Business Cycles Explained: Austrian Theory

Business Cycles Explained: Austrian Theory


The Austrian theory postulates that entrepreneurs
are tricked or fooled by government-engineered increases in the money supply. Here’s a
simple example of how the scenario runs: The central bank inflates the supply of money.
The real interest rate falls because there are more funds to be lent out. As the real
interest falls, entrepreneurs borrow more. They undertake longer and more ambitious projects,
and eventually, according to the Austrian theory, those longer and more ambitious projects
cannot be sustained, they turn a loss rather than a profit, and eventually the boom becomes
a bust. [The Housing Bubble] To consider a specific example, it’s been
argued by many Austrians that the housing bubble was in fact an illustration of Austrian
business cycle theory. In the years 2001 to 2004, the Fed really was somewhat loose with
credit, nominal interest rates were quite low, there was a housing bubble. People borrowed
a lot more money; they borrowed more than they should have. People thought the good
conditions, the low interest rates on mortgages, the easy availability of credit, and the rising
home prices would continue forever. That wasn’t the case. Eventually the bubble burst, these
trends were reversed, and we had a lot of long-term construction projects and housing
and mortgage decisions that turned out in retrospect to have been big mistakes. [Austrian Remedies] Austrians propose some different remedies
for stopping the problem in the first place. To stop the problem in the first place, Austrians
have argued we should either have a gold standard or tighter money or some kind of monetary
rule. The belief is it would then be harder to fool entrepreneurs because, in terms of
monetary conditions, it is believed they would be more stable or at least entrepreneurs would
know what to expect. [Explaining the Great Recession] Austrians and Keynesians give very different
readings of the 1920s and the subsequent Great Depression. According to a lot of Keynesians
and also monetarists, there’s some critical negative period between 1929 and 1932, and
if only we had stopped aggregate demand from contracting so radically, we would have had
a much stronger economy. The Austrian view is different. According to the Austrians there
was a lot of loose money and monetary expansion in the 1920s. Entrepreneurs took on projects
which were too ambitious, and once those longer-term projects are in place, Austrians often believe
there’s not any way you can back out of the jam you’re in, that a lot of those investments
will turn bad. Now on this question I’m not actually so much of an Austrian when it
comes to the Great Depression, but that’s one way of thinking about the difference between
the two points of view. Austrians locate the problem more in a kind of original sin of
inflation, which once it has been committed is very hard to get out of. Monetarists and Keynesians tend to think that
if you can boost aggregate demand or maintain aggregate demand at the proverbial last minute
that you’ll actually succeed in making the cycle a much less severe one. [Strengths and Weaknesses] Strengths and weaknesses of the Austrian theory:
What are they? I think one strength is that we do see a lot of credit bubbles in history,
and on average those credit bubbles are associated with periods of loose monetary policy. The
Austrian theory picks up some important part of this story. There is too much credit put
on the market, entrepreneurs are fooled, and this is one factor that contributes to making
for a recession or depression. But the Austrian theory also has some weaknesses. One is that
for a theory which stresses the virtues of the market, it assumes that entrepreneurs
are tricked rather easily. So say there’s some inflation or an increase in credit. An
entrepreneur doesn’t have to be genius to say, “Hey wait a minute, there’s been
some inflation. I saw this on Fox News; I read about it in the Wall Street Journal.
Maybe I shouldn’t overexpand my business. There’s some inflation. Maybe now is time
to just be a little more cautious.” It’s also the case that looking back in history,
a lot of business cycles are caused by monetary contractions and not by the previous expansion.
So there’s an awful lot of cases where the Austrian theory wouldn’t even potentially
apply.

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About the Author: Oren Garnes

100 Comments

  1. I think even in the Austrian school there is a split between the free bankers (White and Selgin) and 100% reservists (Rothbard). I'm more sympathetic to the former and they argue that the supply of money and credit should be set in the market. Monetary inflation or deflation are just surpluses or shortages which are caused by state interventions. But price inflation or deflation would be the result of changes in productivity, not changes in money supply or demand.

