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Austrian Economics, A Model of Capitalism

Austrian Economics
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Although Austrian economics has many fervent followers, its relative popularity Inside the science of economics is restricted. Neoclassical economics, with its DSGE modeling,1 is a lot more visible to not only the general public but also amongst those instructing future economists. This single focus hasn’t gone without debate and the discussion was renewed after the latest fiscal crisis (Hicks, 1981; Solow, 2008; Caballero, 2010). Without doubt, restricting economic study to just one methodological standard prevents the scientific community by integrating the insights of these fields of economics which have developed independent of the stan- dard (Caballero, 2010). Therefore, some of the key themes which were elaborated by Austrian scholars, like the concept of capital, the concept of entrepreneurship, and the concept of the money-driven business cycle, haven’t or only to some small extent be accommodated by neoclassical economics.

What inhibits mainstream economists from embracing these concepts is, on the 1 hand, the lack of an overall modeling strategy for Austrian economics and, on the other hand, the neoclassical approach is fundamentally unsuited to catch these insights. According to Mirowski (1989), the idea of gen- eral balance isn’t in any way a natural approach to economic thinking. Rather is the balance approach an effort to transcribe the metaphors of 19 th century physics to economic phenomena. However, so as to acquire such a transcription it’s essential to make compromises between mathematical tractability and eco- nomic realism. And thus the equilibrium perspective easily becomes distorted. The”law of one price” is a case in point: it supplies stability models with the symmetry that is necessary to emulate a conservation principle of the physical

1 DSGE is an abbreviation for dynamic stochastic general equilibrium. DSGE models are also Used in new-Keynesian economics, but the expression neoclassical is here employed as to include both strands of literature.

H. Hagedorn, A version of Austrian economics, DOI 10.1007/978-3-658-07077-9_1, © Springer Fachmedien Wiesbaden 2015

2 1 Introduction

Sciences, but it is foreign to all financial processes. Actually, It’s price dispersion And not price unity that makes it possible for markets to develop their coordinating function (Gintis, 2007).

On a similar note, the compliance with the general equilibrium framework led Economists to make widespread use of the rational expectations framework, whose defects have been subjected (e.g. Davidson, 1983). Again, the symmetry between future states of the world and the anticipation thereof doesn’t signify economic insight, but is only postulated from mathematical necessity. The problem of mod- ern macroeconomics can thus be framed as follows: The demand for mathematically tractable models has resulted in a general acceptance of assumptions which are exceptionally unre- alistic at best and have frequently triggered a severe deal of confusion.

This work gives a potential solution for this dilemma. It does so by creating A model that synthesizes elements of post-Keynesian economics and complexity economics with the fundamental tenets of Austrian economics thereby portraying Aus- trian economics at a formal and coherent manner. The model that’s thus established is just as general as a DSGE model, but it’s by all means more realistic and it treats macroeconomics from a completely different perspective. At exactly the exact same time, the proposed model provides a mathematically rigid frame under which the propositions of the school can be inspected.

The centerpiece of the Austrian school is the analysis of the formal consequences Of human actions, a subject which Austrians call praxeology ( Mises, [1949] 2008, pp.1). Economics, according to the research paradigm, is just a subdiscipline of praxeology. This methodological perspective has many consequences. In Austrian economics, valuation not only originates in the human mind and is therefore subjective, but are also valuations only expressed through actions. On the other hand, the things that human beings value are inherently heterogeneous. Thus, in nature, Austrian economics describes the world on the basis of a dy- namic theory of subjective value and a concept of heterogeneous capital. Secondly, in Austrian economics all economic agents are treated as true economic actors rather than as mere reactors for their surroundings, as is characteristic to the neoclassical school. The Austrian perspective thus implies that all financial evaluation is based on the principle of cause and effect, which, as a corollary, suggests the passage of time. Austrian economics therefore depicts the market as a process, rather than the static interdependency of neoclassical economics.

