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Austrian Economics
D. Allen Dalton
ECON 325 – Radical Economics
Boise State University
Fall 2011
Origins
and
Development
Pre-History
• Italian Subjectivist Tradition
– Pierre de Jean Olivi (1248-1298)
– San Bernardino of Siena (1380-1444)
– Ferdinando Galiani (1728-1787)
• School of Salamanca
– Martin de Azpilcueta Navarrus (14931586)
– Luis de Molina (1535-1601)
– Juan de Mariana (1536-1624)
Pre-History
• French Tradition
– Richard Cantillon (1680?-1734?)
• Essai sur la Nature du Commerce en General (1755)
– A.R.J. Turgot (1727-1781)
• Reflections on the Formation and Distribution of Wealth
(1766)
– Etienne Bonnot de Condillac (1714-1780)
• Commerce and Government (1776)
– Jean-Baptiste Say (1767-1832)
• Treatise on Political Economy (1803)
– Frederic Bastiat (1801-1850)
• “A Petition” (Petition of the Candlemakers) (1845)
• Economic Sophisms (1845)
The Founders
• Carl Menger
– Grundsatze (1871) trans.
Principles of Economics
• emphasis on causal-genetic
explanations
• centrality of subjective utility,
uncertainty, adjustments in
disequilibrium, and time
– Investigations on the Method of
the Social Sciences (1883)
• Methodenstreit
The Founders
• Eugen von Bohm-Bawerk (18511914)
– Capital and Interest
(1884,1889,1912)
• Mixture of productivity and time
preference theories of interest
– Karl Marx and the Close of His
System (1896)
• Critique of Marx, especially his
failure to solve the “transformation
problem”
The Founders
• Friedrich von Wieser (18511926)
– Natural Value (1889)
• cost is marginal utility foregone from
application of unit of input to
produce one good rather than
another
• imputation problem; expected prices
of first-order goods determine the
prices of higher order goods
– Social Economics (1914)
20th Century Giants
• Ludwig Mises (1881-1973)
– Theory of Money and Credit
(1912)
– Socialism (1922)
– Human Action (1949)
• Friedrich Hayek (1899-1992)
– Prices and Production (1931)
– The Pure Theory of Capital (1941)
– Individualism and Economic Order
(1948)
Renaissance
• Murray Rothbard (1926-1995)
–
–
–
–
Man, Economy and State (1962)
America’s Great Depression (1963)
Power and Market (1970)
An Austrian Perspective on the
History of Economic Thought (1995)
• Israel Kirzner (1930 - )
– Competition and Entrepreneurship
(1973)
– The Meaning of Market Process (1992)
Modern Representatives
• Roger Garrison
– Time and Money: The Macroeconomics of Capital Structure
(2000)
• Steven Horowitz
– Microfoundations and Macroeconomics (2000)
• Jesús Huerto de Soto
– Money, Bank Credit, and Economic Cycles (2006)
• Roger Koppl
– Big Players and the Economic Theory of Expectations (2002)
• J. Guido Hulsmann
– Mises: The Last Knight of Liberalism (2007)
• Walter Block
– Labor Economics from a Free Market Perspective (2008)
Methodology
Methodology
• Methodological Individualism
• “A Priori” Method
• Praxeology – science of human
action; logic of relationship
between the categories of ends and
means
• Critique of Mathematics and
Econometrics in theory
Methodology
• “..economics is not about things and
tangible material objects; it is about
men, their meanings and actions.” –
Mises, Human Action, p.92
• “Action is guided by plans, i.e., by
thought, and all action has to be
interpreted as the outward
manifestation of such plans… In fact all
phenomena are intelligible only as the
oucome of planned action.” – Lachmann,
“From Mises to Shackle,” p. 57
Methodology
• Nature of economics is that all
economists can do is to attempt to
explain the general patterns arising
from choice
• Behavior is tied to individual
perceptions of means and ends; problem
of knowledge and expectations is of
fundamental concern
• Economizing, not maximizing, behavior
Austrian
Microeconomics
Market as a Process
• Critique of “Perfect Competition”
– “…the perfectly competitive model
portrays (as does each and every
equilibrium model of a market) a
pattern of mutual anticipations and
executed decisions which, if somehow
attained, would lead no participant to
wish that he had acted differently.”
