WEBVTT NOTE Intertemporal Macroeconomic Equilibrium: An Austrian Theory and Its Applications 1 00:00:00.000 --> 00:00:03.000 Why another theory? 2 00:00:03.000 --> 00:00:13.000 We have the Productivity Theory that was upheld by Boehm-Bawerk, by Knud Wichsel, by Hayek, 3 00:00:13.000 --> 00:00:22.000 but it has not had very much success in recent decades, so I will not talk about it anymore. 4 00:00:22.000 --> 00:00:27.000 Then we have the Loanable Funds Market Theory. 5 00:00:27.000 --> 00:00:40.000 It is widely used in the Austrian School today, for instance in modern classics of the Austrian School, the structure of production by Mark Skousen or by Roger Garrison in his time and money. 6 00:00:40.000 --> 00:00:46.000 But can this theory explain macroeconomic equilibrium? 7 00:00:46.000 --> 00:00:53.000 If I refer to Mises, to Hayek and to Rothbard, the answer is probably no. 8 00:00:53.000 --> 00:01:03.000 And the reason is that for the purposes of fundamental analysis, there needs not exist a loanable funds market. 9 00:01:03.000 --> 00:01:14.000 So even if there is no loanable funds market, there will be an aggregate investment equilibrium value and equilibrium originary interest rate and so on. 10 00:01:14.000 --> 00:01:21.000 So there are more fundamental forces at work independently of the monetary loans. 11 00:01:21.000 --> 00:01:28.000 And at last we have the Generalized Loanable Funds Market Theory that was developed by Rothbard. 12 00:01:34.000 --> 00:01:40.000 So here is Rothbard's model. We have a supply of present money, a demand for present money, 13 00:01:40.000 --> 00:01:47.000 and the determination of the macroeconomic equilibrium of investment and the interest rate. 14 00:01:47.000 --> 00:01:55.000 His model encompasses a number of components of what he calls the time market. 15 00:01:55.000 --> 00:02:02.000 So we have three components, the loanable funds market, the exchanges between capitalists, 16 00:02:02.000 --> 00:02:07.000 and the exchanges between capitalists and owners of originary factors. 17 00:02:07.000 --> 00:02:12.000 These exchanges take place at the different stages of the structure of production. 18 00:02:12.000 --> 00:02:40.000 And the problem I have with Rothbard's theory is that, for instance, the exchanges between capitalists and workers are considered, in his theory, as if the workers were the borrowers, they borrow present money and they kind of reimburse, repay the capitalists later with an interest. 19 00:02:40.000 --> 00:02:54.000 So, in his theory here, he formalizes the exchange between capitalists and workers as if it was the exchange between borrowers and lenders of money. 20 00:02:54.000 --> 00:02:59.000 And I think that this is not correct, at least I am not convinced by this theory. 21 00:02:59.000 --> 00:03:05.000 And this is why I have searched for another theory of macroeconomic equilibrium. 22 00:03:05.000 --> 00:03:12.440 So, the point of departure is the concept of the structure of production. 23 00:03:12.440 --> 00:03:18.400 So I do not start at all with a loanable funds market, in fact I will not use it at all in 24 00:03:18.400 --> 00:03:20.560 the presentation. 25 00:03:20.560 --> 00:03:27.520 The structure of production, we have an aggregate consumption, nominal value, nominal value 26 00:03:27.520 --> 00:03:32.800 of investment, an aggregate investment, which is the sum of the investments at the different 27 00:03:32.800 --> 00:03:39.120 in stages, and the concept, very important in this presentation, of capital intensiveness, 28 00:03:39.120 --> 00:03:47.040 which is the ratio of annual aggregate investment to annual consumption. 29 00:03:47.040 --> 00:03:55.560 Now the question is, is this structure with a given capital intensiveness, is it in equilibrium? 30 00:03:55.560 --> 00:04:04.280 Or is the equilibrium structure shorter with a lower capital intensiveness or is it longer 31 00:04:04.280 --> 00:04:06.200 with a higher capital intensiveness? 