Overview of the Austrian School theories
of capital and business cycles and
implications for agent-based modeling
Presentation to New School for Social
Research Seminar in Economic Theory and
Modeling
For more information see
cameroneconomics.com
Background and Motivation
The “Austrian School of Economics” lost its
prominence in the 1930s with the rise of Keynesian
economics. One of the reasons for this (see Hayek
1995) is that Austrian School macroeconomic theory
could not be adequately formalized with
mathematics, as was done with John Maynard
Keynes's ideas from the General Theory. When
F.A. Hayek won the Nobel Prize in 1973 this created
a resurgence of interest in the ideas of the Austrian
School. Our research is a further continuation of
this resurgence in Austrian School ideas.
Generalized Notes on the “Austrian School of Economics”
1) The Austrian School is not an argument for laissez-faire capitalism.
(Hayek believed in the negative income tax, and, that many
institutions belonged in society because they evolved into society,
and thus exist for a reason.)
2) The Austrian School can be seen as a methodology approach which is
wary of the unintended consequences of government intervention and
its effect on the price system which is seen as the coordinating factor
in a society’s economy.
3) The Austrian School methodology prioritizes logical reasoning over
empirical relationships because it assumes the economy is too
complex to model causality.
4) The Austrian School uses the individual as entrepreneur as basis for
analytical approach and the subjectivity of decision-making. It is thus
skeptical of the validity of other economic schools of thought,
especially those using generalized aggregations.
5) Hayek later in life lost faith in general equilibrium theory, thus agentbased modeling might be valid method to evaluate some Austrian
School concepts.
Hayek uses a triangle to graphical represent an economy and the
disaggregated, simultaneous, heterogeneous capitals in an economy
(the capital structure of an economy).
.
.
Bohm-Bawerk alone among the Austrians wanted to aggregate capital into an “average period of production.”
We have formalized this concept by making the average period of production as given by at Capital Index (K),
and
Where i = (1, 2, …, k), k is equal to the number of the highest stage of production in the economy (in our
model k = 5, where five represents the mining stage of production); x is each stage of production, and w is the
weight of the production stage’s quantity of capital in relation to the quantity of capital in the economy as a
whole. In this economy, K = .4(1) + .25(2) + .20(3) + .10(4) + .05(5) = 2.15.
Austrian School capital theory assumes natural or normal rates of interest under
which an economy (society as living organism) creates a natural capital structure,
which in turn provides for, under the ‘animal spirits’ of human action and
creativity, capital accumulation, economic growth and increasing standards of
living.
The theory of natural rates of interest (matching the
endogenous preferences of savers and borrowers) assumes
also that an economy experiences natural business cycles
(or “colds” in biological terms) the downturns of which are
overcome over time by the ‘animal spirits’ of human
action.
It is only when external bodies enter the natural economy
(in this case monetary policy interest rate manipulations)
that the natural capital structure is upset, creating
incentives which cause malinvestment in unsustainable,
longer stages of production and, due to the opportunity
costs of scarce resources, reduced consumption.
Malinvestment prolongs a natural economic
downturn and associated unemployment because the
sticky over-investment in unproductive sectors needs
to be “worked-out” (or in biological terms, cleansed)
from the system. This cleansing process takes longer
than if there had not been unnatural malinvestment.
It is when “unhealthy” investment is purged from the
economy that healthy investment and (sustainable)
economic development continues based on subjective
tastes and risk preferences of society’s individual
entrepreneurial actors.
Austrian School capital theory is based on simultaneous, heterogeneous, capitals,
each with a unique level of risk. Note that the alpha risk measure is actually a proxy for
market uncertainty, the technology, the regulatory environment, the labor pool, the
climate and/or resource dependency, the competitive factors, ‘rational expectations’
based on limited information, and local knowledge surrounding the investment in the
stage of production as envisioned by the entrepreneur. Alpha i, therefore, of course,
varies with the subjective knowledge of each entrepreneur.
Here is a graphical-analogical model example of creative destruction. Let’s
assume a technology shock which effects alpha 3, what is the result of productivity,
employment and investment in this and other stages of production?
Austrian Capital Theory and Agent-Based Modeling
The Basic Model: Models subjective unique risk preferences generalized into
three classes, with bounded, “sticky”, investment functions based on time lags for
investment to move from one stage of production to another. Unemployment
based on investment time-lags, with lay-offs beginning at higher stages of
production. Economy operates over-time showing results on accumulation,
distribution, growth, employment and population.
• Starts with three ‘classes”, 1) rich start with 2 capital units, earn investment returns only
and are more risk seeking than middleclass, 2) middleclass start with one capital unit, earn
both wage income and investment returns, and 3) poor earn wages only.
•Assumes all wages spent.
•Capital hires wages. Each capital worker unit initially allocated in economy according to
weight of stage of production in capital structure of economy.
•Poor moves to middle class after 20 periods of work; when poor moves to middleclass
another poor is born. Each agent lives 40 years.
•Middleclass moves to rich after accumulating second capital unit.
•Interest rate change takes three periods , moving from lower to higher stages of
production, before fully integrated into investment decisions.
• Model allows for varying endowments , and risk preferences, within classes.
For Further Reference
Bohm-Bawerk, Eugen. 1891. The Positive Theory of Capital. London: Macmillan and Co.
Garrison, Roger. 2001. Time and Money: the Macroeconomics of Capital Structure. New York: Routledge.
Garrison, Roger. 2007. “Capital-Based Macroeconomics,” on-line slide show, http://www.slideshare.net/fredypariapaza/capitalbasedmacroeconomics, accessed 10/6/07.
Hayek, Friedrich A. [1931] 1966a. Prices and Production. New York: Augustus M. Kelley Publishers.
Hayek, Friedrich A. [1933] 1966b. Monetary Theory and the Trade Cycle. New York: Augustus M. Kelley.
Hayek, Friedrich A. 1995. Contra Keynes and Cambridge: Essays, Correspondence. Edited by Bruce Caldwell. Chicago: University of Chicago.
Hoppe, Hans-Hermann. 1993. The Economics and Ethics of Private Property. Boston: Kluwer Academic.
Keynes, John M. 1931. “The Pure Theory of Money. A Reply to Dr. Hayek.” Economica (11) 34, 387-397.
Kurz, Heinz D. 1990. Capital, Distribution and Effective Demand: Studies in the “Classical Approach” to Economic Theory. Cambridge, UK: Polity
Press.
Kurz, Heinz and Salvadori, Neri. 1992. Theory of Production I. Milan: Instituto di ricera sulla Dinamica dei Sistemi Economoci (IDSE).
Menger, Carl. [1871] 1950. Principles of Economics. Glencoe, IL: Free Press.
Mises, Ludwig. [1932] 1990. “The Non-Neutrality of Money”, in Money, Method and the Market Process, Richard M. Ebeling, ed., from lecture
given to New York City Economics Club. Norwell, MA: Kluwer Academic Publishers.
Mulligan, Robert F. 2006. “An Empirical Examination of Austrian Business Cycle Theory.” Quarterly Journal of Austrian Economics 9 (2), 69-93.
Schumpeter, Joseph R. 1950. Capitalism, Socialism and Democracy. New York: Harper & Row.