Economics - General

Austrian Business Cycle Theory

John Quiggin373 Comments

I’ve long promised a post on Austrian Business Cycle Theory, and here it is. For those who would rather get straight to the conclusion, it’s one I share in broad terms with most of the mainstream economists who’ve looked at the theory, from Tyler Cowen , Bryan Caplan

and Gordon Tullock at the libertarian/Chicago end of the spectrum to Keynesians like Paul Krugman and Brad DeLong.

To sum up, although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn’t developed in any positive way since then. The central idea of the credit cycle is an important one, particularly as it applies to the business cycle in the presence of a largely unregulated financial system. But the Austrians balked at the interventionist implications of their own position, and failed to engage seriously with Keynesian ideas.

The result (like orthodox Marxism) is a research program that was active and progressive a century or so ago but has now become an ossified dogma. Like all such dogmatic orthodoxies, it provides believers with the illusion of a complete explanation but cease to respond in a progressive way to empirical violations of its predictions or to theoretical objections. To the extent that anything positive remains, it is likely to be developed by non-Austrians such as the post-Keynesian followers of Hyman Minsky.

Update There’s a fascinating discussion linking to this post here. In French, but clear and simply written. Anyone with high school French and a familiarity with the issues should be able to follow the main points.

First, some history and data. Austrian Business Cycle Theory was developed in the first quarter of the 20th century, mostly by Mises and Hayek, with some later contributions by Schumpeter. The data Mises and Hayek had to work on was that of that of the business cycle that emerged with industrial capitalism at the beginning of the 19th century and continued with varying amplitude throughout that century. In particular, it’s important to note that the business cycle they tried to explain predated both central banking in the modern sense of the term and the 20th century growth of the state. The case of the US is of particular interest since the business cycle coincided with a wide range of monetary and banking systems: from national bank to free banking, and including a gold standard, bimetallism and non-convertible paper money.

This NBER data goes back to 1857, but there was nothing new about the business cycle then (Marx, for example, had been writing about it for a decade or more). The US experienced serious “panics”, as they were then called in 1796-97, 1819 and 1837 [1] as well as milder fluctuations associated with the British crises of the 1820s and 1840s.

The typical crisis of the 19th century, like the current crisis, began with bank failures caused by the sudden burst of a speculative boom and then spread to the real economy, with the contraction phase typically lasting from one to five years. By contrast, recessions since 1945 have generally lasted less than a year, and have mostly been produced by real shocks or by contractionary monetary and fiscal policy.

According to the theory, the business cycle unfolds in the following way. The money supply expands either because of an inflow of gold, printing of fiat money or financial innovations that increase the ratio of the effective money supply to the monetary base. The result is lower interest rates. Low interest rates tend to stimulate borrowing from the banking system. This in turn leads to an unsustainable boom during which the artificially stimulated borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas that would not attract investment if price signals were not distorted. A correction or credit crunch occurs when credit creation cannot be sustained. Markets finally clear, causing resources to be reallocated back towards more efficient uses.

At the time it was put forward, the Mises-Hayek business cycle theory was actually a pretty big theoretical advance. The main competitors were the orthodox defenders of Says Law, who denied that a business cycle was possible (unemployment being attributed to unions or government-imposed minumum wages), and the Marxists who offered a model of catastrophic crisis driven by the declining rate of profit.

Both Marxism and classical economics were characterized by the assumption that money is neutral, a ‘veil’ over real transactions. On the classical theory, if the quantity of money suddenly doubled, with no change in the real productive capacity of the economy, prices and wages would rise rapidly. Once the price level had doubled the previous equilibrium would be restored. Says Law (every offer to supply a good service implies a demand to buy some other good or service) which is obviously true in a barter economy, was assumed to hold also for a money economy, and therefore to ensure that equilibrium involved full employment

The Austrians were the first to offer a good reason for the non-neutrality of money. Expansion of the money supply will lower (short-term) interest rates and therefore make investments more attractive.

