Steve Horwitz
As most CP readers probably know, Leland Yeager passed away at age 93 on April 23rd. Many prominent economists with connections to Austrian economics have written very laudatory obituaries of a man who I think was the most underappreciated monetary theorist of the 20th century. I’d like to say some words about Yeager’s contributions as well, focusing on the way in which his work is central to a broader Austrian-oriented macroeconomics. This post will be personal, in the sense that my own work is heavily influenced by Yeager and many of the themes I address below are fleshed out in depth in my Microfoundations and Macroeconomics: An Austrian Perspective from 2000.
Let me start with a story. In the acknowledgements of that book, I wrote “Although [Yeager] has long been a sympathetic critic of Austrian economics, it is my personal mission in this book to convince him that Austrian macroeconomics is more than its business cycle theory, and that it can be rendered consistent with his own work.” I will add that Yeager was indeed one of the imagined audiences looking over my shoulder as I wrote that book. I also meant what I wrote there very sincerely. When Yeager first read the book, he was unpersuaded, even though he wrote a largely positive review. I was disappointmented. However, in classic Yeager fashion, I got a letter from him sometime later where he said that he went back and reread some or all of the book, and told me that he was too harsh in that judgment the first time around. I had mostly persuaded him of the large-scale compatibility of his approach and that of the Austrians. Being Yeager, he still found things to disagree about, but this little story is indicative of his immense intellectual honesty and integrity. He was honest to a fault, which is a quality too often lacking today, but one I very much appreciated while interacting with him as a younger scholar. (I would say exactly the same thing about my friend George Selgin as well, even though his intellectual honesty was a source of much more direct discomfort when I was a very young scholar!)
So why should Austrians pay attention to Yeager’s work? The key is his understanding of the role money plays as a medium of exchange. His “Essential Properties of the Medium of Exchange” is the piece to read if you only read one of his journal article contributions. Once we understand money as the generally accepted medium of exchange, several important insights follow.
First, money is one half of every exchange. All purchases of goods and services are sales of money. This point has a further implication that is even more important: because money is half of every exchange, every market for goods and services is also a market for money. It is even more helpful to see this from the other side: if every market is a money market, money has no market or price of its own. This last insight leads us to what I think is the most important conclusion to draw from this line of reasoning. If money has no market or price of its own, there is no single place where excess supplies or demands for money can be cleared by market processes. When the market for shoes is out of equilibrium, we expect that responses by market actors will change the price of shoes in a way that tends to clear the market. What Yeager’s argument suggests is that no such single-market mechanism exists for monetary disequilibria. I will return to this point in a moment.
A second part of Yeager’s work on monetary theory is the importance of the difference between people’s desired and actual money holdings. This is an idea that goes back at least as far as Mises’s cash balance approach to the demand for money, which can be found in its earliest form in The Theory of Money and Credit. Because we “routinely” accept money in the belief that we will be able to spend it later, we can find ourselves with more of our wealth in the form of money than we would prefer. If we assume, with Mises, that the demand for money is a demand to hold real money balances (i.e., a stock of purchasing power, not just nominal dollar amounts), we might find our actual money holdings diverging from what we would prefer given the current array of market prices. Notice that this conception of the demand for money is like any other demand: it’s a set of plans at various prices/values of the good in question. The only difference is that the “price” of the good in the case of money is the inverse of the price level, or the purchasing power of money. And that, in turn, depends on the prices of the countless goods and services available for purchase.
What do people do when their actual and desired money balances diverge? They attempt to get them back in line by adjusting their actual holdings. The case that concerned Yeager the most was where actual holdings were less than desired holdings, or where money was in excess demand. Given the influence that the early American monetarists such as Harold Davenport and Clark Warburton had on him, plus being aware of the work of Friedman and Schwartz on the Great Depression, it’s not surprising that he would focus on the economics of an excess demand for money. In his “Individual and Overall Viewpoints in Monetary Theory,” he stressed the point that while each individual can attempt to adjust his money holdings in the face of an excess demand, it was impossible for everyone to succeed in doing so without either a change in the price level, to make the existing nominal money supply grow in real terms to satisfy the demand for real balances, or a change in the nominal money supply that provided more purchasing power at the existing price level.
