Skip to main content

Advertisement

SpringerLink
Log in

Nobelity and novelty: Finn Kydland and Edward Prescott’s contributions viewed from Vienna

  • Published:
The Review of Austrian Economics Aims and scope Submit manuscript

Abstract

The awarding of the Nobel Prize in Economics in 2004 to Finn Kydland and Edward Prescott represents an opportunity to evaluate their contributions in light of Austrian economics. We lay out the basics of their contributions—the general equilibrium approach to economic fluctuations and the game theoretic approach to policy—and argue that they have tenets similar to those of Austrianism. We argue that their methodology parallels Austrian methodology in several significant ways that have gone unnoticed. We conclude that Kydland and Prescott’s Nobel Prize suggests Austrian approaches can have a more prominent impact than they have had in the past.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. “General equilibrium approach,” is Kydland and Prescott’s (1991b) label for their methodology. Their methodology is also referred to variously as RBC, new classical (NC), and stochastic dynamic general equilibrium (SDGE) methodology. However, these terms can also be applied more specifically (e.g., RBC theory as the specific hypothesis that technology shocks drive business cycles) or more broadly (e.g., NC methodology as that which insists on rational, maximizing behavior). In lieu of a broadly accepted label, we simply adopt the Nobel Laureates’ own terminology.

  2. Though KP never explicitly use this three-point summary, Kydland and Prescott (1991b, 1996) are the most clear expositions of the GEA. These two papers are quoted below extensively and the three points of the summary are made forcefully and prominently in their texts.

  3. Models need not be mathematical, but the parenthetical reference “mathematical, macroeconomic” signals that throughout this paper the mention of models will imply this type unless stated otherwise explicitly.

  4. Kydland and Prescott (1991b: 164) would plead the case of the representative agent on this point: “[The Solow (1956) growth model] was not fully neoclassical, however, because the consumption-savings decision was behaviorally determined.....With the consumption-savings decision endogenized [by a representative agent] Solow’s growth model becomes fully neoclassical with agents’ maximizing subject to constraints and market clearing.” Many Austrians, of course, would not accept this construct as “human reason and will causing certain action,” e.g., see Hülsmann’s (1999) critique of neoclassical economics as an attempt to “analyze how people act as a corollary or sequel of given circumstances” (5); rather than Austrian attempts to “explain the realized manifestation of human action... as a corollary of the non-realized part” (5), i.e., purposes and foregone alternatives. Also of note, Rothbard’s critique sounds similar to points raised in KP’s advocacy of the GTA (see below).

  5. This statement need not, of course, be interpreted as ideological. It can be interpreted as a purely positive statement that particular methodologies tend to lead to particular conclusions logically.

  6. Key assumptions in this framework are constant returns to scale in labor and capital, diminishing returns with one of these factors held constant, diminishing marginal utility on the part of consumers, maximization based on rational expectations, and market clearing.

  7. For a critique of the type of sustainable growth described in the Garrison framework, see Salerno (2001). Salerno (2001) describes an alternative scenario of secular growth based on falling time preferences. For a theory of secular growth that is based purely on capital accumulation with constant time preferences and is consistent with Garrison’s framework, see Young (2009).

  8. Garrison (2006) offers a rudimentary incorporation of technological change as a factor explaining aspects of the business cycle that has some parallels with RBC. For an overview of the contributions and implications of Garrison’s analysis relative to modern mainstream macroeconomics, see Cochran (2001).

  9. See Amman and Kendrick (2003) for a modification of control theory in the spirit of Lucas’ suggestion.

  10. The difference between a Keynesian model’s forecast and the prediction of the Kydland and Prescott (1977) model is that, in the Keynesian model, forecasts are determined entirely by the sign and magnitude of parameters as econometrically estimated while, in the KP model, the prediction is deduced purely from the model’s equations.

  11. It should be noted that the counterfactual analysis referred to above is quite different than the interpretation of economic laws of counterfactual laws as argued for extensively by Hülsmann (2000, 2003, 2004). Hülsmann’s counterfactual laws allow for causal explanations of human action and probable statements about how some factors affect human behavior. And despite their allowance of certain quantitative statements (Hülsmann 2003: 75–76), such statements are not in terms of a quantitative accounting of, e.g., the variance of certain macroeconomic aggregates, such as in the GEA.

