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The view from Vienna: An analysis of the renewed interest in the Mises-Hayek theory of the business cycle

Abstract

We review the post-crisis literature that engages Austrian business cycle theory and we discuss what is being said that is correct, what is being said that is incorrect, and what is not being said that ought to be said. This last category is important due to the fact that the post-crisis literature engaging Austrian business cycle theory has not addressed advances in the theory made since the days of Mises and Hayek. We also highlight three key areas of contemporary economics where Austrian business cycle theory has the potential to do significant work.

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Notes

  1. 1.

    Other papers that refer to the ABCT are Lal (2010); Oppers (2002) and W. R. White (2009).

  2. 2.

    For a closer evaluation of DSGE and Hayek’s theories, see L. H. White (forthcoming).

  3. 3.

    It is probably no accident that Borio and Disyatat use the word “paradigm” to refer to “Austrian” and “non-Austrian” economics. On this topic see Caldwell (2013); Kohn (2004) and Zanotti and Cachanosky (2015).

  4. 4.

    Other Austrian-friendly themes stressed by the authors include the dangers associated with attempts to stem off the inevitable bust-recalculation period by further easing money creation (Hume and Sentance 2009, p. 1449) and the importance of institutions in defining incentives that shape agent behavior, and hence macroeconomic outcomes (p. 1452).

  5. 5.

    Interestingly, Diamond and Rajan (2009a, pp. 1–2) also discuss the possibility of a positive shock to future wealth, which also incentives additional current consumption due to the equation of marginal utility from consumption across the life cycle. This bears some resemblance to modifications made to ABCT by Garrison (2001), but Diamond and Rajan do not discuss this particular link.

  6. 6.

    Callahan and Garrison (2003) ask if the ABCT can contribute to explain the dot-com bubble. These references goes unmentioned in Diamond and Rajan’s paper.

  7. 7.

    See also W. R. White (2013).

  8. 8.

    Taylor’s implicit endorsement of artificially-low interest rates as contributing to unsustainable investment cycles as “classic” seems to be an overstatement. This seems to imply that such an explanation is, if not accepted orthodoxy, a part of the mainstream economic narrative. However, the influence in Friedman (1964, 1993) in dismissing the artificial boom-inevitable bust story might be too strong to refer as “classic” the excess of credit explanation. If this were a “classic” explanation, why the sudden renewed interest in the ABCT?

  9. 9.

    In this way ABCT foresaw the “signal extraction” problem of Lucas (1972).

  10. 10.

    Larger booms are associated with larger busts, all else being equal, in the sense that more malinvestments made during the boom requires more malinvestments to be liquidated during the bust. But whithout specifying additional institutional details, e.g., the ease of resource reallocation via the entrepreneurial market process following the bust, we cannot make any stronger claims.

  11. 11.

    The problem of sheer ignorance, namely, not knowing what is unknown, is also emphasized in some strands of ABCT. These “unknown unknowns” cannot be subject to a rational price calculation because of its radical character. However, to not know what is unknown is not irrational, but arational (Evans and Friedman 2011; Garrison 1986). This arational presence in all economic agent behavior can explain why they may not behave as strict rationality predicts but at the same time such behavior is not irrational.

  12. 12.

    For recent “Austrian” literature dealing with the problem of rational expecations see Cachanosky (2015); Callahan and Horwitz (2010); Carilli and Dempster (2001) and Evans and Baxendale (2008).

  13. 13.

    For empirical studies see Bismans and Mougeot (2009); Cachanosky (2014b); Carilli and Dempster (2008); Hoffmann (2010); Keeler (2001); Lester and Wolff (2013); Luther and Cohen (2014); Mulligan (2002, 2005, 2006, 2013); Murphy et al. (2009); Ravier and Lewin (2012); and Young (2012).

  14. 14.

    A fourth member of Garrison’s model, usually set aside for simplification purposes, is the “consumer triangle” which differentiates between more and less durable goods. A house, for instance, has a larger “consumer triangle” than dinner a restaurant.

  15. 15.

    For a review of other monetary business cycle theories that evolved contemporaneously to the ABCT see Haberler (1937). Mises (1943, p. 252) saw the ABCT as contintation of credit-cycle theories: “I wish, however, to stress one more point. Why call this monetary or credit expansion theory of the trade cycle the “Austrian” or the “Austro-Wicksellian” theory? Of course, I am very grateful for the honour paid in this way to me and to my country. But why forget that his theory is a continuation, perfection and generalisation of the Currency theory? Neither Wicksell nor I myself nor Professor Hayek have ever forgotten to emphasise this point.”

  16. 16.

    For a review on the effects of the New Deal see Anderson (1949); Reed (1981) and Rothbard (1963).

  17. 17.

    There is a crucial difference between an assumption that simplifies the economic problem under study and an assumption that changes or eliminates the problem being studied.

  18. 18.

    Even though the graphical exposition of stages of production is mentioned in contemporary work as the “Hayekian triangle,” it was first proposed by Jevons (1871, pp. 229–236).

  19. 19.

    The fact that longer and more capital intensive projects are more sensitive to changes in the discount rate is a well-established financial principle. A theory that depicts the effects of monetary policy on the present value of the cash-flow of potential investments is not working with a model that describes an “as if” economy, but a theory that works on how investment decisions are actually made in the market. To reject the insights of ABCT is to reject the relationship between discount rates and present value of cash-flows as described by the modified duration.

  20. 20.

    This is a response to Hummel (1979), who argues that under fiat currencies a central banks does not need to stop an expansionary policy as described by the ABCT.

  21. 21.

    For a discussion in monetary non-neutrality in the long run see Ravier (2010b).

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Cachanosky, N., Salter, A.W. The view from Vienna: An analysis of the renewed interest in the Mises-Hayek theory of the business cycle. Rev Austrian Econ 30, 169–192 (2017). https://doi.org/10.1007/s11138-016-0340-5

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Keywords

  • 2008 crisis
  • Subprime crisis
  • Austrian business cycle theory
  • Jel Codes
  • B53
  • E32
  • E52