
But this is unsustainable, and
the next phase of the cycle
will be a movement back
toward the sustainable PPF.
In this phase of the cycle, a
collapse of the money supply
can give leverage to the
contraction, making the
depression much deeper than
can be accounted for solely in
terms of the prior misallocation
of resources.
The discoordination of the
economy characteristic of a
policy-induced boom-bust cycle
sets the stage for a secondary
contraction—a spiraling of the
economy to some point inside
the PPF.
Watch the economy
respond to an injection of
money through credit
markets!
Watch the economy
respond to an injection of
money through credit
markets!
Common Confusions


For simplicity, the model that has
been produced shows a reduction in
the interest rate causing an
unsustainable boom.
However, all that is needed to initiate
an unsustainable boom is that the
actual interest rate be below the
natural interest rate.
Common Confusions


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.
Roger Garrison, Time and Money: The Macroeconomics of Capital
Structure, London: Routledge, 2001.
Time and Money develops and
defends this capital-based
macroeconomic framework and
compares it to the alternative
frameworks associated with
Keynesianism and Monetarism.
Going beyond the issues of growth
and cyclical variation, the book also
deals with deficit spending, credit
controls, tax reform, and more.
Excerpts from the book plus some
supplementary material can be found
at http://www. auburn.edu/~garriro
F. A. HAYEK