Austrian business cycle theory

Glossary definition: The periodic alternation of upswing (boom) and crisis or recession. In the Austrian theory it is caused by credit expansion.

In plain words

The business cycle is the recurring sequence of a boom, when firms expand and employment grows, and a crisis or recession, when many of those plans are abandoned.

The rate of interest is the price of time: it shows how willing people are to save rather than consume now. When the central bank and the banks create new credit and push the interest rate below the level that real saving would bring, that signal is falsified.

An example

With cheap loans entrepreneurs start long-term projects, such as new housing, factories and shopping centres, as if the resources to finish them had been saved. But consumers have not saved more; they are spending too. Prices of materials and wages rise, interest rates go up, and it turns out that many projects cannot be completed: the half-built buildings are the boom’s “malinvestments”.

The Austrian viewLudwig von Mises set out the theory in The Theory of Money and Credit (1912), and Friedrich A. Hayek developed it in Prices and Production (1931), building on Böhm-Bawerk’s theory of capital. The bust is not the disease; it is the cure, the necessary liquidation of malinvestments. New credit expansion to “save” the boom only postpones and enlarges the crisis. There is one prevention: no credit created without real saving.

In the original“But a business cycle research institute is of no help in endeavors to avoid the recurrence of depressions.”

Ludwig von Mises, Human Action, XXXVIII. The Place of Economics in Learning · 1. The Study of Economics · mises.org ↗

Definitions are from the site’s Glossary; the examples and the “Austrian view” are Praxeologos’s reading. Links to outside sources open in a new tab.