Austrian Business Cycle Theory Research Articles

On the Ethics of Fair Value Accounting: Distributive Effects, Distributive Injustice, and Implications for Social Peace

Fair value accounting is at the heart of arguably the world’s most prominent accounting standards, particularly US GAAP and IFRS. Fair value measurement has been the subject of intense debate. Among other things, it has been analyzed from an ethical perspective. However, this discussion has mainly been limited to the judgment involved in fair value measurement and the ethics of fair value in its ability to provide decision-useful information to interested parties. This study pushes the boundaries by adding a new dimension to the discussion of the ethics of fair value accounting by examining its ethics from a more systemic and societal perspective. Drawing on Austrian business cycle theory, it argues that fair value accounting facilitates certain distributive effects in inflationary monetary environments, thereby contributing to distributive injustice and potentially to social discord. In this respect, fair value accounting—in contrast to historical cost accounting—should not be considered fair or just, but unethical instead.

The central banking system paradox

The conventions of monetary theory assume the central banking system (CBS) as the starting point for achieving the stability and efficiency of the financial system. This paper stresses the stability-efficiency thesis based on the Austrian business cycle theory (ABCT). It argues that the stability-efficiency thesis under CBS poses a paradox for two main reasons. First, central banks' interest rate handling causes business cycles, yielding the intertemporal discoordination of the money and goods markets. Second, a central bank's lender-of-last-resort role is an incentive to call for further interest rate handling, making the chance of smooth business cycles difficult or impossible. This paradox is empirically analyzed and discussed through the True Money Supply (TMS) performance in the United States's business cycle phases between 1975 and 2022. Consistent with the ABCT, the research results unlock the paradox by showing that CBS causes business cycles. Some policy implications are outlined for further research and revision of monetary theory.

Post-Pandemic Business Cycle in Poland and in the United States in the Light of the Austrian Business Cycle Theory

Abstract The purpose of the article is to examine the post-pandemic business cycle in Poland and in the United States in the light of the Austrian business cycle theory. The study shows that this theory satisfactorily explains the post-pandemic business cycle. Moreover, it seems that the Austrian business cycle theory explains some important facts better than competing theories of business cycle. The analysis also indicates that the post-pandemic business cycle differs significantly in many respects from previous business cycles – and that these differences could be explained within the framework of the Austrian business cycle theory.

Austrian vs Post Keynesian explanations of the business cycle: an empirical examination

Neoclassical economists posted many mea culpas after they completely missed the Financial Crisis of 2008. Some heterodox schools of thought, however, claimed to have seen it coming. Among these were the Austrians and Post Keynesians. There was a surge in references to Austrian Business Cycle Theory in both the scholarly and popular press, while Post Keynesians like Steve Keen took to the blogosphere to warn people of the coming crash. One is led to wonder, however, if both can truly lay a legitimate claim to such accurate precognition when their theoretical underpinnings are so radically different? Can it be that deviations of the actual from the “natural” rate of interest were to blame at the same time that Keynes/Kalecki-style boom-bust cycles were emerging? To answer this question, an empirical test is run comparing the explanatory power of models based on each theory. Rather than limit this to just the period around the Financial Crisis, the test covers 1962 through 2020. The overall results are then compared, as well as the fit just leading up to and through the recession of 2008Q1 to 2009Q2. The results suggest that the Post Keynesians have a considerably stronger case than the Austrians.

오스트리아학파 경기순환론에 대한 공공선택학파의 대응

Since Mises’ advocacy and Hayek’s refinement, ABCT(Austrian Business Cycle Theory) has been well formulated and showed valid explanation on actual economic business cycles as well. This article reveals how Public Choice responded to ABCT and how they developed its own ideas on business cycle. Gordon Tullock criticized Rothbardian sense of ABCT, followed by severe response from Sallerno. Some essential points on this argument were extracted to compare the basic difference of Tullock and Rothbard. ABCT activates business cycle when gov’t(central bank) ‘artificially’ lower the interest rate. Public Choice theorists focus on ‘why’ they do that. For ABCT, whether or not they have good intention is not important. PBCT, however, more emphasize that was done for the selfish political interests that politicians or bureaucrats have in political context. Austrians suggested new meaning to ‘bust’ phase of economic cycle, which under neo-classcical economics school long have been ignored as ‘bad’ event. ABCT assumes two key concepts; heterogeneity of capital, and mal-investment. PBCT is unfamiliar to those. So PBCT frequently does not identify the difference between over-investment and mal-investment, and assumes homogeneity of capital. It’s because Public Choice stands on neo-classical economics, not Austrian sense of economics. Then, four political business cycle theory(PBCT) models were reviewed: Opportunistic, Partisan, Rational Opportunistic, and Rational Partisan model. Austrians focusing on market process met Public Choice Theorists focusing political market met on the theme of business cycle. ABCT shows how ‘visible hand’ gives impact on market economy, and PBCT shows what impact business cycle has to political market. Each mutually gives sound tension, plus contributes to complementary explanation on overall business cycle.

