Objectives and Background:
Real business cycle theorists see
the pattern of expansion and contraction present in economic data as the
economy’s response to exogenous productivity shocks. These “modern theories of business cycles
attribute cyclical fluctuations to cumulative shocks and disturbances that
continuously buffet the economy. In other words, without shocks there are no
cycles” (Chatterjee 2000, 1). Money and central bank
policy is largely irrelevant with respect to economic expansions and downturns.
But, while policy errors do not cause downturns, counter-cyclical policies are counterproductive, they entail costs in excess of benefits
(Prescott 1986, 21 and Chatterjee 1999, 18).
Austrian business cycle theory and real
business cycle theory may be somewhat complementary. The real business cycle
model regards fluctuations in factor productivity as the major source of
fluctuations in economic activity. These fluctuations in total factor
productivity, ‘the effectiveness with which workers and machinery generate
value-added” (Chatterjee 1999, 19), are usually
identified with the ‘Solow residual’. The Solow residual is developed by modeling an economy with
competitive markets and constant returns to scale using an aggregate production
function of the form Q = Af(K,N), where A, the Solow
residual, is a shift parameter representing exogenous technical progress or a
productivity shock, K is a measure of the capital stock, and N is a measure of
labor input (Lewin 1999,76). Proponents conclude that the model can
account for about 70% of the post-war business cycle phenomenon (Kyland and Prescott 1991). But critics contend there is “no
independent corroborating evidence for the large technology shocks that are
assumed to drive business cycles” (Stadler 1994,
1751).
While one should not deny that fluctuations
in key aggregates may be the result of agents’ responses to exogenous shocks,
one should expect historical studies would be able to identify the shocks. A
capital-based macroeconomic model provides some possible answers. What is
identified as a technology shock in the highly aggregated production function
model may be better modeled in an Austrian capital framework as a change in the
structure of production. The explanation relies on the Austrian use of a lower
level of aggregation (Garrison 2001, 224-29).
If the above specified production function is incomplete, if it fails to identify all relevant inputs, then the shift factor A picks up the effects of the unidentified or omitted inputs. “Identifying and talking about them renders them ‘endogenous” (Lewin 1999, 76). Clearly, from an Austrian perspective, such a production function is incomplete.
When
capital is viewed as a structure, there is at any point in time not just one
technology known by all and used by all, but a multiple of technologies either
in use or available for use. Time preference and available saving limit not
only the amount of investment, but also the type of capital goods and
technologies invested in. With high time preferences and limited saving,
investments are, in general, production plans to meet more immediate needs.
Investment projects are shorter, less labor saving, and/or less durable. The
complex combination of resources that makes up the structure of production is
less productive. With lower time preferences and less limited saving,
production plans
provide for greater future provision. Investment projects are on
average longer, more labor saving, and/or more durable. In broad aggregate
measures the results of such investment choices should show up as increased
total factor productivity, the ‘shock factor’ in the real business cycle literature.
At a lower level of
aggregation, what looks like an economy’s response to a ‘positive technology’
shock may be in fact an economy’s response to credit creation.
The productivity increase is in reality endogenous. Or it could be a combined response; the
economy is subjected to a truly exogenous productivity shock in new knowledge
or improved production techniques. The greater potential productivity of new
investments projects of all types increases the demand for credit, but the
higher demand for credit is partially accommodated by credit creation. In
either case, the economy-wide response will be a combination of sustainable and
unsustainable growth. Part of the expansion of investment during the response
period will be malinvestment. As the malinvestments are discovered and corrected, productivity
will decline and show up in aggregate data as a negative productivity shock.
The money and credit creation during the expansion, rather than being harmless
(or helpful) endogenous response of banks to changing market conditions, set
the stage for the boom-bust pattern of the cycle.
Results/Expected
Results and Discussion:
Chatterjee (2000, 10) recognizes that real business
cycle theory does not address the issue of the ‘ultimate source of cyclical
volatility because the random shocks in the RBC model result from variations in
unspecified factors …” A capital-based macroeconomics can help fill in the
blanks and provide a better understanding of the underlying market processes.
In fact, the empirical results reported in the real business cycle literature
can be reinterpreted in a way that provides historical support for Austrian
business cycle theory and a capital based macroeconomics.
Capital based macroeconomics
developed from the insights of Mises and Hayek
requires a blending of monetary and capital theory. The effects of monetary changes on the
distribution of spending and the structure of production are important. Changes in money that increase credit availability can cause
unsustainable growth. Analysis that ignores this feature of the economy
can and does present a misleading picture of the medium run, the series of
short run adjustments that eventually result in the fabled long.
Garrison (2001) argues that a key
feature of capital-based macroeconomics is that it provides the macroeconomics
of the medium run. The Austrian theories of capital and credit creation theoretically
separate sustainable from unsustainable growth. The long run is the series
of short run adjustments. The Austrian model thus provides a single model
of the short run, the medium run, and the long run. While business cycle phenomena
may be caused by exogenous shocks or inappropriately tight monetary policy,
much of the actual cyclical activity is best interpreted as the consequence
of credit created unsustainable growth. This type of cyclical activity is
preventable with an appropriate monetary framework, but may be difficult to
correct with short-run macroeconomic policy. A monetary policy based on the
principle of sound money would accommodate sustainable growth without generating
endogenous instabilities and unsustainable growth.