8. Ludwig von Mises on Inflation and Expectations

CHAPTER 8

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Ludwig Von Mises on Inflation and Expectations

I. Introduction

Among Ludwig von Mises’s most important contributions to monetary theory are his sophisticated analyses of the social consequences of inflation and of the formation and evolution of inflationary expectations.¹ Mises’s explanation of the inflationary process is characterized by an emphasis on the kind of relative price effects that are inconsistent with the long-run neutrality of money. Probably for this reason, modern proponents of the quantity theory of money have generally neglected Mises’s theory. And although modern quantity theorists² recently have begun to address Mises’s analysis, they have for the most part misconceived his view of the nature and durability of these effects.

Modern Austrian economists, for their part, generally ignore Mises’s theory of inflationary expectations. Some have either denied that Mises proposed such a theory or denied that he succeeded in integrating it with his overall vision of the economic process. For example, the late Ludwig Lachmann strongly implied that Mises offered no theory of expectations.³ And even such a careful Mises scholar as Richard M. Ebeling,⁴ while admitting that Mises “did attempt to formulate a constructive theory of expectations and their formation in the market process,” concluded that Mises failed to fully integrate his theory of expectations formation with his theories of money and of entrepreneurship.⁵ However, at least one sympathetic neoclassical monetary theorist⁶ has taken note of Mises’s analysis of the development of expectations about the future purchasing power of money during historical episodes of inflation, criticizing it as an inconsistent amalgam of elements of the rational and adaptive expectations theories.

In the next section of this paper, I briefly review Mises’s distinctive “step-by-step,” or sequential analysis of changes in the the supply of money and demonstrate how this analysis implies that money is nonneutral in the long run as well as in the short run. In the third section I contrast Mises’s description of the inflationary process and its effects with the account given by the modern quantity theorists. I argue that recent monetarist criticisms of Mises’s description of the consequences of unanticipated monetary inflation are based on a failure to adequately appreciate the subtleties of Mises’ analysis. I also describe how Mises’s analytical method led him to an explanation of the positive employment effect typical of initially unanticipated inflation that differs markedly from the explanation derived from the Friedman-Phelps natural rate hypothesis. In the fourth section of the paper, I present a comprehensive account of Mises’s theory of expectations, showing how it is integrated with his praxeological approach to economic theory and elucidating the crucial role it plays in his analysis of the effects of an ongoing monetary inflation.⁷ I also address the attempt to interpret Mises’s writings on inflationary expectations in terms of macroeoconomic expectations-formation mechanisms. The fifth section reviews Mises’s discussion of the German hyperinflation to illustrate how his theory of expectations is woven into his economic analysis. I conclude by summarizing the lessons that contemporary economists can learn from Mises’s analysis of the inflation process.

II. Mises’s Analytical Method and the Long-Run Nonneutrality of Money

In his autobiographical Notes and Recollections,⁸ written in 1940 but not published until 1978, Mises gave the following description of the “step-by-step” method of analyzing monetary phenomena, which he had formulated in his 1912 work The Theory of Money and Credit:

The step-by-step analysis must consider the lapse of time. In such an analysis the time-lag between cause and effect becomes a multitude of time differences between single successive consequences. Reflection on these time-lags leads to a precise theory of the social consequences of changes in the purchasing power of money.

As Mises⁹ proceeded to point out, such an analysis yields a “theory of the inevitable nonneutrality of money,” implying “… that changes in purchasing power of money causes prices of different commodities and services to change neither simultaneously nor evenly, and that it is incorrect to maintain that changes in the quantity of money bring about simultaneous and proportional changes in the ‘level’ of prices.”

Mises thus conceived inflation as a time-spanning process in which an increase in the stock of money invariably results in a sequential adjustment of prices, which necessarily alters relative prices and brings about a reallocation of productive resources and a redistribution of real income and wealth. The specific temporal sequence in which prices are adjusted, and thus the identity of those market participants experiencing gains or losses, is not deducible from economic theory. Rather, it depends concretely on the specific point at which the new money is injected into the economy and on the marginal utility schedules of those who receive and spend the new money.

One sympathetic neoclassical economist, James Rolph Edwards, points out, “[Mises’s] description of the inflationary process is more complex and realistic than the sort of ‘airplane spreading analysis’ (involving miraculous equiproportional additions to cash balances) that economists all too frequently indulge in.”¹⁰ Unfortunately, Edwards erroneously concludes that Mises imagined this “lagged price adjustment process” as reaching completion “only when the original price relations were restored.” As I argued in chapter 2, however, Mises took great pains to deny that either the instantaneous demand curve or the Patinkinite market equilibrium curve for nominal cash balances can ever take on the shape of a rectangular hyperbola under dynamic realworld, conditions. Moreover, Edwards¹¹ commits a blunder in elementary price theory when he insists that the relative position of the group of sellers whose receipt of the new money occurs late in the inflationary process is restored at the end of the process, although their “losses suffered in the interim go uncompensated.” Logically, it is just such uncompensated losses (and gains) that permanently alter the pattern of individual wealth holdings, market demands, and relative prices, and therefore result in a revolution and not a restoration of the relative positions of various groups of sellers in the new long-run equilibrium, or what Mises called the “final state of rest.”

Thus, as Mises¹² stated, “Precisely because the price increases have not affected all commodities at one time, shifts in the relationships of wealth and income are effected which affect the supply and demand of individual goods and services differently. Thus, these shifts must lead to a new orientation of the market and of market prices.” Moreover, as Mises contended in criticizing Irving Fisher’s formulation of the quantity theory, Fisher was led to contrive his artificial dichotomy between monetary theory and value theory as a makeshift defense against just such a charge of elementary logical error. Wrote Mises:¹³

One thing only can explain how Fisher is able to maintain his mechanical Quantity Theory. To him the Quantity Theory seems a doctrine peculiar to the value of money; in fact he contrasts it outright with the laws of value of other economic goods.… With as much justification as that of Fisher and Brown for their mechanical formula for the value of money, a similar formula could be set out for the value of any commodity, and similar conclusions drawn from it.¹⁴

In fact the efforts by neoclassical monetary theorists following Patinkin to “integrate monetary and value theory” missed the point, because they were aimed at repairing the Fisherian dichotomy without coming to terms with the value-theoretic error embodied in the neutral-money doctrine.

III. The Inflationary Process: Mises Versus the Quantity Theorists

In analyzing the social consequences of inflation, Mises recognized that unanticipated inflation modifies the relative wealth positions of creditors and debtors. He also endorsed Fisher’s original analysis of the adjustment of the nominal interest rate to an anticipated fall in the purchasing power of money. In fact, Mises¹⁵ considered the emphasis on the link between fluctuations in the value of money and the formation of the interest rate to be “Fisher’s most important contribution to monetary theory.” In addition, Mises originated¹⁶ the argument that inflation causes a falsification of capital accounting that leads to an overstatement of profits and brings about unintended consumption of the social stock of capital. This occurs because depreciation quotas for capital goods during inflation continue to be computed on the basis of their historical costs rather than their (necessarily higher) replacement costs. The entrepreneurs may dispose of these “accounting” profits by increasing their own consumption, by cutting prices to consumers, or by bidding up the wage rates of laborers. In the latter two cases, a one-time redistribution of wealth from one group to another accompanies the “consumption of capital.”

What Mises clearly regarded as the most important effect of inflation, however, is the permanent redistribution of income and wealth that results from the sequential and uneven adjustment of prices to an addition to the stock of money. For Mises,¹⁷ “… the social consequences of changes in the value of money are not limited to altering the content of future monetary obligations.” In fact, as Mises¹⁸ argued, in a continuing inflation that comes to be more or less correctly anticipated by the public, the effects on short-term credit transactions are mitigated by the Fisherian inflation premium that becomes incorporated into loan contracts. In the case of long-term credit, where it is much more difficult to forecast the precise degree of depreciation of the monetary unit, a commodity with a relatively stable value, such as gold or foreign currency, is substituted for the depreciating money as the “standard of deferred payments.” Mises¹⁹ also suggested that adjusting accounting procedures for durable equipment to reflect replacement rather than historical costs would be a practicable method for greatly reducing or eliminating the unintended consumption of capital and the associated redistribution of income from capitalist-entrepreneurs to other groups in society that occurs during inflation.

