Garrison Recommends Putting Capital Theory with Expectations Back into Macroeconomics

In a letter of August 1989, Lachmann posed to me a direct question about Mises’s and Hayek’s neglect of expectations (a neglect he referred to in a subsequent letter as “a simple matter of historical fact”). “Do you agree with me that in the 1930s Hayek and Mises made a great mistake in neglecting expectations, in failing to extend Austrian subjectivism from preferences to expectations?” His particular phrasing of this question links it directly to his 1976 article, in which he traced the development of subjectivism “From Mises to Shackle.” Also, Lachmann’s question was a leading question, followed immediately with “What, in your view, are the most urgent tasks Austrians must now address?” Lachmann himself had spent several decades grappling with expectations. He recognized in an early article ([1943] 1977) that expectations in economic theorizing present us with a unique challenge. They cannot be regarded as exogenous variables. We must be able to give some account of “why they are what they are.”

But neither can expectations be regarded as endogenous variables. To do so would be to deny their inherent subjectivist quality. This challenge always emphasized but never actually met by Lachmann has been dubbed the “Lachmann problem” by Roger Koppl (1998: 61).

My response to Lachmann did not deal head-on with the Lachmann problem but focused instead on Hayek and Keynes and derived from considerations of strategy. Hayek was trying to counterbalance Keynes, whose theory featured expectations but neglected capital structure. Without an adequate theory of capital, expectations became the wild card in Keynes’s arguments. Guided by his “vision” of economic reality, a vision that was set in his mind at an early age, he played this wild card selectively — ignoring expectations when the theory fit his vision, relying heavily on expectations when he had to make it fit. Hayek’s countering strategy is made clear in his Pure Theory of Capital (1941: 407ff.): “[Our] task has been to bring out the importance of the real factors [as opposed to the psychological factors], which in contemporary discussion are increasingly disregarded.” But in countering Keynes’s “expectations without capital theory,” Hayek produced — or so it could be argued — a “capital theory without expectations.” In response to Lachmann’s question about the most urgent tasks, I suggested that we need to put capital theory (with expectations) back into macroeconomics and that my inspiration for working in this direction was Lachmann’s own writings.

—Roger W. Garrison, Time and Money: The Macroeconomics of Capital Structure, Foundations of the Market Economy (London: Routledge, 2002), 16.