Dr. Miguel A. Alonso   THE AUSTRIAN THEORY OF BUSINESSCYCLES IN THE CONTEXT OF THE ECONOMIC           CYCLES LITERATURE   ...
Dr. Miguel A. AlonsoScheme of the seminar: 1. Introduction 2. Real business cycles versus monetary cycles 3. The Austrian ...
Dr. Miguel A. Alonso1. Introduction
Dr. Miguel A. Alonso One of the eternal debates in Macroeconomic Theory, is if money isshort-term neutral or, on the cont...
Dr. Miguel A. Alonso Hume (1752) establishes several controversial aspects that willcharacterize part of the program of a...
Dr. Miguel A. Alonso During the last decade, we have observed important studies thathave been developed to analyze the as...
Dr. Miguel A. Alonso A summary reading of these works, allows us to conclude that, ingeneral, Humes prediction of long-ru...
Dr. Miguel A. Alonso The necessity of making compatible the apparent long-run neutralityof money with its possible short-...
Dr. Miguel A. Alonso2. Real business cycles versus       monetary cycles
Dr. Miguel A. Alonso In general terms, during a boom-bust cycle, it can be observed that:   The volume of production of ...
Dr. Miguel A. Alonso Throughout the 20th century, lots of economists tried to give anexplanation to economic cycles of va...
Dr. Miguel A. Alonso Throughout the 20th century, lots of economists tried to give anexplanation to economic cycles of va...
Dr. Miguel A. Alonso The analysis of business cycle theories, can be faced by consideringthe effects of monetary perturba...
Dr. Miguel A. Alonso         Real business cycle models Usually, real business cycle theory (Kydland and Prescott, 1982;L...
Dr. Miguel A. Alonso         Real business cycle models Usually, real business cycle theory (Kydland and Prescott, 1982;L...
Dr. Miguel A. Alonso         Real business cycle models Nevertheless, it can be verified the existence of models that, by...
Dr. Miguel A. Alonso3. The Austrian Theory of endogenousmonetary cycle: An approach based on   intertemporal structure of ...
Dr. Miguel A. Alonso An important weakness in the core of contemporary macroeconomictheory, is the absence of a theoretic...
Dr. Miguel A. Alonso But we cannot arrive at the long-term without crossing for a sequenceof short-runs (Mises, 1949)......
Dr. Miguel A. Alonso• In Austrian Macroeconomics, it is possible to find two characteristicswhich are not considered in ot...
Dr. Miguel A. Alonso 3.1. The origins of the Austrianapproach: the monetary theory of          Knut Wicksell
Dr. Miguel A. Alonso One of the most important contributions of Wicksell isthe distinction between the concepts of natura...
Dr. Miguel A. Alonso Therefore, a cheap credit policy will throw the economyto a situation of macroeconomic disequilibriu...
Dr. Miguel A. Alonso3.2. Garrisonian Macroeconomics  The Austrian Business Cycle
Dr. Miguel A. Alonsoa) Core principles of Capital Based         Macroeconomics
Dr. Miguel A. Alonso• In a summarized form, Austrian theory shows how a monetary shockcan induce an intertemporal miscoord...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importa...
Dr. Miguel A. Alonso     Agents take decisions in an environment of imperfect                          knowledge Monetary...
Dr. Miguel A. Alonso      Agents take decisions in an environment of imperfect                           knowledge It is ...
Dr. Miguel A. Alonso The combination of all these principles, offers a representation of amacroeconomic system in which: ...
Dr. Miguel A. Alonsob) Graphical characterization ofcapital based Macroeconomics
Dr. Miguel A. Alonso Garrison defines three graphical instruments which are the constitutiveblocks of his representation ...
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  • Logotipo seminario de la luiss (ingles) i parte

    1. 1. Dr. Miguel A. Alonso THE AUSTRIAN THEORY OF BUSINESSCYCLES IN THE CONTEXT OF THE ECONOMIC CYCLES LITERATURE Prof. Dr. Miguel A. Alonso Neira Departamento de Economía Aplicada I Universidad Rey Juan Carlos de Madrid
    2. 2. Dr. Miguel A. AlonsoScheme of the seminar: 1. Introduction 2. Real business cycles versus monetary cycles 3. The Austrian Theory of endogenous monetary cycle: An approach based on intertemporal structure of capital
    3. 3. Dr. Miguel A. Alonso1. Introduction
    4. 4. Dr. Miguel A. Alonso One of the eternal debates in Macroeconomic Theory, is if money isshort-term neutral or, on the contrary, it creates cyclical movements inproduction and employment.  Although the great majority of economists accept that the long- term effects of money relapse totally on prices, also many of them admit that the monetary disturbances can have real effects at the short-run. In a speech delivered in 1995, Robert Lucaspointed out: “The tension between two incompatible ideas, that the variations in money are neutral at the long-run and that they induce movements in production and employment in the short-term, has been the center of Monetary Theory at least since Humes writings”.