  2. Re: xcvsdxvsx,

    "rather its more of a prisoners dilemma sort of situation. "

    I couldn't agree with you more and disagree with the good professor. Indeed, many entrepreneurs weren't tricked but what are they going to do? Tell the client to go fuck himself? They still need the business and, if that means expanding to get it, they will do it. That is the PERVASIVE nature of artificially-lowered interest rates.

  3. But, wait a second: You, professor, say that previous downturns were the result of credit contraction and not the previous expansion. What created the EXPANSION in the first place? By what you're saying, the solution would not be not to manipulate the interest rate but to keep INFLATING lest we have a "contraction"! That's the Keynesian prescription in a nutshell! Suddenly, your own objection becomes the very same thing you're trying to fight!

  4. Its really surprising to me that the professor didn't already know this. Its not as if i figured it out on my own, idk who figured it out first but this is pretty much common knowledge stuff among austrains.

  5. No it's not. They Keynesian prescription is to apply fiscal policy. Traditional Keynesianism doesn't give much importance to monetary policy. What Cowen said is that in some cases there is a contraction in money supply that does not follow an expansionary cycle. In such cases, Austrian theory cannot even potentially apply.

  6. The Volcker monetarist experiment in the 1980s. There is no expansionary cycle that led to a bust, but rather a deliberate contraction o money supply that controlled inflation and caused a recession due to fall in aggregate demand. Guys, I like Austrians in some stuff, but we shouldn't take science as a religion. All theories fail. They are meant to fail exactly because, as Hayek warns, we cannot presume know the complexity of the social fabric.

  7. Mr Volcker's decisions in the 1970s are an example of monetarist success,not failure. Following the GD,"pump priming"became the order-of-the-day.Decades of monetary expansion led to high inflation and increasing unemployment (stagflation). This aided Friedman in the development of the long-run Philips curve.

    The monetarist medicine for hyper inflation was practiced all over the world,and it worked.By the 1980s inflation had cooled. Economists call the monetarist period "The Great Moderation" 😉

  8. "They Keynesian prescription is to apply fiscal policy. Traditional Keynesianism doesn't give much importance to monetary policy."

    Keynes' "General Theory" was pretty much the foundation of all modern macroeconomic ideas,and it definitely incorporated elements of monetary economics. Indeed, Friedman based many of his ideas on Keynes', but tempered his conclusions.

    Keynes worked to fix the liquidity trap of the GD,which was caused by severe monetary contraction. This is monetary economics. =)

  9. Agreed! I believe that Austrian theory accurately shows one type of boom and bust cycle, but they fail miserably in developing a viable modern solution. They always return to the concept that monetary deflation is healthy for the economy and only represents a temporary correction. This is rubbish, imo, and they fail to show how 2% inflation can't continue forever. =)

  10. Re: carlosandresgoaes,
    "Traditional Keynesianism doesn't give much importance to monetary policy."

    But we're not talking about "traditional" Keynesianism. Besides, Keynes himself gave more importance to monetary policy than you think, writing about it and even giving advice about it – see Keynes On Monetary Policy 1910-1946

    As for what Cowen said, it makes no sense. A monetary contraction that leads to a crisis has to come from a previous expansion. He simply moves the goal posts.

  11. The Great moderation was time when credit was use to buffer it plus this is time of dot com boom which a lot wealth was created so a lot credit could be paid back. 2000 a lot stupid ceos deicide it go to outsource so wealth transferred to third world countries. so people use credit make for lost wages plus housing bubble created little wealth so bubbles was huge. when deflation forces equal inflation forces the bubble popped and most credit supply was used up.

  12. Doesn't make much sense towards the end of the video when he claims that some recessions are caused by contractions alone….

  13. cheap available credit (because the fed keeps interest rates low), combined with government guarantees and subsidies artificially increases demand, causing prices to rise. Because the demand is artificial it will not sustain and will likely crash, at which point you will probably see a lot of falling prices.

  14. This is not really accurate. The businesses are not always being irrational. Moral hazard is the biggest problem and he is totally leaving this out.

