Transcript “Austrian” theory of the business cycle

Austrian Economics in Transition
Harald Hagemann
University of Hohenheim, Stuttgart
Università degli studi di Cassino e del Lazio Meridionale
March 4, 2016
Austrian Economics in Transition
Course Outline
1. The Austrian School in the Interwar Period
2. Schumpeter’s theory of economic development
3. Hayek’s Austrian theory of the business-cycle
Slide 2
March 4, 2016
Austrian Economics in Transition
1. The Austrian School in the Interwar Period
a)
b)
c)
d)
e)
f)
g)
h)
The Family Tree of Austrian Economics
Emigration of Austrian Economists in the 1930s
Monetary theory and business-cycle theory
The socialist economic calculation debate
Capital Theory / The role of time in economics
The theory of international trade
Game theory
General equilibrium theory
Slide 3
March 4, 2016
Austrian
Transition
1. a.) The Family
Tree ofEconomics
AustrianinEconomists
Slide 4
March 4, 2016
Austrian
Economics
in Transition
1. b.) Emigration
of Austrian
Economists
in the 1930s
Nazi Germany 7 April 1933 Restoration of Civil Service Act
- Dismissal of scientists for racial and/or political reasons
Austria March 1938 “Anschluss” to Nazi Germany
221 out of 253 dismissed economists emigrated
51 of them had got their PhD at an Austrian University
50 from the University of Vienna
13 before 1918
37 after 1918
Two observations
1.
2.
Importance of Austrian economics (much higher share relative to population)
The University of Vienna had almost monopolized academic education in Austria,
a situation substantially different from Germany
Slide 5
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Austrian
Economics
in Transition
1. b.) Emigration
of Austrian
Economists
in the 1930s
In Vienna economics in the interwar period was still taught in the law faculty.
1919-26
The three chairs in economics formerly held by Böhm-Bawerk, Wieser
and Carl Grünberg became vacant. Neither of them went to Schumpeter or
Mises who had the proper age and excellent publications such as
Schumpeter (1911), The Theory of Economic Development
Mises (1912), The Theory of Money and Credit
Instead the three chairs went to
 Othmar Spann, a reactionary and antisemitic supporter of the corporate state who
strongly opposed the methodological individualism of the Austrian School.
 Count Ferdinand Degenfeld-Schonburg, and
 Hans Mayer, whose contributions on value, price and utility theory and the
imputation problem did not make a lasting impact.
Slide 6
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Austrian
Economics
in Transition
1. b.) Emigration
of Austrian
Economists
in the 1930s
This was a clear signal for promising young economists on the low career
prospects, particularly for Jews, social democrats, and liberals.
Therefore many of them had left Austria long before 1938
Schumpeter
Hayek
Freiburg
Machlup
Princeton
Haberler
Mises
1925  Bonn
1931  LSE
1932  Harvard
1950  Chicago
1962 
1933  SUNY Buffalo
1950  Johns Hopkins
1961 
1934  Geneva
1934  Geneva
1936  Harvard
1940  New York
Many of them had been in the U.S. before with a two-years fellowship of the
Rockefeller Foundation
Morgenstern
since
1938  Princeton
1930 managing editor of the Zeitschrift für Nationalökonomie
Slide 7
March 4, 2016
Economics
in Transition
1. c.) Monetary Austrian
theory and
business-cycle
theory
Since Menger’s article ‘On the Origin of Money’ (EJ 1892) and his
contribution on ‘Money’ to the Handwörterbuch der Staatswissenschaften
monetary theory had been a major subject of Austrian economics. Ludwig von
Mises’s Theory of Money and Credit may be regarded as a typical outcome of
the ideas of the Austrian School.
Against the background of the hyperinflationary processes in Austria and
Germany after the end of World War I Mises made important revisions in the
second edition of the book published in 1924. Whereas in 1912 Mises still had
stressed that the primary impulse for a boom does not proceed from excessive
credit creation, and located only one of several possible causes for economic
fluctuations in the credit sector (see Mises, 1912: 434), he now identified
banks as the main culprits responsible for an excessive credit creation by
artificially lowering the rate of interest on loans below the natural rate, thereby
inducing a period of unsustainable expansion. The inevitable consequence of
such a credit-induced boom is a bust.
Slide 8
March 4, 2016
Economics
in Transition
1. c.) Monetary Austrian
theory and
business-cycle
theory
Mises’s argument that excessive credit by the banking sector is the decisive cause of
cyclical fluctuations is most clearly stated in his Monetary Stabilization and Cyclical
Policy (1928). The natural rate of interest is that rate which tends towards equilibrium
on the market or, what Mises later preferred to call ‘the final state of rest’. Any
prosperity brought about by the availability of easy credit according to Mises could be
logically proved to be an illusory one. The ‘mania for lower interest rates’ generates
a monetary policy which, sooner of later, must necessarily always lead to crisis and
depression.
Mises saw a remedy against the mania for lower interest rates and excesses of credit
creation in the free banking alternative. There bankers would recognize soon that it is
in their own interest to restrain the issue of fiduciary media. While not entirely
eliminating economic fluctuations, economic crises would be much reduced. Mises
(1928) thus became an early advocate of free banking as the alternative to a centralized
monopolistic banking system, which some years later became the subject of
investigation in the doctoral dissertation of Vera Smith The Rationale of Central
Banking and the Free Banking Alternative (1936) written under the supervision of
Hayek at the LSE.