Yield curve as forward indicator of recession: Austrian economics insights

This is a heterodox review on macroeconomics according to the Austrian Economics. The Austrian business cycle theory explains the origin of boom-bust cycles based on the difference between natural interest rates and banking rates, which comes from the artificial processes of monetary and credit expansion. This difference is the yield curve, an instrument to detect the deviation of monetary policies, and a forward indicator of business cycles. This article studies the impact of yield curve slope on the requirements for access to bank credit, and the distorting effect of expansionary monetary policies on the capital structure. In an environment of artificially low interest rates, these distortions become an accumulation of long-term failed investments that markets cannot assume, with the consequent readjustment or recession. To detect these distortions and to control the bust, it could be useful the yield curve illustrates here.

The United States' First Business Cycle: An Austrian Interpretation of the Panic of 1797

This paper argues that a boom-and-bust trade cycle was set into motion by the credit expansion of the First Bank of the United States, culminating in the Recession of 1797. This episode constitutes the first of many economy-wide business cycles in the history of the United States that are explained by Austrian business cycle theory.

Non-resonating cycles in a dynamic model for investment behavior

• We introduce a model to describe the mechanism which causes non-resonating cycles to persist and resonating cycles to cease. • The model is inspired by Austrian business cycle theory and satisfies the conditions of Kolmogorov-Arnold-Moser theory. • We find that, for cyclical motions to remain stable, the ratios of their cycle lengths should be sufficiently irrational. • De Groot et al. (2021) found the ratios between cycle lengths in GDP in 25 countries to be close to the golden ratio. • This suggests that the detected cycles in the latter study are non-resonating and remain stable in the long run. Schumpeter (1939) conjectured that there exist many, or perhaps even an indefinite number of subcycles in an economy, but that in the long run only a few subcycles remain stable and persist, whereas others become unstable and cease. In this paper, we build upon this idea, hypothesizing that, for subcycles to persist in a multiple cycle structure, their cyclical lengths should not be close multiples. We formalize our theory using a mathematical model for investment behavior, inspired by Austrian business cycle theory. The model is quasi-periodic and satisfies the conditions of Kolmogorov–Arnold–Moser theory. This enables us to describe the dynamic properties of the model. We conclude that the cycles of the system should be non-resonant for the motions to remain stable in the long run. That is, that the ratios of the cycle lengths should be sufficiently irrational. Coupling this with the recent empirical findings of De Groot et al. (2021), who measured the ratios between subcyle lengths in GDP in 25 OECD countries and found them to be close to the golden ratio φ , we conclude that the detected cycles therein are non-resonant and remain stable.

Introduction to the Inclusion of the Real Interest Rate with other factors in Phillips Curve Analysis

This paper summarizes the arguments and counterarguments within the scientific discussion on the issue regarding the Inclusion of the Real Interest Rate with other factors in Phillips Curve Analysis. The main purpose of the article is to cause economists to consider the inclusion of the real interest rate in Philips Curve analysis. Earlier economists have examined the Phillips Curve, including Irving Fisher (1926). Later Phillips (1958, 1961) made enough of impression to give the Phillips Curve its appellation (1958, 1961). Further work has been done by Freidman, Phelps Lucas, Rapping and others. Shifts from the Short Run Phillips Curve (SRPC) to the Long Run Phillips Curve (LRPC) have been explained primarily through workers not realizing their real wage has decreased until some time has passed. Also, this shifting from the SRPC to the LRPC is due to producers thinking that demand for their products has had a real, sustained increase, producers finally realize that is not true. This article agrees with those factors being present but also posits the idea of changes in the real interest rate affecting the shift form the SRPC to the LRPC. This brief article summarizes the conclusions of five econometric papers that suggest that the real interest rate should be included in Phillips Curve Analysis. The research empirically confirms and theoretically proves that the five articles with econometric evidence suggest that the real interest rate be included in Phillips Curve Analysis. Though Austrian economists consider capital in their theories, Austrian economists do not use Phillips Curve analysis but instead employ Hayekian Triangles. The results of the research shows that inflation and unemployment have a stable and inverse relationship. These results can be useful for economic analysts, government, financial experts, policymakers.

