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Issues Concerning Hayekian Triangles and Phillips Curves, with Real Wage and Real Interest Variables”

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Issues Concerning Hayekian Triangles and Phillips Curves, with Real Wage and Real Interest Variables” “Issues concerning Hayekian triangles and Phillips curves, with real wage and real interest variables” AUTHORS Paul F. Gentle Mark Thornton Paul F. Gentle and Mark Thornton (2014). Issues concerning Hayekian triangles ARTICLE INFO and Phillips curves, with real wage and real interest variables. Banks and Bank Systems, 9(2) RELEASED ON Monday, 23 June 2014 JOURNAL "Banks and Bank Systems" FOUNDER LLC “Consulting Publishing Company “Business Perspectives” NUMBER OF REFERENCES NUMBER OF FIGURES NUMBER OF TABLES 0 0 0 © The author(s) 2021. This publication is an open access article. businessperspectives.org Banks and Bank Systems, Volume 9, Issue 2, 2014 Paul F. Gentle (China), Mark Thornton (USA) Issues concerning Hayekian triangles and Phillips curves, with real wage and real interest variables Abstract Bellante and Garrison (1988) view both conventional Phillips curve analysis (focused on real wages) and the use of Hayekian triangles (focused on real interest) to be useful in explaining business cycles. Five econometric papers have been published, with New Keynesian, New Classical Phillips Curves and similar models of conventional Philips Curve Models, with one major difference, the real interest rate variable has been added. These ideas are presented with sug- gestions for further study. Keywords: Phillips curve, Hayekian triangles, aggregate supply curve, economic history. JEL Classification: B53, E12, E24, E40, N24, N12. Introduction¤ third section of this paper provides two historical examples, using Phillips curve and Hayekian trian- Bellante and Garrison (1988) compare the use of gles analysis – the Great Depression and the recent Hayekian triangles, which focuses on the interest Housing Bubble, including its aftermath. The last rate and conventional Phillips curves, which focuses section provides concluding remarks. on wage rates. Despite their different focuses, they point out that both start with the kernel of truth of 1. Hayekian triangles the Quantity Theory of Money. That is both deal Bellante and Garrison (1988) argue that the conven- with disequilibrium processes, employ short-run tional Phillips curve and the Hayekian triangle pro- and long-run effects, employ endogenous self- vide complementary ways of explaining and charting reversing market processes, and involve monetary business cycles. The conventional Phillips curve ex- disturbances that produce short-run effects that are amines the economy, responding to monetary injec- non-neutral and long-run effects that are neutral. tions in terms of labor markets. The Hayekian triangle They conclude that the use of conventional Phillips examines the economy responding to monetary injec- Curves and Hayekian triangles should be seen as tions in terms of capital markets. Austrian economists complementary forms of macroeconomic analysis. remind us that capital is heterogeneous and some capi- Gentle (1984) supports the idea that New Classical, tal can also be destroyed in the process and that les- New Keynesian and similar models should consider sens the productivity of the workers (Bellante and incorporating a real interest rate variable, which is Garrison, 1988; Ravier, 2013). different from the conventional Phillips curve Anal- ysis, that Bellanate et al. (1988) discuss. Recent eco- The Hayekian triangle represented in Figure 1 de- nometric studies (Gentle et al., 2005, 2007, 2013; picts an economy with a structure of production (hy- Chen and Gentle, 2010, 2011) use a standard real potenuse), and the corresponding level of consump- wage rate variable for Phillips curve analysis and real tion (vertical line height). This model is designed to interest rate variable. These studies incorporate New show in part the impact of changes in the real interest Classical, New Keynesian and similar models and all rate on the structure of production, that is, how capi- produce significant results. There is an important tal goods are arranged in order to produce consumer difference in how capital is dealt with by Hayekian goods. A longer structure of production (base of the Triangles, compared to how it is not dealt with all by triangle) indicates what Bohm-Bawerk called “a conventional Phillips curve models. In Gentle et al. more roundabout means of production” or more (2005, 2007, 2013) and Chen and Gentle (2010, simply production time. An example of a longer, 2011), the real interest rate is expected to impact more roundabout structure of production would be a capital, with the use of lagged variables in those stu- dairy farm where cows are milked by robots and dies indicating capital being transformed into differ- where the milk is transported