Modern Macroeconomics.pdf

504 Modern macroeconomicsties – no matter what institutional arrangements are in place and no matterwhat macroeconomic policies are pursued. In fact, the Austrian theory of thebusiness cycle is a theory about a policy-induced departure – first in onedirection and then in the other – from the economy’s production possibilitiesfrontier.For Keynes, increased saving leads to recession. This proposition, however,did not transform his paradox of thrift into an excess-saving theory ofrecessions. As already indicated, Keynes believed that saving preferenceswere not likely to change. The recession-inducing changes, in his view, werealmost always spontaneous changes on the demand side of the loanable fundsmarket.Keynes and Hayek were critical of one another’s efforts to explain recessions,but their assessments of one another’s books generated more heat thanlight and failed to produce a head-to-head comparison of the contrastingviews. Despite all the interpreting, reinterpreting and reconstructing ofKeynesian ideas over the last three-quarters of a century, it is instructive tocompare (in this and the following sections) the Austrian and (original)Keynesian views on the nature and causes of business cycles (see Garrison,1989, 1991, 2002).According to the Austrians, the market is capable of allocating resources inconformity with intertemporal preferences on the basis of a market-determined(natural) rate of interest. It follows, then, almost as a corollary that an interestrate substantially influenced by extra-market forces will lead to an intertemporalmisallocation of resources. This latter proposition is the essence of the Austriantheory of business cycles. The cyclical quality of the departures from theeconomy’s production possibilities frontier derives from the self-correctingproperties of a market economy. Misallocations are followed by reallocations.Note that the market is not judged to be so efficient as to prevent from theoutset all policy-induced misallocations. As Hayek (1945) has taught us, itcannot allocate resources in accordance with the ‘real factors’ (consumer preferences,technological possibilities and resource availabilities) except on thebasis of information conveyed by market signals, including, importantly, therate of interest. It is movements in the interest rate, along with the correspondingmovements in input prices and output prices, that give clues to the businesscommunity about what those real factors are and about how they may havechanged.The Austrian theory of the business cycle is a theory of boom and bust withspecial attention to the extra-market forces that initiate the boom and themarket’s own self-correcting forces that turn boom into bust. We have alreadyseen that increased saving lowers the rate of interest and gives rise to agenuine boom, one in which no self-correction is called for. The economysimply grows at a more rapid rate. By contrast, a falsified interest rate that