Keynes's Not-So-General Theory and the Supposed Impotence of Monetary Policy

In 1935, John Maynard Keynes wrote to George Bernard Shaw:

“I believe myself to be writing a book on economic theory which will largely revolutionize—not, I suppose, at once but in the course of the next ten years—the way the world thinks about economic problems.”

After he published The General Theory, Keynes’s formulation of economics was received as though it was revolutionary, especially by his younger followers. Many older economists were not quick to embrace Keynes’s doctrine. As David Laidler points out, “Pigou and Knight in particular, were scornful of his claims to novelty (Fabricating the Keynesian Revolution, 21).” In The General Theory Keynes draws upon arguments from both his contemporaries and past economists, but especially in the case of his contemporaries, he typically fails to cite them. So what did Keynes actually contribute to economic theory? His main contribution was to call attention the need for economic analysis where the macro-economy fails to reach an equilibrium, but this contribution is obscured by a framing of the argument that ignored the economic significance of institutional collapse and his denial of the ability of monetary policy on its own to aid the process of recovery.

In the opening chapter of The General Theory, Keynes immediately clarifies his stance and his goals. “The postulates of the classical theory,” Keynes writes, “are applicable to a special case only and not to the general case (3).” The particular case, according to Keynes, is the case of full employment and the general case includes all states where the economy operates below full employment. He builds his theory with the belief that the economy does not typically operate at full employment, but rather “without any marked tendency either towards recovery or toward complete collapse (249).” If both of these claims are true, then in most circumstances the classical model is inadequate to employ in analysis. For the sake of remaining concise, I shall only briefly state that this proposition is untrue. Empirical investigation shows that the economy tends to move toward the long-run outcome predicted by the classical model (Kehoe and Prescott 2007). Only in the case of a general fall in prices and sticky wages is there a shortfall in demand where the economy operates below its potential (Galloway and Vedder, 89-97; Leijonhufvud, 49-50).

                

It appears that Keynes’s theory is the “special case”. Not only is it special, it is so particular as to call into question its applicability altogether. That is, Keynes questions the efficacy of monetary policy and its ability to return aggregate demand to its potential. In order for his theory to be useful, it needs to be better than just a second best option, which, if monetary policy is effective, is the ranking to which the theory must be relegated. As Hawtrey explained in a paper critiquing the support of Keynes and others for increased capital outlays as a remedy for depression,

Currency depreciation is far the most satisfactory measure of revival. Not only is it better balanced, but it is quicker and easier to bring about. I have already pointed out that a capital programme regarded as a measure for breaking the vicious circle of depression is likely to be too slow and too gradual to be successful, and I have suggested that, when cheap money fails to bring about a prompt revival, there is more to be hoped from an open market policy, the purchase of securities by the central bank. I should be inclined to leave the question at that, confident that a sufficient purchase of securities would overcome any depression however severe. For whereas cheap money reaches a limit when the rate of interest approaches zero, the purchases of securities can be increased indefinitely.

. . . The capital programme has the grave disadvantage of coming into operation tardily and gradually. Nor is it possible to say how great a programme will is needed to resolve the deadlock or whether any practicable programme will be great enough. If a capital programme were the only means of resolving the deadlock, we should have to make the best of it, but I believe that there are good reasons for supposing that a sufficiently liberal measure of open market purchases by the central bank would be bound to achieve this object.

. . . Since a programme of capital outlay offers so limited and doubtful a contribution towards revival, I think it is regrettable that excessive prominence is given to it by economists. (456-58)

The need for capital outlays is contingent on Keynes’s claim that the price level will not respond to an increase in the money supply when the economy is at less-than-full employment because he proposes that the price level is primarily a function of wages. If interest rates are too low to encourage investment, entrepreneurs will not invest, and therefore, output will remain stagnant.

The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money.

. . . But the most stable, and the least easily shifted, element in our contemporary economy has been hitherto, and may prove to be in future, the minimum rate of interest acceptable to the generality of wealth-owners. If a tolerable level of employment requires a rate of interest much below the average rates which ruled in the nineteenth century, it is most doubtful whether it can be achieved merely by manipulating the quantity of money. (308-9)

As Keynes links changes in the price level with changes in employment, this is his subtle way of saying that an increase in money will not lead to an increase in investment as holders of the new money will not lend it out. As mentioned in my last post on The General Theory, tremendous deflation occurred in England, Keynes home country, between 1929 and 1931. This continued in gold standard countries generally, including the U.S., until 1933. During this period of deflation, we can expect that the [hypothetical] equilibrium nominal rate of interest was negative for an extended period of time. Remember that,

i = π + r

Ex post real rates for this period are in the double digits during some years! (For example, see Thayer Watkins calculations for the U.S. here) The dramatic fall of in investment during this time period suggests that this was out of equilibrium play.