  15. Also most Austrians believe that minor economic downturns are unavoidable. The downturn only becomes a depression when the government gets involved. Major depressions are caused by the governments attempts to control them. He is really explaining this badly. The entrepreneurs who ran banks and got bailed out were being very rational. As were the many people who made tons of money in real estate.

  16. His critique that business owners wouldn't be tricked is not very realistic. Being a great entrepreneur doesn't mean you understand monetary policy or economics. When expanding your business you are put in a situation where you need to trust the price system and that includes the price of interest rates to determine the profitability of your business.

  17. The sad part of watching this is Paul Krugman has his own column, because he's a "prominent economist" but I can barely read him because he just repeats the same talking points you hear in the Dem's campaign commercials. Yet this guy actually teaches you something about economics.

  18. An entrepreneur doesnt have to be a genius to acknowledge inflation. How ever, it take a sharp mind to figure out at which point the whole thing will turn around. Until that point, there might potentially be alot of money to make. So even though they know about inflation the desire for a better standard of living are likely to cause a different decision. There would not have been a housing bubble if people only had to recognize inflation.

  19. Of course business cycle are recorded to be caused by monetary contraction. But the problem in the first place is the foregoing monetary expansion. its the same as hangover is not caused by drinking alcohol, hangover comes when you stop the drinking of alcohol. ofcourse that is true, but you would most likely not have had a hangover if you hadn't been drinking alcohol in the first place.

  20. It's not about whether or not entrepreneurs realize that there is inflation; it's about competing with all the other businesses who also want to make money off the boom. If you don't expand, someone else will take advantage of the easy credit and take your spot in the market. Competition forces businesses to take advantage of the easy credit and interest rates putting them in a tough spot when the whole thing comes crumbling down.

  21. Wasn't the Monetarist's view of the great depression that the FED allowed the money supply in the US to drop significantly?

    I'm no expert, so if I'm wrong, let me know, it's always good to be informed. 🙂

  22. So homeowners were competing with each other to see who could get the biggest house due to inflation fearing their neighbor might get a better house then them, hmm.

  23. no i was speaking specifically about capital investment in that comment. However the same low interest rates that cause inflation do also incentivize people to buy homes they cant actually afford.

  24. "speaking specifically about capital investment" According to the ABCT the homes would have had to been the capital.
    " incentivize people to buy homes "Why homes, at most what the ABCT can do is say that lowering the interest rates is pouring gasoline on a fire, but it can't what caused it.

  25. I am for free floating interest rate genius, doesn't mean you have to tie the money supply to a metal with no tangible benefits. Digging up gold from SA and burying it in a vault in NY is a waste of labor & capital.

  26. You do know that you're free to change currency right? No one is stopping you from changing dollar to franc, yen or even gold.
    No I support a sales tax with rebate. It discourages spending & encourages savings.
    Dollar is not going to crash.
    Dollar is not going to crash. You know why all the quantitative easing hasn't showed up as inflation? Because there is high demand for the dollar in the world, and will be as long as it's the reserve currency.

  27. True, there is an amazing article about how rational expectations would actually make things worse (prisoner's dilemma) on mises.org, forgot the author.

  28. I don't know how true that is. Do you have any source for that? Banks don't usually deposit more than required in reserve ratio. They can also make more money lending than interest on reserves.

  29. The 2nd criticism is entirely invalid. Austrians argue that the monetary contraction (or a slow in the monetary expansion) is the trigger that ends the boom and begins the bust.

    In addition, his criticism assumes to know what is causing the business cycle (monetary contraction). How can you reasonably criticize a theory by assuming the theory is wrong?

    It would be great if he could re-state his 2nd criticism more clearly.

  30. In the US you actually aren't very free to change currency. There are significant taxes on non-Fed currencies. Passing gold/silver as money is explicitly illegal in many cases.

    I'd be happy to dig up the references if you need them.

  31. Dollars would not be worth zero very quickly. First, taxes would still need to be paid with dollars. Get-out-of-jail-free cards are inherently valuable 🙂

    In addition, there are also so many contracts priced in US dollars that it will take a lot of time for people to switch their contracts to some other currency.

