The Dynamics of the Interest Rate in the Austrian Business Cycle Theory

Abstract

This study investigates the behaviour of the interest rate over the business cycle that is predicted by the Austrian theory of economic fluctuations. The first part briefly introduces the Austrian approach and develops some of its basic tools. The second part focuses on the gap between the market rate of interest and the natural rate. The sources and consequences of this gap are studied in detail. Much emphasis is put on processes that eventually bring about a closure of this gap. Monetary policy is then identified as the main creator of this gap. Subsequent parts of the paper investigate limits of its power to keep this gap opened. The following sections find additional reasons why the market interest rate may deviate from its natural counterpart. The last section discusses the influence of the monetary policy on the natural rate itself and concludes with recommendations of great caution the central bank should follow in conducting the monetary policy.