Slide 9
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Austrian
Economics
in Transition
1. d.) The socialist
economic
calculation
debate
E. Barone (1908), ‘The Ministry of Production in the Collectivist State`
in F.A. Hayek (ed.) (1935), Collectivist Economic Planning:
Critical Studies on the Possibility of Socialism
British debate in the 1930s
Hayek versus the so-called ‘neoclassical socialists’ Lange, Lerner and Dickinson
German language debate in the 1920s
Foundation of socialization committees in Austria and Germany after WWI
Activists Otto Bauer, Rudolf Hilferding and Emil Lederer were fellow students of
Schumpeter and Mises in Böhm-Bawerk’s seminar in 1905
Schumpeter was a member of the German Socialization Commission
Jan.-March 1919, when he had to resign because of his appointment of Austrian
Minister of Finance
Slide 10
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Austrian
Economics
in Transition
1. d.) The socialist
economic
calculation
debate
Key topic: question of how socialist planners might grapple with the allocation
problems of a complex society
It was Ludwig von Mises (1920) who in a famous paper developed the thesis that
economic calculation in a socialist commonwealth is impossible because there is no
price formation on free markets, and therewith launched the socialist calculation debate
in the German language area in the 1920s, which found its sequel in Britain in the
1930s.
It should be pointed out, that Mises only fully developed his essential argument that the
economy is in a process of permanent change and that therefore the data necessary for
efficient planning are not available, only in the second 1932 edition of his book on
socialism (Gemeinwirtschaft 1922), in which he sharpened his thesis not least because
of the critique which had been raised against his views by Jacob Marschak, Karl
Polányi and others. All the more so this holds for Hayek’s important writings since
1935 in which he developed the argument on the dispersion of knowledge and the
problem of decision-making with uncertainty and incomplete information.
Slide 11
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Austrian
Economics
Transition
1. e.) Capital Theory
/ The
role of in
time
in economics
According to Machlup (1982) the essential components of Austrian economics consist
of
(1)methodological individualism
(2)methodological subjectivism
(3)tastes and preferences
(4)the concept of opportunity costs
(5)marginalism and the
(6)time structure of production.
From the perspective of late twentieth-century Austrian economics Kirzner (1994, I:
XIX) criticizes Machlup for the absence of emphasis on markets and competition as
processes of learning and discovering in an environment of Knightian uncertainty.
Kirzner, I. M. (ed.) (1994), Classics in Austrian Economics. A Sampling in the History
of a Tradition, 3 vols., London: Pickering & Chatto.
Slide 12
March 4, 2016
Austrian
Economics
Transition
1. e.) Capital Theory
/ The
role of in
time
in economics
The time structure of production is particularly relevant for questions of
capital theory which in its Austrian form had been mainly shaped by BöhmBawerk. The Austrian theory of capital and Böhm-Bawerk’s concept of the
average period of production played a significant role in the famous ‘triangle
chapter’ of Hayek’s Prices and Production. However, the 1930s were
characterised by a capital controversy which was as fierce as the later
Cambridge-Cambridge controversy in the 1960s. A key axis of the capital
debate in the 1930s was the Hayek-Knight controversy. It was Oskar
Morgenstern in particular who gave contributions on capital theory and the
role of time in economics, to which his friend Paul Rosenstein-Rodan (1930)
had already made an important contribution in the very first issue, prominent
space in the Zeitschrift für Nationalökonomie.
Slide 13
March 4, 2016
Austrian
Economics
Transition
1. e.) Capital Theory
/ The
role of in
time
in economics
Morgenstern (1935) himself also published an important paper in
which he contributed to the critique of the average period of
production a concept which Hayek finally gave up in his Pure
Theory of Capital (1941), a project into which Hayek had
embarked in 1934 to defend the core of Austrian capital theory
against Knight and other critics. His adoption of the notion of a
multidimensional heterogeneous capital structure left the readers
puzzled over the remains of an Austrian theory of capital.
Slide 14
March 4, 2016
Economicstrade
in Transition
1. f.) The theoryAustrian
of international
Haberler’s work in international economics in the
interwar period has been often and rightly celebrated
for brilliant theoretical innovations (Baldwin QJE
1982, Samuelson, Obituary, EJ 1996). Undoubtedly,
his most important theoretical contribution was the
reformulation of Ricardo’s theory of comparative costs
in his article ‘The Theory of Comparative Costs and its
Use in the Defence of Free Trade’ (Haberler 1930), in
which he introduced the ‘production substitution
curve’, today’s production-possibility frontier or
transformation curve, allowing for several factors of
production. Haberler’s contribution revolutionised the
theory of international trade and paved the way for the
subsequent work of Ohlin, Samuelson and others.
Slide 15
March 4, 2016
Economicstrade
in Transition
1. f.) The theoryAustrian
of international
In his later textbook The Theory of International Trade (1933)
Haberler made full use of his new concepts and, moreover,
integrated real and monetary aspects of international economics,
also employing supply and demand functions in the analysis of
currency markets. He also integrated international aspects into his
theory of economic fluctuations. In this respect the chapter on the
international aspects of business cycles in Prosperity and
Depression has to be regarded as a highly innovative
contribution. Haberler’s discussion of how the degree of capital
mobility and the exchange rate system influence the international
transmission of business cycles is particularly noteworthy.
Slide 16
March 4, 2016
Austrian Economics in Transition
1. g.) Game theory
von Neumann, John, Morgenstern, Oskar, Theory of Games and
Economic Behaviour, Princeton UP 1944. The cooperation
between the two authors was only realized at the Institute for
Advanced Study in 1939-43.
The roots of game theory can be traced back to Morgenstern’s
Vienna habilitation thesis on economic forecasting (1928), which
had been written while Morgenstern was a Rockefeller
Foundation Fellow in the USA 1926–27, and to his 1935 article
on ‘Perfect Foresight and Economic Equilibrium’. In these
writings Morgenstern emphasized the incompatibility of perfect
foresight and economic equilibrium. Morgenstern had early on
recognized that in the great majority of human actions the
decision maker faces one or more other decision makers who can
either cooperate with him or compete or confront him.
John von Neumann (1928) Zur Theorie der Gesellschaftsspiele.
Slide 17
March 4, 2016
Austrian Economics in Transition
1. g.) Game theory
Slide 18
March 4, 2016
Austrian Economics
1. h.) General equilibrium
theory in Transition
Mathematical Colloquium
Karl Schlesinger gave a seminar ‘On the Production Equations
of Economic Value Theory’ in March 1934, in which he
discussed the question of a general, positive and unique solution
of a general equilibrium system. He stimulated Abraham Wald
to give the first consistent proof for the existence of a general
equilibrium for a stationary economy a year later. It was then
John von Neumann who in 1936 in Menger’s Vienna
Colloquium expanded the proof for the general case of a growing
economy.