    5. 5. Dr. Miguel A. Alonso Hume (1752) establishes several controversial aspects that willcharacterize part of the program of academic research of the followingcenturies.  He assumes that money is long-term neutral, but in the short-run he is nearer to Richard Cantillons theses.  In other words, in the short run, a monetary expansion not only doesn’t provoke a proportional increase in absolute prices, but also distorts the relative prices structure of the economy, changing the incentives system that guides the decision taking process of the agents.  Therefore, there would be a “transitional period”, in which the real side effects of money, would depend on the form in which money is put into the economy (“Cantillón effect”, 1755). These transitional periods could be lengthy and recurrent, giving place to monetary cycles.
    6. 6. Dr. Miguel A. Alonso During the last decade, we have observed important studies thathave been developed to analyze the assumption of money neutrality,not only in the long-run but also in the shor-run .  Friedman and Schwartz (1963) attribute the Great Depression of the 30s to mistakes of monetary policy.  Moreover, they show that as bigger is the growth of money supply, the larger is the corresponding increment of production above its natural trend, and vice versa.  Kydland and Prescott (1990) and Walsh (1998), also offer evidence that the variations of the monetary stock preceded the cyclical movements of the short-run production.
    7. 7. Dr. Miguel A. Alonso A summary reading of these works, allows us to conclude that, ingeneral, Humes prediction of long-run money neutrality, has receiveda strong support in the academic literature.  However, nothing is said about the evolution of relative prices (which are hidden in absolute prices) that could give place to the so- called “Cantillon Effects”.  On the other hand, the effects of monetary expansions on real activity (specially in the short term), continue creating important debates in modern Economic Theory.  ¿Is it money short-run neutral? Depending on how this question is answered, it is possible to find different interpretations on the origins, real or monetary, of cycles.
    8. 8. Dr. Miguel A. Alonso The necessity of making compatible the apparent long-run neutralityof money with its possible short-term real effects, led to thedevelopment of a very active research area: the so-called monetarytheories of the business cycles.  In these models, monetary expansions have real side effects (or even in the long-run if we consider the contributions of some Austrian authors) as a consequence of:  Imperfect information problems.  Wages and/or prices rigidities derived from the establishment of long-term contracts, efficiency wages, or menu costs.
    9. 9. Dr. Miguel A. Alonso2. Real business cycles versus monetary cycles
    10. 10. Dr. Miguel A. Alonso In general terms, during a boom-bust cycle, it can be observed that:  The volume of production of different sectors is affected with different degrees of intensity.  Inflation and interest rates tend to show a different behavior depending on to the phase of the cycle in which we are.  Sectorial employment moves on the same direction than the level of production of each of the sectors .
    11. 11. Dr. Miguel A. Alonso Throughout the 20th century, lots of economists tried to give anexplanation to economic cycles of variable duration. Any of thesetheories tries to determine three essential aspects: What kind of shocks, real or monetary, affect the economy in amore intensive way. What type of structure is necessary to propagate theperturbances: non-competitive markets, rigidity of prices and/orwages, or incomplete information with regard to prices, real wagesor interest rates.  It can be assumed that economic cycles are the result of rational agents equilibrium reactions in a economic world that works efficiently.
    12. 12. Dr. Miguel A. Alonso Throughout the 20th century, lots of economists tried to give anexplanation to economic cycles of variable duration. Any of thesetheories tries to determine three essential aspects: What kind of shocks, real or monetary, affect the economy in amore intensive way. What type of structure is necessary to propagate theperturbances: non-competitive markets, rigidity of prices and/orwages, or incomplete information with regard to prices, real wagesor interest rates. What kind of factors impinge on the persistence of cycles:duration of wage contracts, processes of accumulationor.deaccumulation of inventories, credit channel, intertemporal ........ dimension of capital...
    13. 13. Dr. Miguel A. Alonso The analysis of business cycle theories, can be faced by consideringthe effects of monetary perturbances in all the approaches considered.  This criterion allows us to classify these theories in:  Models of real cycles: that accept the assumption of money neutrality, even in the short-run.  Models of monetary cycle: which assume that money is non- neutral in the short-run (or even in the long-run).  Lets consider briefly the main characteristics of real business cycle models.
    14. 14. Dr. Miguel A. Alonso Real business cycle models Usually, real business cycle theory (Kydland and Prescott, 1982;Long and Plosser, 1983) is builded under three essential assumptions:1. It is a general equilibrium model with competitive markets that clear continuously at the corresponding equilibrium prices.2. It is based on a structure of representative agent who is endowed with rational expectations. This agent maximizes continuously an objective function in a perfect information world.3. The agents know the structure and the functioning of the economic system in which they must adopt their decisions.
