Competition as market progress: An Austrian rationale for agent-based modeling

Economists recognize competition as fundamental to economic science. General equilibrium is not competition; Austrians, like other economists, have sometimes confused the two. The socialist calculation debate and the elimination of competition by socialists in the Soviet Union offer insight into danger of using an equilibrium framework to study competition. Current policy models are based on a general equilibrium framework, but heterogeneous interactive agent-based models are rising to challenge them. Austrian economists should embrace this new direction and guide the creation of agent-based models of the economy.     

The Microfoundations of Austrian Economics through a New Classical Theoretical Lens

This paper is an attempt to contribute to the microfoundations debate by discussing the distinctive methodological characteristics of the Austrian school, and how they relate to different conceptions of equilibrium and general equilibrium models. Further, we shall focus on one specific branch of the Austrian school (those who see markets as exhibiting equilibrating tendencies) and one specific branch of neoclassical economics (the New Classical School) to highlight some hitherto overlooked points of tangency. Indeed, we shall use the monetary theories of Hayek and Lucas to argue that the limitations of New Classical models may lead to Austrian solutions.     

How Compatible are Public Choice and Austrian Political Economy?

The Review of Austrian Economics - Public Choice relies heavily on equilibrium analysis in its models of government failure. Austrians are suspicious of equilibrium analysis owing to its reliance...     

The P* model and Austrian prices

In theP ^* model the price level is determined by the money stock per unit of potential out-put and the long-run equilibrium level of the velocity of money. This article applies this model to Austria. Problems in identifying permanent shocks to potential output and/or velocity lead to the rejection of such models of the price level, but their first-difference version is not so suspect. While evidence is found of a long-run relationship between Austria inflation and money growth, even the first-difference version of theP ^* model is rejected for Austria. Since Austria is a small economy, closely tied to Germany, the article also investigates whether Austrian prices are tied to a GermanP ^* measure. This hypothesis is also rejected, but there is a statistically-significant long-run relationship between Austrian and German inflation. Moreover, Austrian money growth remains significant even in this relationship.This article was written while the author was a Visiting Scholar at the Austrian National Bank. The author is indebted to Fritz Breuss, W. Jahnke, and Dieter Proske for help in obtaining the data used here, and for useful discussions about the data, relevant theoretical issues and results. The comments of the referees on an earlier version are also gratefully acknowledged. The views expressed here are those of the author and are not necessarily those of the Austrian National Bank, the Federal Reserve Bank of St. Louis, or the Board of Governors of the Federal Reserve System.     

Evenly rotating economy: A new modeling technique for an old equilibrium construct

In the middle of the twentieth century, just five years before Arrow and Debreu proved the existence of an equilibrium for a competitive economy in the Walrasian system, Ludwig von Mises introduced the English-speaking world to his alternative equilibrium construct: the evenly rotating economy. In contrast to Arrow and Debreu, which characterizes equilibrium as a unique vector of prices and quantities, Mises depicts equilibrium as a pattern of behavior. After reviewing the Misesian conception of equilibrium and its failure to take hold in the profession, I turn to the modern literature. I contend that the evenly rotating economy is a special case of the now-prevalent class of search-theoretic exchange models. As such, I argue that this class of models is particularly well suited for applications considered by economists working in the Austrian tradition.     

Examining social processes with agent-based models

It is plain that the Austrian revival that began in the 1970s has yet to succeed in convincing the mainstream of the academy to jettison their physics-based mathematical models in favor of the sort of models and forms of argumentation that contemporary Austrians advocate. Agent-based computational modeling is still in its relative infancy but is beginning to gain recognition among economists disenchanted with the neoclassical paradigm. The purpose of this paper is to assuage concerns that readers might have regarding methodological consistency between agent-based modeling and Austrian economics and to advocate its adoption as a means to convey Austrian ideas to a wider audience. I examine models developed and published by other researchers and ultimately provide an outline of how one might develop a research agenda that leverages this technique. I argue that agent-based modeling can be used to enhance Austrian theorizing and offers a viable alternative to the neoclassical paradigm.     

On the optimality of limit cycles in dynamic economic systems

The purpose of this paper is to derive conditions for the optimality of a limit cycle in a dynamic economic system and to interpret them economically. A fairly general two-state continuous-time nonlinear optimal control problem is considered. It turns out that for this class of models three different economic mechanisms can be identified as the possible source of limit cycles. One relates to an intertemporal substitution effect expressed in terms of complementarity over time, the second one is a dominating cross effect between the state variables of the system (i.e., the capital stocks in our model), and the third one is positive growth at the equilibrium.We acknowledge the helpful comments by William A. Brock, Gerhard Sorger, Franz Wirl, and two anonymous referees. The research was partly supported by the Austrian Science Foundation under contract No. P6601.     

