Monetarists Have Effectively Countered Keynesians on Many Fronts, but They Both Ignore a Capital Structure in Macroeconomics and Business Cycle Theory

A stocktaking of the modern alternatives to the Austrian theory suggests that capital-based macroeconomics may be due for a comeback. Conventional Keynesianism, whether in the guise of the principles-level Keynesian cross, the intermediate IS-LM, or the advanced AS/AD is formulated at a level of aggregation too high to bring the cyclical quality of boom and bust into full view. Worse, the development of these tools of analysis in the hands of the modern textbook industry has involved a serious sacrifice of substance in favor of pedagogy. Students are taught about the supply and demand curves that represent the market for a particular good or service, such as hamburgers or haircuts. Then they are led into the macroeconomic issues by the application of similar-looking supply and demand curves to the economy as a whole. the transition to aggregate supply and aggregate demand, which is made to look deceptively simple, hides all the fundamental differences between microeconomic issues and macroeconomic issues. While these macroeconomic aggregates continue to be presented to college undergraduates, they have fallen into disrepute outside the classroom. One recent reconsideration of the macroeconomic stories told to students identifies fundamental inconsistencies in AS/AD analysis.

Conventional monetarism employs a level of aggregation as high as, if not higher than, that employed by Keynesianism. While Milton Friedman is to be credited with having persuaded the economics profession--and much of the general citizenry--of the strong relationship between the supply of money and the general level of prices, his monetarism adds little to our understanding of the relationship between boom and bust. The monetarists have effectively countered the Keynesians on many fronts, but they share with them the belief that macroeconomics and even business cycle theory can safely ignore all considerations of capital structure.

--Roger W. Garrison, "Introduction: The Austrian Theory in Perspective," in The Austrian Theory of the Trade Cycle and Other Essays, ed. Richard M. Ebeling (Auburn, AL: Ludwig von Mises Institute, 1996), 21-23.

The Austrian Theory of the Business Cycle Emerges from a Simple Comparison of Savings-Induced Growth with a Credit-Induced Boom

The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust.


--Roger W. Garrison, "The Austrian Theory: A Summary," in The Austrian Theory of the Trade Cycle and Other Essays, ed. Richard M. Ebeling (Auburn, AL: Ludwig von Mises Institute, 1996), 112.

The English Currency School and the Monetary Explanation of the Trade Cycle

The monetary explanation of the trade cycle is not entirely new. The English "Currency School" has already tried to explain the boom by the extension of credit resulting from the issue of bank notes without metallic backing. Nevertheless, this school did not see that bank accounts which could be drawn upon at any time by means of checks, that is to say; current accounts, play exactly the same role in the extension of credit as bank notes. Consequently the expansion of credit can result not only from the excessive issue of bank notes but also from the opening of excessive current accounts. It is because it misunderstood this truth that the Currency School believed that it would suffice, in order to prevent the recurrence of economic crises, to enact legislation restricting the issue of bank notes without metallic backing, while leaving the expansion of credit by means of current accounts unregulated. Peel's Bank Act of 1844, and similar laws in other countries, did not accomplish their intended effect. From this it was wrongly concluded that the English School's attempt to explain the trade cycle in monetary terms had been refuted by the facts.

--Ludwig von Mises, "The 'Austrian' Theory of the Trade Cycle," in The Austrian Theory of the Trade Cycle and Other Essays, ed. Richard M. Ebeling (Auburn, AL: Ludwig von Mises Institute, 1996), 25-26.