Tomorrow, I’ll be taking the GRE; so, I’m behind in my reading — I’m still (slowly) working my way through R.W. Clower’s Monetary Theory (a great collection of essays) and David Glasner’s Free Banking and Monetary Reform. I’ve also started re-reading Daniel Kuehn’s recent piece for Critical Review, “Hayek’s Business Cycle Theory: Half-Right” (here is the working paper version). My intention is to ultimately comment on the whole thing, but for now I have a few words about a claim Daniel makes in the introduction,

[F]or decades most macroeconomists have considered Friedrich A. Hayek’s work on the business cycle inconsequential…

I’m not sure this is true.

In 1974, Friedrich Hayek and Gunnar Myrdal were awarded the Nobel Memorial prize, “for their pioneering work in the theory of money and economic fluctuations.” Why was Hayek awarded the Nobel prize for a theory that, according to Daniel, most macroeconomists have considered “inconsequential.”

Robert Lucas published “Unemployment in the Great Depression” in 1972, when he was developing an intertemporal theory of the business cycle (in 1979, he published “An Equilibrium Model of the Business Cycle“). Lucas and others would turn this into a “real business cycle” (RBC) model. While the dynamic forces of the business cycle are different than those suggested by Hayek, the intuition behind RBC is very similar to that of Austrian Business Cycle Theory (ABCT).

Both ABCT and RBC try to explain the business cycle within the context of rational agents, who are always trying to maximize their respective functions. In order to explain why rational agents end up acting in a way that leads to the business cycle, both Hayek and Lucas pointed to price distortions and both believed that ultimately only money could be responsible for an intertemporal disequilibrium (see Kyun Kim, Equilibrium Business Cycle Theory in Historical Perspective). In his 1977 paper, Lucas even modeled overinvestment leading to the business cycle.

In fact, Lucas went as far as to cite Hayek’s business cycle theory as one of the main intellectual precursors of real business cycle theory.

Another economist, although by that time he had probably lost most of his presence in the profession, who returned to Hayekian business cycle theory was John Hicks. In 1973, Hicks published Capital and Time, developing his own “neo-Austrian” theory. G.L.S. Shackle was another economist who continued to discuss and develop a Hayekian capital theory, relating it to the business cycle. Of course, both G.L.S. Shackle and John Hicks were directly influenced by Hayek, when the latter was still at the London School of Economics during the late 1930s and early 1940s.

Perhaps Hayek’s theory had been largely forgotten during the Keynesian Revolution of ~1940–1960, although I think even this claim is a stretch, but by the late 1960s, Hayek’s research program began to be taken in various directions. None of them in the direction an Austrian would prefer, but still in ways directly linked to some of the basic building blocks of ABCT. So, I cannot agree with Daniel. Hayek’s business cycle research, whether explicitly or implicitly, has been front and center in macroeconomics since, at least, the 1970s. His 1974 Nobel Memorial prize represents this re-emergence in the academic debate.

Austrians who, at the time, were leading the school would know better than me, but it’s a shame that Austrians didn’t join the debate in the leading journals — that is, it’s a shame they didn’t adopt RBC’s modeling techniques to try to model their own story, at a time when their general approach began to spread throughout the profession. But, it seems to me there was much more emphasis in breaking away from equilibrium theory; that’s what I get from, for example, Rizzo’s and O’Driscoll’s The Economics of Time and Ignorance. Mises died in late 1973; Rothbard was the intellectual leader of the school and saw no benefits in going in the direction of RBC; Hayek was involved in social theory (he also published a couple of monographs on monetary theory, but this was a limited excursion); others were looking to pursue an intellectual relationship with the Post Keynesians; etc. I think we missed out on a golden opportunity, and we’re much worse off because of it.