  12. Of course, some may argue that because the growth model is justified by accounting for the stylized growth facts, while accepted a priori for business cycle analysis it is still instrumentalism through the back door, so to speak. This is fair and the parallels between Austrianism and GEA are certainly not perfect.

  13. Cochran et al. (2004), which was discussed previously, is another example of Austrian counterfactual analysis of particular business cycles, in that case those of Japan and the US in the 1980s and 1990s. Montgomery (2006) also provides empirical support for Austrian claims regarding the long-distributed lag result from the heterogeneity of capital.

  14. The social planner is a construction often indistinguishable from the now-ubiquitous representative agent of mainstream macroeconomic models.

  15. Tabellini (2005) discusses KP contributions and its relation to additional sources of their ideas.

  16. Though far removed from the time when KP chose the example of flood insurance, the US Gulf Coast experience in the wake of Hurricane Katrina demonstrates just how important a point the example makes.

  17. Recent textbooks discussion include Drazen (2000) and Persson and Tabellini (2000).

  18. Carilli and Dempster (2001) are a recent example of Austrians using game theory to model the interactions between bankers and investors during a credit-induced boom (which leads to the inevitable bust) along the lines of Austrian business cycle theory.

  19. von Mises (1963, 116) is more than skeptical about the value of game theory: “There is not the slightest analogy between playing games and the conduct of business within a market society.” However, Mises goes on to add: “He who interprets the conduct of business as trickery is on the wrong path.” Perhaps he would not be as dismissive of the KP result that policy makers fail in their manipulations due to the strategic responses of individuals across the economy.

  20. Generally, OC theory will be inappropriate if the structure is not policy invariant. So individual expectations could irrationally change in response to policy and the general result would still hold. Amman and Kendrick (2003) attempt to provide stochastic control methods for a macromodel where parameters vary over time both randomly and systematically with policy.

  21. Empirically, the Lucas critique has found little support. See Ericsson and Irons (1995) for a survey. The common standard for evaluating the critique is whether relationships across macroeconomic variables are “super exogenous” to policy parameters (Engle and Hendry 1993). A recent paper questions this result by constructing a model economy with optimizing agents forming rational expectations and then demonstrating (1) that a policy regime change alters reduced form parameters significantly and (2) super exogeneity tests do not reject parameter stability in simulated data from the model of sample size similar to actual empirical studies (Linde 2001). However, another recent paper demonstrates that backward-looking macromodels are more stable and fit the data better than forward-looking models based on optimizing agents with rational expectations (Estrella and Fuhrer 2003).

  22. However, von Mises (2000: 29) stresses the time invariance of individuals’ preferences rather than expectations. That expectations change in the face of policy creates a much more systematic and effective argument against optimal control than assuming economically important swings in preferences.

  23. Hoppe’s (1997: 52) comments suggest that the Lucas/KP view may hit the mark closer than Mises’: “Notwithstanding this ultimate uncertainty of our knowledge concerning the external world, however, as a result of contingent circumstances, the relative stability and regularity in the concatenation of external objects and events, it has been possible for mankind to accumulate a vast and expanding body of practically certain knowledge.” Furthermore, “This knowledge does not render the future predictable, but it helps us predict the effects to be produced by definite actions.” Lucas/KP focus on changes in the “contingent circumstances” of the policy environment and how that affects predictability.

  24. Prescott (1986: 105) notes that Lucas (1985) criticized the (1982) paper on this point. Prescott implies that the criticism is valid.

  25. Cochran et al. (2004) prefer a purely Austrian interpretation of the recent Japanese experience. For the US experience, they posit a positive technology shock in the 1990s (a la RBC theory) accompanied by monetary expansion and a subsequent Austrian boom–bust.

  26. Hayek (1933: 54–56) draws this distinction early on: “The simple fact that economic development does not go on quite uniformly, but periods of relatively rapid change alternate with periods of relative stagnation, does not in itself constitute a problem” and “It is sufficiently explained by the adjustments of the economic system to irregular changes in the data,” or what KP would refer to as shocks. Austrian theory, on the other hand, describes the “phenomena of the upward trend of the trade cycle and of the culminating boom [which] inevitably bring about a slump.”