Mises²⁰ therefore argued (in sharp contrast to modern quantity theorists) that the most significant social consequence of the variation in the purchasing power of money is the “uncompensatable changes” in income and wealth that occur “… because of the uneven timing of the price changes of the various goods and services.” Thus every change in the quantity of money leaves indelible imprints on the relative-price structure and therefore on the pattern of wealth and income distribution.

Recently, Thomas J. Humphrey has argued²¹ that “the Austrian School’s contention that monetarists invariably ignore relative price and real output effects in the monetary mechanism” is based on a misconception. Humphrey then goes on to impressively demonstrate that monetarists, like Milton Friedman, as well as their forerunners, including Fisher and Clark Warburton, do indeed take into account “the temporary nonneutral real-sector effects of monetary changes” (emphasis added). But, of course, recognition only of short-term relative price and real output effects that are inexplicably and exactly reversed in the course of the monetary adjustment process to yield the long-run neutrality of money does not constitute the resolution but the very crux of the problem that Austrian monetary theorists identify with the Fisherian quantity theory.

Humphrey misunderstands the basis of the Misesian proposition that any explanation of the monetary adjustment process must proceed in terms consistent with general value theory and with the inescapable fact that prices adjust sequentially over time. Thus Humphrey²² touts Fisher’s allusions to “contractual restraints, legal prohibitions, and the inertia of custom [which] render individual prices sticky” as a complete and convincing explanation of the “real” effects that invariably accompany monetary changes.

Humphrey²³ further claims that Austrians ignore the effect of increased employment caused by inflation’s temporary distortion of the relative price between labor and output, that is, the real wage rate, an effect which has been particularly stressed by Friedman. This charge is uninformed at best. In an article published in 1958,²⁴ the same year A.W. Phillips’s famous article²⁵ was published and a full decade before Friedman unveiled his “natural rate” hypothesis in his Presidential address to the American Economic Association, Mises anticipated the essential points of Friedman’s article. According to Edwards,²⁶ Mises set forth “… virtually all of the essential arguments Friedman later made on the subject in his Presidential address. The existence of a natural rate of unemployment conditioned by the state of real wages is clearly implicit.… The existence of a short-run trade-off between inflation and unemployment and the nonexistence of a long-run tradeoff due to some sort of expectations adjustment are both explicit elements of the argument.” Referring to an even earlier essay by Mises,²⁷ Edwards²⁸ states that “Mises even more clearly anticipated Phelps and the accelerationists.”

More important, for Mises, in contrast to Friedman and the natural-rate theorists, the “real wage/employment effect” attributable to inflation does not depend on the conjecture that “selling prices of products typically respond to an unanticipated rise in nominal demand faster than prices of factors of production,”²⁹ combined with an ad hoc assumption regarding the relatively slow rate at which laborers adapt their expectations about money’s future purchasing power to their experience of its depreciation. In fact, in Mises’s step-by-step exposition of the inflation-adjustment process, an industry may find the real wage rates it must pay decreasing or increasing, depending on the specific point at which the additional quantity of money first impinges on individual value scales and the exact sequence of individual cash balance adjustments that is then set in train. Thus, for example, an inflation precipitated by an expansion of bank loans for purposes of business investment entails rising, not falling, real wage rates and, therefore, a negative employment effect for lower-order capital and consumer goods’ industries, that is, those industries that are late in the chain of spending of the newly-created fiduciary media.

As Mises³⁰ explained “… in the regular course of banking operations the banks issue fiduciary media only as loans to producers and merchants.… [T]hese fiduciary media are used first of all for production, that is to buy factors of production and pay wages. The first prices to rise, therefore, as a result of an increase of the quantity of money … caused by the issue of such fiduciary media, are those of raw materials, semimanufactured products, other goods of higher orders, and wage rates. Only later do the prices of goods of the first order [i.e., of consumers’ goods] follow.” In this case, which still regularly recurs in modern economies, because the rise in wage rates precedes the rise in consumer goods’ prices, unanticipated inflation does not produce the paradigmatic Friedmanite real wage/employment effect.

Mises³¹ did appreciate, moreover, that the issue of fresh fiduciary media via the expansion of bank credit to business ignites a process of monetary depreciation that will typically “follow a different path and have different accompanying social side effects from those produced by a new discovery of precious metals or by the issue of paper money.” In the case of the latter two sources of new money, the ensuing process of depreciation may feature the phenomenon of wage rates generally lagging behind the rise in commodity prices, resulting in a general decline in real wage rates and the phenomenon of “forced saving,” that is, the redistribution of wealth and income from wage earners to entrepreneurs. Mises³² even allowed that such an effect on real wage rates may occur “If monetary depreciation is brought about by an issue of fiduciary media, and if wage rates for some reason do not promptly follow the increase in commodity prices.”

Thus Mises³³ was adamant in his conclusion that, in an economy with unhampered labor markets:

… forced saving can result from inflation but need not necessarily. It depends on the particular data of each instance of inflation whether or not the rise in wage rates lags behind the rise in commodity prices. A tendency for real wages to drop is not an inescapable consequence of a decline in the monetary unit’s purchasing power. It could happen that nominal wage rates rise more or sooner than commodity prices.

Mises’s analysis led him to seek in another direction for the explanation of the observed positive effect of inflation on the employment of labor. His explanation begins with initially-prevailing conditions of excess supply in labor markets that are hampered by minimum wage laws and by the restrictionist policies of legally privileged unions. It is under these conditions, which have prevailed in most industrial economies since the 1920s, that unanticipated inflation via bank credit expansion can lower real wage rates toward market-clearing levels and increase the employment of labor. As Mises³⁴ argued:

Under conditions of [the inflationary] boom, nominal wage rates which before the credit expansion were too high for the state of the market and therefore created unemployment of a part of the potential labor force are no longer too high and the unemployed can get jobs again. However, this happens only because under the changed monetary and credit conditions prices are rising or, what is the same expressed in other words, the purchasing power of the monetary unit drops … inflation can cure unemployment only by curtailing the wage earner’s real wages.

Both Mises and Friedman recognize that when the discovery is made by laborers that their real wage rates have been eroded by inflation, supply of labor curves in nominal wage space shift leftward, driving up real wage rates toward former levels. For Friedman, inflationary monetary forces have displaced the real economy and this countermovement therefore represents its return to the quasi-general equilibrium state of the “natural rate of unemployment,” according to Friedman,³⁵ “the level that would be ground out by the Walrasian system of general equilibrium equations, provided there is imbedded within them the actual structural characteristics of the labor and commodity markets.” In Mises’s analysis, in contrast, the reversal of the drop in real wage rates occurs because “… the unions ask for a new increase in wages in order to keep pace with the rising cost of living and we are back where we were before, i.e., in a situation in which large scale unemployment can only be prevented by a further expansion of credit.”³⁶

Now, unlike the Chicago price theorists, Mises and the Misesian wing of the modern Austrian school do not believe that the market economy is ever at, or even within sight of, long-run general equilibrium.³⁷ Rather, the structure of realized market-clearing prices is seen by Austrians as functioning, despite its non-general-equilibrium character, to continuously coordinate the uses and technical combinations of available resources in light of entrepreneurial forecasts of constantly shifting future market conditions, including consumer preferences.³⁸ Hence, for Mises, in direct contrast to Friedman, it is the decline in real wage rates toward their market-clearing levels brought about by unforeseen inflation that is equilibrating—albeit crudely and temporarily; the ensuing restoration of the former level of real wage rates by renewed union restrictionism, on the other hand, marks a reversion to a pervasive and chronic disequilibrium situation in which the labor market is precluded from establishing even a momentary equilibrium of supply and demand, while the market’s long-run tendency to generate a structure of final equilibrium wage rates and optimal allocation of labor is permanently stifled.

In his critique of the monetarists for downplaying the role of labor unions in shaping the inflationary process, Gottfried Haberler³⁹ presents a Misesian analysis of what he identifies as a money–fueled “wagepush inflation,”⁴⁰ and contends that the monetarists implicitly assume “a few islands of monopoly in a vast competitive sea; where monopolies existed wages and prices would be higher, production and consumption lower, but unemployment would be transitory and moderate because the labor and other productive resources set free in the monopolized areas would find employment, at somewhat lower wages, in the large competitive sector.” While Haberler⁴¹ disputes the empirical validity of this assumption even for conditions prevailing in the U.S. economy in the early 1970s, the significant point for our discussion is that the monetarist analysis is applicable only to those situations where the assumption in question holds true. Eschewing the monetarist focus on general equilibrium, Mises⁴² explicitly predicated his analysis of the modern inflation-adjustment process on the existence of what he called “institutional” unemployment of labor created by political policies that foster labor union “restrictionism” and rigid wages.