Deflation during these years was the result of a collapse of the banking system in the U.S. and of the international gold standard. Between 1929 and 1931, U.S. had experienced a tremendous increase in demand for money. This had made the Depression, to that point, one of the worst on record. Low levels of output in combination with a fragile unit-banking system that struggled to remain solvent prevented recovery. Between May 1931 and March 1933, a series of banking panics led to an increase in cash balances for a fearful public, and therefore, a continuation of the contraction of the money stock (Friedman and Schwartz, 308-315). Unit banking in the U.S. prevented the spread of liquidity which would have likely prevented or slowed the process – banking panics were prominent in the U.S. during this period, a problem not experienced by countries lacking this restriction.

Furthermore, some central banks had begun hoarding gold at the end of the 1920s and continued this practice into the 1930s. The prime offenders were the Bank of France and the Federal Reserve. The bank of France increased its holdings from 7 percent to 27 percent of the world’s total gold reserves (Board of Governors 1943, 544-55). In the U.S. gold holdings shrank only slightly as a proportion of the world’s gold reserves as board members at the Federal Reserve refused to adopt a policy of easy money until February 1932. Even then, they did so timidly until prodded by congress in the following months. By this time, the collapse of the banking system in the U.S. was already under way. 

If there were bottlenecks in production that resulted from interest rates failing to allocate resources across time, the demand deficiencies were the fault of bad monetary policy. Excessive deflation was the result of gold hoarding and tight monetary policy more generally. This being the case, fiscal policy is an unnecessary band-aid if the policy goal is to offset dramatic falls in aggregate demand. Aggressive monetary policy would have done just fine to offset the deflation, as is evidenced by the end of the first phase of the Great Depression in 1933 when FDR devalued the dollar.

Austrian Cycle Theory and Ecological Macro

A draft of my paper with Richard Wagner is up on SSRN.

Traditional Austrian cycle theory starts from general equilibrium and explains how an expansion of bank credit unmatched by an expansion of saving can create a cycle of boom-and-bust, and with the bust followed by restoration of normality. In contrast, this paper offers a non-equilibrium reformulation of those earlier Austrian insights, which expands and refocuses the analytical agenda of macro theory. Our key analytical feature is the conceptualization of a macro economy as constituted through an open-ended ecology of plans. Within this framework, macro variables are not primitives but are derivative from micro-level interaction. In turn, the computation of optimizing actions is beset with undecidability. The theory of entrepreneurial choice that is suitable for this analytical framework is based on rule-following or algorithmic choice and not on computational maximization. What results is a macro ecology, the internal operation of which entails natural volatility. What are called policy actions, moreover, operate inside and not outside the ecology, and can create induce volatility within the ecology.

Savings ≠ Investment: Keynes's Peculiar Economic Theory from Peculiar Economic Times

“An act of individual savings means – so to speak – a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand, – it is a net diminution of such demand.” (Keynes, The General Theory, 211)

Keynes’s proposition implicitly includes two circumstances where the supply of savings cannot be aligned with demand for loanable funds – i.e., S ≠ I. In one case, individuals who increase their cash balances pull money from the economic system and put it, so to speak, in their pockets. If that money had been in the banking system, then this will also result in a decrease in the supply of loanable funds. The assumption is that, due to liquidity preference – preference to hold cash on hand rather than on deposit – savings is split between cash holdings and money saved in the financial system.

There is another circumstance where savings cannot be aligned with investment. Even where savings is defined classically – as in, money saved in the financial system – under a scenario of severe deflation, the interest rate will fail this task. Imagine that the inflation rate, π, plus the real rate of interest, r sum such that:

π + r < 0

or in other words

π < -r

The nominal rate is approximately defined by the above sum. If the equilibrium nominal rate is negative, than that rate will not be realized. Assuming the actual nominal rate remains positive, there will be an excess supply of savings over the demand for savings.