Considering most Austrian economists’ neglect, often hostility
towards mathematical methods, it is not without a certain irony
that the two areas of game theory and general equilibrium theory
are highly mathematical and that Carl Menger’s son Karl played a
major role in the latter field.
Slide 19
March 4, 2016
Economics
in Transition
1. The Austrian Austrian
School in
the Interwar
Period
Conclusion
Austrian economics in the interwar period was certainly wrestling with capital
and time, equilibrium and business cycles as well as the possibilities and
limitations of economic socialism. The preceding short survey of important
contributions of Austrian economics in the interwar period has shown that
Boehm (1992: 1) was right in his assessment that ‘interwar Austrian economic
thought is a venture of many dimensions that does not easily lend itself to a
reduction to some invariable standard. The label “Austrian economics” is
merely a shorthand expression for what is, in fact, an ill-defined body of ideas
with many facets’. Boehm also pointed out ‘that in the 1930s Austrian
economics […] suffered from a series of blows it proved rather difficult to
recover from […], notably in the Hayek–Sraffa exchange, the capital
controversies, and the debates with the Keynesians’ (ibid: 3), an assessment
which is heavily strengthened by Mark Blaug in his commentary.
Slide 20
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Austrian Economics in Transition
2. Schumpeter’s theory of economic development
a) From ‘crisis theory’ to ‘business-cycle theory’
b) Schumpeter’s ‘Triad’: Innovations, pioneering entrepreneurs and
bank credit
c) The ‘Schumpeter-Hahn cycle’ versus the ‘Mises-Hayek cycle’
d) Business cycles and growth cycles: Schumpeter’s fascination by
Kondratieff’s ‘long waves’
e) The ‘lost seventh chapter’: Schumpeter and the German Historical
School
Slide 21
March 4, 2016
Schumpeter‘s
theory of economic
development
Economics
in Transition
2. Schumpeter‘s2.Austrian
theory
of economic
development
Joseph A. Schumpeter (1883 - 1950)
1908:
Habilitation in Vienna
Das Wesen und der Hauptinhalt der theoretischen Nationalökonomie
1909:
a.o. Professor Czernowitz
1911:
Professor Graz
1912:
Theorie der wirtschaftlichen Entwicklung
(1934 Theory of Economic Development)
1919:
Austrian Finance Minister
1921:
President Biedermann Bank
1925:
Professor, University of Bonn
1932:
Harvard University
1939:
Business Cycles: A Theoretical, Historical, and Statistical Analysis of the
Capitalist Process (German 1961)
1942:
Capitalism, Socialism and Democracy
1954:
History of Economic Analysis
Slide 22
March 4, 2016
Austrian Economics
in Transitiontheory’
2. a.) From ‘crisis-theory’
to ‘business-cycle
In the Preface to the first German edition of The Theory of
Economic Development Schumpeter (1911, p. VIII) points out that
he had started his analysis with the concrete theoretical issues
involved in the crisis problem in 1905. Furthermore, he makes clear
that this book and his earlier one on Das Wesen und der Hauptinhalt
der theoretischen Nationalökonomie (The Nature and the Main
Content of Theoretical Economics) (Schumpeter 1908) form an
entity, although the second one can be read independently of the
first one. The division of labour between the two books can be
understood best with regard to the two masters Walras,
Schumpeter's great hero, and Marx, whose views on the long-run
development of the capitalist economy form a life-long challenge
for Schumpeter.
Slide 23
March 4, 2016
Austrian Economics
in Transitiontheory’
2. a.) From ‘crisis-theory’
to ‘business-cycle
In the Preface to the Japanese edition he emphasizes that Walras provided
us with a theory which embraces “the pure logic of the interdependence
between economic quantities”, whereas Marx's genuine contribution to
economics is “a vision of economic evolution as a distinct process
generated by the economic system itself” (Schumpeter 1937, pp. 165-6).
This corresponds to the distinction between static and dynamic analysis,
which plays a major role in his work. Due to the influence of Frisch in
contrast to the 1926 German edition in the 1934 English edition the terms
“statics” and “dynamics” are fully replaced by the concepts of the
“circular flow” and “economic development”.
Slide 24
March 4, 2016
2.Austrian
Schumpeter‘s
theory of economic
development
Economics
in Transition
2. b.) Schumpeter‘s
‘Triad’
Accordingly, Schumpeter’s economic dynamics deals with the changing
of the data of the static system, or the destruction of the circular flow by
the carrying out of new combinations that includes the five cases of the
introduction of new methods of production, new products, the opening of
new markets, new sources of supply, and new forms of organization. In
Schumpeter’s system economic dynamics is strongly linked to the
phenomenon of economic development. The main carrier of economic
development is the pioneering entrepreneur, who is an endogenous
force in the economy and in marked contrast to the great majority of
people limited to taking routine actions only.
Slide 25
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
In Schumpeter’s view not only the final chapter 6 but in fact any single
page of his Theory of Economic Development is dedicated to the problem
of the business cycle, and analyzing business cycles “means neither more
nor less than analyzing the economic process of the capitalist era”
(Schumpeter 1939, p. V). Economic Development in the sense of
Schumpeter is endogenous, spontaneous and discontinuous. It is the task
of dynamic theory to explain the origin and effects of these transition
processes which essentially are a disturbance of equilibrium.
Slide 26
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (1)
The importance of innovations and credit is at the very
center of Schumpeter’s Theory of Economic Development. As Streissler has emphasized, it were not the figure
of the pioneering entrepreneur and the importance of
bank credit for economic development that were new in
Schumpeter but rather the idea of creative destruction
by innovations and the notion that bank credit was the
prerequisite of innovations and of the foundation of new
enterprises.