There’s an obvious implication about the (sub)optimality of market outcomes here, though more obvious to a generation of economists for whom arguments about rational expectations are second nature than it was 100 years ago. If investors correctly anticipate that a decline in interest rates will be temporary, they won’t evaluate long-term investments on the basis of current rates. So, the Austrian story requires either a failure of rational expectations, or a capital market failure that means that individuals rationally choose to make ‘bad’ investments on the assumption that someone else will bear the cost. And if either of these conditions apply, there’s no reason to think that market outcomes will be optimal in general.

A closely related point is that, unless Say’s Law is violated, the Austrian model implies that consumption should be negatively correlated with investment over the business cycle, whereas in fact the opposite is true. To the extent that booms are driven by mistaken beliefs that investments have become more profitable, they are typically characterized by high, not low, consumption.

Finally, the Austrian theory didn’t say much about labour markets, but for most people, unemployment is what makes the business cycle such a problem. It was left to Keynes to produce a theory of how the non-neutrality of money could produce sustained unemployment.

The credit cycle idea can easily be combined with a Keynesian account of under-employment equilibrium, and even more easily with the Keynesian idea of ‘animal spirits’. This was done most prominently by Minsky, and the animsal spirits idea has recently revived by Akerlof and Shiller. I suspect that the macroeconomic model that emerges from the current crisis will have a recognisably Austrian flavour..

Unfortunately, having put taken the first steps in the direction of a serious theory of the business cycle, Hayek and Mises spent the rest of their lives running hard in the opposite direction. As Laidler observes, they took a nihilistic ‘liquidationist’ view in the Great Depression, a position that is not entailed by the theory, but reflects an a priori commitment to laissez-faire. The result was that Hayek lost support even from initial sympathisers like Dennis Robertson. And this mistake has hardened into dogma in the hands of their successors.

The modern Austrian school has tried to argue that the business cycle they describe is caused in some way by government policy, though the choice of policy varies from Austrian to Austrian – some blame paper money and want a gold standard, others blame central banks, some want a strict prohibition on fractional reserve banking while others favour a laissez-faire policy of free banking, where anyone who wants can print money and others still (Hayek for example) a system of competing currencies.

Rothbard (who seems to be the most popular exponent these days) blames central banking for the existence of the business cycle, which is somewhat problematic, since the business cycle predates central banking. In fact, central banking in its modern form was introduced in an attempt to stabilise the business cycle. The US Federal Reserve was only established in 1913, after Mises had published his analysis.

Rothbard gets around this by defining central banking to cover almost any kind of bank that has some sort of government endorsement, such as the (private) Bank of England in the 19th century, and arguing for a system of free banking that would avoid, he asserts, these problems. But, on any plausible definition of the term, the US had free banking from the Jackson Administration to the Civil War and that didn’t stop the business cycle (Rothbard offers some historical revisionism to argue that the Panic of 1837 didn’t really happen, but that wasn’t what US voters thought when they threw the Jacksonians out in 1840). And free banking in late 19th century Australia (our first quasi-central bank was the Commonwealth Bank established in 1915) didn’t prevent a huge boom and subsequent long depression around 1890. Overall, the US was much closer to free banking throughout the 19th century than in the period from 1945 until the development of the largely unregulated ‘shadow banking’ system in the 1990s, but the business cycle was worse then (how much worse is a matter of some controversy, but no serious economist claims it was better).

To sum up, the version of the Austrian Business Cycle Theory originally developed by Hayek and Mises gives strong reasons to think that an unregulated financial system will be prone to booms and busts and that this will be true for a wide range of monetary systems, particularly including gold standard systems. But that is only part of what is needed for a complete account of the business cycle, and the theory can only be made coherent with a broadly Keynesian model of equilibrium unemployment. Trying to tie Austrian Business Cycle Theory to Austrian prejudices against government intervention has been a recipe for intellectual and policy disaster and theoretical stagnation.

373 thoughts on “Austrian Business Cycle Theory”

  1. I knew from Skidelski’s biography of JMK that he and Hayek were friends, but I hadn’t realised the way in which some of their ideas were actually so compatible. It does seem that Hayek let his political/ideological prejudices get in the way of his economics.

