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Saturday, December 1, 2001

Microfoundations and Macroeconomics: An Austrian Perspective by Steven Horwitz

An Excellent Foundation of an Austrian-School Approach to Macroeconomics

Routledge · 2000 · 276 pages · $100.00

Reviewed by Gene Callahan

Professor Steven Horwitz of St. Lawrence University has written an important new book laying the foundation of an Austrian school approach to macroeconomics. Horwitz is not addressing only fellow economists: While this book is certainly not an introductory work (don’t give it as a gift instead of Economics in One Lesson), it is readily accessible to any reader who follows the economic arguments put forth in this magazine.

Horwitz begins by stating his agenda. He hopes to advance Austrian macroeconomics, seeking to demonstrate to mainstream macroeconomists that a viable alternative vision exists, one that adeptly treats many problems ignored by the mainstream approach. He explains that the Austrian themes of subjectivity, methodological individualism, and the market process focus macroeconomic explanation on the behavior of the individual in response to economy-wide disturbances, such as inflation or deflation.

Following the introduction is an excellent chapter that traces the development of a distinctive Austrian approach to economics and describes the history of Austrian interaction with the emerging neoclassical paradigm, which since has come to dominate the profession. Horwitz highlights the time when these two traditions nearly merged, before diverging again. In the 1930s Lionel Robbins incorporated certain Austrian insights into Marshallian economics, helping to define the neoclassical school. This Austrian-Marshallian synthesis focused on the properties of equilibrium markets, which were taken to be a good approximation of the real world. However, Hans Mayer’s critique of price theories that simply assumed equilibrium foreshadowed F.A. Hayek’s work on knowledge and prices. Austrians moved away from Robbins’s formulation of economics, emphasizing the freedom and unpredictability of human action. Austrians came to view general equilibrium as a model of an unreal and unobtainable world, which nevertheless aids our view of the market process.

Horwitz goes on to discuss the role of capital in macroeconomics. As Ludwig von Mises, Ludwig Lachmann, and Israel Kirzner have pointed out, the salient aspect of capital goods is that they are a part of someone’s plan to produce one or more consumer goods. Because of the goal-oriented nature of capital goods, it won’t do to aggregate “society’s capital” and confine economic analysis to this aggregate. Many entrepreneurial plans contain elements incompatible with others’ plans, so it is not possible for them all to succeed. Horwitz faults both neoclassical and Keynesian analysis for neglecting this heterogeneity of capital.

The next topic taken up is the theory of monetary equilibrium. Horwitz uses this equilibrium construct as a foil to highlight the consequences of inflation and deflation, a classic Austrian use of static constructs. He defines monetary equilibrium as a situation where the supply of and demand for money are in balance. This seems trivial, until we realize that the means by which most markets move toward equilibrium, a change of price for the single good in question, cannot work for money—as Leland Yeager points out, money has no market, and no price, of its own. After a disturbance in the supply of or demand for money, all prices in the economy must adjust. This process takes time and does not occur uniformly across the economy.

Horwitz goes on to highlight the effects of this time lag in this adjustment process, employing the classic Austrian theory of the business cycle, as developed by Mises and Hayek, and the theories of “Austrian fellow travelers” Yeager, Axel Leijonhufvud, and W. H. Hutt. The section on the unjustly neglected Hutt was especially enlightening, focusing on the importance Hutt placed on the institutional barriers to rapid price adjustment. Horwitz closes by speculating on the policy implications of Austrian macroeconomics, deciding that free banking offers the best hope of smoothly adjusting the money supply as needed.

I have a couple of quibbles with the book. Horwitz is mistaken, I think, when he contends that Mises was firmly against fractional reserve banking. Also, while in one chapter Horwitz refutes Hans-Hermann Hoppe’s ethical argument about the relative wealth effects of inflation, he employs nearly the same argument in another chapter. However, these are minor blemishes in an otherwise excellent book.

Gene Callahan is an adjunct scholar with the Ludwig von Mises Institute and author of Economics for Real People.

  • Gene Callahan is a writer and economist who teaches at the State University of New York at Purchase.