long distances for ent uses. processing. In this example, production of goods such as milk and cheese, are packaged and trans- In the next section of this paper, there is a descrip- ported long distances to grocery store shelves. A tion of the Hayekian triangle model and its similari- shorter, less roundabout structure of production ties and differences with the Phillips curve. The would be an individual who walks to the barn and second section of this paper, summarizes conven- milks a cow for a quart of milk and consumes it. A tional Phillips curve theory and our desire to have longer, more roundabout structure of production is real interest rates and real wages considered. The more efficient and productive and once it is put in place, produces more goods (Garrison, 1989). The ¤ Paul F. Gentle, Mark Thornton, 2014. Hayekian triangle describes the process of growth as 8 Banks and Bank Systems, Volume 9, Issue 2, 2014 follows: consumers save more and consume less. ment for a time by drawing workers into activities This increases the supply of savings and results in, made temporarily attractive by the expenditure of ceteris paribus, an initial decrease of consumption additional money created for that purpose”. As these and a fall in the rate of interest. This lower interest long-term capital projects are developed, entrepre- rate encourages entrepreneurs to borrow more and neurs find that the amount of resources available is invest more, particularly in long-term investments, less than anticipated and soon prices and interest which increase efficiency and productivity. Capital rates start to rise making the projects more costly and goods resources are moved away from consumption less profitable. As these entrepreneurs bid up the and used in capital and time intensive production prices of things like raw materials and gasoline, they processes. As capital goods are integrated into the create price inflation and reduce the real incomes of overall structure of production of the economy there their consumers, thus reducing their sales revenues. is eventually an increase in the quantity of consum- As these projects come on line and start producing, er goods. In the case of the dairy industry this markets become saturated with inventory and prices would involve the design, building and installation begin to fall making the projects less profitable than of the milking robots, the trucks, and the central anticipated. Therefore instead of initiating economic processing plant. Once the project is completed, growth, the central bank has ignited a self-reversing more goods can be produced relative to the amount process that culminates in a cluster of entrepreneurial of resources used up. errors, better known as a recession or bust. This second process of the business cycle is one that is The Austrian or Hayekian analysis of business cycles started at the central bank (Garrison, 1994). has key features. Instead of a savings induced de- crease in the interest rate, the source of loanable Hayek assumed that the new money is injected funds is the central bank who issues unbacked fiat through credit markets – that the central bank, in money. Ludwig Von Mises (1912) first described the effect, pads the supply of loanable funds with newly “Austrian” theory of the business cycle in the Ger- created money. The result is a drop in the interest man language edition of The Theory of Money and rate, since there is an increase in loanable funds. Credit. Moreover his student, Friedrich von Hayek, When the interest rate increases later on, this is not developed this theory and presented it to the greater due wholly to an increase in inflation. Although in- world of economists. Hayek (1935) first used the flation increases the interest rate, the interest is also triangle diagram to explain business cycles (Garri- increased beyond that because of another factor. This son, 1994). Mises and Hayek show that an artificial other factor has to do with firms bidding up prices in reduction of the interest rate, below the market rate the latter stages of production. It is an additional would stimulate the production of long-term capital increase in the interest rate beyond the inflation pre- projects and initiate a lengthening of the structure of mium (Bellante and Garrison, 1988). production. The difference between this scenario and the previous one is that there is no new savings; no The Hayekian triangle depicts the economy as a resources have been set aside for this expansion. Not right triangle. The level of economic development is only are consumers not saving more, they are actual- depicted as the length of the horizontal link and the ly saving less and consuming more. This is induced level of consumption is the length of the vertical by lower interest rates and the wealth effect, which line. Bellante and Garrison (1988) show that the discourage savings. It is the increase
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