In propounding his novel theory of union activity, Mises⁴³ argued that labor unions are unconcerned with the configuration of the demand curve for their product because they “… do not aim at monopoly wage rates.” Unions are “restrictionist,” and not monopolistic, organizations, because they “… are not concerned with what may happen to the part of supply which they bar from access to the market.” While a monopolistic pricing policy is advantageous only if total revenue earned at the monopoly price equals or exceeds the total revenue earned at the competitive price (or if total cost falls more rapidly than total revenue between the competitive and monopoly prices), “Restrictive action … is always advantageous for the privileged group and disadvantageous for those whom it excludes from the market. It always raises the price per unit and therefore the total net proceeds of the privileged group. The losses of the excluded group are not taken into account by the privileged group.”⁴⁴

An important implication of Mises’s analysis is that the ability of unions to restrict supply in labor markets is much greater and less predictable than would be the case if they were merely engaged in monopolistic pricing, because, in the case of restrictionism, the desired shift of the supply curve to the left cannot be explained solely on the basis of the configuration of the total revenue and total cost curves. Thus, if we accept Mises’s explanation of union activity, real wage rates may not be determinate in a strictly catallactic generalequilibrium model from which the concept of a natural rate of unemployment is deduced. This means that economists would have to draw their assumptions regarding union goals and plans from outside the system of catallactic theorems, that is, from historical analysis. They then must be prepared to admit that these goals are apt to shift, possibly rapidly, producing corresponding shifts in the natural rate and thus undercutting the practical usefulness of this concept.

The Misesian position has been recognized and challenged by monetary disequilibrium theorists, Dan E. Birch, Alan A. Rabin, and Leland B. Yeager.⁴⁵ Although they also reject Friedman’s explanation of the positive effect of inflation on employment and real output, they do not accept the explanation of the phenomenon offered by W.H. Hutt,⁴⁶ which is essentially the Mises-Haberler view presented above. Indeed, they dismiss it out of hand because it dares to suggest that “villainy” is afoot in the pricing process in form of restrictionist pricing of labor by unions and governments.⁴⁷

Hutt rebutted an earlier article by Yeager that argued that the shrinkage of real output below its potential level is generally attributable to unanticipated changes in aggregate monetary expenditure, which generate disequilibrium “income constraints” of the Clower-Leijonhufvud type. According to Hutt “… the crucial continuity [of the market-clearing process] is always dependent upon valuing and pricing, whether or not monetary policy is flexible, rigid, inflationary or deflationary—that is, independently of the factors which determine the purchasing power of the monetary unit.”⁴⁸ Elsewhere, Hutt countered a similar argument by Leijonhufvud by pointing out, “… at wage rates equal to the ‘marginal prospective product,’ all labor is immediately employable.”⁴⁹ (Emphasis is added.)

IV. Mises’s Theory of Expectations

This brings us to the vexed question of Mises’s approach to the theory of expectations formation and adjustment, and his view of the role that expectations play in the adjustment of real variables to monetary inflation. Edwards⁵⁰ argues, “Mises’s statements on the adjustment and effects of expectations in The Theory of Money and Credit seem to contain two distinct and somewhat contradictory attitudes and associated mechanisms.” He also adduces evidence that Mises shifted back and forth in this work between the adaptive-expectations and rational-expectations approaches. In fact, at some points in his writings, Mises also appeared to have employed the assumption that expectations regarding movements of the future purchasing power of money are “rigidly inelastic” with respect to current changes in realized prices, and that such movements are thus anticipated to be completely reversed in the course of the agent’s planning horizon.⁵¹ At other times, Mises⁵² regarded expectations as apparently “unhinged” from recent experience of objective market conditions, so that a small increase in the quantity of money following upon a long interlude of price stability can drive the demand for money rapidly toward zero and precipitate an explosive upward spiral of prices. Mises also characterized the simultaneous actions of different groups of individuals operating on different markets as often dominated by different kinds of inflationary expectations. Nonetheless, the “contradictions” that Edwards⁵³ detects among Mises’s various statements on inflationary expectations are superficial only and are resolved within an integrated praxeologico-historical account of the nature and formation of expectations.

According to Mises, any human action is aimed at substituting a more satisfactory state of affairs (from the point of view of the actor) for the state that would emerge without the action. Because of the lapse of time between the inception and the outcome of every action, the future conditions that an action will impinge upon and transform can never be known with certainty but must be forecast by the agent. Thus human action is inherently entrepreneurial, or, as Mises⁵⁴ puts it, “Every action is a speculation, i.e., guided by a definite opinion concerning the uncertain conditions of the future.”

However, although praxeology can indisputably establish expectations as a logical prerequisite of every act of choice, it cannot shed light on the content or temporal evolution of expectations. Praxeology deals with the logical structure and implications of action, and, as such, “… is not concerned with the events which within a man’s soul or mind or brain produce a definite decision between an A and a B.… . Its subject is not the content of these acts of choosing, but what results from them: action.”⁵⁵ For insight into the concrete process of expectations formation, Mises⁵⁶ directs us to the method of “specific understanding” (Verstehen) as it is utilized in the historical disciplines and “as it is practiced by everybody in all his interhuman relations and actions.”

The specific understanding that is brought to bear by the historian in explaining past events is a mental process which “… establishes, on the one hand, the fact that, motivated by definite value judgments, people have engaged in definite actions and applied definite means to attain ends they seek. It tries, on the other hand, to evaluate the effects and intensity of the effects of an action, its bearing upon the further course of events.”⁵⁷ This method of proceeding is based on the insights of what used to be referred to derisively by experimental psychologists as “literary psychology,” a discipline which Mises⁵⁸ redubbed “thymology.” The word thymology, is a derivative of the classical Greek term denoting the mental faculty that was believed to be the source of thought, volition, and emotion. According to Mises,⁵⁹ thymology is itself a historical discipline, which:

… derives knowledge from historical experience [from] observation both of other people’s choices and of the observer’s own choosing.… It is what a man knows about the way in which people value different conditions, about their wishes and desires and their plans to realize these wishes and desires. It is the knowledge of the social environment in which a man lives and acts or, with historians, of a foreign milieu about which he has learned by studying special sources.

The thymological method allows the historian to “understand” a complex historical event, in the dual sense of enumerating its causes, as far as they proceed from human values and volitions, and weighting the contribution of each of the causes to the observed outcome. The weights of the various causal factors, of course, cannot be quantitatively and mechanically determined but are a matter of the historian’s necessarily subjective “judgments of relevance.”⁶⁰ Just as thymological experience serves as the basis for the historian’s interpretive understanding of past events (so far as they depend on social and not natural causes), it also conditions the actor’s “specific understanding of future events” or, in current terminology, his formation of expectations about the future.

Like the historian, the acting individual must base his forecast of future conditions on an understanding both of the factors operating or likely to operate in producing the future outcome and of the degree of influence exercised by each of these factors in the emergence of the final result. But these two problems, that is, of “enumeration” and of “weighting,” are precisely the problems that must be solved by the historian who seeks to explain the emergence of the same situation in retrospect. Moreover, as Mises⁶¹ pointed out, “The precariousness of forecasting is mainly due to the intricacy of this second problem [of weighting]. It is not only a rather puzzling question in forecasting future events. It is no less puzzling in retrospect for the historian.” It is to emphasize the fact that the historian and the acting individual both must use the thymological method in solving the same type of problems that Mises⁶² referred to them, respectively, as “the historian of the past” and “the historian of the future.”

As noted earlier, concerning expectations, all that can be logically inferred from the action axiom, (which states that individuals behave purposefully by using means to achieve ends) is that they are a universal category of action, because all actions necessarily are future-oriented and take place under uncertainty. Logical deduction from the action axiom yields no information to the economist about the content and adjustment of expectations; nor is it permissible, from Mises’s point of view, for the economist to simply “assume” an expectations adjustment mechanism for the purposes of generating testable hypotheses about observed economic variables. Assumptions about expectations that are to be used to supplement the action axiom in deducing catallactic theorems, like many of the other subsidiary assumptions of praxeological reasoning, must be drawn from the general thymological experience of the theorist or from more formal historical research. Mises⁶³ stressed that the incorporation of such experience-based assumptions into the chains of praxeological deduction does not alter the rigidly formal and aprioristic character of economic theory, but renders it useful for comprehending specific phenomena of real human life and action. Without such a strict delimitation of its assumptions, praxeology—and, therefore, economics also—would lose its function as a science and become merely “mental gymnastics or a logical pastime.”