  27. Hoover’s discussion is sometimes complementary and consistent with our own, but some of his conclusions seem implausible. For example, Hoover (1988: 233–234) sees a parallel between the radical subjectivism and methodological individualism of Austrians and that of New Classicals. Given that New Classical macroeconomic theory claims “microfoundations” based on mathematically modeled infinitely lived representative agents, we believe that most Austrians would reject the parallel that Hoover sees.

References

  • Amman, H., & Kendrick, D. (2003). Mitigation of the Lucas critique with stochastic control methods. Journal of Economic Dynamics and Control, 27, 2035–2057.

    Article  Google Scholar 

  • Basse, T. (2006). An Austrian version of the Lucas critique. Quarterly Journal of Austrian Economics, 9, 15–26.

    Article  Google Scholar 

  • Block, W., & Barnett, W. (2006). Gallaway and Vedder on stabilization policy. Quarterly Journal of Austrian Economics, 9, 57–81.

    Google Scholar 

  • Bordo, M., & Kydland, F. (1995). The gold standard as a rule: An essay in exploration. Explorations in Economic History, 32, 423–454.

    Article  Google Scholar 

  • Bordo, M., Erceg, C., & Evans, C. (2000). Money, sticky wages, and the great depression. American Economic Review, 90, 1447–1463.

    Google Scholar 

  • Carilli, A., & Dempster, G. (2001). Expectations in Austrian business cycle theory: An application of the prisoner’s dilemma. Review of Austrian Economics, 14, 319–330.

    Article  Google Scholar 

  • Cass, D. (1965). Optimum growth in an aggregative model of capital accumulation. Review of Economic Studies, 32, 233–240.

    Article  Google Scholar 

  • Cochran, J. (2001). Capital-based macroeconomics: recent developments and extensions of Austrian business cycle theory. Quarterly Journal of Austrian Economics, 4, 17–25.

    Google Scholar 

  • Cochran, J., Yetter, N., & Glahe, F. (2004). Capital-based macroeconomics: Boom and bust in Japan and the US. Indian Journal of Economics and Business, 3, 1–16.

    Google Scholar 

  • Drazen, A. (2000). Political economy in macroeconomics. Princeton: Princeton University Press.

    Google Scholar 

  • Engle, R., & Hendry, D. (1993). Testing super exogeneity and invariance in regression models. Journal of Econometrics, 56, 119–139.

    Article  Google Scholar 

  • Ericsson, N., & Irons, J. (1995). The Lucas critique in practice: Theory without measurement. In K. Hoover (Ed.), Macroeconometrics: Developments, tensions, and prospects. Boston: Kluwer Academic.

    Google Scholar 

  • Estrella, A., & Fuhrer, J. (2003). Monetary policy shifts and the stability of monetary policy models. Review of Economics and Statistics, 85, 94–104.

    Article  Google Scholar 

  • Faber, M., Manstetten, R., & Proops, J. (1996). Ecological economics: Concepts and methods. Cheltenham: Edward Elgar.

    Google Scholar 

  • Foss, N. (2000). Austrian economics and game theory: A stocktaking and an evaluation. Review of Austrian Economics, 13, 41–58.

    Article  Google Scholar 

  • Friedman, M. (1953). Essays in positive economics. Chicago: University of Chicago Press.

    Google Scholar 

  • Friedman, M. (1968). The role of monetary policy. American Economic Review, 58, 1–17.

    Google Scholar 

  • Garrison, R. (1991). New classical and old Austrian economics: Equilibrium business cycle theory in perspective. Review of Austrian Economics, 5, 91–103.

    Article  Google Scholar 

  • Garrison, R. (2000). Book review of Faber et al. (1999). Quarterly Review of Austrian Economics, 3, 85–88.

    Article  Google Scholar 

  • Garrison, R. (2001). Time and money: The macroeconomics of capital structure. New York: Routledge.