Strategic saving decisions in the infinite-horizon model

We study a mechanism that prevents the long-run distribution of wealth from becoming degenerate in the Ramsey–Cass–Koopmans model when households have different time-preference rates. This mechanism is based on the observation that price-taking behavior is no longer justified when all wealth is owned by a single household. Formalizing this observation, we obtain a model with a unique stationary equilibrium in which, depending on the parameter constellation, any number of households can own positive stocks of capital. We characterize this equilibrium and show for example that an increase in the dispersion of the time-preference rates across households unambiguously increases aggregate output. Whereas the main results are derived for a rather general class of production functions, we devote a separate section to the special case of the Cobb–Douglas technology for which the equilibrium conditions are particularly simple. The research reported in this paper forms part of the project “Economic Growth with Strategic Saving Decisions” supported by the Austrian Science Fund (FWF) under project number P17886. Comments from Robert Becker, Edward Green, Takashi Kamihigashi, David Levine, Fabrizio Zilibotti, anonymous referees, and participants at various conferences and seminars are gratefully acknowledged.     

Accounting for the business cycle: Nominal rigidities, factor heterogeneity, and Austrian capital theory

An Austrian interpretation of the New Keynesian small menu cost model of the business cycle is proposed. Austrian and New Keynesian business cycle theories share the feature that the cycle is generated by rigidities which prevent the economy from adapting instantaneously to changing conditions. Austrian business cycle theory is capital-based, focusing on credit expansion which artificially lowers interest rates and causes an investment boom and unsustainable business expansion. In contrast, the New Keynesian small menu cost model of the business cycle is based on nominal rigidities which prevent markets from clearing. Small menu costs introduce dichotomous behavior, where firms find it locally optimal to avoid instantaneous output price adjustments in the face of the cost, but this local optimum results in economy-wide output and employment fluctuations which are much greater in relative magnitude. The small menu cost model of the business cycle is extended and reinterpreted in light of Austrian business cycle theory with heterogeneous, multiply-specific capital, thus providing a rigorous formalization of the Austrian business cycle. The Austrian interpretation of this New Keynesian model fortuitously addresses several of its shortcomings. JEL classification B53, E12, E23, E32     

Hayek, Keynes, and modern macroeconomics

The Great Recession seems to be creating a change in the trend of macroeconomic thinking. Prior to the financial crisis of 2008, dynamic stochastic general equilibrium (DSGE) models dominated the macroeconomics literature without any apparent challengers on the horizon. Since then, however, we have seen an increasing interest in macroeconomic models that address the state of confidence (??animal spirits??), complexity, cognition, and radical uncertainty. Most of the renewed interest in animal spirits, complexity, cognition, and radical uncertainty has come from a more or less ??Keynesian?? perspective. We discuss the potential to emphasize these elements from a more ??Hayekian?? perspective and argue that Austrian approaches to macroeconomics along these lines are more likely to resonate with mainstream economists than in years past.     

Time-consistent protection with learning by doing

Can a government induce efficiency gains in his domestic industry by protecting it against foreign competition? Would such trade protection be time consistent? The present paper builds a dynamic equilibrium model that accounts for learning-by-doing effects that link firms’ strategies over time. The model shows that the existence of dynamic economies of scale suffices to overcome the traditional government's lack of commitment of its tariff policy. This paper compares the infinite horizon Markov perfect equilibrium of this game with the dynamic equilibrium under commitment as well as the static Nash equilibrium. Equilibrium strategies are derived in closed form by solving a linear-quadratic differential game. Optimal trade policy involves higher tariff levels than in the static setup in order to account for future gains in efficiency. Under reasonable assumptions, the unique stable MPE is characterized by a domestic price and tariff that decrease as experience accumulates, thus supporting the future liberalization of trade as an equilibrium feature of this dynamic game.     

The problem of order in Austrian economics: Kirzner vs. Lachmann ∗

The current controversy among Austrian economists concerns the precise way in which time and ignorance is to be incorporated into market analysis. While both sides think the market process is fundamentally orderly and coherent, they disagree about how to conceptualize that order. One side, associated mostly with Israel Kirzner, conceives of economic order in the conventional sense of a system converging towards a neoclassical notion of equilibrium. The Austrian contribution to this analysis is to emphasize the important role of entrepreneurial alertness in bringing about convergence towards equilibrium. Kirzner's theory of alertness is able to incorporate partial ignorance into economic analysis, but it does not give a satisfactory account of the consequences of real time.