32 00:04:06.200 --> 00:04:11.320 This is the problem from which I start. 33 00:04:11.320 --> 00:04:19.200 So now I turn to the presentation of this model. 34 00:04:19.200 --> 00:04:22.880 And this model rests upon two determining elements. 35 00:04:22.880 --> 00:04:26.520 First there is the productivity of the lengthening of the structure. 36 00:04:26.520 --> 00:04:31.840 The lengthening of the structure is synonymous with an increased capital intensiveness or 37 00:04:31.840 --> 00:04:34.960 a greater capital accumulation. 38 00:04:34.960 --> 00:04:41.840 So here the idea is that if lengthening the structure brings a great increase in the total 39 00:04:41.840 --> 00:04:50.120 product, then people will tend to save more and augment capital intensiveness. 40 00:04:50.120 --> 00:04:56.240 Then there is the intensity of time preference, so here it is quite obvious if time preference 41 00:04:56.240 --> 00:05:01.560 is strong, if the preference for the present is high then people will tend to consume more 42 00:05:01.560 --> 00:05:06.960 now and reduce saving and investment, capital intensiveness will decline and conversely 43 00:05:06.960 --> 00:05:11.920 if time preference is low people will tend to consume less now, increase their saving 44 00:05:11.920 --> 00:05:13.840 and so on. 45 00:05:13.840 --> 00:05:21.960 So the model shows how that these two aspects of choice interact and how their interaction 46 00:05:21.960 --> 00:05:26.960 leads or can lead to macroeconomic equilibrium. 47 00:05:26.960 --> 00:05:32.420 Here is the model and from the formal point of view I have borrowed it from Hayek in the 48 00:05:32.420 --> 00:05:34.260 Pure Theory of Capital. 49 00:05:34.260 --> 00:05:41.100 He has a similar model, formally similar but theoretically different. 50 00:05:41.100 --> 00:05:48.620 So horizontally we have the final production, the quantity of final produce that is produced 51 00:05:48.620 --> 00:05:53.060 each year and it is during the current year. 52 00:05:53.060 --> 00:06:01.480 And on the vertical axis we have all the future years, so the final product that will be produced 53 00:06:01.480 --> 00:06:05.980 next year and the year after and the year after and so on and so forth. 54 00:06:05.980 --> 00:06:12.220 And since it will be always the same product that will be produced in the future years, 55 00:06:12.220 --> 00:06:17.460 it can change in the current year, but in the future years always the same product will 56 00:06:17.460 --> 00:06:19.500 be made, the same product. 57 00:06:19.500 --> 00:06:24.780 So we only need one axis for all the future products. 58 00:06:24.780 --> 00:06:31.580 We have here the line of 45 degrees and the representation of a structure of production, 59 00:06:31.580 --> 00:06:33.860 a reproducible structure. 60 00:06:33.860 --> 00:06:45.860 So this point represents a structure of production that produces the quantity Q1 during the current year, Q1 next year and Q1 the year after and Q1 and Q1 and so on and so forth. 61 00:06:45.860 --> 00:06:53.860 So this structure is reproduced each year and by hypothesis here the factors are efficiently utilised, 62 00:06:53.860 --> 00:07:03.860 Which means that on account of the capital intensiveness, Q1 is the maximum final produce that the structure can offer. 63 00:07:03.860 --> 00:07:09.860 This is an efficient structure in a very straightforward meaning of the term. 64 00:07:09.860 --> 00:07:14.860 Now, the first element is the transformation curve. 65 00:07:14.860 --> 00:07:20.860 The transformation curve will indicate what happens when people save or desave. 66 00:07:20.860 --> 00:07:25.500 For instance, if people decide to save, 67 00:07:25.500 --> 00:07:29.140 then they will consume less in the current year. 68 00:07:29.140 --> 00:07:32.220 We see the arrow to the left. 69 00:07:32.220 --> 00:07:36.060 And next year, the structure will be heightened. 