  2. It’s not fair to say that Austrians are running away from the interventionist implications of their theory. Non-neutrality of money leads to misallocation but trying to fix it usually makes things worse because it’s so difficult to pin down where the problem is.

    I found a nice model which makes this point:

    An Exploration of Neo-Austrian Theory Applied to Financial Markets: An Exploration of Neo-Austrian Theory Applied to Financial Markets. Harald Benink, Peter Bossaerts. The Journal of Finance, Vol. 56, No. 3 (Jun., 2001), pp. 1011-1027

    Anyway, very interesting post. Nice to see some positive engagement with Austrians!

  3. “Both Marxism and classical economics were characterized by the assumption that money is neutral…”

    Actually, the long-run neutrality of money is a thesis of neo-classical economics, including “New Keynesians”, isn’t it? And could you cite some source for Marx adhering to the “neutrality of money” thesis? In my understanding, he insisted that any full-fledged system of commodity production presupposed the existence of money circulation driving it, such that money had a quasi-autonomous status. Though he operated within the then prevailing convention of hard “commodity money”, he was far from taking it as a fundamental store of value, Austrian-style, which would be a version of what he criticized as “fetishism”. (Needless to say, he had no use for “Say’s law”). And he held credit as endogenous to the production/business cycle, tracing out especially the tendency of financial “asset” prices to seriously gap out and diverge from underlying realizable costs/prices of production, thus forming accumulations of “fictitious capital”, as a key part of his theory of crises.

  4. I have always found the most useful implication of Austrian theory to be the concepts of systemic “malinvestment” and overinvestment in relatively unproductive sectors – investment overhang – as the (psychologically inevitable) results of credit availability in a boom period. These concepts are derivative primarily of Schumpeter in the forms that I have found interesting (though Hayek’s fundamental insight about the information function of the price mechanism underlies the concept), and they provide a very useful critique of theories of efficient capital markets.

    Taken to their logical conclusion, these concepts – perhaps interpreted through the lens of Galbraith’s description of the investment boom in “The Great Crash” provide a solid justification for relatively tight regulation of financial intermediation and credit markets.

  7. JQ, I suspect from other similar coverage like Scott Sumner‘s that there is more to Austrian stuff than you describe. I certainly found his post and readers’ follow up illuminating, although I’m still digesting it.

    How long does stuff stay in moderation before getting through on Weekend reflections, by the way?

  8. Orthodox Marxism – ossified dogma???!!!!

    Marx – money as a veil ????!!!!!!

    Gratuitous quips like that are meaningless, lack rigor, and damage reputations.

    Marx’s understanding of money was as ‘specie’ and he separately discussed credit. Today in the OECD we tend to conflate money and credit as the same – dollars. Money for Marx was not a veil.

    Quiggin’s ‘ossified dogma’ similarly has no basis, and he produced no evidence. He is just pandering to low grade academic staff room jokes and undergraduate giggling.

  9. PML, there’s nothing in the moderation queue.

    Chris, can you point to any interesting recent contributions to economics that fit within an orthodox Marxist viewpoint, and would contradict my judgement of ossification? If so, and if there’s any interest from other readers, I’d be happy to spell out my reactions in more detail.

  10. That’s odd, JQ. I just went and tried posting there again, only to get “Duplicate comment detected; it looks as though you’ve already said that!”. Anyway, I added a new leading sentence to bypass that, so it should be in moderation now as it didn’t go straight up.

  13. John

    I do not think that Marxism necessarily makes “interesting recent contributions to economics” – if by this you mean the economics essentially following Samuelson. It is not clear what you mean by recent?

    However, you can find interesting recent contributions to political economy. See for example David Schweickart and James Lawler in “Market Socialism: The Debate Among Socialists”, ed. Bertell Ollman (Routledge 1998). It has a useful and interesting Bibliography at p193f.

    The TSSI movement revisitation of value theory is interesting – summarised on Wikipedia.

    In Australia, Bruce McFarlane’s book, “Radical Economics” (Croom Helm 1982) is also interesting and easy to read.

