When L.H. White writes, people read!
Larry White has just released a must read working paper on SSRN, “Hayek and Contemporary Macroeconomics”. While the abstract is not optimistic, the paper actually provides much to encourage those pursing a capital-structure based macroeconomics and working to apply Austrian business cycle theory (ABCT) to current macroeconomic issues and policies. The abstract:
F. A. Hayek’s macroeconomic theory and policy ideas have gained renewed attention since the recent boom-and-bust cycle followed the basic Hayekian narrative of an unsustainable cheap- money boom ending with a crash. Only to a very limited extent, however, do we find Hayek’s ideas on the agenda of mainstream macroeconomic researchers since Robert Lucas’s research program gave way to “Neoclassical” and “New Keynesian” DSGE models. We find examples of deeper interest on the periphery of the mainstream. Hayek’s influence on today’s macroeconomic policy discussions remains similarly limited, although he has become an icon to some opponents of loose monetary policy.
While the hardcore DSGE economists, with the exception of G. Calvo, both new Keynesian and real business cycle theory (RBC), have been relatively impervious to Hayekian, Misean, Rothbardian, or Garrisonian influence despite the abject failure of their models and the relative strength of the Austrian boom-bust in the explaining recent macroeconomic events, Larry White concludes with reason for hope, coming mostly from the Bank of International Settlements (BIS) where William R. White has been sounding an Austrian alarm since at least 2006 (“Is price stability enough?”).
Larry White’s conclusion:
Present-day mainstream macroeconomics is dominated by Walrasian (DSGE) models with restrictions added to generate Keynesian properties. Although DSGE modelers have been trying to incorporate financial variables since the 2007 bust, distortions in the structure of capitalistic production remain almost entirely off the radar. Not since Robert E. Lucas Jr. in the 1980s have monetary policy shocks been emphasized. Accordingly this research exhibits little of a Hayekian character.
Some researchers on the periphery of the mainstream, however, especially Claudio Borio and William R. White, have emphasized credit booms and recognized Hayek as a fore-runner. In a recent opinion piece, Borio (2013) has called for models of the financial cycle that have the following features:
• The booms should not just precede but cause the busts: busts are fundamentally endogenous, the result of the vulnerabilities and distortions built up during the boom.
• The busts should generate debt and capital stock overhangs – the natural legacy of the preceding unsustainable expansion.
• And potential output should not just be identified with non-inflationary output: as the previous evidence indicates, output may be on an unsustainable trajectory even if inflation is stable.
To have these features, he argues, macroeconomic theories must “capture more deeply the monetary nature of our economies: the banking sector does not just allocate given resources but creates purchasing power out of thin air. In all probability, all this may require us to rediscover the merits of disequilibrium analysis.” Provided only that “the banking sector” here is understood to include the central bank, this is a research agenda with a potentially strong Hayekian flavor.
White provides an excellent short summary of the development of Freidman’s counter revolution to the failed Keynesianism of the 1960-1970s as it eventually evolved into the dominant DSGE modeling of today’s modern macro. I found this extremely interesting as my journey into Austrian economics began with dissatisfaction with this approach especially as my research with Fred Glahe led me to believe Hayek and Mises had more adequately countered the Keynesian approach. The work twenty years later eventually resulted in our Keynes-Hayek Debate book of 1999.
White also highlights Calvo’s ABCT scenarios; one attributed to Mises and two to Hayek. The scenarios:
Mises consistently attributed the boom-initiating shock to unexpectedly expansive policy by a central bank trying to lower the market interest rate. Call this Scenario 1. Hayek added two alternate scenarios. In Scenario 2, already discussed above, fresh producer optimism about investment raises the demand for loanable funds, and thus raises the natural rate of interest, but the central bank deliberately prevents the market rate from rising by expanding credit. In Scenario 3, in response to the same kind of increase the demand for loanable funds, but without central bank impetus, the commercial banking system by itself expands credit more than is sustainable.
Calvo calls for a blending of 1 and 3. Better would be if both Austrians and others would pay more attention to Garrison’s broader interpretation of ABCT as a variation of a theme; the element of each unique cycle is credit creation which can only occur to a significant degree with fractional reserve banking granted extra-legal privileges which usually require central bank turbocharging whatever else is going on in the economy. Garrison’s two important recent contributions (here, 446): “The terms boom and bubble are often used interchangeably in the literature on business cycles.
- It may be preferable, however, to use boom—or more specifically artificial boom—to refer to the credit-induced simultaneous expansion to various degrees of different interest sensitive sectors of the economy and to use bubble to refer to the artificial boom’s most dramatic manifestation. Which sector reveals itself as the bubble depends on the circumstances in which the credit expansion occurs.”
- ABCT, when applied to an historical episode is a variation on a theme (Time and Money Ch. 6 or Andrew Young). Often central bank policy contributes to bubbles and booms by “As indicated earlier, artificial booms entail a turbocharging of whatever else is going on at the time.”
Nicholas Cachanosky provides a more detailed list of ABCT in the mainstream here.
My (despite the incorrect attribution) more detailed discussion of White, Borio, and Calvo is here.