The first of these cases, where demand to hold cash increases, is unlikely to be very troubling long term. Only in the circumstance where individuals make a substantial shift to holding base money, as opposed to using deposit slips, checking accounts, etc…, will this result in substantial contraction. This happened during the Great Depression and was the result of tight monetary policies under a gold standard, beggar-thy-neighbor tariff policies, and suspicion – a not incorrect suspicion – that gold in banks might be confiscated. We should not be surprised that there was a banking collapse in the U.S. in 1931 and that GDP continued to fall alongside a tidal wave of deflation for another two years.

Which brings us back to the second point. The rate of deflation after 1929 led to a divergence between the equilibrium nominal rate and the actual nominal rate. Within two years, prices of consumer goods in the U.S. had fallen by nearly 30%. Unless the real rate of interest was excessively high, the equilibrium nominal rate had to be negative at the time.

It is under such unusual circumstances that Keynes wrote his treaty. But Keynes pays little attention to the sources of these problems; Again, these were tight monetary policies under the gold standard and the initiation of tariffs. It should be no surprise that Keynes comments at the beginning of The General Theory that “the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience (3).” He was certainly right concerning the economic situation that he had observed. What makes little sense is why he paid such little attention to the actual impediments to economic recovery. I’m tempted to credit his Utopianism, as reflected by his active interest in eugenics and his desire to use fiscal policy “as a deliberate instrument for the more equal distribution of incomes (95).” Keynes was interested in radically changing the discipline and the depression had given him the opportunity.

Building Micro-foundations: Rules, Entrepreneurship, and Emergent Macro

In considering the appropriate framework for modeling a macroeconomics of market processes, consider two Austrian suppositions: humans act purposively and all social and economic phenomena are the result of individual action. As I have suggested before, a rule-based macroeconomics can include both of these. It allows us to include the entrepreneur in our analysis. As equilibrium is not part of this framework, we can integrate aspects of both Kirznerian and Schumpterian entrepreneurship. For Kirzner, the entrepreneur is guided “to nudge the market in the equilibrative direction” by the lure of pure profits and pain of pure losses (1997, 73).” Yet this inclusion of entrepreneur in the process of equilibration promotes an uncomfortable synthesis as “continual change in tastes, resource availabilities, and known technological possibilities always prevent the equilibrative process from proceeding anywhere near to completion (72).” Preference sets and profit opportunities exist in a kaleidic world where the fulfillment or change of one leads to changes in others. Thus, the entrepreneur operates in a world of uncertainty. It is as though she fires at a moving target whose velocity is inconsistent.

Kirzner’s entrepreneur suffers from “entrepreneurial error” whereas Schumpeter’s entrepreneur can move the economy away from equilibrium as she interrupts the plans of other entrepreneurs (Schumpeter 1982, 131-32, 225-36). According to his hypothesis, error is systematic. Respected entrepreneurs might lead others into a sector where they earn profits for an extended period of time. Presumably, this occurs in a sector where there exists, or is expected to exist, high demand. More entrepreneurs will follow and compete amongst one another to coordinate resources and nurturing innovation where it is most needed. Inevitably, failure must occur where entrepreneurs cluster as rates of return fall and borrowing costs increase. In every step, the decisions of an entrepreneur and the results of that decision exhibit an effect, whether small or large, on those with whom she competes and indirectly on the emergent macrophenomena that otherwise constrain her actions (Hodgson 1986). Equilibrium models fail to capture the kaleidic nature of the world in which we live.

At the heart of the work from Mises, Hayek, Schumpeter, and Kirzner is the interaction between individuals and institutions that emerge by the agglomeration of individuals’ actions. The trend of modern Austrian macroeconomics has not been in this direction. What is needed is not that Austrian economics “catch-up” to the modern paradigm, “but an effort to create the contemporary analytics that might have been created had Austrian macro theorizing continued to evolve since 1940 with the same robustness that it exhibited before 1940 (Wagner 2003, 98).” This revision must concentrate on rules that guide decision-making and human action and the emergent nature of institutions that constrain those rules. Only such a radical paradigm shift can procure substantive microfoundations. Building upon the examples of Schumpeter and Kirzner, we can begin to envision a world comprised not of homogeneous, perfectly informed agents subject to the calculus of optimization, but heterogeneous agents who are imperfectly informed, interpret information subjectively, and who persist in experimentation in order to pursue profit opportunities and avoid failure.