Slide 27
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (2)
The innovating entrepreneurs need financial means for
their investment activity which is given to them in form
of credit by the banking system. Schumpeter shares
Wicksell’s view that the disturbance of economic
equilibrium primarily emerges because of an enlargement
of profitable investment options, leading to an increase of
the natural rate of interest in Wicksell’s Interest and
Prices (1898), rather than by a lowering of the money
rate of interest below the level of the natural rate by the
banks, thereby causing a period of expansion which is
unsustainable.
Slide 28
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (3)
The latter is emphasized in the works of his two compatriots
Hayek’s Prices and Production and Mises’s Theory of Money
and Credit. There, the bust is the inevitable consequence of
the credit-induced boom in which the reallocation to
excessively roundabout methods of production is corrected.
Mises’s argument of excessive credits by the banking sector as
the decisive cause of cyclical fluctuations is most clearly
stated in his Monetary Stabilization and Cyclical Policy
(1928), in which he not only distances himself from views still
held by Schumpeter but even from his own earlier views.
Slide 29
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (4)
Schumpeter’s assumption that available resources are fully
utilized in the stationary circular flow implies that the carrying
out of new combinations requires a different employment or
reallocation of these resources. The entrepreneur must resort
to credit if she wishes to carry out new combinations since
they cannot be financed by the returns from established
production activities. Schumpeter also considers “saving” as a
result of previous development. The financing of innovations
by means of credit is the function of the banking system. In
Schumpeter’s view the banker is not the trader but the
producer of purchasing power. “[C]redit is essentially the
creation of purchasing power for the purpose of transferring it
to the entrepreneur, but not simply the transfer of existing
purchasing power” (Schumpeter 1934, p. 107).
Slide 30
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (5)
The consequence of the creation of new purchasing power
“out of nothing”, i.e. not rooted in previous savings, is an
increase of aggregate demand in monetary terms, which leads
to an increase in prices. The credit-induced inflation acts as a
tax on the mere managers stiffened in routine actions thereby
implying a reallocation of productive resources. Although
interest on capital is a monetary phenomenon, it is ultimately
based on a real factor: the productivity-enhancing effects of
innovations. Schumpeter thus makes forced savings, which
play an important role in the analyses of his contemporaries
Wicksell, Mises, Hayek and Robertson (“imposed lacking”)
but were already an argument in Henry Thornton as early as
1803, an integral part of his theory.
Slide 31
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (6)
However, in contrast to Mises and Hayek who were adherents of the
orthodox doctrine that only voluntary savings can create sustainable
capital and held the view that the granting of a volume of credit
which transcends the level of voluntary savings by the banking
system inevitably leads to a crisis, the creation of money and credit
for Schumpeter is an essential condition for the financing of
innovational activities and thus development in competitive
capitalism. Moreover, “the credit system is no very active factor in
the mechanism of cycles. It adapts itself to the demand which comes
from entrepreneurs and submits to contraction by their repayment of
loans. In both cases its role is rather a passive one” (Schumpeter
1931, p. 17).
 idea of endogeneity
Slide 32
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Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (7)
Schumpeter opposed the idea that the succession of prosperity and depression
is a purely monetary phenomenon. Three factors are considered:
1. The competition for the scarce means of production causing price increases
of investment goods in the boom.
2. The decline in prices when the new products enter the markets as the
consequence of the enlarged productive capacities, thereby making a
depression unavoidable.
3. Then the entrepreneurs use their returns for paying back their debts causing
a credit deflation just in that period when the additional goods which could
take away inflationary pressure as a consequence of the “abnormal” credit
inducing the boom could be produced in a regular manner.
Slide 33
March 4, 2016
Austrian
Economics in Transition
2. b.) Schumpeter‘s
‘Triad’
Credit and Innovations in Schumpeter’s BCT (8)
Schumpeter’s views found the most innovative resonance in
the contemporary German literature in Lucien (L.) Albert
Hahn’s Volkswirtschaftliche Theorie des Bankkredits
(Economic Theory of Bank Credit) (1920), a fact which is
explicitly emphasized by Schumpeter in the second edition of
TED when he refers the reader to Hahn’s “original and
meritorious book, which has essentially advanced our
knowledge of the problem” at the beginning of his discussion
of the nature and function of credit (Schumpeter 1934, p. 95,
fn. 1).
Slide 34
March 4, 2016
2. c.) The ‘Schumpeter-Hahn
cycle’ versusinthe
‘Mises-Hayek cycle’
Austrian Economics
Transition
L. Albert Hahn’s Economic Theory of Bank Credit
Hahn emphasizes, as later Keynes, the deflationary effects of voluntary
savings and the positive effects of an expansionary credit policy for
innovations and employment. A key statement reads:
“Capital formation is not the result of saving but of credit.”
(Hahn 1920, p.120)
Hahn takes up Schumpeter’s distinction between “normal” and
“abnormal” credit and elaborates the distinction between
“non-inflationary” credit (in the amount of overall savings) and
inflationary credit due to the money-creating ability of the banking
sector.
Slide 35
March 4, 2016
2. c.) The ‘Schumpeter-Hahn
cycle’ versusinthe
‘Mises-Hayek cycle’
Austrian Economics
Transition
Schumpeter vs. Hahn (1)
However, Schumpeter (1926) in the 2nd German edition
of TED, feels obliged to keep some distance from Hahn,
whose much stronger emphasis on the directly
production-enhancing effects of an inflationary credit
creation caused his accusation as an “inflationist”, when
he points out: “Against his formulation it appears to me
correct to say: although not by existing goods, the
quantity of new purchasing power that it is possible to
create is supported and limited by future goods.” (p. 165)
Slide 36
March 4, 2016
2. c.) The ‘Schumpeter-Hahn
cycle’ versusinthe
‘Mises-Hayek cycle’
Austrian Economics
Transition
Schumpeter vs. Hahn (2)
It is clear that for Schumpeter the spending of credit for
innovative investments is decisive, not for increased
consumption. This becomes particularly evident in his
statements on capital which is regarded as a fund of
purchasing power. “Capital is nothing but the lever by
which the entrepreneur subjects to his control the
concrete goods which he needs, nothing but a means of
directing the factors of production to new uses, or of
dictating a new direction for production.” (TED 1934,
p.116).
