Austrian business cycle theory (ABCT) is a body of hypotheses embodying particularly Austrian insights and assumptions. The canonical variant associated with Ludwig von Mises and Friedrich A. Hayek is particularly well suited to the Great Depression. However, it is an inadequate account of the recent US recession and financial crisis. This chapter develops a suitable ABCT variant that explicitly incorporates not only the economy’s time structure of production but also (1) its structure of consumption and (2) its risk structure. The continuous input–continuous output nature of the housing market is highlighted, along with the Treasury and the Federal Reserve’s roles in externalizing the risk associated with government-sponsored entities’ (GSEs’) debt. The chapter then extends Roger Garrison’s graphical framework to illustrate this ABCT variant.
Mauro Baranzini and Amalia Mirante
This chapter reviews and assesses the genesis and development of the Cambridge post-Keynesian school of income and wealth distribution, the foundations of which were laid in particular by Nicholas Kaldor, Richard Kahn, Luigi Pasinetti, and Geoffrey Harcourt from the middle 1950s onward. The focus of their analysis was to investigate the relationship between the steady-state rate of profits on the one hand, and the saving propensities of the socioeconomic classes and the growth rate of the economy on the other. During half-century and more about 200 scholars have published in this area no fewer than 500 scientific papers and book chapters, as well as thirty volumes. This post-Keynesian school of economic thought has gained a safe entry into the history of economic analysis. In order to evaluate this vast scientific literature this chapter has divided it into eight specific lines: (1) the introduction of a differentiated interest rate on the wealth of the classes; (2) the introduction of the monetary sector and of portfolio choice; (3) the introduction of the public sector, and the Ricardian debt/taxation equivalence; (4) the inclusion of other socioeconomic classes; (5) the introduction of microfoundations; (6) the analysis of the long-term distribution of wealth and of the income share of the socioeconomic classes; (7) the overlapping generation model and the intergenerational transmission of wealth; (8) other general aspects, in particular the applicability of the Meade-Samuelson and Modigliani Dual Theorem.
John P. Cochran
The recent revival of boom-bust business cycles and the worldwide slow recovery from 2009–2012 has renewed interest in the analysis of a money-production economy developed by Keynes and capital-structure-based Austrian macroeconomics developed by Hayek, Mises, Rothbard, and, most recently, Garrison. Both approaches identify time, money, banking, financial markets, interest, and investment as the major sources of coordination failure leading to recession or depression. When compared with single-aggregate modern macroeconomic models, both Keynes’s and the Austrians’ models, with their lower level of aggregation, provide a better understanding of how an economy goes wrong, However, the chapter argues that Keynes’s model is flawed because it lacks a capital-structure foundation. Keynesian macroeconomic policy is generally unnecessary and, if applied consistently, destabilizes the economy. Austrian economics and its capital-based macroeconomics provide better guidance on cause, recovery, and, more important, prevention.
The “dynamics of interventionism” refers to the central contribution of Austrian economics to the analysis of government failure. This chapter outlines that contribution in the areas of regulatory dynamics and transfer dynamics and focuses on the role of incentive problems and especially of knowledge problems in driving the mixed economy toward either interventionism or disinterventionism. These dynamics operate in the broad range of politicoeconomic systems that lie between laissez-faire capitalism and collectivist central planning. The chapter examines the rationale for various kinds of interventions, macroeconomic and microeconomic, traces their consequences, and explains why those consequences tend to generate systemic instability in the mixed economy. It also offers an overview of some of the milestones in the development of Austrian political economy.
This chapter explores the Kaldorian approach to endogenous growth theory. The central principles of this approach are explored, including the claims that growth is (a) demand led, with trade playing a central role in aggregate demand formation; and (b) path dependent. It is shown that both the actual and natural rates of growth are path dependent in the Kaldorian tradition. The implications of inequality between the actual and natural rates of growth are investigated, and it is shown that mechanisms exist within the Kaldorian tradition that are capable of reconciling these growth rates. This results in the sustainability (in principle) of any particular equilibrium value of the actual rate of growth.