Those who endeavor to develop this research program might model in terms of agents with heterogeneous rule sets. Rules are the source of order that guide macroeconomic phenomena (Page 2008, 118). As Wagner (2011, 435-36) notes there is a difference between the order apparent in a parade, where many individuals act uniformly appearing to comprise a single or few units, and a piazza, where individuals are not coordinated externally, but manage to avoid one another. This occurs because individuals can coordinate amongst one another by creating complementary rule sets guiding their action. Scott Page describes the process in a story of a stampede:

In applying an equilibrium game theory model to explain dynamic phenomena, we’re doing the equivalent of using a snapshot to describe the behavior with the stampede. This snapshot cannot tell us what will happen next… the behavior of the bison during the stampede is rule based, not optimal, and it produces complex patterns not equilibria. (2008, 120)

The stampede is less complex than the piazza, as bison lack the degree of intentionality exhibited by humans, but the basic mechanism is the same. No one agent guides either process. Individual agents interact and produce emergent phenomena by their interactions. This logic applies to the actions of and interactions between entrepreneurs and the macro phenomena that result from these. These phenomena are not objects of choice that can be appropriately studied with macroeconomic equilibrium models, at least not with these models alone. Nor can they be studied by assuming that the modeler knows - even only in the probabilistic sense – the ends that individuals will move toward. We do not know what will result from these interactions. A rule-based macroeconomics allows for this open-endedness that complex systems engender.

Hodgson, Geoff. “Behind Methodological Individualism.” Cambridge Journal of Economic 10 (1986): 211-224.

Kirzner, Israel. “Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach.” Journal of Economic Literature 35, no. 1 (March 1997): 60-85.

Page, Scott. “Uncertainty, Difficulty, and Complexity.” Journal of Theoretical Politics 20 (2008) : 115-149.

Schumpeter, Joseph. The Theory of Economic Development. New Brunswick, NJ: Transaction Publishers, 1982.

Wagner, Richard. “Institutions, Emergence, and Macro Theorizing: A Review Essay on Roger Garrison’s Time and Money” The Review of Austrian Economics 16, no. 1 (2003): 97-112.

Wagner, Richard. “A Macro Economy as an Ecology of Plans.” Journal of Economic Behavior and Organization 82 (2011): 433-444.

Methodological Individualism – A Reformulation

It has not been unpopular from some scholars to attack methodological individualism as an unnecessary constraint on economic analysis. Individual action does not occur in an institutional vacuum. To reduce economics, or any social science, to only individual choice ignores the significance of emergent phenomena that shape the world we live in. Geoff Hodgson makes a passionate call for a reasoned compromise:

Despite the impression given by many adherents of methodological individualism, it is quite legitimate to deny that only purposes or actions of individuals are explanatory… These beliefs [about individual autonomy] are not undermined by a conviction that whilst people are, on the one hand, purposeful and have real choices, they are, on the other, moulded by their cultural and institutional environment. (Hodgson 1986, 222)

Hodgson claims that Austrian economists overlook this feature in their research. Just as macroeconomics can benefit from microfoundations, macro – or emergent – foundations are always implicit in microeconomic analysis.

Though his claim has legitimacy, Hodgson’s critique of his opponents is more sweeping than merited. In the same work, Hodgson lumps together the views of Hayek and Mises concerning methodological individualism and social wholes. Hayek’s formulation of social exchange and development clearly includes collectives as actual entities, even if he is not always consistent. These entities exist in the form of rules that guide action, which when adopted, create norms not dependent on any single person. “Society can thus exist only if by a process of selection rules have evolved which lead individuals to behave in a manner which makes social life possible (Hayek, 1973, 44 quoted in Andreozzi 2005).” This insight from Hayek presents those who seek to reformulate the nature of the individual in society a preliminary goal post from which to begin analysis. Society can be analyzed, in part, by the rules that it embodies. But first I shall review the conception of methodological individualism often promoted by Austrian economists.

In the textbook version of Austrian economics, only individual action matters. This leads to a tendency to disregard the formative nature of institutions. Institutions serve individuals, not the other way around. As Ludwig von Mises described in his canonical work Human Action,

…Methodological individualism, far from contesting the significance of such collective wholes, considers it as one of its main tasks to describe and to analyze their becoming and their disappearing, their changing structures, and their operation. And it chooses the only method fitted to solve this problem satisfactorily.

