Macroeconomics
Wicksell’s theory of inflation has inspired the development of modern macroeconomics in many ways. Coordination failures of the interest-rate mechanism were at the centre of macroeconomic thinking in the 1920s and 1930s, and most of the more prominent approaches that discussed intertemporal disequilibrium can be described as having a Wicksell connection (Leijonhufvud 1981).
In view of the macroeconomic instabilities of the inter-war period - with its waves of inflation and deflation, and finally the Great Depression - it was quite natural to use Wicksell’s theory of cumulative processes for explanations of cycles and crises. The Austrians Ludwig von Mises and Friedrich A. Hayek did it, and so did - with a fundamentally different approach - Erik Lindahl, Gunnar Myrdal, Bertil Ohlin and other members of the Stockholm School. In his General Theory of Money, Interest and Employment (1936), John Maynard Keynes chose the opposite version of Wicksell’s cumulative process: he emphasized that, even in free competition with flexible prices, changes in quantities may happen before price changes, and that they may even prevent the latter. He considered the price level to remain more or less constant, while reductions of effective demand lead to lower real output and underemployment in multiplier processes. Wicksell had delivered the methodical key for Keynes’s proposition that market forces will not always tend to produce full employment.However, Wicksell’s ideas can also be found in monetarist and New Classical macroeconomics that firmly oppose the Keynesian approach. Milton Friedman (1968) coined the term “natural rate of unemployment" with reference to Wicksell’s natural rate of interest, in order to postulate the automatic restoration of labour market equilibrium once people learn to adapt to inflation. It is doubtful, though, that Wicksell would have consented to Friedman’s transfer of notions, as he had a rather different view of unemployment (Boianovsky and Trautwein 2003).
Modern macroeconomics has in recent years reached a consensus view that is generally described as the “New Neoclassical Synthesis”. The core contribution to this view, Michael Woodford’s Interest and Prices (2003), has the title in common with Wicksell’s 1898 treatise. Moreover, its combination of New Classical and New Keynesian elements is described as “the neo-Wicksellian model”. It is a framework in which deviations of actual output from potential output are caused by discrepancies between the interest rates that are set by the central bank and the natural rate of interest. The discrepancies can be eliminated by feedback rules (such as a Taylor rule) that bear resemblance to Wicksell’s rule for monetary policy. However, the new synthesis proceeds from the basic assumption that the system is continuously in intertemporal equilibrium, essentially determined by the rate of time preference. Wicksell would hardly have approved of this turn away from his focus on imbalances of investment and saving plans. There are good reasons to assume that the creative potential of Wicksell’s ideas has not been exhausted yet.
Hans-Michael Trautwein
See also:
Eugen von Bohm-Bawerk (I); James M. Buchanan (I); Capital theory (III); Income distribution (III); Erik Lindahl (I); Thomas Robert Malthus (I); Ludwig Heinrich von Mises (I); Money and banking (III); Richard Abel Musgrave (I); Public economics (III); David Ricardo (I); Stockholm (Swedish) School (II); Marie-Esprit-Leon Walras (I).