The Inverted Yield Curve, Austrian Business Cycle Theory, and the True Money Supply

Ever since Campbell Harvey’s (1986) doctoral dissertation, academic economists have studied the ability of an inverted yield curve to “predict” an impending recession with impressive accuracy given suitable specifications. Many economists (including Campbell) explain the correlation by neoclassical “consumption smoothing,” while others attribute the connection to monetary policy’s ability to affect the business cycle. We agree with Cwik (2004 and 2005) that the Misesian circulation credit theory of the trade cycle, relying on both monetary and “real” (capital structural) elements, is superior to both flavors of mainstream explanation. In this paper, our contribution is to show that the growth rate of the Rothbard-Salerno measure of the “true money supply” tracks movements in Treasury bond spreads remarkably well. This provides additional support for our claim that the Austrian theory of the business cycle explains the “predictive power” of the yield curve better than the mainstream approach.

The Macroeconomy and the Real Estate Market: Evidence from the Global Financial Crisis and the COVID-19 Pandemic Crisis

This paper investigates the impact of the macroeconomy on Vietnam real estate market (REM). The research data were collected by the authors on a quarterly basis, from the third quarter of 2004 to the last counterpart of 2020. The authors utilize the Autoregressive Distributed Lag (ARDL) approach. The results reveal that REM is negatively influenced by the macroeconomy (interest rate and global crisis) in the short run and long run. This result is completely consistent with the wealth effect theory, the Austrian Business Cycle Theory (ABC), as well as the Arbitrage Pricing Theory (APT). However, the findings in this paper are valuable empirical evidence on the impact of the macroeconomy on REM in Vietnam, a developing country with relatively nascent REM. In particular, this study has achieved novelty compared to previous studies by finding the negative impact of the global crisis on REM, where the global crisis is defined to include the global financial crisis and the Coronavirus (COVID-19) pandemic crisis. Based on this, Vietnam needs to operate macroeconomic policies flexibly and in accordance with each period in order to develop REM in a stable and sustainable manner.

Keynesian Supply Shocks and Hayekian Secondary Deflations

In response to the COVID-19 lockdown policies, Guerrieri et al. (2020) developed a new concept: the Keynesian supply shock. A Keynesian supply shock is an aggregate supply shock that leads to an even larger aggregate demand shock. This paper suggests that Keynesian supply shocks are very similar to the secondary deflations suggested by Hayek (1931), and US data from the 2007–09 financial crisis show that these concepts may help to explain employment dynamics in the midst of a crisis. This fact implies that long-standing policy advice based on Austrian business cycle theory would be useful in responding to Keynesian supply shocks.

The Case against the New "Secular Stagnation Hypothesis"

The new “secular stagnation hypothesis” developed by Lawrence H. Summers attempts to justify why the demand stimulus applied in the aftermath of the global financial crisis failed to revive growth in a satisfactory manner. Building on previous ideas of Keynes, Hansen, and Bernanke, Summers claims that excess savings together with feeble investment drove the natural rate of interest down to zero and advanced economies into stagnation. As the US monetary policy rate is not allowed to fall below the zero bound, Summers calls for “quantitative easing” and more expansionary fiscal policy to spur investment demand. This paper refutes Summers’s hypothesis by revealing its internal inconsistencies and presenting both theoretical arguments and empirical evidence on the long-term evolution of savings, investment, productivity, and capital stock. It also estimates the natural rate of interest following the approach of Salerno (2020), which is further refined based on Rothbard’s “pure interest rate” theory. The calculation shows that the natural interest rate did not drop to zero after the global financial crisis, but has actually remained consistently and significantly above the federal funds rate and the bank loan prime rate. This not only invalidates Summers’s central claim, but confirms once more the explanatory power of the Austrian business cycle theory in relation to the main trigger of the global financial crisis and its subsequent unfinished recovery.