70 00:07:36.060 --> 00:07:40.220 It will be at the higher point and remain there, for instance, 71 00:07:40.220 --> 00:07:45.180 if people decide not to save, not to save in the following year. 72 00:07:45.180 --> 00:07:50.660 So an additional saving will bring the structure to a higher point next year. 73 00:07:50.660 --> 00:07:58.420 And then the next year, if nothing changes, the production will be Q2, and so on and so forth, each year. 74 00:07:58.420 --> 00:08:11.460 They can also want an additional consumption, they de-save, in which case the structure in the following year will be lower. 75 00:08:11.460 --> 00:08:20.500 There is just one transformation curve for all the structure of production along the axis, it is translated horizontally. 76 00:08:20.500 --> 00:08:28.900 Now, the element of time preference, and yes, I will use indifference curves, 77 00:08:28.900 --> 00:08:38.420 but I must say immediately that the concept of indifference curve here is purely used for convenience, 78 00:08:38.420 --> 00:08:46.500 for pedagogical presentation. It can be entirely discarded from the presentation, but then 79 00:08:46.500 --> 00:08:49.500 The presentation will be longer and more difficult to catch. 80 00:08:52.300 --> 00:08:56.500 So here we have three structures of production 81 00:08:56.500 --> 00:09:00.700 that offer the same inter-temporal satisfaction, 82 00:09:00.700 --> 00:09:04.100 which means that people are indifferent 83 00:09:04.100 --> 00:09:07.700 between remaining at the current structure, 84 00:09:07.700 --> 00:09:11.700 so producing Q1 this year and next year and next year, 85 00:09:11.700 --> 00:09:15.100 or saving the quantity S, 86 00:09:15.100 --> 00:09:25.780 This is the structure on the left, but then they must be compensated by a sufficiently greater increase in production, Q2, 87 00:09:25.780 --> 00:09:34.180 or they may decide to consume more now on the proviso that their future consumption, Q3, will not be too low. 88 00:09:34.180 --> 00:09:38.220 So this is an indifference curve, very straightforward. 89 00:09:38.220 --> 00:09:46.780 And we have also the map of indifference curves that appears here, very standard, in a way. 90 00:09:46.780 --> 00:09:50.580 Now we put the two curves together, so it's very simple. 91 00:09:50.580 --> 00:09:55.340 We put the transformation curve and we put the indifference curve. 92 00:09:55.340 --> 00:10:00.820 And we have a structure where the two curves cross in this way. 93 00:10:00.820 --> 00:10:06.380 This structure is an inter-temporal macroeconomic disequilibrium. 94 00:10:06.380 --> 00:10:08.020 Why? 95 00:10:08.020 --> 00:10:13.460 Because we see here that people can increase their inter-temporal satisfaction, 96 00:10:13.460 --> 00:10:17.100 they can get to a higher indifference curve. 97 00:10:17.100 --> 00:10:22.900 Once again, I could make the presentation without using at all the concept of indifference curves, 98 00:10:22.900 --> 00:10:26.540 but it would be a bit less convenient. 99 00:10:26.540 --> 00:10:29.820 So we see that people can increase. 100 00:10:29.820 --> 00:10:38.660 The stream where they save S and reach the future production and consumption Q2 101 00:10:38.660 --> 00:10:44.500 is preferred to remaining at the same structure Q1, Q1, Q1, Q1. 102 00:10:44.500 --> 00:10:47.660 They increase their inter-temporal satisfaction and visually it means 103 00:10:47.660 --> 00:10:52.420 that we move from one indifference curve to a higher one. 104 00:10:52.420 --> 00:10:55.060 So this structure is in disequilibrium. 105 00:10:55.060 --> 00:10:58.620 People will choose here in this case to save more, 106 00:10:58.620 --> 00:11:08.980 increase, heighten the structure of production, and we will reach, not necessarily, but generally and most likely, an equilibrium. 107 00:11:08.980 --> 00:11:13.620 So this is a representation of what I call the inter-temporal macroeconomic equilibrium. 