When Robert Lucas created modern “state of the art” macroeconomics, time and time again Lucas explained that he was attempting to recapture the pre-Keynesian “equilibrium” macroeconomics pioneered by Friedrich Hayek. But as any Hayekian will tell you (see the work of Roger Garrison, e.g. here, here, and here) Lucas essentially blew it. Lucas “didn’t get it” and sent the macroeconomists off on a wild goose chase for 30 years. (Not, of course, that you can’t learn a great deal from a wild goose chase or a failed research program). Lots of economists are starting to complain, including L.S.E. economist Willem Buiter.
BONUS — In October Buiter took Hayek’s forward-looking capital-based disequilibrium economics and re-interpreted it into a labor-based, backwards-looking Marx/Keynes model. Here’s Buiter’s introduction to that discussion:
Much of contemporary economics does not view capital as dated labour inputs – a view popular with the Austrian School of Mises and Hayek, with clear antecedents in Marx (Karl, not Groucho). Instead it has just two kinds of inputs – instantaneously variable inputs, like labour and raw materials, and fixed inputs like capital goods. Instantaneously variable inputs are hired and immediately produce output which is sold on the market without any lags. Fixed input decisions are taken one year, the capital equipment is installed the next year and starts producing output for which is available for sale the year after that.
This view of the production process means that the cost of capital, interest rates and credit conditions, including credit rationing, don’t have any impact on potential output (supply) over horizons relevant for cyclical stabilisation policy. Their effect on demand, through fixed investment, inventory investment, consumption and net exports, is recognised of course, so the impact of tighter credit conditions, including credit rationing because of a credit crunch, is always assumed to be a lower output gap – demand falls but supply remains unchanged or, equivalently, actual output declines but potential output is unaffected in the short and medium term.
Once we recognise that all production takes time, credit conditions can influence effective supply (effective potential output) even in the short run. Labour is hired this month, produces output next month which is sold at the end of the month after that. Assuming labour is paid no later than the end of the month in which it is performed, the employer has to find enough credit to pay for one month’s worth of wages and one month worth of inventory of finished goods if he is to produce at all, even if the fixed capital is installed and ready to go.
While the effect of higher interest rates on short-run supply may not be very significant as long as credit is freely available at whatever the level of interest rates happens to be, credit rationing – unsatisfied demand for credit at the rates prevailing in the markets – can have a brutal effect on effective supply, even in the short run.
We are currently going through the most severe credit crunch affecting industrial countries for three generations ..
UPDATE: Will Wilkinson weighs in — “I don’t believe it was offered in this spirity, but I think Buiter does a servicable job of explaining why my fave econ gurus — F.A. Hayek, James M. Buchanan, Douglass North, and Vernon Smith — will make you smarter than your local macro textbook.”