A FINANCIAL ANALYSIS OF RESWITCHING

The classical Austrian Business Cycle Theory (ABCT) is based on an inverse relationship between the so-called Average Period of Production (APP) or ‘roundaboutness’ and the interest rate. According to Böhm-Bawerk (1884 [1891]), the APP is the weighted average time that a unit of labor is locked up in the production process1; moreover, there is a positive relationship between savings (the ‘subsistence fund’) and the APP: the higher the latter the higher the former, which implies an inverse relationship between interest rates and the APP. Thus, a lower interest rate will lead to a higher APP ceteris paribus. Hayek (2008) based his Hayekian triangles on Böhm-Bawerk’s work: a lower (higher) interest rate leads to a more (less) rounda- bout structure of production, increasing (decreasing) the APP. Including Mises’s (1921) business cycle theory into the analysis, whenever the interest rate is pushed lower than its ‘natural level’, either by the central bank or the banking system, there is an unsus- tainable extension of the APP that will generate an economic boom; the crisis will irremediably follow, as the APP will pull back towards its natural level. From this brief characterization of the ABCT, it is easy to notice the key role of the inverse relationship between interest rates and roundaboutness; without it, there is no connection from changes in interest rates and roundaboutness, and the ABCT falls apart. The reswitching of techniques is precisely a counterexample to that relationship, as it claims there are situations in which lower interest rates do not lead to more roundabout productive struc- tures. The organization of this paper is as follows: the next section describes the reswitching of techniques as stated by Samuelson (1966) and the implication for the classical ABCT, based on a phys- ical measure of roundaboutness; section 3 analyzes the alternative of applying corporate finance to the ABCT following Cachanosky and Lewin (2014). Section 4 is a financial analysis of Samuelson’s example, argues why modified duration should replace Böhm- Bawerk’s APP as a measure of roundaboutness, and shows why it does not represent a paradox to the ABCT when the financial approach is used. Sections 5 and 6 address the question from two additional perspectives: a neoclassical with fully flexible prices but fixed techniques and the Austrian related dynamic efficiency.

DEMAND FOR MONEY AND HAYEKIAN TRIANGLES

Friedrich August von Hayek (1935) developed a specific business cycle theory in which interactions between the real and monetary sectors play a central role. In the first version of the theory, shocks to the money supply deflect market interest rate from the natural level and thus give false signals to entrepreneurs about relative demand between present goods and future goods. This idea was represented in a simple graphical tool, which was later called the Hayekian triangle. The structure of capital and the production process are depicted in a diagram that maps flows of resources from early stages of production to late stages, and finally to the hands of the consumer. On the basis of this theory, the prelimi- nary recommendation for the monetary authority was to freeze the money supply in order to prevent fluctuations in the structure of production (Hayek 1928).

Net Present Value, Duration, and CAPM in Light of Investment Theory: A Comment on Kruk

In her paper “Corporate Risk Evaluation in the Context of Austrian Business Cycle Theory” recently published in this journal, Joanna Kruk aims to investigate how artificially low interest rates resulting from central bank intervention distort individual investment appraisals and ultimately result in both entrepreneurial misjudgment and resource-wasting malinvestment, fueling the business cycle. She identifies entrepreneurs’ net present value calculations, supposedly unadjusted for risk, as a major issue and suggests adjusting those calculations for risk via both the duration method and the Capital Asset Pricing Model to mitigate the distorting effects. Her argumentation is, however, trapped in neoclassical reasoning and is adversely affected by several misconceptions of the net present value criterion. This comment seeks to reveal those fallacies and explain how to address uncertainty when using net present value calculations to make those calculations part of the solution rather than part of the problem of entrepreneurial misjudgment. The findings are derived from German investment theory rooted in the Austrian school of thought, meaning that they differ compared to those of neoclassical finance theory.