    Book  Google Scholar 

  • Garrison, R. (2006). From Keynes to Hayek: The marvel of macroeconomics. Review of Austrian Economics, 19, 5–15.

    Article  Google Scholar 

  • Hansen, G., & Prescott, E. (1993). Did technology shocks cause the 1990–1991 recession? American Economic Review, 83, 280–286.

    Google Scholar 

  • Hartley, J., Hoover, K., & Salyer, K. (1998). Real business cycles: A reader. London: Routledge.

    Google Scholar 

  • Hayek, F. (1935). Collectivist economic planning. London: Routledge.

    Google Scholar 

  • Hayek, F. (1944). The road to serfdom. Chicago: University of Chicago Press.

    Google Scholar 

  • Hayek, F. (1960). The constitution of liberty. Chicago: University of Chicago Press.

    Google Scholar 

  • Hoover, K. (1988). The new classical macroeconomics: A skeptical inquiry. New York: Blackwell.

    Google Scholar 

  • Hoppe, H. -H. (1997). On certainty and uncertainty—or: How rational can our expectations be? Review of Austrian Economics, 10, 49–78.

    Article  Google Scholar 

  • Hughes, A. M. (1997). The recession of 1990: An Austrian explanation. Review of Austrian Economics, 10, 107–123.

    Article  Google Scholar 

  • Hülsmann, G. (1999). Economic science and neoclassicism. Quarterly Journal of Austrian Economics, 4, 3–20.

    Article  Google Scholar 

  • Hülsmann, G. (2000). A realist approach to equilibrium economics. Quarterly Journal of Austrian Economics, 4, 3–51.

    Article  Google Scholar 

  • Hülsmann, G. (2003). Facts and counterfactuals in economic law. Journal of Libertarian Studies, 17, 57–102.

    Google Scholar 

  • Hülsmann, G. (2004). The a priori foundations of property economics. Quarterly Journal of Austrian Economics, 7, 41–68.

    Article  Google Scholar 

  • Keeler, J. P. (2001). Empirical evidence on the Austrian business cycle theory. Review of Austrian Economics, 14, 331–351.

    Article  Google Scholar 

  • Koopmans, T. C. (1965). On the concept of optimal economic growth. In The econometric approach to development planning. Amsterdam: N. Holland.

  • Kydland, F. (1975). Noncooperative and dominant player solutions in discrete dynamic games. International Economic Review, 16, 321–335.

    Article  Google Scholar 

  • Kydland, F. (1977). Equilibrium solutions in dynamic dominant player models. Journal of Economic Theory, 15, 307–324.

    Article  Google Scholar 

  • Kydland, F., & Prescott, E. (1977). Rules rather than discretion: The inconsistency of optimal plans. Journal of Political Economy, 85, 473–491.

    Article  Google Scholar 

  • Kydland, F., & Prescott, E. (1982). Time to build and aggregate fluctuations. Econometrica, 50, 1345–1370.

    Article  Google Scholar 

  • Kydland, F., & Prescott, E. (1991a). Hours and employment variation in business cycle theory. Economic Theory, 93, 161–178.

    Google Scholar 

  • Kydland, F., & Prescott, E. (1991b). The econometrics of the general equilibrium approach. Scandinavian Journal of Economics, 1, 63–81.

    Google Scholar 

  • Kydland, F., & Prescott, E. (1996). The computational experiment: An econometric tool. Journal of Economic Perspectives, 10, 69–85.

    Google Scholar 

  • Kydland, F., & Prescott, E. (1997). A response from Finn E. Kydland and Edward C. Prescott [to Milton Friedman]. Journal of Economic Perspectives, 11, 210–211.

    Google Scholar 

  • Laidler, D. (1982). Monetarist perspective. Cambridge: Harvard University Press.

    Google Scholar 

  • Lewin, P. (2001). The development of Austrian economics: Revisiting the neoclassical divide. Review of Austrian Economics, 14, 239–250.

    Article  Google Scholar 

  • Linde, J. (2001). Testing for the Lucas critique: A quantitative investigation. American Economic Review, 91, 986–1005.