    Most unbiased commentators may find the “The New Palgrave – Marxian Economics” ed. J Eatwell, M Milgate, P Newman (Macmillan 1990), of some interest. All contributors provide Bibliographies.

  14. Is (involuntary) unemployment in the recessionary aftermath of a deflationary (or disinflationary) episode “caused” by real wages that are too high?

  15. Thanks for this! I had always wondered why Austrian-influenced economists always display such a strange mix of insight and absolute stupidity.

  16. John Quiggin, I agree with Chris Warran that the TSSI work (particularly Kliman’s “Reclaiming Marx’s Capital”) is the first step in a non-ossified direction within Marxist economics. (Although I don’t think Kliman could be called “orthodox” and he is no fan of the bulk of Marxist economics.)

    Chris Warren you’re absolutely right that Marx did not regard money as a veil, but Quiggin did not say Marx’s economics, he said MarxIST economics, and he is correct that Marxist economics generally viewed money as a veil.

    I should point out that Marx was a follower of Thomas Tooke and John Fullarton, the main exponents of the so-called Banking School, whose views on credit money are quite similar to the enogenous-money theories of today’s Post Keynesians. Their theories ran directly contrary to the money-is-a-veil doctrines of Hume, Ricardo and the later Currency School.

  17. John Quiggin:

    As an example of a contemporary economic theorist drawing on Marxian/classical sources, you might look up Anwar Shaikh. And, yes, a similar assessment of Marx’ economics would be appreciated. Hopefully, you would do much better than that fatuous turd Brad DeLong recently emitted. (Yes, my comment there was deleted after remaining 2 days, probably because I suggested his scholarly ethics/competence on the matter were, um, less than stellar).

  18. The Austrian analysis is sound and has yet to be surpassed. Marxist analysis is poor and cannot be supported by either logic or real world observations.

    If the Austrians show that interventionism makes things worse it makes no sense for them to advocate interventionism just so that they can gain more political clout because they would undermine their own credibility.

  19. The Austrians like most people make money too complicated. Money is a measure of value that facilitates the trading of goods and services. Money is also a means of allocating ownership of goods and services. Another feature of money is that it can be traded and is a commodity.

    Problems arise because each person measures value differently and because we argue over who should own what. However, the mechanics of how a money system operates is simple. It is the emergent properties resulting from using money that gives rise to complexity.

    It is worthwhile looking at the operation of other systems like the communication of ants or bees to see how simple communications mechanisms gives rise to complex group behaviour. Change the underlying communications mechanisms in small ways and it can cause radically different outcomes. Money is about the communication of value. Change the way the communication happens and the system will have different outcomes.

    We do not have to theorise about money in terms such as neutrality or non neutrality of money. Such ideas are emergent properties of the way the money system operates given a particular set of rules.

    Here is another way to think about money. Instead of thinking about “meaning” think about the mechanics. If we change the mechanics of the money system then we will get different emergent properties. We observe that the mechanics of how the current money system works gives rise to business cycles, inflation, asset bubbles and recessions. Let us change the mechanics of how the money system works and see what happens.

    One of the things we can easily change about the money system is the way we increase the money supply.

    For trading purposes we only need enough money to handle the amount of trade we conduct at any particular time. In a society where there was very little exchange of goods then we would need very little unless everyone decided to trade at the same time. For ownership purposes we need more money because we allocate the ownership of the goods and services and we often want to rent out our goods and services through the creation of loans. But, there is a limit on the amount we need for rental purposes. This limit is the total value of all goods and services that can be rented out both now and for some period in the future. If we create too much money or if we do not have enough then the system will adjust itself with inflation or recessions.

    The way we currently increase the money supply is through the issuing of loans with money that does not yet exist. Most loans are issued with money that exists and is on deposit but some loans are issued without there being money on deposit. The way the system works we have no idea whether the money we used for a given loan was new money or whether it already existed.

    If we changed the system so that before a loan could be given the money already existed and was on deposit then we are likely to solve most of the problems with the current money system. The problem now becomes one of deciding how much new money to create and who gets ownership of it and how to move to a new system.

    At the moment new money is created through loans and the ownership of the money is given to those who already have assets.