108 00:11:13.620 --> 00:11:19.620 The two curves are tangent, this is the mathematical conveniency and visualization. 109 00:11:19.620 --> 00:11:27.860 The two curves are tangent, which means that at this point, people do not wish to save more, they do not wish to consume more, 110 00:11:27.860 --> 00:11:31.380 They just wish to remain exactly at the same point. 111 00:11:31.380 --> 00:11:39.860 The structure is in a final equilibrium, whereas here the structure was not in equilibrium. 112 00:11:39.860 --> 00:11:41.060 Pretty simple. 113 00:11:41.060 --> 00:11:46.460 If the curves cross a different way, for example in this case, 114 00:11:46.460 --> 00:11:51.460 the equilibrium, they will choose to consume more now and less in the future, 115 00:11:51.460 --> 00:11:56.060 and the equilibrium will be at a lower point, a lower structure. 116 00:11:57.860 --> 00:12:07.860 So, the results of this model. There is an existence and stability of equilibrium. Existence, not necessarily. 117 00:12:07.860 --> 00:12:17.860 We could have, from a purely mathematical point of view, I would say, here, the case where people choose to save and accumulate capital without limit. 118 00:12:17.860 --> 00:12:22.860 And so the point of the structure would rise up and up and up and up and never stop. 119 00:12:22.860 --> 00:12:27.660 Well, it could happen from a mathematical point of view, so not very interesting. 120 00:12:27.660 --> 00:12:34.860 And the convergence process is an effect of the inter-temporal actions of the agents who save or dis-save. 121 00:12:38.860 --> 00:12:42.860 Now, let's take a look at this equilibrium. 122 00:12:42.860 --> 00:12:52.660 The question is, what is the equilibrium value of capital intensiveness, and above all, what is the equilibrium interest rate at this point? 123 00:12:52.860 --> 00:13:11.860 In Rothbard's theory we had a very simple and straightforward answer because in his theory at the point where the two curves cross we have simultaneously the aggregate investment and the equilibrium interest rate determined. 124 00:13:11.860 --> 00:13:16.860 But now we see that we need to take a step further. 125 00:13:16.860 --> 00:13:39.860 So first, capital intensiveness. And here the problem is, I think, quite simple, because there is a point-to-point correspondence between the transformation curve and there is just one transformation curve that moves horizontally between the structures along the axis, the 45 degrees line. 126 00:13:39.860 --> 00:13:52.860 There is a point-to-point correspondence between the transformation curve and the curve that relates the final produce of the structure and the capital intensiveness that we see here. 127 00:13:52.860 --> 00:13:56.860 It's not more difficult or more complicated than this, I think. 128 00:13:56.860 --> 00:14:04.860 So here it's simple, once we have an equilibrium structure, where the two curves, the transformation and the difference curve are tangent, 129 00:14:04.860 --> 00:14:12.860 we can get the value of the capital intensiveness of the structure following this curve. 130 00:14:12.860 --> 00:14:21.860 The real problem and difficulty with this model is the interest rate, the determination of the interest rate. 131 00:14:21.860 --> 00:14:31.860 In 1990, Pascal Salin, French economist, has written a macroeconomic textbook, but it's in French. 132 00:14:31.860 --> 00:14:38.860 And in the first chapter, he has a model of equilibrium that is really similar, not exactly the same, 133 00:14:38.860 --> 00:14:42.860 but really similar to the one that I have elaborated here. 134 00:14:42.860 --> 00:14:48.860 But then in the second chapter, when he wanted to determine the interest rate and investment, 135 00:14:48.860 --> 00:15:03.380 He switched completely the theory and he introduced borrowers and lenders and borrowers borrow at interest, lenders lend at interest and there is the haggling of the market and the interest rate is determined, etc. 136 00:15:03.380 --> 00:15:14.620 This is something that I, in this model, want to completely make disappear, completely make disappear. 