This chapter provides an overview of the issues raised by free banking. A central objective is to set out the core theory of free banking, draw out its predictions, and then compare those predictions against the abundant historical evidence from the many free (or relatively free) banking systems of the past. The evidence is largely supportive of the predictions of free banking theory and, in particular, of its claim that an unregulated banking system would be stable. The evidence also supports the predictions made by free banking theory that government intervention weakens the financial system—often in profound and misunderstood ways—and causes many of the problems it is ostensibly meant to cure.
Jesus Felipe and John McCombie
The aggregate production function, one of the most widely used concepts in macroeconomics, is also the one whose theoretical rationale is perhaps the most suspect. The aggregate production function is one where output has to be a value, rather than a physical, measure, regardless of the precise unit of observation, whether, for example, it is for the firm or an individual industry. The value measure has to be used because of the heterogeneity of output and capital, such as value added or gross output in the case of output. These constant price measures are not physical quantities. This chapter shows that the specifications of all aggregate production functions, using value data, are nothing more than approximations to an accounting identity. After describing the accounting identity and the Cobb-Douglas production function, the chapter demonstrates that the results of the estimation of production functions that find increasing returns to scale and externalities are simply due to misspecification of the underlying identity, and that the estimated biased coefficients may actually be predicted in advance.
During the global financial crisis of 2008–9, the name of Hyman Minsky (1919–1996) was frequently cited in the media. Minsky devoted his entire career to the problem of financial fragility, which he always regarded as the principal threat to US capitalism. His financial instability hypothesis summarized the reasons that the system is vulnerable to financial crises, why nevertheless a catastrophe like the Great Depression had not happened again, and what must be done in order to prevent a recurrence. Minsky always placed financial markets at the center of his analysis. In his “Wall Street vision,” the crucial economic relationship is that between investment banker and client, not factory-owner and worker. Although money is central to his vision, it operates in a rather unusual way. Minsky died in 1996, before the “new consensus” (or New Neoclassical Synthesis) in macroeconomics had firmly established itself, but he would certainly have been a severe critic of its treatment of money and its neglect of finance.
Robert Dixon and Jan Toporowski
Kaleckian economics may be broadly defined as the economic theories enunciated by Michał Kalecki (1899–1970) and the extensions of those theories by economists who were influenced by him. In 1933, Kalecki published his first analysis of the business cycle under capitalism, arguing that it was due to the instability of investment, which in turn was caused by fluctuations in capitalists’ profits. During the 1950s, Kalecki was influential in the monopoly capitalism school of Marxists, through the work of Paul Sweezy and Josef Steindl. Post-Keynesian economics spliced Kalecki’s price and business cycle theory onto more orthodox Keynesian concerns about aggregate demand and full employment. This chapter explains the key features of Kalecki’s analysis of a capitalist economy with reference, where appropriate, to the standard two-sector model. It then looks at Hyman Minsky’s extension of Kalecki’s ideas and examines Kalecki’s macroeconomics in the short run. It also discusses what it is about a capitalist economy that makes it prone to crises and persistent involuntary unemployment. The chapter also assesses the political aspects of full employment.
Historically, financial crises have been commonplace. Why did the latest episode almost derail the world economy? The macroeconomics developed by John Maynard Keynes and his close followers provides the only plausible set of answers, including rising income inequality that spilled over into debt accumulation at the same time as household consumption rose, low real interest rates, massive expansion of financial assets and liabilities as investors borrowed heavily (increased leverage) to buy assets with rising prices, and an ample supply of imports and capital inflows from the rest of the world to the United States. In an accommodating political economy environment these factors linked the real and financial sides of the US economy to create the crisis.
The “L-shaped aggregate supply curve” is routinely treated as nothing more than a primitive version of a Phillips curve. This is misleading because it is in fact a later reconstruction, based on a presumption of the superiority of the Phillips curve, of a well-developed theoretical outlook. That outlook saw the problems of inflation and unemployment as substantially separate ones. The theory of wage determination, in particular, was intensively studied with little reference to the level of unemployment and understood with little regard to the marginal product of labor. Contact with that vision was lost as econometric and other work on the Phillips curve developed, and this explains the later failure to appreciate the ideas of the 1950s. It is suggested that the older ideas are worth revisiting not just for their historical interest, but also on their merits.