    However, we can create money by printing it, not giving any interest on the new money until it is spent, and requiring the money to be spent on producing a new productive asset. We have an opportunity of experimenting with this approach with the formation of the New Broadband Network company.

    The government could finance this by notionally printing the money and giving it to the company. The money does not earn interest until it is spent by the company. The money is allocated by giving everyone in Australia shares in the company. If this was done there is no debt created. New money is produced and we know it will be spent creating a productive asset. It will not cause inflation because the shares in the company will initially be valued at less than the nominal value of the shares.

    If it works for the NBN then it will work for other infrastructure projects. The existing system can remain exactly as it is including the fractional reserve system. The only difference will be that the Reserve Bank will reduce the amount of money it creates to lend to the banks. If it works as expected then the Reserve Bank can get out of the business of creating new money through lending to the banks and get into the business of increasing the money supply through the creation of productive community infrastructure.

    We can move to this system incrementally, observe what happens and see if the change stabilises the money supply.

  20. How did this post get so many links to “entrepreneurial investment sites” John? You must have mentioned the magic word – “Austrian.”

  21. I have a few specific questions and then a short summing up. But first the questions to jquiggin.

    A. Business cycles – Do we not have enough potential instruments and strategems at our disposal to keep the business cycle well damped and avoid booms, busts and unemployment (other than frictional)? If there is resistance to the implementation and use of these is it not due to the “irrational” lobbying, pressure, sway and interests of ‘the cavaliers of credit’ who prefer a boom and bust system to a more stable system because they thrive on the movements of that instability?

    The instruments would be;

    1. Counter-cyclical government spending.
    2. Better control of the issue of credit.
    3. Reform of the fractional reserve system to achieve the above.
    4. Use of government employment as reserve employment and to set a minimum wage.
    5. Better regulation of the creation of financial instruments (onus of proof of need of a new instrument being on the creator)

    B. Is the declining rate of profit a real phenomenon or a Marxist dogma? I’m not asking a rhetorical question. I really want to hear views on this as I have no idea myself on this one.

    C. Am I right in thinking that Smith and Marx both developed / adhered to the labour theory of value? If economic value does not all come from labour or at all come from labour (including intellectual labour) where does it come from? I believe this question will be quite hard to answer.

    Overall.

    To me, that was a very clear essay on the Austrians. An obvious sign that a theory has become a dogma is indeed when empirical obsevations are rejected if they don’t fit the theory. In other words, proponents of such theories say in effect ‘reality is wrong’ rather than ‘my theory is wrong’.

    When we look, for example, at all the benefits that privatisation of government services were supposed to bring us – and see that the benefits did not arrive – we must say, if we are at all guided by empiricism, “the theory was wrong.”

  22. It is allways good when someone argue respectfully trough another school of thought. I respect you for that but my comment is that the Austrian Business Cycle takes are related to the use of fiduciary money as a panacea for economic cycles. The bubble creation by FED is the output to avoid the normal business cycle. The temptation to create stability generates a far worse instability.
    respectfully

  23. Kevin Cox: it will be very difficult to stop private persons from expanding the monetary supply.

  24. In his _Human Action_ (1949), Mises indicated that the credit-induced boom is characterized by “malinvestment and overconsumption,” a phrase he used repeatedly in his exposition of his business cycle theory. In other words, both C and (early-stage) I increase during the boom. Hayek used the phrase “forced saving” to mean “artificially induced capital accumulation”—making his “forced saving” equivalent to Mises’ malinvestment. Hayek ignored the overconsumption aspect of the boom but did recognize the upward pressure on consumer-good prices. I reconcile, to the extent possible, Mises’ and Hayek’s views in my “Forced Saving and Oversonsumption in the Austrian Theory of the Business Cycle” (2004): http://www.auburn.edu/~garriro/strigl.htm.

    The Austrians do reject rational expectations in this term’s common meaning. It flies in the face of Hayek’s 1945 article on the role of prices. Essentially, RE means knowing–or behaving as if you know–all the information that undistorted prices would convey. It’s one thing to know or suspect that price signals (expecially interest-rate signals) are being jammed. It’s quite something else to know what the unjammed signal would be. And it’s something else still to act on the basis of what you think prices would be instead of on the basis of what they actually are.

