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Expectation in Austrian business cycle theory: Market share matters

The Review of Austrian Economics volume 28, pages 151–165 (2015)Cite this article

Abstract

One of the most important objections to the Mises-Hayek business cycle theory is the rational expectations critique. The debate between supporters and critics of the Mises-Hayek theory has not paid sufficient attention to the problem of differences in expectations and the market share in the allocation of production factors. I represent financially the effects that occur under the Austrian business cycle theory in the market of production factors as well as how economic imbalances occur when a central bank follows an expansionary policy and entrepreneurs have different expectations.

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Notes

  1. On EVA®, see Stern, Shiely and Ross (2001), Stewart III (1991) and Young and O’Byrne (2001). EVA® is a rearrangement of the free-cash-flow (FCF). EVA® is a registered trademark of Stern Stewart & Co.

  2. For a more detailed discussion of the Mises-Hayek business cycle theory, see Ebeling (1978), Garrison (2001), Hayek (1931, 1933) and von Mises (1949).

  3. For others critics, see Friedman (1993), Hummel (1979) and Yeager (1986). Replies to these criticisms can be found in the references mentioned in this article and in Garrison (1996). The problem of expectations was already discussed by Lachmann (1943) and von Mises (1943).

  4. See Buchanan (1964), Caldwell (1984), Kirzner (1965), Kohn (2004), Kuhn (1962) and Zanotti and N. Cachanosky (2013).

  5. Callahan and Horwitz (2010, p. 212).

  6. See Butos (1997), Garrison (1986, 2001, chapter 1) and Lachmann (1977).

  7. See also Caballero (2010, p. 91). “Rational expectations is a central ingredient of the current core [DSGE] [of macroeconomics]; however, this assumption becomes increasingly untenable as we continue to add the realism of the periphery [real world] into the core. While it often makes sense to assume rational expectations for a limited application to isolate a particular mechanism that is distinct from the role of expectations formation, this assumption no longer makes sense once we assemble the whole model. Agents could be fully rational with respect to their local environment and everyday activities, but they are most probably nearly clueless with respect to the statistics about which current macroeconomic models expect them to have full infomration and rational information.”

    It might be argued that economic agents do not know the correct model of the world but that they act as if they do. Probably for most Austrians this view assumes the answer to the problem that needs to be explained. For a discussion on rational expectations, see McAuliff (1985) and Sargent (2008). For a review of macroeconomics after the introduction of rational expectations, see McCallum (1982).

  8. Wagner (1999, p. 71) seems to consider that the canonical version of the ABCT does not assume rationality in the entrepeneurs when he asserts that “Austrian cycle theory can well incorporate rationality in expectations, indeed, must to do so.”

  9. However, the Mises-Hayek business cycle theory is not the only theory that presents challenges to rational expectations. See Eusepi and Preston (2011) and Fuster et al. (2010).

  10. This assumption also means that the ABCT is valid if the central bank’s monetary policy affects the discount rate of the economic projects used in the market.

  11. The following remarks by von Mises (1912, pp. 399–400) seem to capture this effect: “Now if the rate of interest on loans is artificially reduced below the natural rate as established by the free play of the forces operating in the market, then entrepreneurs are enabled and obliged to enter upon longer processes of production. […] a reduction of the rate of interest on loans must necessarily lead to a lengthening of the average period of production.”

  12. In the Buck Hill Falls Seminar, 1955, Mises offered a similar argumentation: “It is very difficult for a businessman not to be fooled, let us say, when easy money is being offered. When a policy of easy money is being practiced, everybody is optimistic. Business is booming. Now, it is very difficult under such circumstances for a businessman to say: ‘There is something questionable in the whole thing; this boom is only produced by the printing press.’ It is very difficult. And even if the businessman is very clever, clever enough to understand what is going on, he may say, ‘Why should I remain outside? I will also participate in the boom. Of course, I will try to withdraw in time” (von Mises 1955, pp. 83–84, emphasis added).

  13. I borrow the jigsaw puzzle example from Horwitz (2011).

  14. See O’Driscoll and Rizzo (1985, p. 222).

  15. See Bernanke and Gertler (1989, 1990), Bernanke, Gertler and Gilchrist (1996, 1999), Kamber and Thoenissen (2011) and Ćorić (2011).

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  1. Department of Economics, Metropolitan State University of Denver, Campus Box 77, P.O. Box 173362, Denver, CO, 80217, USA

    Nicolas Cachanosky

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Cachanosky, N. Expectation in Austrian business cycle theory: Market share matters. Rev Austrian Econ 28, 151–165 (2015). https://doi.org/10.1007/s11138-014-0267-7

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Keywords

  • Austrian business cycle theory
  • Rational expectations
  • Market share
  • EVA(R)
  • Economic value added