This chapter examines three fundamental propositions regarding money. First, money buys goods and goods buy money, but goods do not buy goods. Second, money is always debt; it cannot be a commodity from the first proposition because if it were, that would mean that a particular good is buying goods. Third, default on debt is possible. The approach taken here is not meant to replace the more usual post-Keynesian economics and institutionalist approach, but rather is meant to supplement them. For example, this discussion is linked to Hyman Minsky’s (1986) work, to the endogenous money approach of Basil J. Moore (1988), to the French-Italian circuit approach, to Paul Davidson’s (1978) interpretation of John Maynard Keynes that relies on uncertainty, to the approaches that rely heavily on accounting identities—and the “K” distribution theory of Keynes, Michał Kalecki, Nicholas Kaldor, and Kenneth Boulding, to the sociological approach of Geoffrey Ingham, and to the chartalist or state money approach. Hence, this chapter takes a somewhat different route to develop more-or-less heterodox conclusions about money.
The Neoclassical Sink and the Heterodox Spiral: Why the Twin Global Crisis has not Transformed Economics
The global financial crisis, when it first emerged in 2007–2008, appeared to be a silver bullet aimed at the heart of neoliberal macroeconomics and efficient-markets financial theory. Several years later, the United States and many Eurozone nations are loaded with cascading debt flows that apparently exceed repayment capacity. Why has the neoliberal approach to financial governance and macroeconomic policy not been repudiated by an economics mainstream whose collective reputation is clearly at stake amid the warning signs of a looming global depression? And what does this turn of events mean for the future of heterodox economic theory? This chapter explores why the twin global crisis has not transformed economics. It first differentiates among three perspectives that shape much thinking in economics: neoliberal economics, neoclassical economics, and heterodox economics. It then looks at the subprime crisis and argues that the subprime crisis and financial market meltdown clearly pointed to failure of government regulation.
In a review of Asset Accumulation and Economic Activity by James Tobin, Hyman Minsky outlined three types of macroeconomic approaches after John Maynard Keynes: the neoclassical synthesis, the New Classical approach, and fundamentalist Keynesian scholarship. Each of the three streams of thought identified by Minsky had trouble finding acceptance. Regarding the fundamentalist Keynesians, Minsky’s third group, this chapter suggests why mainstream economists tended to ignore them, attributing this neglect to a form of dogmatism. The bulk of this chapter, though, focuses on criticism leveled against the two other approaches quite directly, namely, that they had inadequate microfoundations. Unless otherwise stated, the microfoundations referred to in this chapter concern the aggregate manifestations of the general equilibrium (of the Arrow-Debreu type) of maximizing individual agents. Also discussed are the arbitrariness of aggregate demand and its implications, the Sonnenschein-Mantel-Debreu theory, and ontological reduction and explanatory reduction.
James K. Galbraith
This chapter presents an approach to the analysis of the personal distribution of income and pay consistent with post-Keynesian economic analysis. Since the Keynesian tradition is macroeconomic, this raises the question: what is the relationship between inequality and macroeconomics? After a brief discussion of theory and review of recent work in related traditions, the chapter surveys empirical efforts to develop dense and consistent measures of economic inequality suitable for use in macroeconomic studies, using a method based on the between-groups component of Theil’s T statistic. A principal contribution is to show that dense and consistent inequality measures can be computed from many diverse and mundane sources of information, including regional tax collections, employment and earnings, census of manufacturing, and harmonized international industrial data sets. The rich data environment so constructed permits new analyses of patterns of economic change, by region, by sector, and by country, and broadly supports the idea that the movement of inequality is closely related to macroeconomic events at the national and the global level, including war, revolution, and financial crises. Indeed, there is strong evidence that the movement of inequality within countries is dominated by a single global pattern, closely related to changes in the international financial regime.