Slide 37
March 4, 2016
Austrianand
Economics
Transition
2. d.) Business cycles
growth in
cycles
The Business Cycle as a Superposition of Different Waves (1)
In his Business Cycles, Schumpeter (1939) distinguishes four phases of
economic fluctuations: prosperity, recession, depression and recovery, and
presents a three-cycle schema, in which Kondratieff long-waves
constitute the framework where they are combined with the classical
Juglar and the shorter Kitchin cycles. In the preface to the English edition
of TED we find the following statement: ”I took it for granted that there
was a single wave-like movement, viz. that discovered by Juglar. I am
convinced now that there are at least three such movements, probably
more, and that the most important problem which at present faces theorists
of the cycle consists precisely in isolating them and in describing the
phenomena incident to their interaction. But this element has not been
introduced into the later editions” (1934, p. IX).
Slide 38
March 4, 2016
Austrianand
Economics
Transition
2. d.) Business cycles
growth in
cycles
The Business Cycle as a Superposition of Different Waves (2)
This statement is not surprising because the Kitchin and the
Kondratieff cycle were born in the economic literature only in the
1920s. Schumpeter himself was the co-editor of the journal in which
Kondratieff’s famous article on “The long waves in economic life”
was published in German in 1926. However, it is quite interesting to
notice that the idea of superposition of different complexes of
causality was already there when Schumpeter presented the main
ideas on the wave-like fluctuation in economic activity to the
Harvard faculty shortly before the outbreak of World War I.
Slide 39
March 4, 2016
Austrianand
Economics
Transition
2. d.) Business cycles
growth in
cycles
The Business Cycle as a Superposition of Different Waves (3)
Kondratieff (1)-,
Juglar (2)- and
Kitchin (3)-Cycles
Schumpeter’s basic idea that cyclical
fluctuations consist of many waves:
a composite of three cycles of different
length.
Source: Schumpeter (1939), p. 213
Slide 40
March 4, 2016
Austrianand
Economics
Transition
2. d.) Business cycles
growth in
cycles
• Business Cycles
– Kitchin cycle
Length: 3-5 years
Inventory investment
– Juglar cycle
Length: 7-11 years
Machinery equipment
• Growth Cycles
– Kuznets cycle
Length: 15-25 years
Investment in buildings
– Kondratieff cycle Length: 45-60 years
Basic capital innovations
Slide 41
March 4, 2016
Austrianand
Economics
Transition
2. d.) Business cycles
growth in
cycles
The jerky character of economic evolution can hardly be
denied and it is one of Schumpeter’s great merits to emphasize
the importance of integrating the study of business cycles
with an analysis of long-run economic development which
does not follow a steady-state or balanced growth path.
Innovations are not only the decisive impulse of cyclical
fluctuations but the period of their implementation also
determines the different length of the cycles. With some
qualification with regard to the Kitchin the simultaneous
presence of cycles of different order for Schumpeter “is a
problem of interference only and not … a problem of different
causation.“
Slide 42
March 4, 2016
Austrianand
Economics
Transition
2. d.) Business cycles
growth in
cycles
Schumpeter’s monocausality argument also is at odds with the
later understanding of economic theory that the cycles of
different duration are related to different types of investment
goods as the causal factor, i.e. that we have to distinguish
between fluctuations in inventories (Kitchin), fluctuations in
fixed capital investment (Juglar or Marx’s echo effect),
fluctuations in construction investment (Kuznets) and
fluctuations in basic capital goods as the medium for basic
innovations (Kondratieff). Although Schumpeter was willing to
consider and integrate the most recent and important
developments in economic theory, he clearly did not want to
change his early vision laid down in his theory of economic
development.
Slide 43
March 4, 2016
Austrianand
Economics
Transition
2. d.) Business cycles
growth in
cycles
Name
Kitchin cycle Juglar cycle
Type
Business Cycle
Business Cycle
Length
3-5 years
7-11 years
15-25 years
45-60 years
Fluctuations in
fixed capital
investments
Fluctuations in
construction
investments
Fluctuations in
basic
innovations
and/or basic
capital goods
Causal Factor Fluctuations in
inventories
Kuznets
cycle
Kondratieff
cycle
Growth Cycle
Long Waves
Slide 44
March 4, 2016
2. e.) The ‘lost seventhAustrian
chapter’: Schumpeter
and in
theTransition
German Historical School
Economics
Long Waves of Economic Cycles (1)
Long
Waves
Important
Innovations
Prosperity
Recession
Depression
Recovery
1.
Industrial Revolution
(Division of labour,
steam engine)
1782-1802
1802-1825
1825-1836
1836-1845
2.
Railroads, Steel
Mechanization
1845-1866
1866-1872
1872-1883
1883-1892
3.
Electricity, Automobiles,
Chemical Industry
1892-1913
1914-1929
1929-1937
1938-1948
4.
Atomic Energy,
Computer, Robots,
Electronics
1948-1966
1966-1973
1973-1982
1982-1995
5.
Information and
Communication
Technologies,
Biotechnologies
1995-
Slide 45
March 4, 2016
2. e.) The ‘lost seventhAustrian
chapter’: Schumpeter
and in
theTransition
German Historical School
Economics
Long Waves of Economic Cycles (2)
In the “lost seventh chapter” of the first German edition
of The Theory of Economic Development (Schumpeter
1911) ‘Das Gesamtbild der Volkswirtschaft’ (The Overall
View of the Economy), Schumpeter had analysed already
the theoretical and historical development problem and
emphasized the importance of statistical analysis. He
recognized that economic development is essentially
discontinuous since innovations arise unevenly over the
various industries. Entrepreneurs are followed by many
imitators so that innovations tend to cluster.
