Boom-Bust Cycles Validate Austrian Economics
Submitted by QTR's Fringe Finance
By Frank Shostak, Mises Institute
Since the introduction in 1912 of Ludwig von Mises’s Austrian business cycle theory (ABCT) in his book The Theory of Money and Credit, it has been subject to relentless criticism. According to the ABCT, the artificial lowering of interest rates by the central bank via inflationary credit expansion leads to a misallocation of resources on account of the fact that businesses undertake various capital projects that, prior to the lowering of interest rates, weren’t considered profitable. This misallocation of resources is commonly described as an economic boom. The process, however, is brought to a halt once businessmen discover that the lowering of interest rates is not in accordance with consumers’ time preferences.
As a rule, businessmen discover their error once the central bank—instrumental in the artificial lowering of interest rates via artificial credit expansion—reverses. This, in turn, halts the expansion and an economic bust ensues. It follows, then, that the artificial lowering of interest rates by the central bank sets a trap for businessmen by luring them into unsustainable business activities that are revealed once the central bank tightens its interest rate stance.
Critics of the ABCT maintain that there is no justification for the view that businessmen should fall prey again and again to the central bank’s activities. Businessmen are likely to learn from experience, the critics argue, and not repeatedly fall into the trap produced by the central bank lowering of interest rates. Consequently, correct expectations will undo or neutralize the whole process of the boom-bust cycle that is set in motion by the lowering of interest rates. Hence, it is held that the ABCT is not a serious contender in the explanation of modern business cycle phenomena. According to Gordon Tullock,
One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.
According to the critics then, if one allows for the possibility of expectations, this could prevent boom-bust cycles. This way of thinking would be valid if the issue would have been only the lowering and lifting of interest rates. There is no doubt that businessmen would have quickly learned to disregard the ups and downs in interest rates and would have utilized some long-term average of interest rates in their investment decision process.
On the other hand, ABCT is not just about variations in interest rates, but about variations in the monetary policy of the central bank, which amounts also to changes in the money supply growth rate. The inflationary increase in the money supply through the expansionary monetary policy of the central bank sets the platform for the exchanges of nothing for something. This sets in motion the diversion of resources from...(READ THIS FULL ARTICLE, 100% FREE, HERE).