    R.W.Garrison

  25. Vangel

    Very strange statements. You may have misinterpreted Marxist analysis.

    I obviously agree with michaelego. There is a difference between Marx’s political economics and ‘Marxist’ political economics.

    Kliman’s excursion into “intrinsic value” is annoying (and useless). He is no orthodox.

  26. Ikonoclast #21

    Marx did not subscribe to the labour theory of value. Samuelson mis-subscribed Marx to this theory and wrote a peculiar paper about Marx’s supposed Labour Theory of value.

    Marx developed a ‘socially necessary labour theory of value’ with the emphasis on the social determination. Hence with Marx we get political economy – not ‘economics’.

    You can only understand Marxists analysis, if you want, provided you take note of the difference between the classical Labour Theory of value (lampooned by Samuelson) and Marx’s Socially Necessary Labour Theory of Value.

    Marx’s concepts (including Capital and Capitalist Profit) are all based on social relations.

  27. RWG: “It’s one thing to know or suspect that price signals (expecially interest-rate signals) are being jammed. It’s quite something else to know what the unjammed signal would be. And it’s something else still to act on the basis of what you think prices would be instead of on the basis of what they actually are.”

    One thing I don’t quite understand is: if the price system is askew and producing “overconsumption” and “malinvestment” during the boom, and the price is askew, producing involuntary unemployment and underconsumption during the bust, what justification is there for laissez faire in either period? As Quiggan says above, “there’s no reason to think that market outcomes will be optimal in general.

    Do Austrians think that (involuntary) unemployment in a deflationary bust is “caused” by real wages that are too high, and have to come down?

    Bryan Caplan, cited above, seems to think he shares that view with the Austrian School.

    Would deflation, if there had only been more of it, have cured the Great Depression?

    Deflation — a price signal that holding cash is more valuable than investment — seems unlikely to be a clear and optimal “signal”.

  28. Thanks for this! I had always wondered why Austrian-influenced economists always display such a strange mix of insight and absolute stupidity.

    What is the “absolute stupidity” displayed by Austrian-influenced economists?

  29. The post war recoveries you mention are by nominal GDP which is influenced by inflation. If you consider the value of equities adjusted for inflation the post war recoveries fair very poorly compared to the pre-fed era.

    Nominal GDP will recover with enough banknotes, but the real economy that produces things and pays wages accordingly will not. This is the essence of stagflation. The nominal stats will normalize while the labor force shrinks and the cost of living skyrockets.

    You can claim Carter stagflation was an anamoly, and perhaps it is. Only the coming years will tell whether it was a fluke, or as the Austrians claim, a systemic effect.

  30. John — this isn’t very good history of economic thought.

    Hayek’s first work was on the U.S. Federal Reserve System which he worked on in New York in the early 1920s — and his first proto version of the ABCT was written in the context of a paper on the U.S. Federal Reserve System.

    Your paper is full of all sorts of other errors.

    This paper might make it through peer review — but just because peer review on the topic of Hayek has been very, very bad in the professional journals. As Bruce Caldwell puts it, writing papers on false explications of Hayek in the peer reviewed journals is a gold mine for a serious historian of economic thought — errors and BS are everywhere.

    Things have gotten better since in the 1980s, but not so as not to be a continuing embarrassment for the “peer review” process.

  31. John — just got to ask. Have you read anything by Lawrence White or Georg Selgin or Steve Horwitz?

    Just asking.

    John writes:

    “although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn’t developed in any positive way since then.”

  32. Greg Ransom,

    How do the Austrians address the fact that the boom-bust cycle pre-dates the establishment of central banks and pre-dates the establishment of fiat currencies?

