Tomorrow (Monday) my Econ 880 (Austrian Theory of the Market Process I) graduate student class will be discussing 'profits, interest and investment'. Not Hayek's book per se, but the range of topics. This is also a stretch for me since this isn't my area of research. But I have had a fascination with the work of Mises and Hayek (and all the Austrian "macro" researchers/teachers) since my undergraduate days studying with Dr. Hans Sennholz.
For the graduate students, my focus is both to communicate the basic idea (and research puzzles) of how to study intertemporal coordination. I have asked them to think about the relationship between Hayek's 1928 paper on price equilibrium and movements in the value of money, his 1933 paper on price expectations, monetary disturbances and malinvestments, and his 1939 paper on profits, interest and investment in light of the Keynesian avalanche. I am looking at reasons internal to Hayek's own presentation that caused the unusual circumstances that in 1931 everyone was a Hayekian at LSE to nobody remaining a Hayekian at LSE by 1939 (nobody is not quite accurate because Hayek and Lachmann remained). What in the presentation of the theory itself could fail to persuade and thus requires repair?
I don't think either Tyler Cowen's or Bryan Caplan's criticisms provide the answer. Nor does Paul Krugman's. Cowen's criticisms are the most interesting of this group because in Risk and Business Cycles, his adoption of various behavioral assumptions and theoretical perspectives does demonstrate the sensitivity of the Mises-Hayek story to various assumptions. But I have always found those basic assumptions and theoretical perspectives of Mises-Hayek to be quite plausible.
The way I see this, the basic story relies on the following propositions:
(1) Money is non-neutral
(2) Economic adjustments are guided by relative prices
(3) Capital structure in a modern economy consists of combinations of capital goods that are both heterogenous and possess multiple-specific uses
From these three propositions one can see how the manipulation of money and credit can distort relative prices and thus the pattern of exchange and production, and how those distortions are particularly painful because the readjustment/reshuffling of capital good investments is not costless.
It makes no sense to me to grant assumptions which require the actors in the system to fully anticipate all disturbances and thus acts in way that neutralize them before they take place (see my link to Koppl's discussion of magic). Nor does it makes sense to me to pursue macroeconomics via a theoretical perspective that minimizes the costs of disturbances by treating capital maintenance and capital good reshuffling as costless activities. And it certainly makes no sense to me to talk about macroeconomic models that are unconnected to the choices individuals make in the economy about what goods and services to provide, how they will do so, where they should work and live, and what they will buy and at what price and what they will abstain from buying.
But after that, the application of the theory is always unique to specific circumstances and the task of empirical investigation is to hammer out those historical details with the aid of the more general framework laid out.
So far so good, but what is the theoretical scaffolding is flawed? Could it be that the intellectual episode of the 1930s -- the Hayek Story as Hicks called it -- is one where Hayek's own adjustment to the theory did not answer the critics?
In Prices and Production, Hayek is quite clear that he made simplifying assumptions for ease of presentation and because of the pressure of time to translate the lectures into publication. In the Preface to the 2nd edition, he focuses on two such assumptions he made with respect to money and capital that may mislead. The critical one I would like to ask about is related to the velocity of money and its impact on the subsequent development of the Austrian theory. Again, keep in mind this question is being asked by someone innocent of the fine points in monetary theory and who has mainly bought the general bigger picture Mises-Hayek story.
In the preface pp. xii-xiii, Hayek he argued that in his presentation he held the velocity of money fixed and excluded from his story considerations of changes in the velocity of money. He then writes: "The impossibility of dealing expressly with changes in the velocity of circulation so long as this assumption was maintained served to strengthen the misleading impression that the phenomena I was discussing would be caused only by actual changes in the quantity of money and not by every change in the money stream, which in the real world are probably caused at least as frequently, if not more frequently, by changes in the velocity of circulation than by changes in the actual quantity."
Is this "misleading impression" what is behind the disagreements on this blog and elsewhere concerning monetary equilibrium theory? Did Mises-Hayek ever adequately correct the "misleading interpretation" in their respective works? Does Garrison's or Horwitz's work on modern "Austrian" business cycle theory satisfactorily correct the "misleading interpretation"? I don't mean due White, Selgin, Garrison, Horwitz, etc. recognize the point about velocity in their monetary theory, I am asking whether or not this has been incorporated into ATBC. The basic presentations of the theory still seem to me to focus on changes in the supply of money.
How does this change impact our understanding of the historical manifestations of boom-bust cycles in recent experience?