Slide 46
March 4, 2016
Austrian Economics in Transition
3. Hayek’s Austrian theory of the business-cycle
a)
Equilibrium and the business cycle: The methodological
challenge by Adolph Lowe
b) Wicksell’s distinction between the market rate and the natural
(equilibrium) rate of interest
c) Monetary overinvestment: Mises’s theory of money and
credit
d) The time structure of the production process: Triangles and
Böhm-Bawerk’s theory of capital
e) Cantillon effects
f) Ricardo effects
Slide 47
March 4, 2016
Austrian
Economics
in Transition
3. Hayek‘s Austrian
theory
of the business-cycles
Friedrich August Hayek (1899-1992)
1927 – 1931:
Founding Director of the Austrian Institute for
Business-Cycle Research in Vienna (today‘s
WIFO)
1928:
Habilitation in Vienna
1929:
Geldtheorie und Konjunkturtheorie
(Monetary Theory and the Trade Cycle, 1933)
1931:
Prices and Production
London School of Economics
(Tooke Professor of Political Economy)
1941:
The Pure Theory of Capital
1950:
Chicago
1961:
Freiburg
1974:
Nobel prize together with Gunnar Myrdal
Slide 48
March 4, 2016
Austrian
Economics
in Transition
3. Hayek‘s Austrian
theory
of the business-cycles
•
Hayek’s Business-cycle theory is a combination of five building
blocks (Prices and Production, 1931)
(1)
Wicksell’s theory of the cumulative process where price changes are
caused by the discrepancy between the market rate and the natural
(equilibrium) rate of interest;
(2)
Mises’s theory of money and credit in which banks artificially lowering
the money (market) rate of interest are responsible for overinvestment and
a misallocation of resources which necessarily has to be corrected.
(3)
Böhm-Bawerk’s theory of capital with its emphasis on the time structure
of the production process;
(4)
Cantillon effects of changes in the money supply on the price structure
and hence on the structure of production (non-neutrality of money);
(5)
Ricardo effects of a shortage of consumption goods on the production of
investment goods (disproportionality of circulating and fixed capital).
Slide 49
March 4, 2016
Austrian Economics
in Transition
3. a.) The methodological
challenge
by Adolf Lowe
Equilibrium and the Business Cycle (1)
• Lowe’s methodological challenge:
–
–
–
–
The abandonment of static equilibrium theory by Lowe and, among others,
endorsed by Kuznets.
the defence of the equilibrium method by dichotomizing the cycle from the
trend and by introducing money and credit as a propagation mechanism for
cyclical fluctuations in an existing equilibrium configuration, as it was the case
in Hayek's response to Lowe's challenge.
a path-dependent approach without an a priori trend line, as it had been
developed by Schumpeter.
the defence of the prevailing equilibrium approach by denying the need for
the development of a general theory of the business cycle since the business
cycle does not exist and the real problem of analysing concrete-historical cases
of fluctuations with a variety of different factors at work, could be completely
dealt with within the framework of a modern static equilibrium approach (Lutz
1932).
Slide 50
March 4, 2016
Austrian Economics
in Transition
3. a.) The methodological
challenge
by Adolf Lowe
Equilibrium and the Business Cycle (2)
• Lowe: how is business cycle theory possible at all?
“The business cycle problem is not a reproach for, but a reproach
against the static system, because in it it is an antinomic problem. It is
solvable only in a system in which the polarity between upswing and
crisis arises analytically from the conditions of the system just as
undisturbed adjustment derives from the conditions of the static
system. Those who wish to solve the business-cycle problem must
sacrifice the static system. Those who adhere to the static system must
abandon the business-cycle problem.” (Lowe [1926] 1997: 267)
• Kuznets regarded “the equilibrium approach … to be a blind alley
from the point of view of business-cycle theory” (QJE, 1930: 399)
• “… the practice of treating change as a deviation from an imaginary
picture of a rigid equilibrium system must be abandoned” (ibid.:415)
Slide 51
March 4, 2016
Austrian Economics
in Transition
3. a.) The methodological
challenge
by Adolf Lowe
Equilibrium and the Business Cycle (3)
•
•
•
Hayek: The logic of equilibrium theory “properly followed through, can do no
more than demonstrate that such disturbances of equilibrium can only come
from outside - i.e. that they represent a change in the economic data - and that
the economic system always reacts to such changes by its well-known methods
of adaptation, i.e. by the formation of a new equilibrium.” (Hayek 1933: 42-43)
The incorporation of cyclical phenomena into equilibrium theory is the crucial
problem of business-cycle theory and that, accordingly, cycles should be
explained as endogenous outcomes of market processes.
Money and credit as a decisive endogenous propagation mechanism for
business cycles.
• “Yet the concept of equilibrium is just as indispensable a tool for the
analysis of temporal differences in prices as it is for any other investigation
in economic theory. Strictly speaking, its field of application is identical
with that of economic theory, since only with its assistance is it possible to
give a summary depiction of the very great number of different tendencies
of movement which are operative in every economic system at every point
in time.” (Hayek [1928] 1984: 75; emphasis added)
Slide 52
March 4, 2016
Austrian Economics
in Transition
3. a.) The methodological
challenge
by Adolf Lowe
Hayek – Lowe debate (1926 - 33)
•
Hayek agrees with Lowe
-
that the integration of business-cycle phenomena into the system of the theory of
economic equilibrium is the decisive problem of business-cycle theory,
-
in the claim for an explanation of business cycles by an endogenous theory,
-
in his emphasis on the importance of production structures.
•
Hayek differs from Lowe
-
in his adherence to general equilibrium theory also in the explanation of business
cycles ( Lucas and modern equilibrium business-cycle theory, EBC),
-
in identifying money and credit instead of technical progress as the decisive
endogenous factor,
-
in using a vertical instead of a horizontal production structure.
Slide 53
March 4, 2016
Austrian Economics
in Transition
3. a.) The methodological
challenge
by Adolf Lowe
“Old” roots for the Lucas project?
• Lucas “Understanding Business Cycles” 1977: 7 “(…) the
incorporation of cyclical phenomenon into the system of economic
equilibrium theory, with which they are in apparent contradiction,
remains the crucial problem of Trade Cycle Theory” (Hayek [1933]:
33n.)