  33. Just a couple brief comments about the Austrians,- who are want to claim we fail to understand them and the purity of their doctrine, even if we know their intellectual history rather well: 1) they seem to utterly fail to realize the severely deflationary and self-stultifying nature of their “hard money” and limited or “free” banking proposals. This is not a matter of mild deflation, and situations under which it might be argued beneficial, but deflation so severe it would take the capital out of “capitalism”. 2) The mal-investment thesis is actually an old argument between the “general glut” view of business cycles and the inter-sectoral mal-alignment view. In fact, both aspects can be true, though the Austrians labor to vigorously deny the over-production/under-consumption problems. The argument is always that free markets fail only because they are never “free” enough. And in the course of their tergiversations, they manage to remove essential components that make capitalism and “free” markets at all “work”. In the abeyance of Austrian theory, it lives on ideologically through an idolization of “free markets” as reactionary utopianism.

  34. Greg Ransom,

    “John — this isn’t very good history of economic thought.

    Hayek’s first work was on the U.S. Federal Reserve System which he worked on in New York in the early 1920s — and his first proto version of the ABCT was written in the context of a paper on the U.S. Federal Reserve System.”

    I think it’s you who has the problem here. I said “Austrian Business Cycle Theory was developed in the first quarter of the 20th century, mostly by Mises and Hayek” and you accuse me of error on the basis that Hayek wrote in the early 1920s. More importantly the basics of the theory were already in Mises 1912, so writing as if it began with Hayek is a pretty big error.

    If you have a substantive comment to make, and particularly if you want to discuss some ideas you see as important new developments in ABCT, feel free, but I’m not going to respond further to silly pointscoring.

  35. “How do the Austrians address the fact that the boom-bust cycle pre-dates the establishment of central banks and pre-dates the establishment of fiat currencies?”

    The Austrians see the culprit of the boom-bust cycle to be an expansion of credit not backed by savings. This can occur through fractional reserve banking. That is why Austrians support a 100% reserve requirement.

  36. “That is why Austrians support a 100% reserve requirement.”

    Not the smart ones 😉

  37. John — among other things, I’m pointing out the silliness of things like this, you wrote:

    “the business cycle they tried to explain predated both central banking in the modern sense of the term and the 20th century growth of the state.”

    You’re fooling yourself if you thing this is substantive criticism of “Austrian” work of money, banking and business cycles.

    It isn’t. It superficial stuff — mixed with a good bit of ad hominem bashing.

    Why don’t you work on something substantive, that an intelligent person can dig his teeth into?

    This is a pretty good example of the kind of comment that won’t get a response. JQ

  38. Bruce
    “Would deflation, if there had only been more of it, have cured the Great Depression?”

    The Great Depression wouldn’t have been as bad had there not been bank credit deflation caused by fractional reserve banking leading to a loss of confidence in the banks resulting in bank runs. Austrians see fractional reserve banking as fraud. Also Austrians note that it is important to distinguish between types of deflation.

  40. Robert, given that “Austrians see fractional reserve banking as fraud” and that historically, fractional reserve banking has always been central to capitalism, doesn’t that imply that capitalism (as it has actually existed) is inherently fraudulent?

    To put the point less tendentiously, can you point to any current or historical instances of capitalist systems with non-FR banking systems (that is, banks that lend money and fulfil the other standard functions of banking; I’m not counting people who just look after your gold for you), or any reason to suppose that capitalism could function under a 100 per cent reserve requirement?

  41. #23 drscroogemcduck
    Using the scheme proposed it is the issuer of the currency who is in complete control of how much the money supply increases.

    The issuer of the currency determines how much extra currency is needed – by observing – not setting the interest rates on loans.

  42. My rational expectation is that a socialist would have little ability to criticize ABCT, and they have been adequately satisfied. I’m still looking for a worthwhile criticism.

    Again, this is the kind of comment that doesn’t help much. Commenters like Russell and Greg Ransom might like to consider, that, as advocates of a distinctly minority position, talking as if you had long since been proved right doesn’t help your cause. Rather, it illustrates my point about ossified dogma, and raises a suspicion that the reason you dismiss criticism is because you can’t respond to it – JQ

  43. jquiggins

    Capitalism is among other things a system where capital is traded without force or fraud by private individuals. This implies that a fractional reserve banking system is not consistent with capitalism according to the Austrian view.

