Money and Markets: Essays in Honor of Leland B. Yeager

176 Steven HorwitzExcess demands for money and the macroeconomics ofcapital structurePlacing Austrian macroeconomics on the foundations of monetary disequilibriumtheory suggests, in contrast to the older Austrian position, that there are situationswhere the expansion of the money supply is appropriate, independent of anymoney commodity backing it. Should the demand for money rise, we would befacing the sort of Wicksellian cumulative rot discussed earlier. Seen from theAustrian capital-theoretic perspective, we have the reverse of the cycle theory. Thepublic is attempting to supply loanable funds, but the banking system is not producinginvestment in response. The market rate is above the natural rate, signalingfalsely that the public is less willing to part with time than they really are. The resultwill be firms maintaining the length of their capital projects even though the publicis prepared to wait even more, which would justify a longer process of production.Just as the Austrian cycle theory predicts that the abandonment of unsustainablecapital projects will be the manifestation of the intertemporal discoordinationstemming from inflation, the Austrian-infused deflation theory would predict thatunsold inventories on store shelves will be the manifestation of the reverse form ofintertemporal discoordination. Producers continue to produce for a level of consumptionthat is no longer relevant. The attempt to save via money holding hasreduced consumption, thus the ongoing projects of producers should be morefuture oriented than they are. This intertemporal discoordination due to the falseinterest rate signal will lead to inventory accumulation as producers continue theshorter processes of production even though longer ones are justified. Without theexpected consumption expenditure, inventories will accumulate. As we saw above,monetary disequilibrium theory is consistent with the existence of those unsoldinventories: the downward stickiness of prices during the early stages will indeedlead to unsold goods on store shelves.In his 2001 book and in a recent (2004) article, Roger Garrison has put forwarda three-quadrant model that illustrates the interconnections among the market forloanable funds, the economy’s production possibilities frontier as seen in the tradeoffbetween consumption and investment, and the capital structure as seen in thedevice of the Hayekian triangle (see Figure 12.1). In those two contributions,Garrison puts the model through its paces with a variety of scenarios, almost all ofwhich involve expansionary monetary or fiscal policy (as well as the “baseline” ofsavings-induced secular growth). In particular, Garrison uses the Hayekian triangleto illustrate the effects of the boom on the capital structure. During inflation, theartificially lower market rate both encourages the flow of capital resources to theearlier stages of production via its effect on the cost of borrowing, whilesimul taneously encouraging increased consumption and a demand for goods in thevery last stages of production through the induced reduction in savings. As Garrisonnotes, this pits the structure of production against itself by having the hypotenuse ofthe triangle starting with different slopes at each axis, not unlike a train track beingbuilt from opposite directions only to find out that the two pieces are not aligned.Eventually, producers are faced with real shortages of needed capital and cannot