Review of Time and Money: The Macroeconomics of Capital Structure. By Roger W.Garrison. Routledge, 2001. xvi + 272 pgs.
Roger Garrison’s long-awaited book compares and contrasts Austrian business cycle theory with a number of other approaches, including Monetarism, New Classicism, and New Keynesianism. But I propose to concentrate on only one strand in this rich volume.
Professor Garrison has given us an outstanding account of Keynesian economics. After reading his comparison of the Austrian model with that of Keynes, I understood much more clearly than ever before what is at stake in the conflict between the two schools.
Suppose that, in an economy, spending on consumer goods falls. Must depression inevitably ensue? Not at all, say the Austrians. Resources can shift into the production of capital goods. As Hayek in particular stressed, following Böhm-Bawerk, production can be divided into several stages, depending on the distance of the product from consumption goods. Mining iron ore takes place at a much higher stage than inserting a steel plate in a gunshot victim’s head.
So long as resources can freely shift from lower to higher stages of production, “capital-based macroeconomics” contends that a fall in consumer spending need not occasion disaster. As Garrison writes, “Capital-based macroeconomics is designed to show that quite independent of any movements in the general price level, the adjustment of relative prices within the capital structure can bring the intertemporal allocation of resources in line with intertemporal consumption preferences without idling labor or other resources” (p. 53).
But all is not for the best in this best of all possible worlds: We must cope with the malign hand of government. Should the financial authorities, in a misguided attempt to spur production, increase the supply of bank credit, dire results may impend. If the interest rate is driven below the “natural rate”—primarily determined by people’s preferences for present over future goods—investors might be misled.
They may shift unduly to higher stages of production, not realizing that lower interest rates reflect, not a genuine decrease in time preference, but rather financial manipulation. When interest rates rise again to their “true” level, overly optimistic investments face collapse. The process of adjustment to the actual preferences of consumers is precisely, in the Austrian view, the downturn phase of the business cycle.
Garrison skillfully parries a major objection to this approach. Why should investors be misled by the expansion of bank credit? Will not experienced investors tend to treat with caution the new influx of money? As our author notes, so long as businessmen fail to adjust their expectations perfectly, the interest rate will fall, and the prospect of a boom-bust cycle impends. “The notion that the central bank cannot, even for a short period, reduce the rate of interest is as implausible as the notion that it can fool the economy—permanently—into behaving as if market participants are more future-oriented than they actually are” (p. 78).
(Incidentally, I do not understand why Professor Garrison calls “glib” Mises’s response to Ludwig Lachmann’s article on expectations in Economica [1943] [p. 17]. I should have thought that Mises’s main point was identical with Garrison’s: The severity of the cycle depends on the extent to which businessmen have elastic expectations.)
Lord Keynes had an entirely different view. A sharp decrease in consumption spending will lead, not to a shift of investment to higher stages of production, but to a general economic downturn. Because of lowered consumer spending, businessmen’s expectations will tend to the pessimistic. Far from shifting their funds to a different stage of production, they will shrink from investment altogether.
As Garrison makes clear, the problem for Keynes does not lie in wage rates that do not adjust downward to decreasing demand. “The stickiness or flexibility of the wage rate, then, is not at all essential to our understanding of the problem identified by Keynes. The behavior of the wage rate has implications only for the particular way that the problem manifests itself . . . “ (p. 149). The primary problem, once more, is expectations. On the market, these are governed by “animal spirits” and are, in essence, irrational. If business investors fear the worst, the economy will face partial or total collapse.
Here we confront a clear choice. In the Austrian view, investors will meet changes in patterns of spending by shifts in the structure of production. Unless misled by governmental high jinks, they need encounter no major obstacles to these changes. To Keynes, in contrast, investment is volatile and irrational. Gripped by an attack of pessimism, investors will unintentionally cause economic collapse. How can we decide between these conflicting visions?
Our author has uncovered an issue vital to a rational response to our query. Why was Keynes so concerned with irrational expectations? Why, in brief, was he so much in fear of fear? Did Keynes simply generalize too readily from the exceptionally bad conditions of the 1930s? Garrison shows that the primary focus of Keynes’s concern lay elsewhere.
To Keynes, the business cycle was of secondary significance. He denied “that counter-cyclical policies narrowly conceived can save the market economy. Its flaws are too deeply rooted for that. The decentralized decision-making, which is heart and soul of the market economy, must be eliminated or at least severely restricted” (p. 180). When Keynes spoke of a permanent tendency to unemployment under capitalism, he principally had in mind a different issue from that which concerned his critics.
Even a prosperous capitalist economy would not meet Keynes’s extravagant demands. Because the capitalist economy rests on the expectations of investors, production and employment fall far short of what they could be. Suppose investment were centralized under control of the government. No longer would we be at the mercy of evanescent animal spirits. The interest rate would fall to next to nothing, capital would be available without limit, and prosperity would rise to undreamed of heights. Keynes “argues from the belief that in a society with ideal economic institutions the rate of interest would be zero to the conclusion that in our society, with its less than ideal economic institutions, the rate of employment is too low” (p. 185).
Once one sees Keynes’s underlying premise, his system loses its plausibility. He, like many critics of the market, has constructed for himself a utopia “that never was, on sea or land,” and has used this to find capitalism deficient. Judged by ordinary standards, capitalism has not been shown to stand in danger of “unemployment equilibrium.” Only on the basis of his unsupported claim that a radically better economic system is in the offing does his indictment of the free market make sense. Small wonder that Mises mocked Keynes’s pretensions to perform the miracle of turning stones into bread.
But what if Keynes abandoned these far-flung claims? If one restricts his theory to ordinary business cycles, how should we choose between it and the Austrian account? Here I wish that Professor Garrison had been clearer as to the criteria for choice we should adopt. Does the bare existence of the Austrian theory suffice to refute Keynes’s claim that an attempt to save more by reducing consumption “will necessarily defeat itself” (p. 160, quoting Keynes)? Suppose that Keynes admitted that Hayek’s model defines a possible course of the economy. Might he not still contend that his system was preferable? I am not altogether clear how our author thinks Austrians ought to respond.
Professor Garrison’s analysis of Keynes provides me a welcome occasion to mount a hobbyhorse. G.L.S. Shackle, Ludwig Lachmann, and others who stress the radical uncertainty of the future often appeal to Keynes to support their skeptical doctrine. But Garrison makes evident that the uncertainty that troubled Keynes was a specific difficulty with market conditions. In his conception, investment under socialized control would not be uncertain. Thus his system does not rest on some mysterious philosophical argument that rules out knowledge of the future.
Professor Garrison addresses a great many other topics in this outstanding book. I commend to readers especially his attempt to show that Austrian theory is compatible with monetary disequilibrium theory in the style of Leland Yeager. 1
- 1The characterization of Henry Hazlitt’s Failure of the “New Economics” as “the work of an unreceptive and hostile eavesdropper” (p.xi) seems to me much too harsh.