The other side, following Ludwig Lachmann, argues that a full appreciation of the implications of time and ignorance in economics forces us to abandon conventional notions of equilibrium and instead formulate a theory of the ‘kaleidic society’. Lachmann makes a convincing case for the inappropriateness of conventional notions of equilibrium, but fails to weave his critiques into a theory of social order.     

The upper turning point in the Austrian business cycle theory

This paper defends the relevance of Austrian Business Cycle theory (ABCT) within a fiat money regime, by providing an answer to whether a constant rate of credit expansion necessarily leads to a boom-bust cycle. We claim that this scenario has two potential outcomes, (1) a change in money demand brings the economy back towards equilibrium or (2) the economy will shift to a sub-optimal but still sustainable path. We identify capital heterogeneity effects and the Ricardo effect as distinctly Austrian explanations for an upper turning point, even in a fiat money regime.

     

The Emergence of Money in Commodity Exchange,or Money as Monopolist of the Ability to Buy

Abstract

Money's emergence in commodity exchange remains an unresolved issue within economic theory. Current general equilibrium models offer an explanation that rests on the economic advantages of a universally accepted means of exchange that is partly established through social custom. These models neither fully explain money's unique ability to buy, nor theorise the customary practices required for money's emergence. They are dominated by Menger's earlier analysis of money's emergence, which pays more attention to the social foundations of money but is still hampered by Austrian individualism. An alternative explanation is given here, drawing on Marx's theory of value but involving a thorough reworking of it. An analytical process is established through which money finally emerges as monopolist of the ability to buy. Particular social custom, whose determinants are consistent with the social underpinnings of commodity exchange, plays a vital role in money's emergence.     

Nobelity and novelty: Finn Kydland and Edward Prescott’s contributions viewed from Vienna

The awarding of the Nobel Prize in Economics in 2004 to Finn Kydland and Edward Prescott represents an opportunity to evaluate their contributions in light of Austrian economics. We lay out the basics of their contributions—the general equilibrium approach to economic fluctuations and the game theoretic approach to policy—and argue that they have tenets similar to those of Austrianism. We argue that their methodology parallels Austrian methodology in several significant ways that have gone unnoticed. We conclude that Kydland and Prescott’s Nobel Prize suggests Austrian approaches can have a more prominent impact than they have had in the past.     

Labor search and matching in macroeconomics

The labor search and matching model plays a growing role in macroeconomic analysis. This paper provides a critical, selective survey of the literature. Four fundamental questions are explored: How are unemployment, job vacancies, and employment determined as equilibrium phenomena? What determines worker flows and transition rates from one labor market state to another? How are wages determined? What role do labor market dynamics play in explaining business cycles and growth? The survey describes the basic model, reviews its theoretical extensions, and discusses its empirical applications in macroeconomics.The model has been developed against the background of difficulties with the use of the neo-classical, frictionless model of the labor market in macroeconomics. Its success includes the modelling of labor market outcomes as equilibrium phenomena, the reasonable fit of the data, and—when inserted into business cycle models—improved performance of more general macroeconomic models. At the same time, there is evidence against the Nash solution used for wage setting and an active debate as to the ability of the model to account for some of the cyclical facts.     

A multivariate time series approach to modelling macroeconomic sequences

In this paper we discuss a multivariate generalization of autoregressive integrated moving average models. A methodology for constructing multivariate time series models is developed and the derivation of forecasts from such models is considered. A bivariate model for Austrian macroeconomic sequences is constructed. Furthermore it is discussed whether multivariate time series methods can be expected to lead to a significant increase in prediction accuracy when forecasting macroeconomic series.     

Hotelling–Downs Competition with Free Entry When Voters Have an Option to Contest

Osborne shows that for almost all distributions of voters’ preferences, a pure strategy Nash equilibrium does not exist in the classical Hotelling–Downs model of electoral competition with free entry. We show that equilibrium is generically possible if in addition one allows voters an option to announce their candidacy to compete side‐by‐side with office‐seeking players. The model studied in this paper renders Osborne and the celebrated citizen‐candidate model à la Osborne and Slivinski as two extreme cases. We characterize the equilibrium set with two central questions: (i) can there be equilibria where only voters contest? and (ii) are equilibria with contesting office‐seeking players possible? We also show that in our general setting, extremists are typically voter‐candidates so that in every two‐party contest, office‐seeking politicians stay out of competition.