– Kirzner, “The Driving Force of the
Market,” p. 39
Market as a Process
• Critique of “Perfect Competition”
– “the model cannot be used to ‘explain’
market prices; the model presumes
that everyone has, somehow,
correctly and self-fulfillingly guessed
what the market price is going to be.
…the model treats each market
participant as a price-taker…”
– Kirzner, “The Driving Force of the
Market,” p. 39
Market as a Process
• Hayek’s Foundational Articles
– “Economics and Knowledge”
– “The Use of Knowledge in Society”
– “The Meaning of Competition”
(all in Individualism and Economic
Order)
• Kirzner’s Competition and
Entrepreneurship
Market as a Process
• “Equilibrium…exists if the actions
of all members of the society over
a period are all executions of their
respective individual plans on which
each decided at the beginning of
the period.”
– Hayek, “Economics and Knowledge”
p. 37
Market as a Process
• “The problem which we pretend to solve
is how the spontaneous interaction of a
number of people, each possessing only
bits of knowledge, brings about a state
of affairs in which product prices
correspond to costs, etc., and which
could be brought about by deliberate
direction only by somebody who
possessed the combined knowledge of all
those individuals. But in our analysis…
Market as a Process
• …instead of showing what bits of
information the different persons must
posess in order to bring about that
result, we fall in effect back on the
assumption that everybody knows
everything and so evade any real
solution of the problem.”
– Hayek, “The Use of Knowledge in
Society”
Market as a Process
• “The overambitious plans of one period
will be replaced by more realistic ones;
market opportunities overlooked in one
period of time generate systematic
alterations in the corresponding
decisions for the succeeding period.
Taken over time, this series of
systematic changes in the
interconnected network of market
decisions constitutes the market
process.” – Kirzner, C&E, p.10
Market as a Process
• “As the market process unfold, with one
period of market ignorance followed by
another in which ignorance has been
somewhat reduced, each buyer or seller
revises his bids and offers in the light
of his newly acquired knowledge of the
alternative opportunities…In this sense
the market process is inherently
competitive.” – Kirzner, C&E, , p. 12
Market as a Process
• “Into… a world of men unable to
learn…introduce a group of outsiders who are
able to perceive opportunities …where a good
can be sold at a price higher than that at
which it can be brought. This group of
entrepreneurs…notice profit opportunities
that exist because of the initial ignorance of
the original market participants and that have
persisted because of their inability to learn…”
– Kirzner, C&E, , p. 14
Market as a Process
• Revision of plans by disappointed
individuals constitutes the market
process.
• Entrepreneurs, alert to unperceived
opportunities, help in this revision of
plans.
• As plans are revised, the subjective
data on which individuals base their
plans comes closer into correspondence
with the objective data – reducing
market ignorance.
Analytical Tools
• Supply and Demand – distinction
between supply and production (supply
curves are not based on production)
• Market period and reactions to
disequilibrium
• Ordinal marginal analysis rather than
indifference curve analysis
• Verbal rather than graphical analysis
Austrian
Macroeconomics
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.
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
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
Friedrich A. Hayek
1899 - 1992
Prices and Production
(1931, 1935)
Nobel Prize in Economics
1974
--for pioneering work in
the theory of money and
economic fluctuations and
for penetrating analysis of
the interdependence of
economic, social, and
institutional phenomena.
Ludwig von Mises
1881 - 1973
“The period of production
must be of such a length
that exactly the whole
available subsistence fund
is necessary on the one
hand and sufficient on the
other for paying the wages
of the labourers
throughout the duration of
the productive process.”