Thus, for example, an account of the inflation-adjustment process that is based on the rational expectations hypothesis that “the unobservable subjective expectations of individuals are exactly the true mathematical conditional expectations implied by the [simultaneous-equation macroeconomic] model itself”⁶⁴ may offer an interesting, if idle, praxeological exercise, but it offers no scientific truths about real-world inflation processes. Such a hypothesis contradicts one of the most general and important conclusions of thymology that must be accepted as a datum of economic theorizing, namely, that there exists a broad and unpredictably varying range of differences between human beings in their abilities to anticipate and adjust to change.⁶⁵ The rational expectations approach also rejects the thymological insight that false economic doctrines may powerfully condition the public’s, including bankers’ and entrepreneurs’, forecasts of the future. The influence of these doctrines on economic activity is particularly potent when they are fostered by popular political ideologies, as was and still remains the case with the “cheap money fallacy” and the “balance-of-payments theory” of exchange rates. Similarly, misleading economic doctrines also may be promoted by a layman’s superficial reading of long catallactic experience. Consider, for example, the doctrine that variations in the purchasing power of money are caused solely by extraordinary events emanating from the commodity side of the economy. This doctrine, which dominated economic writings until the mid-sixteenth century and lay opinion up until the inflations following the First World War and which continued to underlie conventional accounting procedures until the inflations of the 1970s, is a precipitate of age-old experience with commodity money standards.

Because the very function of thymology is to provide the acting individual with information about the social factors that are or will be operating to promote or obstruct the achievement of his goals, it is also inconsistent with the assumption of adaptive expectations, which envisages economic agents as eschewing all causal investigation and attempting to forecast future values of an economic variable by mechanically extrapolating from their past errors in forecasting the same variable. For Mises,⁶⁶ a being becomes “thymologically human” as soon as it begins to cast around for specific means to apply to attaining definite goals, and thus begins to investigate the causal relationships between the various elements in its social and physical environment. As a result all market participants, when formulating the specific understanding of the future that guides their catallactic activities, are to some degree, depending on their entrepreneurial abilities, alive to the causal factors that determine prospective economic quantities. In the marketplace, as in every department of social intercourse, therefore, “All are eager to get information about other people’s valuations and plans and to appraise them correctly.”⁶⁷

The thymological method of dealing with expectations also stands in opposition to the position proclaimed by Lachmann,⁶⁸ the late exponent of Shacklian “radical subjectivism,” that expectations are “autonomous” in the same sense as human preferences, and that, therefore, the economist is “unable to postulate any particular mode of change.” In such a world of divergent and unpredictably changing expectations and the speculative shifts of supply and demand curves they continually evoke, according to Lachmann,⁶⁹ the fact that realized prices continually clear markets “has little meaning.” Such a radically nihilistic view of the price coordinating feature of the market economy results from ignoring the fact that an individual’s expectations are derived from thymological and catallactic experience. This view was long ago rebutted by Arthur W. Marget⁷⁰ in the following terms:

For unless we are to make of the so-called ‘method of expectations’ the kind of deus ex machina which … would lead to “the complete liquidation of economics as a science,” we must proceed upon the assumption [which is supported by thymology] that expectations are what they are largely as the result of the experience of economic processes as they have been actually realized in the past and as they are being currently realized in the present.

Thus, “expectations” help to determine “realized” prices. But the prices thus “realized” help to determine expectations with respect to the future course of prices…. When, therefore, it is said that “equilibrium” is “indeterminate” whenever “the final position is dependent upon the route followed” all that this can mean is that no account of the actual functioning of the economic process can be regarded as complete until it undertakes, upon the basis of a study of the successive, actually realized steps in any economic process actually unfolding itself in time, to establish the nature of the considerations likely to determine the nature of entrepreneurial responses to changes in the market situation, including the possible changing nature of the goals whose attainment these responses are designed to aid… [W]e have insisted throughout upon the necessity for accompanying any use of an emphasis upon “expectation” by a tracing of realized processes in all possible detail, in order that these realized processes may be related with all possible precision to the expectations which condition them and to which they give rise. (All emphases in this passage are Marget’s.)

Contrary to Lachmann’s contentions, then, the moment-to-moment structure of realized prices can be explained as a coordinative outcome of past and always fallible speculative anticipations, while yet remaining a meaningful factor in the explanation of the current entrepreneurial forecasts and price appraisements that shape the future course of the market process. Expectations are thus not “autonomous”; they are rigidly circumscribed by the actor’s chosen goals, the experience of success and failure he has acquired in pursuing these and earlier goals, and his entrepreneurial ability, that is, his aptitude for culling information and deducing implications from his experience that are relevant to his future actions. Nor is it “impossible to derive a group’s state of expectations from its state of knowledge”;⁷¹ as an integral element of the human choice process expectations are discoverable by the methods of thymology regularly deployed in everyday life and in historical research and thus accessible to the economist as well. Accordingly, in the final sentence of the preceding quotation, Marget perceptively argued that information about the expectations-formation process can only be derived from thymological experience or historical investigation of “realized” market processes.

Ironically, Lachmann,⁷² despite his strongly avowed antipositivism and radical subjectivism, declared that an actor’s thymological knowledge “… must always remain problematical in the sense in which [the actor’s] knowledge of molecules, machines or the human body is not.”⁷³ But as Mises stressed, while experience–based thymological knowledge is “categorically different” from the experimentally established “facts” of the natural sciences, it is real knowledge nonetheless and is just as indispensable for the planning of action. “To know the future reactions of other people is the first task of acting man.”⁷⁴

The knowledge about future events that thymology yields is not in terms of statistical or “class” probabilities, it is true, but in terms of ranked likelihoods or “case” probabilities.⁷⁵ For example, it is through thymological experience that I “know” (as I write this in 1993) that the likelihood of each of the following events occurring in 1994 is negligible and certainly much lower than the likelihood of, for example, the Clinton health plan passing Congress without significant modification: my being drafted to replace Prince Charles as heir to the English throne; the United States of America being reconstituted as a monarchy; or professional football being displaced in popularity by professional soccer in the United States. I and masses of others regularly and successfully take nonstatistical but thymologically knowable likelihoods such as these into account in planning future actions.

From a thymological standpoint, not only the Lachmannian position but also the Hayekian position on expectations, elaborated so ably in the writings of Israel M. Kirzner,⁷⁶ must be rejected. Expectations of profit gaps between future output prices and resource prices are not formed merely on the basis of “alertness” to information about past price structures; we learn nothing directly about the future by merely absorbing, whether passively or alertly, information about the outcomes of realized market processes.⁷⁷ Entrepreneurial appraisements of future price structures are the outcome of a specific understanding of future market conditions that must be actively produced by deliberately bringing one’s thymological experiences and insights to bear on information about past prices. Such “knowledge” about future profit opportunities is, therefore, emphatically not embodied in the objective (disequilibrium) price signals of the immediate past; its source is rather internal, resting on thymological insight and impinging on external events only through the actions it motivates.

The knowledge that is yielded by thymological investigation of human activities carried out in the market or elsewhere is embodied in what Mises⁷⁸ referred to as “ideal types.” For example, the theoretical explanation of the German hyperinflation of the early 1920s may employ the distinct ideal types “German industrial laborer,” “German entrepreneur,” “German foreign exchange speculator” and so forth, depending on the economic analyst’s reading of the historical record, which includes his own direct experience if it is relevant. Each of these ideal types differs from the others in terms of the experiences, reactions, and appraisements it postulates with respect to the depreciation of the German mark. Only understanding based on experience and careful study of the historical record can decide whether the content and number of ideal types to be introduced at different points in the praxeological chain of theoretical deductions are appropriate. For instance, it may be helpful to distinguish between the “German entrepreneur of 1919” and the “German entrepreneur of 1922” or between the “Prussian civil servant” and “the Bavarian farmer” in order to take account of the impact of different experiences and ideologies on the formation of expectations in reaction to information about a given increase in the money supply. When theorizing about the effect of a new issue of paper money on the demand for money during the final stages of hyperinflation, the economist may register his awareness of the spread of inflationary expectations to even the least entrepreneurial and most ideologically blinkered among the populace by resorting to a single ideal-typical “German income earner.”