When we understand money’s role as a routinely accepted medium of exchange, it’s also clear that the most effective way for individuals to bring actual money holdings up to their desired level is for money holders to restrict their consumption expenditures. It is the one thing that is completely under their control. Trying to earn more income or find a buyer for an asset requires that some other party is willing to part with money. Facing an economy-wide excess demand for money, finding such a willing partner will be nearly impossible (at least not without a dramatic price or wage reduction). So excess demands for money lead to a fall in consumption expenditures.
And this is where the earlier point about money having no market of its own becomes relevant. Monetary disequilibria are resolved by adjustments in the prices of each and every good in the market, not by one price in a “market for money.” As people restrict their consumption, this puts downward pressure on prices across the economy. For a variety of reasons, sellers will not respond immediately by lowering those prices, nor will that pressure on prices be equal in every market. As a result, the excess demand for money will be mirrored by an excess supply of goods as prices temporarily are above market clearing levels by varying degrees. Eventually prices unstick and fall, and set into motion the return to monetary equilibrium, but only after a wrenching process of adjustment that includes rising inventories, rising unemployment, and an increase in idled capital. This process is often referred to as the “Wicksellian rot,” after Knut Wicksell who first offered this sort of story at the turn of the 20th century.
What we end up with here is a story that in many ways mirrors the Austrian business cycle story. If we understand the Austrian conception of prices as knowledge surrogates and the role they play in facilitating the entrepreneurial actions that lead to economic coordination, then we can see how both excess demands (deflation) and supplies (inflation) of money wreak their havoc by distorting individual prices. The relative price effects of the Austrian cycle theory are produced by the same process of people adjusting their actual holdings of money to their desired holdings as we see in the Yeager excess demand for money story. The inability of prices to respond instantly and smoothly to monetary disequilibria sets in motion an adjustment of real variables that constitutes either the deflationary recession in the Wicksell-Yeager approach or the unsustainable boom that characterizes Austrian cycle theory. What Yeager’s work on the foundations of monetary exchange does is give us a consistent theoretical approach to understand the similarities of those two stories.
The other point of commonality between Yeager and the Austrians is the shared lineage from Wicksell. A key difference, however, is that when Mises first put together the rudiments of his cycle theory, he did so by bringing together Wicksell’s work on the market and natural interest rate with the Austrian theory of capital he adapted from Bohm-Bawerk. The issues of capital use and malinvestment have always been central to Austrian cycle theory and are absent from the Yeager-type story on the deflationary side. The reason, of course, is that Yeager has long rejected Austrian capital theory. Even at the time of his death, he had just finished up a co-authored book with Steve Hanke that offers an extended version of his own approach to those questions, which focuses on “waiting” as a factor of production. In my 2000 book, I attempted to sketch out a version of the deflationary story that integrated Austrian capital theory, and I tried to extend that analysis in a book chapter a few years later. I’m still a little unsatisfied with the details of that argument, but I do think the general approach is right. And I suspect that Yeager’s admission that I’d persuaded him was a recognition that such an approach was at least possible, even if he wasn’t fully persuaded it was the right one!
What is especially attractive about Yeager’s approach is that it rests on a solid foundation of microeconomic choice. Another goal I had for my book was to make the case that while there are “macroeconomic” phenomena in the sense that things like monetary disequilibria (or regulation-generated distortions of the interest rate) have economy-wide effects, the ways in which those effects manifest themselves are always through changes in individual prices. Those price distortions lead to microeconomic discoordination that undermines the effectiveness of markets at producing widespread prosperity.
In the end, as Roger Garrison has said, there may be macroeconomic questions, but there are only microeconomic answers. That insight is what unites Yeager’s approach and that of the Austrians. And it is an insight with significant implications for policy, as it points us toward thinking about the kinds of monetary institutions that do best at providing the knowledge and incentives necessary to avoid monetary disequilibria and correct them when they do occur. Avoiding inflation and deflation matters not because of their effects on the economic aggregates that have grown out of what Yeager called “The Keynesian Diversion,” but because they undermine the price-guided microeconomic process of entrepreneurial discovery that produces economic coordination, social cooperation, and widespread prosperity. Understanding this point can help us avoid errors in theory and policy that make monetary disequilibria and their prosperity-destroying consequences more likely.
Leland Yeager’s work was central to this project, even if its importance was not sufficiently appreciated by the economics discipline. Thankfully, as they will for all of us, his contributions live on past his death. The upcoming generations of scholars neglect them at their own peril. Rest in peace, Professor Yeager.