The Theory of
Money and Credit
(1912)
The Elements of
Capital-Based
Macroeconomics
“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).
Production Possibilities Frontier
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
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.
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.
Production Possibilities Frontier
The distance below the 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.
Integrating the
Elements
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 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 slope
Hayekian
of the
triangle
hypotenuse
depictsof
current
the
Hayekian
consumption
triangleasreflects
the
a
output
rate
ofof
interest
the economy’s
consistent
multiwith
stage
the
rate
production
that prevails
process.
in the
The
rate of interest
loanablefunds market.
governs the
allocation of resources among
the stages.
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
This
additionalin capital
productive
is
distributed
capacity
andamong
hencethe
in output
stages is
of production
depicted
by a in
shifting
accordance
outward
with
of
the
anPPF
unchanged
and by rate
a
of
interest.
corresponding
shifting of the
supply and demand for
loanable funds.
Watch the economy grow!
Watch the economy grow!
Saving as a Basis
for Sustainable
Economic Growth
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 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 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.
In thereduced
With
early stages,
consumption
demand
demand,
for
labor the
andderived
other factors
demand
forproduction
of
labor and is
other
increased,
factorsas
of production
the
interest-rate
in the
effect
late
stages is reduced asthe
more-than-offsets
well.
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.
Early-stage
A saving-induced
People
don’t investments
just save;
reallocation
they
during
this transition
allow
of resources
save-up-for-something.
among the
the
increased
demands
stages
Consumption
of production
isfuture
down only
skews
for
goods
the consumption
temporarily—during
pattern of consumable
theto be
watch
accommodated.
The
economy
outputNow
transition
toward
to new
the
growth
future.
grows
more rapidly than
path.
the
economy grow!
before.
Now watch
the economy grow!
Now watch
the economy grow!
Legislating
Low Interest Rates
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.
Manipulating
Interest Rates
with Money
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,
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 resources
Hayekian triangle
committed
is being
to
pulled
the
early
at both
stages
ends
of against
production
the
middle. The
constitute
“malinvestment.”
market process is
set against itself as investors
At the same time, other
and consumers respond in their
resources are allocated to the
own way to a low rate of
late stages in response to the
interest.
“overconsumption.”
The specific course of the boombust cycle beyond the initial malFor a time, increased
investment and overconsumption is
consumption and increased
not wholly determinate. Changes in
investment have their separate
the structure of pro-duction
effects. The economy moves
reflect capital durability,
beyond the PPF, producing an
specificity and the particular
unsustainable level of output.
pattern of complementarity and
substitutability.
The
There
The
lacking
tug-of-war
is anofinvestment
capital
between
andbias in
other
the allocation
consumption
resources
and
of
complementary
investment
resources, is
topartially
however—as
those already
won the
by committed
the
business to
the
community
investment,
production
tries
if process
only
to take
because it
eventually
advantage
has
more brings
“pull”—the
of thethe
artificially
boom
new money
to
anbeing
low
end
rate
lent
andofreturns
predominantly
interest
the
and at
to the
economy
same time
businesses.
to its
satisfy
PPF. increased
consumer demand.
The initial movement of the
economy beyond the PPF
constitutes overconsumption
(the upward movement) and
overinvestment (the rightward
movement).
In this
The
discoordination
phase of theofcycle,
the a
economy of
collapse
characteristic
the money supply
of a
policy-induced
can
give leverage
boom-bust
to the cycle
sets the stage
contraction,
making
for athe
secondary
contraction—a
depression
much
spiraling
deeper of
than
the
economy
can
be accounted
to some point
for solely
insidein
the PPF.
terms
of the prior misallocation
of resources.
Watch the economy
respond to an injection of
money through credit
markets!
Watch the economy
respond to an injection of
money through credit
markets!
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
Austrian
Political Economy
Normative Criteria and Policy
Espousal
• Success at plan coordination rather
than success at resource allocation
• “Free Market”
• Generally critical of price and
incomes policies
• Market liberal to individualist
anarchist