This discussion points to the solution of the continuing controversy between Misesians and Hayekians over whether economic theory can yield knowledge about human learning and interindividual knowledge-diffusion processes. As a branch of praxeology, economic theory per se cannot and need not establish a single proposition about such processes; as in the case of human goals and values, it accepts as given data for its reasoning the concrete details of what participants are capable of learning from the historical market process (as encapsulated in ideal types). The learning processes by which participants in the market acquire and interpret information are not logically deducible from universal and timeless praxeological categories; they must be “understood” or thymologically reconstructed from historical experience and then employed among the supplementary premises of aprioristic praxeological analysis to yield economic theorems that possess both logical and substantive truth.⁷⁹

As Mises⁸⁰ pointed out, “this singular and logically somewhat strange procedure” of analyzing economic phenomena, “in which aprioristic theory and the interpretation of historical phenomena are intertwined,” can lead to serious errors. Indeed, the unsatisfactory and seemingly irreconcilable approaches to expectations that dominate mainstream monetary theory are a result of this failure to appreciate and come to grips with the indispensable role of thymology and history in establishing the subsidiary assumptions of economic reasoning.

It is illuminating to briefly compare Mises’s view of expectations with Hayek’s. In “Economics and Knowledge,” Hayek⁸¹ issued a plea for making equilibrium analysis applicable to the real world by incorporating into it an “empirical element” consisting of “propositions about the acquisition of knowledge” that were adequate to explaining the tendency to equilibrium supposedly observable in the actual economy. He went on to argue in general terms that the solution lay in the introduction into formal economic theory of “ideal types,” meaning “concrete hypotheses concerning the conditions under which people are supposed to acquire the relevant knowledge and the process by which they are supposed to acquire it.”⁸² At this stage of his thinking, and before he had made much progress in selecting the empirically relevant ideal types to serve as supplementary hypotheses, Hayek’s project appeared similar to Mises’s. Nine years later, however, in “The Use of Knowledge in Society,” Hayek⁸³ specifically identified the overarching ideal type to be used in economic analysis as an economy whose prices always approximate their long-run equilibrium values and therefore convey accurate knowledge about the scattered data of the economic system to decentralized decision makers.⁸⁴ Hayek’s assumption of what I have elsewhere called “proximal equilibrium” is a major departure from Mises’s theory of expectations in two ways. First, it banishes genuine uncertainty and the necessity of entrepreneurial forecasting and appraisement of future prices from economic analysis because it implies that “current prices are fairly reliable indications of what future prices will probably be”;⁸⁵ and, second, Mises explicitly denied that the actual economy harbors an empirical tendency to operate close to longrun equilibrium or even to temporally progress toward such a state.⁸⁶

V. Inflationary Expectations and the German Hyperinflation

Mises’s thymological approach to expectations is clearly illustrated in his analysis of historical episodes of inflation, particularly the German hyperinflation after World War One. For example, at the very beginning of the war inflation in Germany in 1914, the ideal-typical German mark holder included workers, entrepreneurs, and bankers. They confronted the general rise in prices with deep-seated inelastic expectations, grounded on their long experience of the gold standard and reinforced by general acceptance of Georg Knapp’s doctrine that State power was the source of money’s value. According to Mises:⁸⁷

When the war inflation came nobody understood what a change in the value of the money unit meant. The businessman and the worker both believed that a rising income in Marks was a real rise of income. They continued to reckon in Marks without any regard to its falling value. The rise of commodity prices they attributed to the scarcity of goods due to the blockade.⁸⁸

Expectations eventually began to adjust, but “it took years” even for German entrepreneurs to recognize and adapt their expectations to the true cause of price inflation, while workers were slower still to adjust.⁸⁹ Even on the loan market, expectations adjusted very slowly. In the early stages of the inflation, after people had disentangled themselves from the grip of their long pre-inflationary experience with commodity money, what may be loosely characterized as adaptive expectations replaced inelastic expectations. During this period, the inflation premium of the nominal interest rate lagged behind the inflation rate “… because what generates it is not the change in the supply of money … but the-necessarily later occurring-effects of these changes upon the price structure.⁹⁰

As the inflation progressed, it started to become clear to those possessing the greatest degree of entrepreneurial foresight that it was likely to persist and even accelerate in the future and that there were pecuniary gains to be reaped from such an occurrence. What may be termed, again very loosely, “rational expectations” began to develop first on the foreign exchange market and then later on the stock and commodity markets. Speculators on the foreign exchange market began to anticipate the effects of current and then future increases in the money supply on domestic prices and therefore on exchange rates, and there came into being a substantial “reverse” lag between the rise of domestic commodity prices and the rise in prices of foreign exchange. Meanwhile, the high profits being earned by speculators on the foreign exchange market drew into this market other speculators who had previously operated on stock and bond markets. Unfortunately the experience, knowledge, and techniques that served these latter speculators well on other markets were ill suited to the foreign exchange market. According to Mises,⁹¹ the ideal-typical stock market speculator of this period was ignorant of “the principles underlying the formation of monetary value” and “look[ed] on the monetary unit as if it were a share of stock in the government.” As a result, he was apt to buy the mark after sharp declines, believing that it was due to appreciate just as sharply because the government remained stable and the economy just as productive. Thus, until they had learned from experience, the actions of the transplanted stock speculators retarded and may even have temporarily arrested the decline on foreign exchange markets of the domestically depreciating currency.

However, as long as most earners of monetary incomes failed to shake loose their ideological blinders and to recognize that their past experience with a commodity money was irrelevant, they were unable to draw the correct conclusions from their current experiences. This caused domestic price inflation to lag behind the growth of the money supply and the decline in the external value of the mark. Eventually, however, after years of experience with inflation, the masses of wage earners and farmers learned that the rising prices were directly linked to increases in the supply of paper money and their faith in the long-run stability of the purchasing power of the mark was shaken to the core. Once the masses developed “rational expectations” based on their hard-won insight into the link between money and prices, they finally realized that monetary inflation was a deliberate policy of government unlikely to be soon reversed and hyperinflation was at hand.

Mises⁹² described this experience-driven evolution of inflationary expectations and abrupt transition from inelastic to rational expectations on the part of the public in dramatic terms:

The first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation [i.e., the supply of money and demand for money]. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise in all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day they restrict their purchases and concomitantly increase their cash holdings.…

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears.… Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper.…

Once people have experienced firsthand a hyperinflationary currency collapse, their knowledge and expectations are permanently altered. Even the slightest increase in the money supply will now lead all strata of the populace to forecast that the political authorities are once again embarking on a policy of deliberate inflation that will culminate in another catastrophic monetary breakdown. The public’s panic-driven attempts to reduce cash holdings, on the basis of expectations that have come “unhinged” from any reasonable appraisement of the objectively evolving economic situation, will quickly catapult the economy into runaway price inflation. As Mises⁹³ observed:

A nation which has experienced inflation till its final breakdown will not submit to a second experiment of this type until the memory of the previous one his faded.… Made overcautious by what they suffered, at the very outset of the inflation they [i.e., victims and witnesses of the 1923 inflation] would start a panic. The rise of prices would be out of all proportion to the increase in the quantity of paper money.…

It remains for us to reconcile Mises’s discussion of the evolution of expectations in the course of a hyperinflation with the pivotal role he attributed to expectations in the context of his theory of the business cycle. Mises⁹⁴ himself realized that there is an important problem that must be resolved. Why is it, he asked, that while the public learns the lessons taught by their experience with hyperinflation sufficiently well to undertake actions that prevent the regular recurrence of this fiat-money phenomenon, “people are incorrigible” when it comes to learning how to avoid the cyclical ups and downs associated with bank credit expansion.⁹⁵ In Mises’s words, “What calls for special explanation is why attempts are made again and again to improve general economic conditions by the expansion of circulation credit [i.e., bank credit in the form of fiduciary media] in spite of the spectacular failure of such efforts in the past.”⁹⁶

The answer to this question, Mises suggested, is twofold. First, there is the ideological factor: deeply ingrained in the minds of bankers and entrepreneurs is the view, which has been long reinforced by erroneous economic doctrines, that rising prices and low interest rates are a prerequisite of favorable business conditions and economic prosperity and therefore should be a goal of economic policy.⁹⁷ Second, this ideological factor makes it even more difficult for entrepreneurs, untrained in technical economics, to perceive the links between interest rates lowered by bank credit expansion, the capital malinvestments of the boom, and the ensuing crisis and depression that are the consequence of the sudden revelation and liquidation of these malinvestinents. As Mises⁹⁸ pointed out, moreover, comprehending these links requires much more recondite knowledge and a more rigorous intellectual effort than that required for grasping the connection between the running of the printing presses and rising prices. Mises’s point is reinforced by the fact that, after the initial phase of the credit expansion, interest rates do not appear unusually low and may even appear high to the entrepreneur because of the rising inflation premium that progressively drives up the nominal rate. So, even if the entrepreneur learned the basic lesson of avoiding an expansion of his operation when interest rates drop to unusually low levels, he would still be enticed into malinvestments as the inflationary boom progressed and nominal rates increased.