Additionally, what distinguishes Austrian economics from other colleges of Thought is its own purely theoretic and essentialist character. Since the proper im- plications of how human beings behave are clarified, Austrian economics isn’t concerned with the particular choices made by individuals or with the circum- stances under which these decisions arise. According to the Austrian understanding such question belongs to various fields of mathematics, namely history and psychology.

1 Introduction 3

Austrian economics limits itself to statements which are true for all activities made by human beings. These statements are true a priori such as the statements of math- ematics and logic and they’re not subject to verification or falsification on the floor of knowledge and details (Mises, [1949] 2008, pp.32). As an example, the law of diminishing marginal utility is logically implied in the idea of activity ( Mises, [1949] 2008, pp.119). Virtually nothing in Austrian economics is assumed. Only ba- sic assumptions like, e.g., capital being heterogeneous are accepted as self-evidently accurate and are thus taken for granted ( Rothbard, 1957). Hence, this strategy assumes al- most universal validity. The mechanisms underlying the proposed model are firmly rooted in this causal-realist and non-positivistic world view. This serves as the model’s epistemological base. Additionally, Austrian economics is here understood in this narrow sense. Much of what runs under the heading of Austrian economics now isn’t directly implied by the logic of activity, but instead by a logic of selection and equilibrium-like theories (Gloria-Palermo, 1999). However, the notion of the model is to highlight the essentialist nature of the Austrian strategy and also to describe economic insights based on procedures which are driven by human actions alone.

The concrete modeling approach taken in the next is agent-based and accounting-based. In other words, all economic activity in the model results from the de- centered actions of agents. These brokers exchange products and services against cash on virtual markets and each of these has a balance sheet that reflects his fiscal and economic circumstance. Implicitly, the agents function as an interface be- tween two economic domains. On the one hand, they pursue particular pre-defined targets and so represent behavioral elements of the model while, on the other hand, they employ standard accounting rules so as to keep an eye on the economic situa- tion and so embody a calculative element inside the model. On the basis of the calculations any result that the model generates can be analyzed via its influence on the system of national accounts. Additionally, the use of an economy-wide accounting strategy means that all markets in which the agents interact are fully interdependent. Yet, this interdependency isn’t accomplished by imposing synchronic- ity, as the equations of motion that govern DSGE models do, but instead emerges from within.

The agent-based character of the model thus makes it possible to run Macroeconomic research while just specifying microeconomic behaviour and, moreover, to reconcile the modeling of complex systems using the praxeological research program. This also suggests that the model does exhibit genuine microfoun- dations, but these shouldn’t be confused with the microfoundations of neoclassi- cal economics. Since all agents in this model function under knowledge constraints and doubt and because all their activities are bound in historical time the idea of the homo oeconomicus, which is germane to neoclassical economics, can’t be

4 1 Introduction

Sustained in the current context. Instead, the agents in this model represent a notion of the homo agens (cf. Mises, [1949] 2008, p.14). In other words, the agents in this version use ways to achieve certain ends and they are boundedly rational in their own actions. These activities alone constitute economic activity.

With this approach the suggested model fills a gap which has long been observed In the financial literature, specifically to combine Austrian economics using the tech- niques of agent-based modeling (e.g. Lavoie et al., 1990; Gloria-Palermo et al., 2002; Koppl, 2006; Vaughn, 1999; Nell, 2010; Gloria-Palermo, 2013). Yet, while many writers point to the compatibility of the theory with the modeling of complex systems, this task has seldom been taken up to this date. To the au- thor’s knowledge, the systems which were developed so far don’t assume the overall character that would make them akin to DSGE models. However, as will be argued in this thesis, it’s likely to develop a disequilibrium model of the sort.

The setup of the model is explained in the next Chapter. Chapters 3 Through 5 define the behaviour of the agents and Chapter 6 describes the func- Tioning of this model. The results are then presented in Chapter 7 and they are discussed in Chapters 8 and 9.

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