Endogenous money is a key feature of post-Keynesian monetary economics and of monetary circuit theory. This chapter highlights the contributions and the evolution of Wynne Godley’s views on money, as they have evolved toward what Godley first called the real stock flow monetary model, which later became known as the stock-flow coherent model, showing that his views encompass post-Keynesian economics and monetary circuit theory. The chapter first recapitulates what it considers to be the main features of post-Keynesian monetary analysis. It then presents the work of Godley and his efforts to develop a systemic understanding of an economy and how money comes about. It also considers the role of banks and how they achieve their portfolio objectives. Finally, it explores how these stock-flow coherent principles fit in the context of an open economy and discusses some implications of the subprime financial crisis for monetary theory.
A Post-Keynesian Perspective on the Rise of Central Bank Independence: A Dubious Success Story in Monetary Economics
Central bank independence (CBI) refers to the relation between the central bank and the state, the legislature and executive. In practice, central banks typically engage in a wide range of activities related to the currency sphere and the financial system. The mainstream literature popularizing CBI features a “narrow central bank” approach that concentrates on central banks’ monetary policy functions only, ignoring important interdependencies between monetary policy on the one hand, and central banks’ historical role as government’s banker (as one link to fiscal policy) and their role in safeguarding the financial system’s stability on the other. This chapter investigates the rise in CBI as an apparent success story in modern monetary economics. The worldwide rise in CBI is partly due to the advent of Economic and Monetary Union (EMU) in Europe. This chapter also discusses the time-inconsistency argument for CBI, post-Keynesian criticisms of CBI, and whether John Maynard Keynes’s model of CBI strikes a sound balance between democracy and efficiency.
Victoria Chick and Sheila C. Dow
Four approaches to money in the macroeconomy have appropriated the name of Keynes or the label “post-Keynesian”: liquidity preference, circuit theory, and the two forms of endogenous money, structuralism and accommodationism. Despite the common appeal to Keynes, there is little apparent common ground between these approaches. Horizontalists reject the very idea of the demand for money to hold, which is at the core of liquidity preference; circuitists reject uncertainty as the source of the existence of money, one of Keynes’s strongest assertions; structuralists reject an unconstrained supply of money, the core of the horizontalist approach. There is even disagreement about the definition of money. This chapter conducts a ground-clearing exercise in order to establish where we all agree: that bank loans create deposits. This exercise is followed by an argument that, contrary to the belief of some horizontalists, liquidity preference is not incompatible with loan-to-deposit causality. The chapter then rehearses the different concepts of money held by circuitists and liquidity preference theorists.
The age of formal mathematics, proving the existence of nonconstructible, noncomputable, undecidable entities in economics, may, in the fullness of time, come to be seen as having occupied an insignificant, sorry period in the grand development of economic theory that was initiated by the classical economists and nobly preserved and enhanced by the development of macroeconomics at the hands of the Swedes and John Maynard Keynes. This chapter attempts to extract precepts from the rich traditions of the many strands of post-Keynesian economics for the modeling of a post-Keynesian theory of aggregate fluctuations. The approach follows the idea of a “constructive engagement with mainstream economics” suggested in persuasive ways by Giuseppe Fontana in several of his writings. The chapter first summarizes the way the classics of nonlinear, nonstochastic, endogenous theories of the business cycle—incorporating, naturally, also growth—satisfy many of the post-Keynesian precepts. It then looks at Hyman Minsky’s approach to modeling economic crisis.
Edward J. Nell
Joan Robinson asked, “What are the Questions?” in her seventy-fifth year. Economics, she felt, was no longer focusing on the important issues; it had become bogged down in the mathematical detail of models. She asked this because she wanted to force the profession to face the fact that there was very little apparent progress in economics. It was time to ask again what was economics supposed to explain, in particular, not only how growth took place, but what was the point of growth and economic expansion, what were they for? This chapter considers two kinds of questions. First are those that concern how each of the different parts of the macro-system work—production, labor market, money and banking, taxation and government spending. Second are those questions about how these different parts interact, how they are tied together to make a system that works in a certain way—inflation and Phillips curves, for example.