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9.7 The Capital-based Macroeconomic Framework

The three components discussed above are assembled in Figure 9.7 to depict

an intertemporal equilibrium in a fully employed macroeconomy. Full employment

is indicated by the locus of this economy on its production

possibilities frontier. The particular location on the frontier is determined by

Figure 9.7 A capital-based macroeconomic framework




S, I






Stages of production

S = I

The Austrian school 497

the loanable funds market, in which the rate of interest reflects the saving

preferences of market participants. The corresponding consumption preferences

are accommodated by the output of the final stage of production in the

Hayekian triangle. Resources are being allocated among the stages of production

on the basis of the cost of investment funds, such that the rate of

return in the real sector, as reflected in the slope of the triangle’s hypotenuse,

corresponds to the rate of return in the financial sector, as depicted by the

market-clearing interest rate in the loanable funds market. Figure 9.7 and

subsequent figures are adapted from Garrison (2001).

For an economy in a macroeconomic equilibrium as just described, the

rates of return (in both the real and the financial sectors) can be summarily

described as ‘the natural rate of interest’. Parametric changes, such as a

change in saving preferences, can change the natural rate. For instance,

increased saving preferences will cause the market-clearing rate of interest

to be lower and the slope of the triangle’s hypotenuse to be a shallower one.

The capital-based macroeconomic framework is designed to show (i) how

market forces establish a new natural rate in response to some parametric

change and (ii) how the economy reacts to policies aimed at maintaining an

interest rate in the financial sector that is inconsistent with – typically

below – the natural rate. Uses of these analytics to deal with other macroeconomic

issues, such as deficit finance and tax reform, are demonstrated

in Garrison (2001); some extensions of Austrian business cycle theory are

suggested by Cochran (2001).

In its simplest interpretation, Figure 9.7 depicts a steady-state, no-growth

economy. There is no net investment. The positive level of saving and investment

shown in the loanable funds market is just enough to offset capital

depreciation. As capital goods wear out and are replaced, the Hayekian

triangle is maintained from period to period in terms of both size and shape.

This is the circumstance that corresponds to the first two periods of Figure

9.2. If, as is ordinarily the case, investment exceeds capital depreciation, the

economy experiences secular growth in all its dimensions. The production

possibilities frontier shifts outward, both the supply and demand for loanable

funds shift rightward, and the Hayekian triangle changes in size but not – or,

at least, not necessarily – in shape. This is the circumstance that corresponds

to the last several periods of Figure 9.2. It should be noted that secular growth

in which there is no change in the shape of the Hayekian triangle presupposes

that the supply of loanable funds and the demand for loanable funds shift

rightward to the very same extent, such that there is no change in the rate of

interest. Ordinarily, we would think of the increased income and wealth that

economic growth makes possible as being accompanied by an expanding

time horizon and hence by an increased inclination to save. Factoring in

increased saving preferences would allow for a reduction in the rate of

interest and a change in the shape as well as of the size of the Hayekian