Mises’s Three Concepts of Equilibrium

Equilibrium can be a tricky subject, as different economists have different definitions of the concept. Mises employs 3 different concepts, as follows:

“[sc. Mises] posits not one, but three notions of equilibrium that he claims underlie his analysis. The first, the ‘plain state of rest,’ is a temporary state in which all currently desired transactions have been made and, for the moment, no one wants to trade. His example of such a state is the close of the trading day in the stock market ....

The second equilibrium notion Mises employs is the “final state of rest,” the state toward which the market tends if there is no change in the data. This apparently is Mises’ analogue to general equilibrium. Whereas the plan state of rest is a phenomenon that is routinely found in markets, the final state of rest is an “imaginary construction” in that it can never be achieved in reality, although it is a necessary analytic tool for understanding the direction of price changes.

Finally, Mises posits yet a third equilibrium notion, the “evenly rotating economy,” or the “ERE.” This, too, is an imaginary construction of what the market would be like if there were no changes in the data. In this construction, however, people continue to be born, to live and to die, and capital is accumulated at a rate just sufficient to maintain current patterns of consumption and investment. It is a condition in which the same products are consumed and produced over and over again, and all prices equal the prices established in the final state of rest .... Whereas the first two notions have their analogues in contemporary economics, the ERE seems to be unique to Mises.” (Vaughn 1994: 81–82).

Mises describes the nature of money in the ERE:

“Then there is a second deficiency. In the imaginary construction of an evenly rotating economy, indirect exchange and the use of money are tacitly implied. But what kind of money can that be? In a system without change in which there is no uncertainty whatever about the future, nobody needs to hold cash. Every individual knows precisely what amount of money he will need at any future date. He is therefore in a position to lend all the funds he receives in such a way that the loans fall due on the date he will need them. Let us assume that there is only gold money and only one central bank. With the successive progress toward the state of an evenly rotating economy all individuals and firms restrict step by step their holding of cash and the quantities of gold thus released flow into nonmonetary—industrial—employment. When the equilibrium of the evenly rotating economy is finally reached, there are no more cash holdings; no more gold is used for monetary purposes. The individuals and firms own claims against the central bank, the maturity of each part of which precisely corresponds to the amount they will need on the respective dates for the settlement of their obligations. The central bank does not need any reserves as the total sum of the daily payments of its customers exactly equals the total sum of withdrawals. All transactions can in fact be effected through transfer in the bank’s books without any recourse to cash. Thus the ‘money’ of this system is not a medium of exchange; it is not money at all; it is merely a numeraire, an etheral and undetermined unit of accounting of that vague and indefinable character which the fancy of some economists and the errors of many laymen mistakenly have attributed to money. The interposition of these numerical expressions between seller and buyer does not affect the essence of the sales; it is neutral with regard to the people’s economic activities. But the notion of a neutral money is unrealizable and inconceivable in itself. If we were to use the inexpedient terminology employed in many contemporary economic writings, we would have to say: Money is necessarily a ‘dynamic factor’; there is no room left for money in a ‘static’ system. But the very notion of a market economy without money is self-contradictory.” (Mises 1996: 249)

The ERE was not used by Hayek as his equilibrium model in Prices and Production, although there are of course similarities (and the ERE does appear in later Hayekian versions of ABCT). I do not think Wicksell’s model in his monetary equilibrium theory is an ERE either (if readers think I am wrong, I would like to hear why).

Hayek makes it clear in Prices and Production that he working in the general equilibrium tradition, which would be Mises’s “final state of rest”:

“it is my conviction that if we want to explain economic phenomena at all, we have no means available but to build on the foundations given by the concept of a tendency toward an equilibrium. For it is this concept alone which permits us to explain fundamental phenomena like the determination of prices or incomes, an understanding of which is essential to any explanation of fluctuation of production. If we are to proceed systematically, therefore, we must start with a situation which is already sufficiently explained by the general body of economic theory. And the only situation which satisfies this criterion is the situation in which all available resources are employed.” (Hayek 2008: 225).

Wicksell had already used Walras’ theory of general equilibrium and combined it with Bohm Bawerk’s theory of interest, to try and establish the conditions of monetary equilibrium (Loasby 1998: 54). Hayek developed an intertemporal equilibrium theory in 1928 in his paper “Intertemporal Price Equilibrium and Movement in the Value of Money” (Hayek 1984 [1928]), but did not use this in Prices and Production. Instead, “he reverted to the stationary equilibrium approach, by adopting the simple stationary-equilibrium model put forward by Wicksell in Interest and Money as the starting point for his analysis” (Donzelli 1993: 57). This was a stationary equilibrium model:

“Wicksell’s theory of monetary equilibrium, whose influence was to be crucial, was built on the foundations of his critique of the Quantity Theory. He effectively believed that the velocity of circulation of money proper was unstable since, under certain institutional conditions, it is possible to reduce the use of money through control of credit and thus to affect its velocity of circulation. The demand for credit of the banking system is governed by the difference between two rates: the supply price of bank credit, or money rate of interest, and a rate which Wicksell defined first as a ‘natural rate’, which would equalise savings and investment in an economy without money, and then as a ‘normal’ rate: the equilibrium interest rate on loanable funds in a monetary economy …. Hayek retained the idea of a disparity between these rates as a driving force behind the processes of expansion and contraction, as well as the role of credit in allowing a demand for produced and non-produced investment goods in excess of voluntary savings. Demand is then pushed above the value of goods supplied, leading to increased prices and a rationing of consumers – a forced saving. Equality of these interest rates represents monetary equilibrium.” (Hénin 1986: 39)

BIBLIOGRAPHY

Donzelli, F. 1993. “The Influence of the Socialist Calculation Debate on Hayek’s view of general equilibrium theory,” Revue Européenne des Sciences 31.96.3: 47–83.

Hayek, F. A. 1984 [1928]. “Intertemporal Price Equilibrium and Movement in the Value of Money,” in R. McCloughry (ed.), Money, Capital and Fluctuations. Early Essays, Routledge & Kegan Paul, London.

Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala.

Hénin, P.-Y. 1986. Macrodynamics: Fluctuations and Growth: A Study of the Economy in Equilibrium and Disequilibrium, Routledge & Kegan Paul, London.

Loasby, B. J. 1998. “Co-ordination Failure: Economic Theory in the 1930s,” in P. Fontaine and A. Jolink (eds), Historical Perspectives on Macroeconomics: Sixty Years After the General Theory, Routledge, London. 53–64.

Mises, L. 1996. Human Action: A Treatise on Economics (4th revised edn), Mises Institute, Auburn, Ala.

Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition, Cambridge University Press, Cambridge and New York.