• “By “equilibrium theory” we here primarily understand the modern
theory of the general interdependence of all economic quantities, which
has been most perfectly expressed by the Lausanne School of
theoretical economics” (Hayek [1933]: 42n.)
Slide 54
March 4, 2016
3. b.) Wicksell‘s distinction
betweenEconomics
the market ratein
andTransition
the natural rate of interest
Austrian
Wicksell’s theory of the cumulative process (1)
It was Wicksell's main achievement to have elaborated an analysis
in which time and money are subjected to the marginal principle.
The market rate of interest serves the double function of
coordinating the supply and demand for all loanable funds and at the
same time the supply and demand for real capital in terms of saving
and investment. An increase (decrease) in savings due to a change in
individuals’ intertemporal preferences would lead to a lower
(higher) rate of interest and a lengthening (shortening) or more
(less) roundabout method of production. The natural rate of interest
acts as the centre of gravitation for the market rate of interest which
in monetary equilibrium also equals the marginal physical
productivity of real capital.
Slide 55
March 4, 2016
3. b.) Wicksell‘s distinction
betweenEconomics
the market ratein
andTransition
the natural rate of interest
Austrian
Wicksell’s theory of the cumulative process (2)
Wicksell’s ideas on the dis- and reequilibrating mechanism of
divergences between the money and the natural rate of interest
provided an important building block for Austrian business-cycle
theory as it was developed by Mises and particularly Hayek, who
combined Wicksell’s analysis of the cumulative processes with the
doctrine of “forced saving” (see “A Note on the development of the
doctrine of ‘forced saving’” (1932); reprinted as chapter VII in
Hayek 1939) to generate a monetary theory of the business cycle in
which injections of money or bank credit lead to overinvestment
and thereby to a distortion in the time structure of production which
is unsustainable. In principle two major impulses which can cause a
divergence between the two rates of interest have to be
distinguished:
Slide 56
March 4, 2016
3. b.) Wicksell‘s distinction
betweenEconomics
the market ratein
andTransition
the natural rate of interest
Austrian
Wicksell’s theory of the cumulative process (3)
1. an improvement in profit expectations due to technical progress which
causes an increase in the natural rate of interest and investment
demand;
2. a generous granting of credit by the banking system which leads to a
fall of the money rate of interest below the natural rate.
Whereas the first impulse is real and a “natural” one, the second impulse
is a monetary one and, in the view of Mises and Hayek, “artificial”.
Although Wicksell mainly elaborated his cumulative process analysis for a
better understanding of changes in the general level of prices and his
business-cycle theory remained a fragment or an “enigma” (Wicksell
[1907] 1951), we have to note that “Wicksell was, in short, so impressed
by the real elements in cyclical fluctuations, and in particular those
involving investments activity that he treated monetary aspects of the
cycle as peripheral.” Laidler (1991: 146)
Slide 57
March 4, 2016
3. b.) Wicksell‘s distinction
betweenEconomics
the market ratein
andTransition
the natural rate of interest
Austrian
Wicksell’s theory of the cumulative process (4)
Thus Wicksell emphasizes technology shocks and perceives in real
factors which lead to an increase in the natural rate of interest the
essential reason for business cycles.
With the emphasis on technical progress Wicksell stood in the
German tradition of such diverse authors as Marx and Schumpeter.
In the contemporary debate with Hayek and Mises this argument
was made by Löwe and Burchardt who, with explicit reference to
Wicksell, pointed out that, although changes in the market rate of
interest are important for movements of the price level, the real
impulse for the disturbance of equilibrium is given by technical
progress which increases the natural rate.
Slide 58
March 4, 2016
3. c.) Monetary overinvestment:
Mises‘s theory
of money and credit
Austrian Economics
in Transition
Ludwig von Mises had established himself as the first leading
representative of a monetary theory or credit view of the business
cycle in the German language area with the publication of his The
Theory of Money and Credit (1912). Mises can be recognized as the
pioneer of a typically “Austrian” theory of the business cycle. It is
a central element of his “circulation credit theory” that the banking
system grants a volume of credit which transcends the level of
voluntary savings, thereby causing a misallocation of resources.
The boom thus contains the seed of its later correction.
Slide 59
March 4, 2016
3. c.) Monetary overinvestment:
Mises‘s theory
of money and credit
Austrian Economics
in Transition
Mises took over the theorem of the two interest rates from
Wicksell. However, he criticised the latter for concentrating too
narrowly on the effects of this divergence on the absolute level of
prices, thereby overlooking the impact of additional credit for the
structure of production. The expansion of credit and the lowering
of the money rate of interest below the natural rate creates an
artificial or “unhealthy boom” (Mises [1936] 1983: 4) in which
entrepreneurs are forced to enter upon longer processes of
production. However, despite the initial increase in productive
activities the consequences finally are negative ones because the
gratuitous nature of credit contains the seeds of its own destruction.
Slide 60
March 4, 2016
3. c.) Monetary overinvestment:
Mises‘s theory
of money and credit
Austrian Economics
in Transition
“But there cannot be the slightest doubt as to where this will lead. A time
must necessarily come when the means of subsistence available for
consumption are all used up although the capital goods employed in
production have not yet been transformed into consumption goods. This
time must come all the more quickly inasmuch as the fall in the rate of
interest weakens the motive for saving and so slows up the rate of
accumulation of capital.” (Mises [1924] 1981: 401)
Thus the excess investment generated by credit creation and the artificial
lowering of the money rate of interest below the natural rate is stopped by
a shortage of savings before the lengthening of the production processes
are coming to fruition. A further injection of credit could prolong the
process but would make things even worse since inflation would
accelerate and the corrective crisis aggravate.
Slide 61
March 4, 2016
3. c.) Monetary overinvestment:
Mises‘s theory
of money and credit
Austrian Economics
in Transition
Hayek from the beginning followed Mises’s view that
discrepancies between the money and the natural rates of interest
cause discrepancies in the structure of production, i.e. a deviation
of the allocation of productive resources to capital goods and
consumptions goods which differs from the allocation in
equilibrium. He criticizes Wicksell for focussing on changes in the
purchasing power of money in his cumulative process analysis, as
well as Löwe and Burchardt for only identifying general price
changes as monetary effects. According to Hayek “monetary
theory has by no means finished its work when it has explained the
absolute level of prices.”