137 00:15:14.620 --> 00:15:21.500 So, there is another theory that I will elaborate from this model, 138 00:15:21.500 --> 00:15:24.220 and this is the Fetter-Mises theory, in fact, 139 00:15:24.220 --> 00:15:29.180 the theory developed by Frank Fetter and Ludwig von Mises. 140 00:15:29.180 --> 00:15:31.340 It's based on the degree of time preference, 141 00:15:31.340 --> 00:15:36.940 so in this theory of interest, interest is quite simply a price differential, 142 00:15:36.940 --> 00:15:40.780 difference in price between present and future goods. 143 00:15:40.780 --> 00:15:48.900 And if the degree of time preference prevalent in society increases, 144 00:15:48.900 --> 00:15:55.500 people prefer more the present, then the price differential will be greater, 145 00:15:55.500 --> 00:16:00.420 and the interest rate will be greater, and conversely. 146 00:16:00.420 --> 00:16:07.980 So this is a theory that does not use at all the loanable funds market. 147 00:16:07.980 --> 00:16:18.540 We have here an index in this model of the intensity of time preference. 148 00:16:18.540 --> 00:16:27.820 It is the slope of the curve, a higher slope at the point that crosses the 45° line. 149 00:16:27.820 --> 00:16:34.140 A higher slope means a higher degree of time preference and a lower slope, a lower degree of time preference. 150 00:16:34.140 --> 00:17:00.140 So we have this, we know, we don't know the quantitative relationship of course between the slope of the curves and the level of the interest rate but we know that the indifference curve with a higher degree of time, with a higher slope leads to a higher degree of time preference and a higher interest rate and the one with the lower degree leads to a lower interest rate. We know this. 151 00:17:00.140 --> 00:17:03.540 The problem is a bit more complicated when we compare two structures. 152 00:17:03.540 --> 00:17:05.940 And I have to go very fast right now. 153 00:17:05.940 --> 00:17:08.940 I'm running out of time. 154 00:17:08.940 --> 00:17:11.340 When we compare two different structures like this, 155 00:17:11.340 --> 00:17:14.340 there's a problem because the level of wealth is not the same. 156 00:17:14.340 --> 00:17:20.940 So I think that the slope of the curve is not a very satisfying index. 157 00:17:20.940 --> 00:17:28.340 And it seems to me that the elasticity which takes into account the level of wealth 158 00:17:28.340 --> 00:17:33.340 And so the sacrifice that you make by saving depends on the level of wealth. 159 00:17:33.340 --> 00:17:37.340 The elasticity is a better index of time preference. 160 00:17:37.340 --> 00:17:42.340 So we could have something like this and the interest rate here appears. 161 00:17:42.340 --> 00:17:47.340 Of course, the curve of the interest rate can increase or decrease or remain constant, the lower curve here. 162 00:17:47.340 --> 00:17:52.340 I have drawn a decreasing because it's the most likely possibility. 163 00:17:52.340 --> 00:17:57.340 So here the model, we have a structure of production in disequilibrium. 164 00:17:57.340 --> 00:18:07.340 We reach equilibrium, we have the corresponding equilibrium capital intensiveness, and we have the corresponding equilibrium interest rate. 165 00:18:07.340 --> 00:18:12.340 So I must now jump to the conclusion. 166 00:18:12.340 --> 00:18:25.340 This model offers a different foundation for the nature of inter-temporal macroeconomic equilibrium, the convergence process, the determination of equilibrium interest rate and investment, 167 00:18:25.340 --> 00:18:39.340 The effects of a lowering of time preference and of technical progress can be quite nicely analysed in the framework of this model.