ECON 1110 Lecture Notes 9

ECON 1110 Lecture Notes 9 - ECON 1110 Intermediate...

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ECON 1110 Intermediate Macroeconomics James R. Maloy Spring 2011 Lecture Notes for Topic 9: Austrian Economics Readings: Murray Rothbard, America’s Great Depression, Ch. 1 and 2 The most notable figures in Austrian economics are Mises and Hayek. The website mises.org is the best source of information on Austrian theory. I. The Role of Money The Austrian theory of the business cycle centres on the role of money in the economy, on the grounds that any general (as opposed to industry or firm-specific) change in business activity transmits through the medium of exchange. Rothbard essentially notes the quantity theory of money: a change in the supply of or demand for money will lead to a change in overall prices. Higher demand for money (such as comes when production increases and more goods are bought and sold), given a fixed money supply, will increase the purchasing power of that money, e.g. falling prices. An increase in the money supply, demand held constant, will reduce the purchasing power of that money, e.g. higher prices. Therefore, any change in business activity is reflected in this relationship. However, this relationship alone does not explain why it is that business activity can go through extended boom periods, followed by depression. Before continuing, it is important to note that Austrians do not define “inflation” as a change in the price level. Rather it is defined as an expansion of money and credit. “Deflation” is a contraction of money and credit. Generally increasing prices are often a symptom (although not a necessary component) of a money/credit inflation while generally decreasing prices are likewise often a symptom of a money/credit deflation. Note that in a fractional reserve system the expansion of bank credit creates money via the money multiplier process (and vice versa). II. The Cluster of Error Austrian theory argues that business cycles occur when errors become clustered; e.g. most/all businesses simultaneously overproduce, etc. The job of the entrepreneur is, of course, to forecast the future and invest appropriately; in a pure market economy the 1
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market dishes out rewards and punishments based on the success of their decisions. However, during the business cycle errors become clustered such that many firms face similar problems. Rothbard notes that three key feature of these business cycles. First, why is it that the entrepreneur’s forecasts all simultaneously fail? Second, similar to Keynes’ observations regarding volatile business investment, is that capital-goods industries are subject to wider fluctuations than consumer goods industries. In particular, industries that provide raw materials, construction or equipment are most susceptible to the business cycle. Finally, during the boom period the supply of money typically increases; it often falls in the subsequent depression. Austrians typically argue that in a pure free market, business errors are randomly
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ECON 1110 Lecture Notes 9 - ECON 1110 Intermediate...

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