Austrian vs. Monetarists; M. Skousen

Monetarists: Who's Right About Hayek? " ... neither author gave much attention to Hayek's Prices and Production. It is just as well. The book is obscure and incomprehensible." -Professor Allan Meltzer, Mt. Pelerin Society meeting Cannes, France, September 27, 1994 In Defense of Hayek read Prices and Production. "Years ago," he replied. I suggested he needed to read it again. Far from incomprehensible, I find Hayek's little volume clear and profound. And, in the next generation, it may well come out of obscurity. According to Stephen Kresge, editor of Hayek's works, a new edition of Prices and Production is scheduled to be published by the University of Chicago Press in the near future. It's great to learn Hayek's breakthrough book will again be in print. In my paper, "I Like Hayek," I extolled the virtues of Hayek's Prices and Production. Recently, I purchased a firstedition, paying the princely sum of 350 pounds sterling. Did I overpay?

Not at all. Hayek's model forms the basis of a new macroeconomics that is far supe riorto the Keynesian, Monetarist, and Marx ist models currently in vogue. I believe Hayek's first edition will soon be worth substantially more than a first edition of Keynes's General Theory. In two of my books, The Structure of Production and Economics on Trial, I res urrect the Hayekian model, transform it into a useful four-stage model, and bring it up to date with empirical data. In fact, the four stage Hayekian model acts as my principal forecasting model. Among the many models used to forecast the economy and the financial markets, I believe that Hayek's theory is in large mea130 Mark Skousen is an economist at Rollins Col lege, Winter Park, Florida 32789, and editor of Forecasts& Strategies,one ofthe largest invest ment newsletters in the country. For more infor mation about his newsletter and books, contact Phillips Publishing Inc. at 800-777-5005.

T he late Friedrich A. Hayek founded the Mont Pelerin Society in 1947in an effort to regenerate support around the world for free markets and free minds after the war. His contribution to economic and social thought was the subject of the society's meetings in Cannes, France, last Septem ber. Henri Lepage, the conference orga nizer, did a marvelous job paying tribute to the society's originator. A major debate developed at the confer ence between the Austrians (followers of Mises) and the Monetarists (followers of Friedman) regarding Hayekian economics. Allan Meltzer, the highly respected mone tarist at Carnegie-Mellon University, ap plauded Hayek's emphasis on uncertainty, the costs of information, and the concepts of coordination and spontaneous order, but rejected out of hand the macroeconomic model and business cycle theory Hayek developed in Prices and Production in the early 1930s. "The book is obscure and incomprehensible," he declared.

His remark reminded me of Keynes's brusque dismissal ofPrices and Production: "one of the most frightful muddles I have ever read" and a "thick bank of fog.,,1 After his presentation, I talked to Profes sor Meltzer and asked him when he had last AUSTRIANS VS. MONETARISTS: WHO'S RIGHT ABOUT HAYEK? 131 sure the right kind of model. As an applied financial economist, I use Hayek's model on a regular basis to predict the direction of inflation, output, and the prices of financial assets, including which country funds to invest in. Of course, it is not the only ingredient I use to forecast the business cycle, but it is always an important consid eration. The model does an excellent job of explaining the recent boom-bust cycles in the United States and Japan. The Austrian model offers a highly prac tical picture of economic activity, one that the layman or businessman can easily relate to. Based on Hayek's diagrams in Prices and Production (known as Hayekian triangles), I have developed a four-stage model to analyze the economy and forecast trends (see figure).

Time and Money This four-stage model offers a straight forward view of the economic process. My students call it "Skousen's stairs," because it looks like four steps. The vertical axis represents "time" and the horizontal axis represents "money." As Roger Garrison points out, time and money are the building blocks of a basic macroeconomic model.2 As the diagram demonstrates, all goods and services pass through a series of produc tion processes, from raw commodities to usable consumer products, whether it be Time (stages of production) Natural Resources Manufacturing Wholesale trade Final Retail Consumer Markets Money ($) Source: Mark Skousen, The Structure of Production (New York University Press, 1990), p. 171, and Eco nomics on Trial (Irwin Professional Publishing, 1991, 1993), p. 35. shoes, computers, or food on the table. Value is added at each stage as the inputs are transformedand movedalongtoward the next stage, moving closer and closer to the final retail market. Sir John Hicks recognized the common-sense approach of this Austrian model: "The concept of production as a process in time . . . is not specifically 'Aus':' trian.' It is the typical businessman's view point, nowadays the accountant's viewpoint, in the old days the merchant's viewpoint."3 In teaching this Austrian model, I findthat students of business, accounting, marketing, and engineeringrelate to it right away. It is a logicalapproach, confirmingthat the purpose of all economic activity is to take unusable, unfinished "inputs" and transform them into more useable, finished "outputs" with the ultimateaim of satisfyingthe wants and needs of consumers. The factors of production land, labor, and capital-work together to bring this about. Thus, we see in this dia gram that the capitalistic system is not only competitive but cooperative as well, an often-overlooked characteristic.

The four-stage model of the economy can also be used to demonstrate a correct ver sion of Aggregate Supply and Aggregate Demand, which are inaccurately portrayed in today's textbooks. It can show how macroeconomic equilibrium is achieved, how economic growth takes place, and how macroeconomic disequilibrium creates a business cycle. (See chapters 7-9 of The Structure of Production.) It also offers a powerful new way to introduce the principles of microeconomics, the theory of the firm and the role of land, labor, capital and entrepreneurship. In short, an updated version of Hayek's model forms the basis of an exciting new tool in economics and can serve as the basis ofa versatile, fully-integrated model of both micro and macro in economics textbooks. I am working on such a textbook, tentatively entitled Economic Logic. Stay tuned. D 1. John Maynard Keynes, "The Pure Theory of Money: A Reply to Dr. Hayek," Economics 11 (1931), pp. 394, 397.

2. Roger Garrison, "Time and Money: The Universals of Macroeconomic Thinking," Journal of Macroeconomics 6:2 (Spring, 1984), pp. 197-213. 3. John Hicks, Capital and Time (Clarendon Press, 1973), p.12.