First we must realize that all actions are performed by individuals. A collective operates always through the intermediary of one or several individuals whose actions are related to the collective as the secondary source… The hangman, not the state, executes a criminal. (1996, 43)

But the hangman receives authority from the “state”. The state is an entity that is bigger than any one person. While any action requires an individual, the state practically subsumes them when they act as its agent. Individual action is constrained by the state apparatus. Individuals might move in and out of the state, but the state remains. This may have been part of the decisions of particular individuals, but those individuals are logically replaceable by others. Methodological individualism in the strict sense that Mises presents it breaks down. But this need not be so if we accept an interaction between institutions and individuals, which in some instances Mises comes close to acknowledging.

Mises’s argument is likely skewed due to his context which appears to have promoted confusion between political individualism and methodological individualism in his writing. During his career, he battled collectivist perceptions that had been common in Germany like the idea of a fatherland, the volk, and so on. These colloquial references to the collective lack much substance beyond culture. But many collectives are well formed. This does not prevent Mises from denouncing analysis of collectives more generally,

It is illusory to believe that it is possible to visualize collective wholes. They are never visible; their cognition is always the outcome of the understanding of the meaning which acting men attribute to their acts. We can see a crowd, i.e., a multitude of people. Whether this crowd is a mere gathering or a mass (in the sense in which this term is used in contemporary psychology) or an organized body or any other kind of social entity is a question which can only be answered by understanding the meaning which they themselves attach to their presence. And this meaning is always the meaning of individuals. Not our senses, but understanding, a mental process, makes us recognize social entities. (43)

In terms of imaginary collectives that lack substantial structure, Mises is more correct than not. Collectives like government, corporations, and religious groups, however, do not fall under the same category as a crowd. We might better understand these institutions as rules and structure that are epiphenomena of particular networks. As rules become formalized through building of indigenously introduced exogenous institutions, they are embodied in a real, existent entity that govern interactions within particular networks (Boettke, Coyne, and Leeson 2008). Analysis then includes not only the individual, but also the system. Interactions occur within network and between networks, with different networks embodying different norms and rule sets. These rules more tightly constrain the actions of agents within the system than do informal norms, thus we can observe the interaction between the individual agent and emergent phenomena concretized by the creation of formal institutions.

This process has been recognized within development literature, but it has not been explicictly stated in regard to methodological individualism. In their presentation of the process of social development, North, Wallace, and Weingast present three doorstep conditions for moving into what they call an open-access order where political violence is constrained and political power is systematized and contestable (2009). Their second doorstep condition for entering an open-access order is the creation of perpetually lived institutions in both the public and private spheres of life:

The capacity to form and support perpetually lived organizations has direct consequences for a society’s ability to structure social relationships over time. The creation of legal personalities for organizations constitutes an essential element of perpetual life; it is inherently impersonal because it is defined without reference to any specific individuals. (2009, 158)

The growth of well-developed institutions both constrain and expand the option sets of individuals. They perform a coordinating function amongst individuals by providing boundaries for individual action. When the state takes action, it is not so important who serves as its agent, only that someone does. Something bigger than the individual molds the actions of every individual within their network.

These coordinating functions also interact with one another. When institutions collide, some amount of conflict results. To be clear, action always occurs at the individual level. When robust institutions are included and, in this case, when they conflict, the nature of the action changes. One might say that two nation’s militaries battled one another. In reality, many individuals with weapons attacked one another, but in doing so, they acted as agents of the state. Their constraints change the moment they put on uniforms and are depending on the role they adopt or are assigned. This sort of analysis makes little sense without recognizing the existence and importance of emergent institutions like the state and the constraints placed upon its agents.

The world is dynamic. Social economy must be modeled as such. Methodological individualism need not be discarded. It must be integrated into a deeper form of analysis. Its general spirit is correct. Action occurs at the individual level. The individual, however, is constantly engaged in a conversation with society about what his or her actions should and can be. Society, in this sense, is defined not simply as everyone else, but also as the formal and informal institutions that constantly influence one’s actions. Mises and Hayek may not have been amenable to studying why people act as they do, as this is not a question of prime interest to economists. Economists should ask how and why one’s options are shaped and constrained by emergent institutions. The search for an answer to this will enable us to form a more robust method of analysis.

