Lesson 7 of 8
Three diagrams joined
Garrison's formal presentation puts the triangle, a frontier and a loan market on one page. What that made explicit, and what the simplification costs.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Garrison's framework joins four graphical devices: the Hayekian triangle, a production possibilities frontier, the market for loanable funds and markets for labour.
- Joining them makes the theory's claims checkable. A change has to be consistent across all of the diagrams at once, or the story does not hold together.
- Garrison says the trade-off between simplicity and realism is struck in favour of simplicity, and he says it about his own construction.
The triangle on its own shows a shape changing without saying what changed it. Garrison's Time and Money, published in 2001, puts the triangle next to the other pictures the argument needs and makes them share their axes.
What each diagram is doing in the framework
- 1Market for loanable fundsWhere the rate is set, and by which source of supply
- 2Production possibilities frontierThe trade-off between consumption now and later
- 3Hayekian triangleHow the commitment is spread across distance from consumption
- 4Markets for labourWhere the people actually move between stages
What joining them buys
A discipline. In Prices and Production the triangle changes shape and the reader has to take on trust that the resources were available to make it happen. In Garrison's presentation the frontier is on the same page, so a lengthening that would require an economy to move outside the frontier is visibly impossible.
Likewise the loan market. The same lower rate can appear from saving or from credit, and in the joined picture the two cases send the frontier and the triangle in different directions. That difference is what the previous course spent two lessons on, and here it is a property of a diagram rather than a paragraph.
What Garrison says about the triangle itself
He is precise, and unusually candid for a partisan of a theory. He calls the triangle a heuristic device, describes it as highly stylised, and dates it to the second of the 1931 lectures.
On the trade-off, he writes that in his framework simplicity is chosen over realism deliberately. He notes that the triangles leave much out of account, and adds in the same passage that the more realistic figures Hayek attempted in The Pure Theory of Capital in 1941 to allow for durable capital leave a great deal out too.
His defence is that a device is worth having when it accounts for a lot on the basis of a little, which is the defence anyone would offer for a supply and demand curve.
What the formalisation costs
Three things, and Garrison names two of them himself.
It commits to a particular shape. A triangle with a straight edge assumes original factors applied at a constant rate, which Hayek said there is no reason to assume.
It sits on a tradition that stopped developing. Garrison observes that Austrian capital theory effectively ended with Hayek's 1941 book, that the sequence of teaching frameworks mainstream macroeconomics went through has no counterpart here, and that his own style of argument may look anachronistic as a result.
And the third is the one this course keeps returning to. A framework built to show that capital is heterogeneous has to draw capital as an area, and an area is a single number.
How to use it as a reader
As a consistency check on anything you read about a cycle, including from people in this tradition. Four questions: where did the funds come from, what happened to the split between consuming now and later, which stages moved, and who changed jobs. An account that answers only one of the four is not yet an account.
Check yourself
Which four devices make up Garrison's capital-based framework?
- The triangle, the Keynesian cross, IS-LM and a Phillips curve
- The Hayekian triangle, a production possibilities frontier, the market for loanable funds, and markets for labour
- Four versions of the triangle at different dates
Show the answer
Answer: B.
He names exactly these in the first chapter of Time and Money, comparing the triangle's simplicity to that of the Keynesian cross.How does Garrison describe the trade-off in his own construction?
- Realism is chosen over simplicity
- Simplicity is chosen over realism, deliberately, and he says the triangles leave much out of account
- He claims no trade-off exists
Show the answer
Answer: B.
He adds that the more realistic figures Hayek attempted in the 1941 Pure Theory of Capital also leave much out, and defends the device on the ground that it accounts for a lot from a little.What does putting the frontier beside the triangle rule out?
- Any change in the rate of interest
- Claims that would require the economy to produce more of everything from the same resources
- The existence of unemployment
Show the answer
Answer: B.
A story that lengthens the structure and raises consumption with no change in employment is a move outside the frontier, and the joined diagram makes that visible.Sources
- Garrison, Time and Money: The Macroeconomics of Capital Structure, 2001, chapter 1, for the four graphical devices of the capital-based framework, for the triangle described as a heuristic device and as highly stylised, for the trade-off between simplicity and realism being struck in favour of simplicity, for the comparison with the Keynesian cross and with Marshallian supply and demand, for the remark about the figures in Hayek's 1941 book, and for the observation that Austrian capital theory effectively ended with that book and that Austrian macroeconomics is missing a stage of development the mainstream went through.
- Hayek, Prices and Production, first published 1931, second revised edition 1935, lecture II, for the triangle Garrison takes as his point of departure and for the statement that there is no reason to assume the sloping edge is linear.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The example of the contradictory claim is invented to show how the joined diagrams behave. It describes nobody's argument in particular.
- Only the preface and the first two chapters of Time and Money were read for this lesson, from the author's own published pages. Nothing is attributed to the later chapters where the framework is actually run through the cycle.
- Formalising a theory built on heterogeneity into diagrams with single-valued axes is itself one of the objections made to this literature, and it is taken up properly in the course on the case against the theory.