Mises⁹⁹ concluded: “Nothing but a perfect familiarity with economic theory and a careful scrutiny of monetary and credit phenomena can save a man from being deceived and lured into malinvestments.” Certainly, thymological analysis reveals to the economist that the assumption that entrepreneurs in the contemporary world possess a grasp of the Austrian theory of the business cycle is patently false and would lead to erroneous theoretical deductions. But Mises also chided the “many economists” who “take it for granted” in dealing with concrete instances of credit expansion that the future will be like the past and the theorist need not take into account the effect of learning on entrepreneurs’ expectations. Thus, Mises¹⁰⁰ argued, “It may be that businessmen will in the future react to credit expansion in a manner other than they have in the past. It may be that they will avoid using for an expansion of their operations the easy money available because they will keep in mind the inevitable end of the boom. Some signs forebode such a change.”

In the paragraph that immediately follows the one from which the foregoing quotation by Mises is drawn and which appeared in the third ( 1966) but not the first edition ( 1949) of Human Action, Mises¹⁰¹ suggested that the the public as well as the financial press had learned the main lessons of the Austrian theory of the trade cycle, which are that the boom causes the ensuing depression and that the boom is engendered by the preceding expansion of bank credit. The formation of expectations on the basis of this knowledge now compelled the monetary authorities to restrict credit whenever the first signs of the boom appeared. And it is to these factors that Mises attributed the marked reduction in the observed duration and severity of cyclical fluctuations during the 1950s.

Mises’s thymological approach to expectations appears to be well suited for guiding applied research on developments in the U.S. economy in the 1980s and early 1990s. For example, the apparently high real long-term interest rates during the so-called “Reagan recovery” may be partially or even mainly explained as a high inflation premium on the real interest rate, which reflects persistent inflationary expectations carried over from the public’s, and especially the bond market’s, experience with the double-digit inflation rates of the Carter years. This Misesian interpretation contradicts the explanation proposed by Keynesians and others which attributes the stubbornly high real interest rates to a “loose fiscal, tight monetary” policy stance. Also, the continued slow recovery from the 1990–1991 recession even in the face of substantial declines in short-term interest rates and increasingly rapid money supply growth might be explained as resulting from the reluctance of entrepreneurs and investors to employ the additional bank credit to finance long-term capital projects, because they expect the rate of return on investment (“the natural rate of interest”) to be eroded by Clinton’s tax increases, increased regulations, and the costs of impending health care legislation.

From the standpoint of pure theory, the thymological approach to expectations, in conjunction with the Austrian theory of the business cycle, provides an account of cyclical fluctuations which, in contrast to the rational-expectations-based Real Business Cycle theory, rigorously maintains the assumption that markets clear instantaneously without having to invoke improbably large regressive technology shocks and intertemporal labor substitution models that rely on improbably elastic responses of the labor supply to transitory fluctuations in the real wage rate.

VI. Conclusion

Mises’s theory of the inflationary process has been either neglected or misunderstood by mainstream monetary theorists, because it is grounded in Austrian price theory. This theory, which owes much more to the works of Böhm-Bawerk and Wicksteed than to those of Marshall and Walras, seeks to explain the determination and the function of the prices that are actually realized in the real world of constant change and disequilibrium. In this setting, money is not merely a numeraire but is a causal factor in the market’s pricing process, and Mises’s step-by-step method of analysis is the only method suited to analyzing such a dynamic economy.

Despite the economy’s disequilibrium character, however, the market-clearing process has an important function to perform in the pricing and allocation of scarce resources, a function that Hutt¹⁰² felicitously described as “the dynamic coordinative consequences of price adjustment.” According to Mises, the coordinative social appraisement process of the market insures that the current price of every scarce resource is equal to its expected marginal revenue product (discounted by the interest rate), and thus that all existing productive resources are always fully employed in those uses that entrepreneurs consider to be most valuable in light of their knowledge of the technological possibilities and their forecasts of future market conditions, including their appraisements of prospective output prices.

As I have argued elsewhere,¹⁰³ a Misesian conceives the market’s coordinative process as extremely hardy and no more liable to be disrupted by market-produced changes in the money-spending stream, such as hoarding, dishoarding, and changes in the production costs of mining gold, than by changes in the “real” data of the economic system. As Mises argued, however, the process can be hampered and distorted by external intervention that undermines or nullifies its market-clearing property in resource markets, a property that may be crudely and temporarily restored by an episode of unanticipated inflation which lowers the real prices of labor and other resources toward equilibrium levels. Thus Mises’s analysis explains the observed effect of inflation on employment and output in a way that is fully consistent with the microfoundations of Austrian monetary theory and does not invoke ad hoc and unrealistic assumptions about the behavior of market participants.

Mises developed a theory of inflationary expectations and of expectations in general that has been largely ignored by contemporary Austrians, mainly because of their tendency to conflate the views of Mises and Hayek. Under Hayek’s assumption of “proximal equilibrium,” which is a situation in which ex ante coordination of individual plans is nearly perfect and prices are normally near their long-run equilibrium values, expectations are a trivial byproduct of the knowledge culled from past prices. For Hayek then, expectations do not require independent explanation.

Kirzner, who follows Hayek in some important respects, posits that alertness to the information conveyed by the price system is a propensity inherent in human action. In his view, entrepreneurs alertly discover gaps between resource and output prices of the immediate past and costlessly exploit these profit opportunites. Kirzner’s procedure effectively transforms entrepreneur-producers into arbitrageurs who are focused on current market conditions and have little interest in the future. This procedure obviates any discussion of how entrepreneurs formulate expectations of the uncertain future on the basis of their thymological experience and knowledge.¹⁰⁴

Perhaps the most valuable lesson economists can learn from Mises’s approach to expectations is the crucial importance of realistic subsidiary assumptions for correctly deducing and applying the laws of praxeological economics to the analysis of real-world economic events and policies. More braodly, Mises’s theory of expectations opens up an avenue to the understanding of the proper role for historical and thymological research in the elaboration of economic theory.

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From: “Ludwig von Mises on Inflation and Expectations,” Advances in Austrian Economics 2 (1995): pp. 297–325.

¹ Mises’s pathbreaking analysis of inflation developed out of his integration of Austrian marginal utility theory with Carl Menger’s cash-balance approach to the demand for money and the monetary process analysis originated by eighteenth-and nineteenth-century economists such as Richard Cantillon, David Hume, and J. E. Cairnes. On Mises’s contributions and doctrinal influences in the area of monetary theory, see Murray Rothbard, “The Austrian Theory of Money,” in Foundations of Modern Austrian Economics, ed. E.G. Dolan (Kansas City: Sheed & Ward, Inc., 1976), pp. 168–84; idem, The Essential Ludwig von Mises, 2nd ed. (Auburn, Ala.: Ludwig von Mises Institute, 1980), pp. 14–23; Joseph Salerno, “Commentary: The Concept of Coordination in Austrian Macroeconomics,” in Austrian Economics: Perspectives on the Past and Prospects for the Future, ed. R.B. Ebeling (Hillsdale, Mich.: Hillsdale College Press, 1991): pp. 367–75; J.R. Edwards, The Economist of the Country: Ludwig von Mises in the History of Monetary Thought (New York: Carlton Press, Inc. 1985); L. Robbins, Money, Trade and International Relations (London: Macmillan, [1952] 1971). In contrast to his analysis of the inflation adjustment process, which has gained substantial recognition, Mises’s innovative approach to expectations has garnered little if any attention, even from Austrian-oriented economists.