  32. The banks don't lose from inflation.

    1) It is the banks that are inflating via fractional reserve banking (the gov't just co-ordinates it). The banks get the new money first, so they start getting interest payments before prices rise.

    2) The banks aren't lending out their own money. The banks borrow from savers. It is the savers who are hurt by inflation, not the banks.

  33. If the entrepreneur can't expand because money is too tight, then he shouldn't expand. Entrepreneurs bid up the interest rates. Those with the highest-return projects will bid the most and therefore get the loans. This is good.

    There are essentially an unlimited number of things that entrepreneurs can invest in. We _shouldn't_ be investing in all of them. A free market in money, even if it is "tight" is the best way to decide which projects get investment.

  34. Not really. Actually, he could turn their investment from long term projects towards shorter-term less risky investments – unless you assume that entrepreneurs can be, as Dr Cowen pointed out, "tricked by monetary policy".

  35. In theory, as the money supply decreases, the purchasing power of each dollar increases. Therefore, as people lose money, the money that they have is worth more.

  36. Not really – if one think is real (ie adjusted) terms. Only if the money supply decreases to a degree which is smaller than the demand for money. Real prices level is determined rather by those who demand money.

  37. short term decline in living standards (contraction) to ensure a stronger, more sustainable recovery in the long term (non-artificial expansion, proper allocation of resources, restoration of a healthy middle class)

  38. competition forces businesses to make dumb myopic decisions? you don't have much respect for the intelligence of business owners…

  39. No, it's not the competition in and of itself, it is rather the malinvestments due to artificially low interest rates and inflation that drives entrepreneurs out of business. The competition just forces them to gamble more. Gambling in a universe where money is arbitrary is speculation and speculation has an increased rate of failure.

  40. Re: Austrian Weakness: it paints entrepreneurs as foolish in an otherwise ideal market.

    I think this misses a point. The loose credit market interest rates are prevented from responding to demand and rising, lowering demand. The loose credit, held low by a central price control mechanism is a subsidy that doesn't merely fool existing entrepreneurs, but encourages new "entrepreneurs" speculators and gamblers. The interest rate is the gatekeeper that keeps idiots out of business.

  41. The criticism that entrepreneurs are easily fooled is a straw man.
    The Austrians recognize quite well the lag between expansion of a money supply and the attendant inflation; this mechanism very easily gives the false sense of security which is needed.
    Indeed, even right up until the month before the 2008 crisis people were saying the housing market was fine, The same right up until the crash of '29.

  42. Also, it's very possible to successfully ride a bubble and then sell before the bust. Even entrepreneurs who know ABCT might attempt that, thinking that they'll be able to see the signs and sell in time.

  43. There were two national banks in the early 19th century. Also, after the second was killed, the state banks effectively took over the role of the national bank. Even after that ended, there were still problems caused by government policies which protected banks against bank runs, so credit expansion by private banks was encouraged. It wasn't all bad, though. 1846-1861, the pre-war, pre-reconstruction independent treasury years were very stable years, apart from a brief, minor recession in 1857.

  44. Also, economists lately have been looking at the 1873s-1879ish "long depression," which was long believed to have been the worst depression before 1929, and many have noticed that that period saw significant increases in per-capita real GNP and in real (deflation adjusted) household income. So the worst "depression" of the 19th century really wasn't a depression at all.

  45. Do Austrians really say ONLY the government can create an inflationary boom? I would think a private central bank could do it just as well. Seems to me the point is that these booms are created when interest rates are set by something other than market forces, which almost always implies some kind of monopoly price-setter, public or private.

  46. I would reject the theory that Business Owners are smart enough not to expand beyond their means. There is no way for them to look forward and say "we were at the top of the bubble".

  47. Professors teaching birds to fly. If you look outside your narrow range of argument you find that booms are the product of a change in technology or instruments, then the bust separates the competent.

  48. You don't think booms like that grows even more by the fact that it's much easier to borrow than it wouldn't have been if it weren't for government intervention?

  49. It's pointless of talking about private vs public, when the private in this context is nothing but a consequence of government policy.

