Capital, monetary calculation, and the trade cycle: The importance of sound money

Abstract

As pointed out by Professor Kirzner (2001, pp. 137 and 140), Mises did not start out with the intent to develop a theory of the trade cycle. The trade cycle argument first appeared in the last few pages of the Theory of Money and Credit (1912). This early development of Austrian business cycle theory was a direct manifestation of Mises’s rejection of the concept of neutral money and “emerged as an almost incidental by-product of his exploration of the theory of banking” (Kirzner 2001, p. 140). This development was an incomplete sketch of the theory, particularly for those not well versed in the capital theoretical foundations of the argument. In fact, Hayek’s first exposition of his version of the theory appears in a long footnote in his 1925 paper “Monetary Policy in the United States after the Recovery From the Crisis of 1920.” The note was added following a suggestion from Gottfried Haberler. Hayek (1999, pp. 105–06 n.) explained that since “no sufficient exposition of the theory I had used was to be found in Mises’s published works and if I was to expect to be understood, I must give a fuller account of the theory underlying my reports of the events described.” The Austrian theory of the business or trade cycle is an intricate blend of monetary theory and capital theory. Mises’s (and Hayek’s) monetary and capital theories differ in both significant and subtle ways from the neoclassical approach. Economists working in the Misesean tradition are still plagued by problems of communication with non-Austrian economists. While the terminology used is similar in both theories, the definition of key terms, the understanding of the nature of the economic problem, and the role of prices, especially prices for the means of production, differ considerably.