    15. 15. Dr. Miguel A. Alonso Real business cycle models Usually, real business cycle theory (Kydland and Prescott, 1982;Long and Plosser, 1983) is builded under three essential assumptions:4. Moreover, they are able to anticipate the effects of any fiscal or monetary intervention based on rules.5. Finally they are able to discriminate between real and monetary shocks. The combination of these elements allows us to define RBCM as:  Equilibrium structures.  Models in which the assumption of short-term money neutrality is verified.
    16. 16. Dr. Miguel A. Alonso Real business cycle models Nevertheless, it can be verified the existence of models that, byrelaxing some of the assumptions of the real business cycle model,refute the short-term money neutrality proposition: 1. Non-competitive markets. Where it is possible to observe the existence of monopolistic or oligopolistic structures. 2. Prices or wages rigidities. Models of “menu costs”, and long- run wage contracts. 3. Problems of imperfect information. In this case, monetary expansions affect the short-term real value of macroeconomic variables, as a consequence of “monetary illusion” or “signal extraction” problems.
    17. 17. Dr. Miguel A. Alonso3. The Austrian Theory of endogenousmonetary cycle: An approach based on intertemporal structure of capital
    18. 18. Dr. Miguel A. Alonso An important weakness in the core of contemporary macroeconomictheory, is the absence of a theoretical basis to establish a real connectionbetween the keynesian short- term with:  markets with lots of rigidities and prone to failures,  underemployment of productive resources,  agents who respond to “animal spirits” and the neoclassical long-term with:  full flexibility of prices and wages,  always efficient markets,  and full employment of productive resources
    19. 19. Dr. Miguel A. Alonso But we cannot arrive at the long-term without crossing for a sequenceof short-runs (Mises, 1949)... Macroeconomics as a discipline needs of an analytical structure tobuild a connection between the keynesian short-run world of“perversion” and neoclassical long-term stage of “perfection”.  Austrian Macroeconomics arises as an attempt of establishing an analytical framework which allows the possibility of a “perfect” work of markets but, at the same time, identifies possible situations under which markets could fail.
    20. 20. Dr. Miguel A. Alonso• In Austrian Macroeconomics, it is possible to find two characteristicswhich are not considered in other approaches:1. The production process is configured by a sequence of stages, which reflects its dynamical and intertemporal character, and the heterogeneity of capital. 2. There exists a natural rate of interest that only depends on real or structural factors of the economy.
    21. 21. Dr. Miguel A. Alonso 3.1. The origins of the Austrianapproach: the monetary theory of Knut Wicksell
    22. 22. Dr. Miguel A. Alonso One of the most important contributions of Wicksell isthe distinction between the concepts of natural interest rateand monetary (or bank) interest rate.  The natural interest rate does not depend on monetary factors, but it is consistent with the rate of return of firms, the capital structure and the availability of resources (saving) in the economy.  If the natural interest rate prevails in the loan market, there will be an equilibrium between saving and investment, and prices will be constant.  The monetary interest rate is the direct result of banking policy.  If, as a consequence of a credit expansion (not financed by a previous increment of saving), the monetary interest rate places below the natural interest rate, firms will demand more credits than necessary, and households will have less incentives to save.
    23. 23. Dr. Miguel A. Alonso Therefore, a cheap credit policy will throw the economyto a situation of macroeconomic disequilibrium, in whicheconomic growth will ignore the volumen of saving and, atthe same time, there will be an increment in prices. For the Austrians, a (relatively) low monetary interest rate can createa capital allocation which is inconsistent with the natural interest rateand, therefore, with the underlying economic realities:  Technology Availability of resources.  Consumption intertemporal preferences. In the Austrian approach, the misallocation of capital created by anartificially low monetary interest rate, is the basis of a fictitious boom (abubble) which contains the seeds of its own destruction.
    24. 24. Dr. Miguel A. Alonso3.2. Garrisonian Macroeconomics The Austrian Business Cycle
    25. 25. Dr. Miguel A. Alonsoa) Core principles of Capital Based Macroeconomics
    26. 26. Dr. Miguel A. Alonso• In a summarized form, Austrian theory shows how a monetary shockcan induce an intertemporal miscoordination of economic activities.• In essence, injections of new money through credit markets, provoke adeviation of monetary interest rates from natural interest rates, creatingan intertemporal misallocation of productive resources .  Capital based macroeconomics allows to identify the basic differences between what is considered to be a process of sustainable growth, and a process of artificial or unsustainable growth.