  50. From what I gather, I believe it IS the private central bank (FED) which does exactly as you mention. Asides from a central bank you have separate competing banks. They do not have the power to create currency but they can relax their borrowing standards which increases the supply of money. The question is, do competing private banks yield the same power as a Central bank which does not compete.

  51. Exactly! Everyone, including entrepreneurs are uncertain about the future (after all, it is uncertainty that drives entrepreneurship in the first place).

    Even if the entrepreneurs believed the Austrian theory (which is most likely not the case), they still have an incentive to borrow from the cheap credit because if they do not, their competitors will and they will suffer.

  52. Exactly this. I'm surprised Tyler misinterpreted this point in his explanation.

    The market can remain out of whack for longer than you can remain solvent.

  53. I don't know anything about economy. I just saw some basic vids about the Keynsian method and this. But the way the Austrian model has been represented here, I can only conclude that it's useless as it seem to apply in a very limited way.

    So to understand economy better, where do I go from here? I really could use help. Thanks.

  54. Are you looking for general economics resources or do you want to focus on the business cycle? Learn Liberty videos are a terrific primer. If you're looking for a curriculum to follow, I've been taking free online courses at Saylor

    saylor.org/majors/economics/

  55. Basically the cycle, and seen from the perspective of the various models (Keynes, Austrian, etc) just beyond the basics. Learn Liberty seems slightly biased to me and if not, it's too introductory.

  56. The Keynsian economic model is flawed it the fact that it is short sighted. Even Keynes would admit that he didn't look at the long term effects of his remedies. He looked at the economy as static. He was very much against savings and focused on increasing spending, but he failed to realize that saving ensures future spending. The Keynesian method leads to massive accumulation of debt. Debt repayment limits spending, so the trade off is short economic gain followed by an economic loss.

  57. The problem with the great depression was the gold standard. If the money supply is static during a boom period, deflation occurs. Deflation causes a reduction in spending which causes a recession or depression. Savings, investing, and consumption spending all are important, but need to stay within a certain balance for a healthy economy. Inflation and deflation both create an imbalance. Part of the reason for the business cycle is a failure of the monetary system to adjust properly.

  58. Ok during the contraction or bust where he says the Austrian theory doesn't apply is dead wrong Because those who Didn't fall for the sucker bet of cheap credit and over leverage now have the opportunity to buy at a vastly reduced price the choice bits of failed companies assets IE JP Morgan after the crash in 1929 swept up huge resources with the profits from shorting the market after he caused the bank runs and after that he and his friends got the right to print money! what a deal!

  59. Someone wrote that because of gold, the money supply was static, that caused deflation and great depression. Further from the truth. There was an great deal of expansion in credit in the 20`s, mostly caused misguidedly by Government. When it burst more credit was pumped to the economy and nothing. Salaries were not allowed to fall with deflation. No new investment was done and the middle class found out that they were not rich at last, that all the appliances and houses bought on credit did not really belong to them. Any resemblance with now is pure coincidence.

  60. Interestingly enough, Milton Friedman argued that the great depression was prolonged by the Federal Reserve keeping the money supply too small. 

  61. It seems to me that the businessmen is not tricked, but he has to follow the herd otherwise he loses.. any bank before 2008 which did not participate in the house bubble had worse performance than the others until the bubble  burst

  62. http://mises.org/daily/2673

    "A common argument against the ABCT is that entrepreneurs are too smart to be fooled by Fed intervention."

  63. I think the Austrian Business Cycle Theory was more relevant to Europe during the Great Depression than the United States.

  64. Just watched it. His critique of the Austrian theory, towards the end, that entrepreneurs are not easily fooled – while sound in theory, is not true in practice. For many reasons, they are willing to be 'fooled'. There is the question of horizons. People do not think long-term. They could be in denial. Quite disappointing to note this shallow criticism of the Austrian school. There are many angles in which they can be criticised. But, not this one.

    Been three years since the video was published. I hope he has had a rethink on it.