Slide 62
March 4, 2016
3. c.) Monetary overinvestment:
Mises‘s theory
of money and credit
Austrian Economics
in Transition
Furthermore, “general price changes are no essential feature of a
monetary theory of the Trade Cycle; they are not only unessential,
but they would be completely irrelevant if only they were
completely 'general' – that is, if they affected all prices at the same
time and in the same proportion” (Hayek [1929] 1933: 117 n. and
123). Consequentially, a stabilization of the price level would not
eliminate cyclical fluctuations. Wicksell had introduced the
important distinction between the stability of the equilibrium of
relative prices and the (in)stability of monetary (general price level)
equilibrium. In contrast to Wicksell’s monetary equilibrium and old
and new monetarist views of the “neutrality” of money Hayek's
monetary equilibrium was not associated with the price level but
with the system of relative prices.
Slide 63
March 4, 2016
3. d.) The time structure
of theEconomics
production process
Austrian
in Transition
Böhm-Bawerk’s theory of capital (1)
Slide 64
March 4, 2016
3. d.) The time structure
of theEconomics
production process
Austrian
in Transition
Böhm-Bawerk’s theory of capital (2)
Slide 65
March 4, 2016
3. d.) The time structure
of theEconomics
production process
Austrian
in Transition
Böhm-Bawerk’s theory of capital (3)
Slide 66
March 4, 2016
Austrian Economics in Transition
3. e.) Cantillon effects
Initially, the economy is in equilibrium. This implies full
employment and a market rate of interest that equates investment
demand with voluntary saving, as determined by intertemporal
consumer preferences. Money is neutral in the sense that it leaves
‘the relative values of goods . . . undisturbed’ (Hayek 1935: 31).
The disturbance which causes cyclical fluctuations is a difference
between the market rate of interest and the equilibrium rate, to the
extent that the lending rates of the banks are lower than the
equilibrium rate. This is perceived as a signal for a profitable
lengthening of production processes. Credit demand will rise and
additional money will be injected into the economy by a
lengthening of the banks’ balance sheets.
Slide 67
March 4, 2016
Austrian Economics in Transition
3. e.) Cantillon effects
Under the assumption that all resources are fully utilized in
equilibrium, a credit expansion implies that producers of capital
goods in the ‘new’ processes of production bid away resources from
‘older’ processes. This is where the Cantillon effect begins to work.
The injection of additional money increases the purchasing power in
those parts of the economy where the money arrives first. The
bidding changes the price structure, reallocates resources and
redistributes incomes (Hayek 1935: 8f and 85ff). Inflation in the
Hayekian sense is thus strictly defined as a rise in the quantity of
money, not in the price level. Inflation is not uniquely reflected in
movements of the price level, and the monetary cause of changes in
the price structure will hardly be perceived as such.
Slide 68
March 4, 2016
Austrian Economics in Transition
3. e.) Cantillon effects
Forced saving
Meanwhile, the redirection of capital towards ‘new’, longer
processes of industrial production reinforces itself since the prices
of capital goods rise faster than the prices of consumer goods. This
leads to a squeeze of the price margins between the stages of
production and a corresponding fall in the rates of return on capital
in the ‘older’, shorter processes. The output of consumption goods
declines, even though consumer preferences remain unchanged and
money incomes have risen with labour demand in the production of
capital goods. Shortages of consumption goods make their prices
rise faster than incomes. This process constitutes the mechanism of
‘forced saving’ which, in Hayek's view, will eventually make the
redirection of resources into less roundabout production profitable.
Yet the boom prevails as long as the credit expansion favours
investment in more roundabout processes.
Slide 69
March 4, 2016
Austrian Economics in Transition
3. e.) Ricardo effects
At some point, the credit expansion must stop. Normally the downturn is
brought about by a rise in the lending rates which makes the completion of
the ‘new’, more roundabout projects unprofitable. However, according to
Hayek it is sufficient that inflation stops to accelerate. Firms in the capital
goods sector will then lose their lead in purchasing power, whereas the
given demand continues to raise the prices of consumption goods. This
increases the price margins and reinforces a fall in real wages whereby
shorter, more labour-intensive processes of production regain their
profitability. The Cantillon effect ceases to be effective, whereas the
Ricardo effect now makes itself felt in a cumulative decrease of the
roundaboutness of production. The structure of production that is produced
by inflation turns out to be unsustainable because of a disproportionality of
fixed and circulating capital, respectively capital and consumption goods
(1935: 9lff). The specific resources employed in the ‘unduly elongated’
processes of production (both capital and qualified labour) become
redundant. Even unspecific resources may not be integrated into the
remaining profitable processes without frictions.
Slide 70
March 4, 2016
Austrian
Economics
Transition
3. Hayek‘s Austrian
theory
of theinbusiness-cycle
Summary: the crisis as a cure
The credit boom is thus inevitably followed by unemployment and capital
destruction. The changes to more productive methods of production turn
out to be futile, unless the credit expansion is accidentally succeeded by an
increase in voluntary saving (Hayek 1939: 180). Even though Hayek did
not write much about the crisis (not to mention the lower turning point), he
essentially regarded the crisis as a cure that has to be waited out (1935: 99).
Credit-induced booms induce activities which tend to restore the initial
equilibrium position of the economy - even if that position is never attained
(1939: 6). The equilibrium rate of interest will not be changed by any
‘purely monetary’ credit expansion, because the corresponding shifts in the
structure of production fail to coincide with the given intertemporal
preferences of the consumers (1933: 221ff, 1941: 406f). Even though
money is bound to be non-neutral in the short run, it tends to be neutral in
the long run. In Hayek's words, money may be a loose joint in the price
mechanism, but it does not break the mechanism.
Slide 71
March 4, 2016