Bibliography

Andreozzi, Luciano. “Hayek Reads the Literature on the Emergence of Norms.” Econ Stor Working Paper no. 0503. 2005.

Boettke, Peter, Coyne, and Leeson. “Institutional Stickiness and the New Development Economics.” The American Journal of Economics and Sociology 64, no. 2 (April 2008): 331-358.

Hodgson, Geoff. “Behind Methodological Individualism.” Cambridge Journal of Economic 10 (1986): 211-224.

Mises, Ludwig von. Human Action: A Treatise on Economics Irvington-on-the-Hudson, NY: Foundation for Economic Education, 1996 [1949].

North, Douglass, Wallace, and Weingast. Violence and Social Orders New York: Cambridge University Press, 2009.

Thoughts on Lachmann, Determinism, and Free Will

In "The Role of Expectations in Economics as a Social Science", Ludwig Lachmann remarks about determinism,

Does Professor Hicks seriously maintain that the same individual confronted with the same kind of change will invariably react in an identical-and incidentally, predictable-manner? Only such invariability of reaction would entitle us to use intensity of reaction as a criterion of classification. (74)

Lachmann is conflating uncertainty with a lack of determinism. If the future is uncertain that does not mean that the events contained therein cannot be predeterimined given an identical starting state at time t. Some readers might remember that I have before made reference to historical time, making a similar claim as Lachmann here. Upon further reflection, I believe that I might have been making the same error.

If the future is uncertain from the point of view of human consciousness, but predetermined, it implies that free will as we conceive it is an illusion. I'm still not sure what to make of this conclusion, maybe more on that in the future.

Rule-Based Macroeconomics: A Possible Avenue for Non-Equilibrium Theorizing

If you have been reading my blog recently, you know that I have not written kindly about the integration of rational expectations and the efficient markets hypothesis into Austrian economics. This might seem strange to any readers who believe that markets work. I sympathize with that perspective, but I believe it is inappropriate to assume this. As I have noted about some modern Austrian macroeconomic models, reliance on RE and EMH assumes disequilibrium out of existence unless it is caused by an exogenous shock. RE and EMH may approximate market outcomes 99% of the time, or even 99.9% of the time, but the remainder, (1 – p), needs to be understood, especially if its source is endogenous.  Imagine if I have a 1/100 or 1/1000 chance of being struck by lightning every time I step outside. The variance of outcome in the case I am struck is high. According to a quick Google search, there is a 10% chance that I die, and some spectrum of other outcomes. I am not interested in the median result – say, I spend one week in the hospital – if 1 in 10 times I end up dead. Furthermore, in a world of fat tailed probability distributions, which seem to better describe the world of finance than Gaussian distributions, I may not want to optimize expected value if I am not sure how fat the tails are. In other words, I may know that my map of possible outcomes does not cover the entirety of possible outcomes, but I am unsure to what extent it is lacking. This is what George Shackle and Israel Kirzner refer to as surprise: outcomes that one is absolutely ignorant of. If it so happens that the possible outcomes I am missing from my probability distribution have much higher expected losses than any outcome within my probability distribution, I may want to consider not optimizing in a way suggested by RE. 

None of this is to say that RE and EMH are not useful. They provide a teleological compass for fruitful economic analysis. In many cases, however, median outcomes do not matter. In these cases, RE and EMH are better described as an Achilles heel of economic analysis.

What is needed is an economic framework that allows for emergent processes, a non-equilibrium framework. We do not know what the economy will look like in ten years – even absent exogenous shocks – neither should agents in our models. (If you disagree, extend the time frame to 100 years.) 

What is needed is not that Austrian economics “catch-up” to the modern equilibrium paradigm, “but an effort to create the contemporary analytics that might have been created had Austrian macro theorizing continued to evolve since 1940 with the same robustness that it exhibited before 1940 (Wagner, 98).” 

What is needed is a macroeconomics that foregoes determinism associated with RE and EMH and concentrates on rules that guide decision-making and human action. Individuals do not approach “truth” directly. They integrate information according to heuristics, and then act to achieve their ends according to their interpretation of information. 

Those who endeavor to develop this research program must model in terms of heterogeneous agents whose actions are determined according to rule sets. The outcomes of interactions between agents acting according to rule sets and the transformation of rule sets over time may shed light on market processes in a way that equilibrium theorizing cannot.