The Capital Asset Pricing Model as Modern Austrian Business Cycle Theory

According to Austrian macroeconomic theory, capital accumulation today generates supply tomorrow. Will that supply match tomorrows demand? In this paper we study this question in a multi-good and risky environment with an efficient financial system. Towards this end we develop a model based on the Capital Asset Pricing Model (CAPM), Rational Expectations, and Linear Homogeneous Production Functions. Within this framework we show how the financial system in the form of CAPM allocates resources across the different sectors in the economy so as to maximize the ratio of expected returns to a measure of risk like the standard deviation of returns for some initial time period t=0. In t=1 a Linear Homogeneous Production Function subject to a random productivity shock determines actual output and the structure of production. The link between t=0 and t=1 is Rational Expectations, the assumption that the subjective probability distribution in t=0 on which real investment decision are made is equivalent to the objective distribution generating the actual output/income in t=1. If total output is more (or less) than expected in t=0, we have a cyclical expansion (or recession) the magnitude of which depends on the spread of the subjective probably distribution in t=0. With this model we discuss: 1) monetary policy under a full reserve banking system with Central bank digital accounts for all; 2) an all-inclusive transaction tax to substitute for the U.S. present tax system; 3) the trade-off between economic growth and the cyclical volatility of the economy; and 4) the advantages and disadvantages of trade deficits.

Reasons for the Demise of Interest: Savings Glut and Secular Stagnation or Central Bank Policy?

This article compares the Keynesian, neoclassical and Austrian expla-nations for low interest rates and sluggish growth. From a Keynesian and neoclassical perspective, low interest rates are attributed to aging societies, which save more for the future (global savings glut). Low growth is linked to slowing population growth and a declining marginal efficiency of investment as well as to declining fixed capital investment due to digitalization (secular stagnation). In contrast, from the perspective of Austrian business cycle theory, interest rates were decreased step by step by central banks to stimulate growth. This paralyzed investment and lowered growth in the long term. This study shows that the ability of banks to extend credit ex nihilo and the requirement of time to produce capital goods invalidates the permanent IS identity assumed in the Keynesian theory. Furthermore, it is found that there is no empirical evidence for the hypotheses of a global savings glut and secular stagnation. Instead, low growth can be explained by the emergence of quasi “soft budget constraints” as a result of low interest rates, which reduce the incentive for banks and enterprises to strive for efficiency.

Austrian business cycle theory: are 100 percent reserves sufficient to prevent a business cycle?

Economists in the tradition of the Austrian school have shown that one type of maturity mismatching can cause maladjustments and business cycles.1 When banks expand credit, by granting loans and creating demand deposits, they generate immediately withdrawable liabilities to finance longer-term loans. The newly created demand deposits do not represent a reduction of consumption, i.e., that characterized by real savings. As a con sequence, in terest rates are artificially reduced under the level they would have been in a free market reflecting real savings and time preference rates.2 Thus, entrepreneurs are prone to engage in more and longer projects than could be financed with the available supply of real savings. Before all projects that are financed by the credit expansion are finished, a bust occurs. An absence of realsavings to sustain the factors of production in the production pro cesses and to produce complementary and necessary capital goods becomes evident. As a result, malinvestments are liquidated and the structure of production is brought in line with consumer preferences again. This is the Austrian Business Cycle Theory (ABCT) in a nutshell.
 As a remedy Austrian economists such as Selgin (1988) and White (1999) have argued that a free banking system would be a means to inhibit the excessive credit expansion that causes business cycles. They maintain that the competition between banks would limit the credit expansion of the banking system effectively. Other Austrians such as Rothbard (1991) and Huerta de Soto (2006) have gone further and advocate a 100 percent re - rerve banking system ruling out credit expansion altogether.3 In this article it is argued that a 100 percent reserve system can still bring about artificial booms by maturity mismatching if there is a central bank or government support and guarantees for the ban king system. Even if we accept the case for a 100 percent re - serve requirement, we see that the maturity mismatching of liabilities and assets (borrowing short and lending long) is itself perilous–and in the same sense that fractional reserves are perilous.

Asset prices - An Austrian Perspective

Abstract: How asset prices should be taken into account in monetary policy is a controversial question in mainstream discussion. These mainstream positions can be differentiated into two broad perspectives: the proactive and the reactive views. The proactive view advocates pricking the asset price bubble, while the reactive view argues against monetary policy targeting asset prices. In this article the relation between asset prices and the Austrian business cycle theory is examined. Following this, a critique of both the proactive and reactive views is provided and implications for monetary policy are deduced.
 Key words: Austrian Economics, Business Cycles, Asset Prices, Central Banks and their Policies.
 JEL Classification: B53, E32, E58.