² Edwards, The Economist of the Country; T.J. Humphrey, “On the Nonneutral Relative Price Effects in Monetarist Thought,” Federal Reserve Bank of Richmond Economic Review 70 (May/June): pp. 13–19.

³ L.M. Lachmann (“From Mises to Schackle: An Essay on Austrian Economics and the Kaleidic Society,” Journal of Economic Literature 14 (March): p. 58) declares that “Mises hardly ever mentions expectations, though entrepreneurs and speculators often enough turn up in his pages. Thus from 1939 onward Schackle had to take on expectations more or less single-handedly, without much benefit of support from the Austrian side.”

⁴ R.M. Ebeling, “Expectations and Expectations Formation in Mises’s Theory of the Market Process,” Market Process 6 (Spring): pp. 12–18.

⁵ According to Ebeling (“Expectations and Expectations Formation,” p. 16), “Mises’s writings on monetary theory … [are] not integrated into his theory of expectations formation, not even in Human Action. His theory is incompletely developed and applied within his own system.” This misinterpretation aside, Ebeling’s article is a valuable overview of Mises’s influences and method in developing his theory of expectations.

⁶ Edwards, The Economist of the Country, p. 104.

⁷ It should be pointed out here that Murray N. Rothbard’s approach to expectations is implicitly Misesian. Thus the fact that Rothbard does not provide a formal explication of Mises’s approach to expectations does not mean Rothbard does not “take the problem of expectations formation seriously” as Ebeling (“Expectations and Expectations Formation,” p. 12) asserts. Ebeling’s implication is logically unwarranted and is easily shown to be in error, once we consider a few of the most notable doctrines expounded by Rothbard in Man, Economy, and State: A Treatise on Economic Principles, 2 vols. (Los angeles: Nash Publishing, [1962] 1970). In his analysis of the pricing process, Rothbard, like the great Austrian price theorists Böhm–Bawerk and Wicksteed, focuses on the determination of actual, moment–to–moment prices, whose determinants include the speculative reservation (“inventory”) demands of sellers. Rothbard also provides explicit and extended treatments of the influence of speculative anticipations on the formation of market supply and demand curves, of the inherently speculative cash-balance demand for money, and of the determination of the purchasing power component of the nominal interest rate. Finally, Rothbard recognizes the key role of the promoting, uncertainty-bearing, price-appraising capitalist-entrepreneur in driving the market process.

⁸ Ludwig von Mises, Notes and Recollections (South Holland, Ill.: Libertarian Press, 1978), p. 59.

⁹ Ibid.

¹⁰ Ibid., pp. 92–93.

¹¹ Ibid., p. 92.

¹² Ludwig von Mises, On the Manipulation of Money and Credit, Percy L. Greaves, ed., trans. B.B. Greaves (Dobbs Ferry, N.Y.: Free Market Books, 1978), p. 96.

¹³ Ludwig von Mises, The Theory of Money and Credit, 2nd ed. (Irvington-on-Hudson, N.Y.: The Foundation for Economic Education, [1952] 1971).

¹⁴ Ibid., pp. 144–45.

¹⁵ Mises, On the Manipulation of Money and Credit, p. 93.

¹⁶ Ludwig von Mises, Nation, State, and Economy: Contributions to the Politics and History of Our Time, trans. L.B. Yeager (New York: New York University Press, 1983), pp. 160–63.

¹⁷ Mises, On the Manipulation of Money and Credit, p. 95.

¹⁸ Ibid., p. 94.

¹⁹ Ludwig von Mises, Human Action: A Treatise on Economics, 3rd ed. (Chicago: Henry Regnery Company, 1966), pp. 425–26.

²⁰ Mises, On the Manipulation of Money and Credit, p. 97.

²¹ T.M. Humphrey, “On the Nonneutral Relative Price Effects in Monetarist Thought,” Federal Reserve Bank of Richmond Economic Review 70 (May/June): pp. 13–19; p. 13.

²² Ibid., p. 15.

²³ Ibid., p. 18.

²⁴ Ludwig von Mises, “Wages, Unemployment and Inflation,” in Planning for Freedom and Sixteen Other Essays and Addresses, 4th ed. (South Holland, Ill.: Libertarian Press, [1958] 1980), pp. 150–61.

²⁵ A.W. Phillips, “The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861–1957,” in Macroeconomic Readings, ed. J. Lindauer, pp. 107–19. (New York: The Free Press, [1958] 1968).

²⁶ Edwards, The Economist of the Country, p. 100.

²⁷ Ludwig von Mises, “Economic Aspects of the Pension Problem,” in Planning for Freedom and Sixteen Other Essays and Addresses, 4th ed. (South Holland, Ill.: Libertarian Press, [1950] 1980), pp. 83–93.

²⁸ Edwards, The Economist of the Country, p. 100.

²⁹ M. Friedman, “The Role of Monetary Policy,” in The Essence of Friedman, ed. K.R. Leube (Stanford, Calif.: Hoover Institution Press, [1968] 1987), p. 395. For a demonstration that the available historical evidence does not support the hypothesis that wages generally lag behind prices during inflation, see A.A. Alchian and R.A. Kessel, “The meaning and Validity of the Inflation–induced Lag of Wages behind Prices,” in Economic Forces at Work, ed. A.A. Alchian (Indianapolis, Ind.: Liberty Press, [1960] 1977), pp. 413–50.

³⁰ Mises, On the Manipulation of Money and Credit, pp. 120–21.

³¹ Ibid., pp. 121–22.

³² Ibid., p. 121

³³ Mises, Human Action, p. 549.

³⁴ Mises, “Wages, Unemployment, and Inflation,” p. 154.

³⁵ Friedman, “The Role of Monetary Policy,” p. 394.

³⁶ Mises, “Wages, Unemployment, and Inflation,” pp. 154–55.

³⁷ As I have argued elsewhere (Joseph T. Salerno, “Mises and Hayek Dehomogenized,” The Review of Austrian Economics 6 (2): pp. 113–46), contemporary Misesians differ sharply from contemporary Hayekians on this issue.

³⁸ Thus, Mises (The Ultimate Foundation of Economic Science: An Essay on Method, 2nd ed. [Kansas City: Sheed Andrews and McMeel, Inc., 1978], p. 65) described the market as “the essence of coordination of all elements of supply and demand.” For a treatment of this concept of moment-to-moment “price coordination” as the foundation of Austrian macro theorizing, see Salerno (“Coordination in Austrian Macroeconomics”). Also see the pathbreaking discussions by William H. Hutt (A Rehabilitation of Say’s Law (Athens: Ohio University Press, 1975); The Keynesian Episode: A Reassessment (Indianapolis, Ind.: Liberty Press, 1979), pp. 137–77). Hutt named and formalized the concept of “price coordination” and first elaborated its relevance to macroeconomic themes, although it had long been an essential part of classical and Austrian microeconomics. Joseph T. Salerno (“William H. Hutt”) provides a survey of Hutt’s contributions to economic theory.

³⁹ Haberler, Economic Growth & Stability, p. 105.

⁴⁰ For Haberler (ibid., pp. 101–02) both “demand-pull” and “cost-push” inflation “… are monetary in the important sense that they require monetary expansion.… [T]here has never, literally never as far as I know, been a case of sustained inflation without a rise in M.” For the continuing Austrian influences on and orientation of Haberler’s later work as an American academic, see Joseph T. Salerno (“Gottfried Haberler”). A similar explanation of the relationship between unions, unemployment, and inflation is offered by F.A. Hayek (“The Use of Knowledge in Society,” in Individualism and Economic Order (Chicago: Henry Regnery Company, [1945] 1972), pp. 53–97). The point of view that ascribes an important role to unions in promoting and conditioning the inflationary process has been described as “Haberlerian” by Friedman and “Pigovian/Hayekian/Haberlerian” by Lionel Robbins (Robbins, et al., Inflation: Causes, Consequences, Cures: Discourses on the Debate between the Monetary and Trade Union Interpretations [Levittown, N.Y.: Transatlantic Arts, Inc., 1974], p. 44). However both of these labels obscure Mises’s contributions referred to above and the fact that Mises (On the Manipulation of Money and Credit, pp. 173–203) outlined the argument as early as 1931 in a German-language publication addressing the causes of the unprecedented depth and persistence of the Great Depression. For evidence supporting the Austrian as opposed to the Friedmanite view of the influence of unions on unemployment, see R.K. Vedder and L.E. Gallaway, Out of Work: Unemployment and Government in Twentieth-Century America (New York: Holmes & Meier, 1993).