  65. My critique of this video:

    1) Interest rates – Given that the government is in no way monetarily constrained, that is, the government can never not have money to pay it's bills, interest rates aren't really an indicator of anything, The Fed targets a particular rate and simply buys and sells bonds to meet that rate. In sovereign money fiat economy with the political (not economic) restrictions removed the natural rate of interest is zero.

    In this sense, interest rates cant tell anyone anything except what the Fed believes is prudent policy.

    2) The housing bubble – The cause of the housing crash goes much, much deeper than simple easy credit. The failure starts in 1998 when, under Clinton, the country runs a surplus. During this period, from 1998-2003 over $2 trillion dollars is drained from the economy. Take the aggregate of government spending and exports (things that add money to your economy) and subtract it from taxes and imports and you get something that looks like this (11.2+4.3) – (11.2+6.8)= negative 2.197 trillion that's (G+E)-(T+I). That's $2 trillion dollars removed from the economy in just 5 years!

    Now I would argue that when you allow that much money to leave your economy something has to fill that void. And from 1998-2007, the supply of money shifts to the private sector. In the 6 year period prior to 1998 (1992-1997) the private sector borrows (mortgages and credit cards) approx $1.8 trillion, in the 6 year period after 1998 (when the government begins running the surplus) the private sector borrows roughly $5 trillion. That's more than 100% increase in private sector borrowing!!!

    Now saying that this is fed entirely by "loose credit" isn't telling the whole story. While I would agree that loans were given to people of poor credit, the underlying problem is one of risk, or more to the point, the risk that was allowed to remain hidden. Even if I conceded that the government forced private companies to make loans to people with poor credit, the government didn't force the industry to hide the risk in MBS', though the government did fail to properly uncover it. If investors had known the true risk in the MBS' they were buying they never would have entered the market as they did and the market for subprime would have stopped in it's tracks.

    Investors would have demanded much higher returns for the risk involved in sub-prime MBS's being sold. This "information" as Austrians like to point out would have had a profound affect on the market for mortgage products. Credit to low credit borrowers would have either stopped or the interest rate would have risen for those borrowers, again, giving the market useful information. I suspect that under those terms, many poor credit borrowers would have turned down the opportunity to buy if interest had been much higher reflecting the true risk of potential sub-prime borrowers.

    The industry didn't care because it was allowed to hide the risk and then sell it back to an unsuspecting private sector.

    In the end, once people had assets to protect and the economy started to stall, people naturally looked to protect their assets via borrowing. Wages were falling and unemployment was increasing at the same time debt as a percentage f income was rising. A perfect storm of bad conditions…..

    3) Gold standard or monetary rule. One need only look at the history of recession and depression under gold and since 1913 to know that we're better off….

    As far as a "monetary rule". How about industries be held criminally accountable when they hide the risk of their products to the public? That would have solved the housing crisis problem.

  66. No no, the austro business cycle theory is perfect. Fewer entrepreneurs would be fooled if they understood the problems of loose monetary policy. For example if everyone had the same knowledge of economics as Peter Schiff, there would be very little malinvestment. But most people get seduced by cheap money.

    Also the busts that were "caused by monetary contractions and not the previous expansion" does not undermine ABCT at all. If there was no artificial boom (even though there probably was), the contraction of the money supply must have been a deliberate policy by the issuers of money. If the government decided to rake in the money supply by 99%, you can be sure there will be some shocks to the market.

    The ABCT argues that no institution should have a monopoly over money. The market should determine money, otherwise you have these failures. If you oppose rent controls, you should also oppose central control over the money supply, because it's the same thing with the same scientific principles… except one is the price of using land and the other is the price of using money…

    You can't fuck with the Austrians, baby 😉

  67. I know the argument is that entrepreneurs should know they are being tricked, but there are problems with that counter argument that I have yet to hear explored. How much is the deception by? How should an entrepreneur adjust the amount by? Also, there is the problem of timing and coordination.