    The Bank of Amsterdam maintained a 100% reserve requirement during the 17th and 18th centuries It became the richest city in the world at that time as well as the financial capital of the world.

  44. Robert,
    If you ban people from having voluntary arrangements with their banks isn’t that force?

  46. I agree that ABCT hasn’t progressed much but that may be due to lack of insitutional funding rather than the uselessness of the explanation. If you combine Minsky with Mises you get a very potent explanation of the dangers of unregulated financial markets.

    Two solutions appear possible: (1) Either regulate the financial industry heavily as a quasi-government institution (similar to 1950s Austrian with Nugget Coombs at the helm) or (2) Deregulate BOTH the financial sector and the monetary system and allow gold or silver to compete with domestic currencies (ie allow bank notes to be redeemable by a public or private mint/bank for value and do not tax capital gains on “real money”).

    What we’ve had is the WORST of all possible worlds: Austrian deregulation of banking AND Keynesian central banking supporting them when they screw up. The disaster was inevitable.

    It is not called moral hazard for nothing.

    And in answer to your question: Yes, the current version of capitalism is fraudulent and many Austrians would consider the US economy post-1913 as a fraudulent form of capitalism.

  47. 1950s Australian, not Austrian. 1950s Australia actually looks pretty good right now…capital controls and all…

  48. Final point: I take issue with bizarre characterisation of the Austrians as taking an irrational a priori view on the beauty of markets.

    Austrians do not have a fixation on free markets, like the Lucas rational expectations academics or the perfect information dogmatists. Austrians are the only free marketeers who understand that people make irrational ill-informed decisions ALL THE TIME.

    The issue is that government (a collection of the same “irrational” idiots as those in the market, just paid on a stipend and therefore even dumber) is EVEN WORSE. And because they tax (ie steal) and because they can currently print money, the danger of the monopoly stupidity of government is far, far worse than the individual stupidity of a diversified collection of market-based idiots all making individual mistakes. The market will muddle through. Governments can kill all of us with their stupidity.

    That is the key free market insight of the Austrians. Not dogma. Realism. About markets. And especially about academics and governments.

  49. jquiggin

    Adam Smith states in the Wealth of Nations written in 1776 that the Bank of Amsterdam “professes to lend out no part of what is deposited in it.”

    http://books.google.com/books?id=70759KjSs0sC&pg=PA198&lpg=PA198&dq=The+Bank+of+Amsterdam+professes+to+lend+out+no+part+of+what+is+deposited+with+it,+but,+for+every+guilder+for+which+it+gives+credit+in+its+books,+to+keep+in+its+repositories+the+value+of+a+guilder+either+in+money+or+bullion.+That+it+keeps+in+its+repositories+all+the+money+or+bullion+for+which+there+are+receipts+in+force,+for+which+it+is+at+all+times+liable+to+be+called+upon,+and+which,+in+reality,+is+continually+going+from+it+and+returning+to+it+again,+cannot+well+be+doubted.+.+.+.+At+Amsterdam+no+point+of+faith+is+better+established+than+that+for+every+guilder,+circulated+as+bank+money,+there+is+a+correspondant+guilder+in+gold+or+silver+to+be+found+in+the+treasure+of+the+bank&source=bl&ots=7SjUbeWbyE&sig=JmDjm7ZnTrlk7pnx6BBwro9SLt0&hl=en&ei=n6n-ScmFEZmEtgO0nvHJAQ&sa=X&oi=book_result&ct=result&resnum=1#PPA198,M1

    According to the article the Bank of Amsterdam “was the first public bank to offer accounts not directly convertible to coin. As such, it can be described as the first true central bank.” based on this it didn’t become a central bank until the late 17th century. It was the 17th century that was considered Amsterdam’s “Golden Age.” This was the period that accounts were still convertible and the the bank had yet to become a central bank.

    This seems to validate the Austrian view that a 100% reserve requirement could function.

  50. Austrian

    “Yes, the current version of capitalism is fraudulent and many Austrians would consider the US economy post-1913 as a fraudulent form of capitalism.”

    fraudulent capitalism is a contradiction of terms.

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