⁴¹ Haberler, Economic Growth & Stability, p. 106.

⁴² Ludwig von Mises, Theory and History: An Interpretation of Social and Economic Evolution (Auburn, Ala.: Ludwig von Mises Institute, [1957] 1985), pp. 76–81.

⁴³ Ibid., pp. 87–81.

⁴⁴ Mises, Human Action, pp. 376–77. An illuminating discussion of the “restrictionist pricing of labor” can be found in Rothbard (Man, Economy, and State, vol. 2, pp. 620–29).

⁴⁵ Dan E. Birch, Alan A. Rabin, and Leland B. Yeager, “Inflation, Output, and Employment: Some Clarifications,” Economic Inquiry 20 (April): pp. 209–21.

⁴⁶ Hutt’s analysis of cost-push or wage-push inflation can be found in W.H. Hutt, The Strike-Threat System: The Economic Consequences of Collective Bargaining (New Rochelle, N.Y.: Arlington House, 1973), pp. 252–70.

⁴⁷ Ibid., pp. 213–14. Hutt appears to have developed his own position on this issue independently of the direct influence of Mises and the Austrians, having been heavily influenced during his formative years as an economist in the 1920s and 1930s by his teacher Edwin Cannan and other economists at the London School of Economics. The LSE economists stressed the coordinative functioning of the market process as the solution to the persistence of depressionary levels of resource unemployment and aggregate real output. See Joseph T. Salerno, Reply to Leland Yeager on “Mises and Hayek on Calculation and Knowledge,” The Review of Austrian Economics 7 (2): pp. 111–25.

⁴⁸ Hutt, A Rehabilitation of Say’s Law, p. 64.

⁴⁹ Hutt, The Keynesian Episode, p. 284.

⁵⁰ Edwards, The Economist of the Country, p. 100.

⁵¹ For Hick’s analysis of the concept of elasticity of expectations, see J.R. Hicks, Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory, 2nd ed. (New York: Oxford University Press, [1946] 1968), pp. 206–40.

⁵² Ludwig von Mises, “The Great German Inflation,” in Money, Method, and the Market Process, ed. R.M. Ebeling (Norwell, Mass.: Kluwer Academic Publishers, [1932] 1990), p. 102–03.

⁵³ Edwards, The Economist of the Country, p. 104.

⁵⁴ Mises, Foundation of Economic Science, p. 51.

⁵⁵ Mises, Theory and History, p. 271.

⁵⁶ Ibid., p. 310.

⁵⁷ Ibid., pp. 264–65.

⁵⁸ Ibid., p. 265.

⁵⁹ Ibid., pp. 272, 266.

⁶⁰ Mises, Human Action, pp. 56–57.

⁶¹ Mises, Theory and History, p. 314.

⁶² Ibid, p. 320.

⁶³ Mises, Human Action, pp. 65–66.

⁶⁴ D.K.H. Begg, The Rational Expectations Approach in Macroeconomics: Theories and Evidence (Baltimore: The Johns Hopkins University Press, 1982), p. 30.

⁶⁵ Mises, Human Action, p. 255.

⁶⁶ Mises, Ultimate Foundation of Economic Science, p. 49.

⁶⁷ Mises, Theory and History, p. 265.

⁶⁸ Lachmann, “From Mises to Schackle,” p. 129.

⁶⁹ Ibid., p. 130.

⁷⁰ A.W. Marget, The Theory of Prices: A Re-Examination of the Central Problem of Monetary Theory, 2 vols. (New York: Augustus M. Kelley, [1938–42] 1966), pp. 228–30, 238 fn. 34, 456.

⁷¹ L.M. Lachmann, The Meaning of the Market Process (New York: Basil Blackwell Inc., 1986), p. 29.

⁷² Ibid.

⁷³ Hans-Hermann Hoppe, (Praxeology and Economic Science (Auburn, Ala.: Ludwig von Mises Institute, 1988), p. 48 fn. 37) uncovers the logical error in Lachmann’s oft repeated asseveration that the “future is unknowable,” particularly future states of knowledge and actions.

⁷⁴ Mises, Theory and History, p. 311.

⁷⁵ In this particular respect, Mises’s theory of risk and uncertainty resembles Keynes’s. For a discussion of this aspect of Keynes’s theory, see Joseph T. Salerno, “The Development of Keynes’s Economics: From Marshall to Millennialism,” The Review of Austrian Economics 6 (1): pp. 9–10, 46–47.

⁷⁶ Israel M. Kirzner, Competition and Entrepreneurship (Chicago: The University of Chicago Press, 1973), idem, Perception, Opportunity, and Profit: Studies in the Theory of Entrepreneurship (Chicago: University of Chicago Press, 1979).

⁷⁷ Various aspects of this controversy are critically reviewed in Joseph T. Salerno (“Ludwig von Mises as Social Rationalist,” The Review of Austrian Economics 4: pp. 26–54) and Salerno (“Mises and Hayek Dehomogenized,” The Review of Austrian Economics 6 (2): pp. 113–46).

⁷⁸ L.v. Mises, Theory and History: An Interpretation of Social and Economic Evolution (Auburn, Ala.: Ludwig von Mises Institute, [1957] 1985), pp. 315–20; Human Action, pp. 59–64.

⁷⁹ This contrasts with Kirzner’s view that “alertness” or the ability to notice or “discover” those changes in one’s environment that promise to redound to one’s benefit is a propensity inherent in human action and constitutes the essence of purposeful behavior (Kirzner, Perception, pp. 13–33). For a critique of Kirzner’s view from a Misesian standpoint, see Salerno, “Mises and Hayek.”

⁸⁰ Mises, Human Action, p. 66.

⁸¹ Hayek, “Economics and Knowledge.”

⁸² Ibid., pp. 47–48.

⁸³ F.A. Hayek, “The Use of Knowledge in Society,” in Individualism and Economic Order (Chicago: Henry Regnery Company, [1945] 1972), pp. 77–91.

⁸⁴ Whether this mental construct can be called an “ideal type” is another question; Hayek himself refrained from using the term in this later article.

⁸⁵ F.A. Hayek, Denationalisation of Money—The Argument Refined: An Analysis of the Theory, and Practice of Concurrent Currencies, 2nd ed. (London: The Institute of Economic Affairs, 1978), p. 82.

⁸⁶ On Hayek’s notion of “proximal equilibrium” and its inconsistency with Mises’s theory of entrepreneurship and appraisement, see Salerno (“Mises and Hayek”) and Salerno (Reply to Leland Yeager on “Mises and Hayek on Calculation and Knowledge,” The Review of Austrian Economics 7, no. 2 (1994): pp. 111–25).

⁸⁷ Mises, “The Great German Inflation.”

⁸⁸ Ibid., pp. 101–02.

⁸⁹ Mises, “The Great German Inflation,” p. 100.

⁹⁰ Mises, Human Action, p. 545.

⁹¹ Mises, On the Manipulation of Money and Credit, p. 20.

⁹² Mises, Human Action, pp. 427–28.

⁹³ Mises, “The Great German Inflation,” p. 102.

⁹⁴ Mises, On the Manipulation of Money and Credit, pp. 132–36.

⁹⁵ Mises, Human Action, p. 578.

⁹⁶ Mises, On the Manipulation of Money and Credit, p. 136.

⁹⁷ Ibid., pp. 138, 146.

⁹⁸ Ludwig von Mises, “‘Elastic Expectations’ and the Austrian Theory of the Trade Cycle,” Economica 10 (August): pp. 251–52.

⁹⁹ Ibid., p. 252.

¹⁰⁰ Mises, Human Action, p. 797.

¹⁰¹ Ibid., p. 798.

¹⁰² Hutt, The Keynesian Episode, p. 285.

¹⁰³ Salerno, “Commentary: The Concept of Coordination in Austrian Macroeconomics.”

¹⁰⁴ For a recent attempt at a thoroughgoing dehomogenization of the Misesian and Hayekian/Kirznerian paradigms see Salerno, “Mises and Hayek.”