    I imagine how hard grocery shopping would be if I weren't allowed to know information about the value and prices of all goods including the food I purchase. Even if eventually I get a bill in the mail that reflects an approximate value of the food I purchased months ago, the time for that knowledge to have utility has since passed. The relevant knowledge is the current marginal utility which inflation obscures. Likewise for houses. Also, if the victim of extortion refuses to use the services offered by the extortionist though the services are valuable, then the loss is even bigger than had the extorted went along. If I try to fight inflation by renting a home and saving money I will simply lose money faster than had I recovered a fraction of the value of the fraud/extortion by going along.

    After reading The Use of Knowledge in Society by Hayek, I'm convinced that this is not a solvable problem. Once the information is destroyed b there is no way to reconstruct what it should have been. That is one reason why government intervention always leads to chaos and socialism never achieves the goals of socialism.

    I would really like to know what consumers and entrepreneurs are supposed to do in the face of fundamentally obscured knowledge, and it seems an impossible problem to fix possibly required a solution to the socialist calculation problem or Hayek's knowledge problem of central planning.

  68. I think a weakness of the Austrian theory is that it poorly explains recessions and depressions which occurred when the currency was, in fact, tied to a gold or silver standard. Its success at predicting collapse under the Federal Reserve System is due largely to the fact that Austrian economists grossly overpredict. If we take type-I statistical errors into account, the Austrian theory has a lousy track record… which isn't too surprising given that the Austrian school is more interested in rationalistic axioms than empirical evidence.

  69. Yes, businessmen know that interest rates are artificially low, but there's a couple of reasons they still start new projects. One, they may perhaps assume that the central bank will keep interest rates low, so that projects with lower returns will still be profitable. Two, given the complexity of the economy, it is difficult to say exactly what sectors of the economy will have a bubble; it's not even necessarily obvious that it is a bubble until it starts to falter. Nobody complains about the economic boom of the Roaring 20's, only the bust of the Great Depression. But if ABCT is right, the Depression couldn't have occurred without the boom of the 20s.

  70. The only real sollution is having no fiat currency and having a freedom to use what currency you want and to create new currencies.

  71. Why did long depression of 1873 and great panic of 1907 happen when gold standard currency was used and least government intervention. Austrian theory is wrong. A better solution is to discourage investments in bubble by taxing the income from any bubble and encouraging more productive ways to earn money by subsidies.

  72. So true! The free market punishes bad ideas, which means there should be an element of extreme caution in building a business. So your classic entrepreneur is far more risk averse when his capital must mostly come out of his own pockets. Under this central banking system, we can make it so that the entrepreneur feels less and less afraid to lose money, hence giving way to bad spending and risks being taken that in different conditions may have never been taken.

  73. Let's think simplicity…that way it is not too difficult. Why in the world would there be a rapid contraction of the money supply? Simple: Because there first was a loose money policy and inflation, worse, hyperinflation is seen on the horizon. Why? Because of those economists, and politicians who benefit from it whether they believe it or not, realize that boosting the money supply to full create employment and greater than full employment without increasing production capacity results in inflation and eventually layoffs. Yet, they still hate Reaganomics. Now if you create increase productive capacity, supply side, and increase the money supply, inflation will be subdued and if you don't steal by printing more money, than you will have the positive deflation and increase purchasing power for the individual resulting in lower input prices, higher volumes of sales, and increase purchasing power as well as wages.

  74. I think credit definitely plays a role in asset bubbles but i'm not convinced about the whole entrepreneurs are "Fooled" part. I personally don't think people create business because interest rates are low, that's pretty irrational if you ask me. Rather, they anticipate what demand would be in the future for their products.

    The housing crisis may be a good example given in the video however, in saying that who decides its a good time to build a house because rates are low? it's a pretty big decision to make when you invest into your most valuate asset (Houses are typically the most expensive asset a individual has). Unless of course people are looking to flip their homes in a few years… or a very active real estate market are pushing houses.

    Another reason might be that individuals anticipate low interest rate environments and hold back on purchasing a home until the credit is easily available then buy, people wouldn't buy two homes but larger than needed homes to maximize their gain (If of course they are flipping their homes) which might just explain the large homes that were purchased during the boom times.

  75. Tyler Cowen rocks. But I could seriously only listen to about 30 seconds of this before the background music got too much and I gave up.

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