    27. 27. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time.  It is defined as a sequence of stages  The intertemporality of capital is reflected in the hayekian triangle.  The capital structure Valor final de la producción occupies an intermediate position between inputs (work and natural resources) and the final output, increasing the intertemporal dimension of the production process. Etapas de la producción
    28. 28. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions.  In a world of imperfect information, prices and interest rates, are a vehicle of information transmission that guides the production and consumption decisions .  If these signals are manipulated by monetary interventions, it will be possible to observe an unsustainable miscoordination between the intertemporal plans of producers and consumers.
    29. 29. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions.  On the other hand, free market (natural) interest rates, offer fiable signals of intertemporal preferences of consumption.
    30. 30. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions. 3. Money can masquerade as saving.  When monetary authorities increase the quantity of money, they generate a differential between the levels of saving and investment.  An artificially low interest rate, creates a miscoordination between the intertemporal plans of decision of the agents.
    31. 31. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions. 3. Money can masquerade as saving. 4. Capital goods are heterogeneous, and reflect certain degrees of intertemporal complementarity. Ricardian effect.  Capital goods can be of higher or lower order. The first ones, are used to produce more investment goods, while the second ones are used to produce inmediate consumption goods.  The miscoordinación originated by a monetary expansion, manifests itself through a process of overinvestment in higher order capital goods.
    32. 32. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions. 3. Money can masquerade as saving. 4. Capital goods are heterogeneous, and reflect certain degrees of intertemporal complementarity. Ricardian effect.  In capital theory, variations of interest rates would create a substitution effect between low order and high order capital goods.  Thus, the miscoordinación originated by a monetary expansion manifests itself as a process of overinvestment in higher order capital goods (in detriment of lower order goods).
    33. 33. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions. 3. Money can masquerade as saving. 4. Capital goods are heterogeneous, and reflect certain degrees of intertemporal complementarity. Ricardian effect. 5. The demand for commodities is not derived from that for work. This is the fourth fundamental proposition of J. S. Mill.  A decrease of consumption does not necessarily imply a reduction of the demand for work (Keynes). Instead, it can imply an increase in the saving level and, therefore, in the future level of consumption.
    34. 34. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions. 3. Money can masquerade as saving. 4. Capital goods are heterogeneous, and reflect certain degrees of intertemporal complementarity. Ricardian effect. 5. The demand for commodities is not derived from that for work. This is the fourth fundamental proposition of J. S. Mill.  In a keynesian world the “derived demand” effect prevails over the “time discount” effect, which characterizes the Austrian approach.
    35. 35. Dr. Miguel A. Alonso Garrison (1986) identifies the key elements of Capital basedMacroeconomics, establishing the importance of each one of them: 1. Production is a process that requires time. 2. Prices send powerful signals, and interest rates facilitate the coordination of intertemporal decisions. 3. Money can masquerade as saving. 4. Capital goods are heterogeneous, and reflect certain degrees of intertemporal complementarity. Ricardian effect. 5. The demand for commodities is not derived from that for work. This is the fourth fundamental proposition of J. S. Mill. 6. Agents take decisions in an environment of imperfect knowledge. 7. Businessmen’s expectations are subjective.
    36. 36. Dr. Miguel A. Alonso Agents take decisions in an environment of imperfect knowledge Monetary manipulations of prices can induce to market participants,to behave of different forms than in other circunstances or scenaries. If market members had all the knowledge, artificial manipulations ofprice information wouldn’t provoke massive mistakes or wronginvestments. Hayek distinguishes two types of knowledge: a) the knowledge ofparticular circumstances of time and place, and b) the theoretical -scientific knowledge.
    37. 37. Dr. Miguel A. Alonso Agents take decisions in an environment of imperfect knowledge It is expected that market participants will have have the first type ofknowledge, but not the second one. Therefore, they will not be able todiscriminate between real and nominal (monetary) shocks on prices. Therefore, businessmen do not have complete information of theunderlying economic realities. In this respect, prices, wages and interest rates, encourage thecoordination of economic decisions, maintaining them in line with theunderlying economic realities.
    38. 38. Dr. Miguel A. Alonso The combination of all these principles, offers a representation of amacroeconomic system in which:  Businessmen take decisions on the basis of their own knowledge and expectations.  In their decisions, they are informed and coordinated by prices, wages, and interest rates movements. Collectively, these firm decisions give rise to an intertemporalcapital allocation that can be sustainable or unsustainable. In this respect, capital based Macroeconomics stablishes that oneof the main focus of Macroeconomics research, should be the studyof the factors that transform a process of economic growth into asustainable one or a self-destrutive process.
    39. 39. Dr. Miguel A. Alonsob) Graphical characterization ofcapital based Macroeconomics
    40. 40. Dr. Miguel A. Alonso Garrison defines three graphical instruments which are the constitutiveblocks of his representation of Capital based Macroeoconomics and theAustrian Business Cycle model.  The market of loanable funds  The production possibilities frontier  The hayekian triangle C Etapas de producción I i i* S, I

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