    Article  Google Scholar 

  • Lucas, R. (1976). Econometric policy evaluation: A critique. Carnegie–Rochester Conference Series on Public Policy, 1, 19–46.

    Article  Google Scholar 

  • Lucas, R. (1979). An equilibrium model of the business cycle. Journal of Political Economy, 83, 1113–1144.

    Article  Google Scholar 

  • Lucas, R. (1980). Methods and problems in business cycle theory. Journal of Money Credit and Banking, 12, 696–715.

    Article  Google Scholar 

  • Lucas, R. (1985). Models of business cycles. Chicago: University of Chicago.

    Google Scholar 

  • Mankiw, N. G. (1989). Real business cycles: A new Keynesian perspective. Journal of Economic Perspectives, 3, 79–80.

    Google Scholar 

  • Montgomery, M. (2006). Austrian persistence? Capital-based business cycle theory and the dynamics of investment spending. Review of Austrian Economics, 19, 17–45.

    Article  Google Scholar 

  • Mulligan, R. (2006a). Accounting for the business cycle: nominal rigidities, factor heterogeneity, and Austrian capital theory. Review of Austrian Economics, 19, 311–336.

    Article  Google Scholar 

  • Mulligan, R. (2006b). An empirical examination of Austrian business cycle theory. Quarterly Journal of Economics, 9, 69–93.

    Google Scholar 

  • Persson, T., & Tabellini, G. (2000). Political economics: Explaining economic policy. Cambridge: MIT Press.

    Google Scholar 

  • Phelps, E. (1967). Phillips curve, expectations of inflation and optimal unemployment over time. Economica, 34, 254–281.

    Article  Google Scholar 

  • Prescott, E. (1977). Should control theory be used for economic stabilization? Carnegie–Rochester Series on Public Policy, 2, 13–38.

    Article  Google Scholar 

  • Prescott, E. (1986). Theory ahead of business cycle measurement. Federal Reserve of Minneapolis Quarterly Review, 10, 9–22.

    Google Scholar 

  • Prescott, E., & Hansen, G. (1993). Did technology shocks cause the 1990–1991 recession. American Economic Review, 83, 280–286.

    Google Scholar 

  • Rothbard, M. (1993). Man, economy, and state. Auburn: Ludwig von Mises Institute.

    Google Scholar 

  • Salerno, J. (2001). Does the concept of secular growth have a place in capital-based macroeconomics. Quarterly Journal of Austrian Economics, 4, 43–61.

    Article  Google Scholar 

  • Solow, R. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics, 70, 65–94.

    Article  Google Scholar 

  • Tabellini, G. (2005). Finn Kydland and Edward Prescott’s contribution to the theory of macroeconomic policy. Scandinavian Journal of Economics, 107, 203–216.

    Article  Google Scholar 

  • von Mises, L. (1963). Human action: A treatise on economics. San Francisco: Fox & Wilkes.

    Google Scholar 

  • von Mises, L. (2000). The equations of mathematical economics and the problem of economic calculation in a socialist state. Quarterly Journal of Austrian Economics, 3, 27–32.

    Article  Google Scholar 

  • Weder, M. (2000). Animal spirits, technology shocks and the business cycle. Journal of Economic Dynamics and Control, 24, 273–295.

    Article  Google Scholar 

  • Young, A. (2009). A capital-based theory of secular growth. Quarterly Journal of Austrian Economics, (in press).

Download references

Author information

Authors and Affiliations

  1. Department of Economics, James Madison University, 447 Zane Showker Hall, Harrisonburg, VA, USA

    J. Robert Subrick

  2. Department of Economics, University of Mississippi, 371 Holman Hall, Oxford, MS, 38677, USA

    Andrew T. Young

Authors
  1. J. Robert Subrick
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Andrew T. Young
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to J. Robert Subrick.

Additional information

We thank an anonymous referee for valuable comments on a previous draft.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Subrick, J.R., Young, A.T. Nobelity and novelty: Finn Kydland and Edward Prescott’s contributions viewed from Vienna. Rev Austrian Econ 23, 35–53 (2010). https://doi.org/10.1007/s11138-009-0079-3

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11138-009-0079-3

Keywords

JEL

Search

Navigation