The Unfortunate Distinction between Macroeconomics and Growth Theory Derives from the Inadequate Attention to the Inter-Temporal Capital Structure

Capital-based macroeconomics rejects the Keynes-inspired distinction between macroeconomics and the economics of growth. This unfortunate distinction, in fact, derives from the inadequate attention to the inter-temporal capital structure. Conventional macroeconomics deals with economy-wide disequilibria while abstracting from issues involving a changing stock of capital; modern growth theory deals with a growing capital stock while abstracting from issues involving economy-wide disequilibria. With this criterion for defining the subdisciplines within economics, the thorny issues of disequilibrium and the thorny issues of capital theory are addressed one at a time. Our contention is that economic reality mixes the two issues in ways that render the one-at-a-time treatments profoundly inadequate. Economy-wide disequilibria in the context of a changing capital structure escape the attention of both conventional macroeconomists and modern growth theorists. But the issues involving the market’s ability to allocate resources over time have a natural home in capital-based macroeconomics. Here, the short-run issues of cyclical variation and the long-run issues of secular expansion enjoy a blend that is simply ruled out by construction in mainstream theorizing. 

—Roger W. Garrison, Time and Money: The Macroeconomics of Capital Structure, Foundations of the Market Economy (London: Routledge, 2002), 34.

Money Has NO Market of Its Own Setting the Research Agenda for Monetary Disequilibrium Theory

Figure 3.7 looks dramatically different, to say the least, from the diagrammatics of conventional macroeconomics. The specific relationship between capital-based macroeconomics and, say, ISLM analysis or Aggregate-Supply/Aggregate-Demand analysis is not readily apparent. To compare and contrast Austrian macroeconomics with its Anglo-American counterpart in any comprehensive way would take our discussion too far afield. A few particular points of contrast, however, will help to put the differences into perspective.

First, unlike ISLM analysis, the graphics in Figure 3.7 do not include a market for money. Neither the money supply nor money demand are explicitly represented. Both in reality and in our analysis of it, money has no market of its own. Understanding the broadest implications of this truth sets the research agenda for monetary disequilibrium theory, which we take up in Chapter 11. Austrians, too, recognize the uniqueness of money in this respect. With trivial exceptions, money appears on one side of every exchange. Money, by definition, is the medium of exchange. But neither the transactions demand for money, as embedded in the classical equation of exchange, nor the speculative demand for money, as conceived by Keynes, make a direct appearance in the Austrian-oriented construction. Consistent with Hayek’s understanding, capital-based macroeconomics treats money as a “loose joint” in the economic system. As Hayek ([1935] 1967: 127) indicated early on, “the task of monetary theory [is] nothing less than to cover a second time the whole field which is treated by pure theory under the assumption of barter.” The three-quadrant construction in Figure 3.7 can be taken to depict, if not actually a barter system, a tight-jointed system. That is, money is assumed to allow market participants to avoid the inefficiencies of barter – without introducing any inefficiencies of its own. So interpreted, the interrelationships shown in Figure 3.7 belong to the realm of pure theory.

—Roger W. Garrison, Time and Money: The Macroeconomics of Capital Structure, Foundations of the Market Economy (London: Routledge, 2002), 51-52.

Economy-wide Disequilibria in the Context of a Changing Capital Structure Escape the Attention of Growth Theorists and Macroeconomists

Capital-based macroeconomics rejects the Keynes-inspired distinction between macroeconomics and the economics of growth. This unfortunate distinction, in fact, derives from the inadequate attention to the inter-temporal capital structure. Conventional macroeconomics deals with economy-wide disequilibria while abstracting from issues involving a changing stock of capital; modern growth theory deals with a growing capital stock while abstracting from issues involving economy-wide disequilibria. With this criterion for defining the subdisciplines within economics, the thorny issues of disequilibrium and the thorny issues of capital theory are addressed one at a time. Our contention is that economic reality mixes the two issues in ways that render the one-at-a-time treatments profoundly inadequate. Economy-wide disequilibria in the context of a changing capital structure escape the attention of both conventional macroeconomists and modern growth theorists. But the issues involving the market’s ability to allocate resources over time have a natural home in capital-based macroeconomics. Here, the short-run issues of cyclical variation and the long-run issues of secular expansion enjoy a blend that is simply ruled out by construction in mainstream theorizing.

—Roger W. Garrison, Time and Money: The Macroeconomics of Capital Structure, Foundations of the Market Economy (London: Routledge, 2002), 34.

Time and Money Are the Common Denominators of Macroeconomic Theorizing

To base macroeconomics on capital theory — or, more precisely, to base it on a theory of the market process in the context of an intertemporal capital structure — is to maintain a strong link to the ideas of the Austrian School. Entrepreneurs operating at different stages of production make decisions on the basis of their own knowledge, hunches and expectations, informed by movements in prices, wages, and interest rates. Collectively, these entrepreneurial decisions result in a particular allocation of resources over time.

The intertemporal allocation may be internally consistent and hence sustainable, or it may involve some systematic internal inconsistency, in which case its sustainability is threatened. The distinction between sustainable and unsustainable patterns of resource allocation is, or should be, a  major focus of macroeconomic theorizing. Systematic inconsistencies can cause the market process to turn against itself. If market signals — and especially interest rates — are “wrong,” inconsistencies will develop. Movements of resources will be met by “countermovements,” as recognized early by Ludwig von Mises ([1912] 1953). What initially appears to be genuine economic growth can turn out to be a disruption of the market process attributable to some disingenuous intervention on the part of the monetary authority.

Though committed to the precepts of methodological individualism, the Austrian economists need not shy away from the issues of macroeconomics. Some features of the market process are macroeconomic in their scope. Production takes time and involves a sequence of stages of production; exchanges among different producers operating in different stages as well as sales at the final stage to consumers are facilitated by the use of a common medium of exchange. Time and money are the common denominators of macroeconomic theorizing. While the causes of macroeconomic phenomena can be traced to the actions of individual market participants, the consequences manifest themselves broadly as variations in macroeconomic magnitudes. The most straightforward concretization of the macroeconomics of time and money is the intertemporal structure of capital — hence, capital-based macroeconomics.

—Roger W. Garrison, Time and Money: The Macroeconomics of Capital Structure, Foundations of the Market Economy (London: Routledge, 2002), 33-34.

The Goods-In-Process Conception of Capital Has a Long and Honorable History

What, then, is the case for capital-based macroeconomics? Considerations of capital structure allow the time element to enter the theory in a fundamental yet concrete way. If labor and natural resources can be thought of as original means of production and consumer goods as the ultimate end toward which production is directed, then capital occupies a position that is both logically and temporally intermediate between original means and ultimate ends. The goods-in-process conception of capital has a long and honorable history. . . .

This temporally intermediate status of capital is not in serious dispute, but its significance for macroeconomic theorizing is rarely recognized. Alfred Marshall taught us that the time element is central to almost every economic problem. The critical time element manifests itself in the Austrian theory as an intertemporal capital structure.

—Roger W. Garrison, Time and Money: The Macroeconomics of Capital Structure, Foundations of the Market Economy (London: Routledge, 2002), 7-8.

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.