1. The Austrian Business Cycle Theory The Madness of Monetary Policy
L. von Mises
D. Ricardo
M. Rothbard
I. Why are there business cycles?
II. The capital structure.
III. Interest, time and the unsustainable boom.
ECO 473 – Money & Banking – Dr. Dennis Foster

2. I. Why are there Business Cycles?
Flaw of Capitalism/Market System
Observable since late 1700s.
Something inherent in the market.
Under-consumption theory.
“Insufficient spending” causes depression.
J. M. Keynes
K. Marx
T. Malthus

3. No, Really, Why are there Business Cycles?
Any theory must explain the following:
Tendency towards repetitive cycles.
“Mammoth” cluster of entrepreneurial errors.
Why depression is more intense in K-goods.
Why retail is the “last and least” to fall.

4. No, Really, Why are there Business Cycles?
Hume/Ricardo & Classical Economics:
It’s not markets, but banking that is the key.
D. Hume
von Mises & the Austrians
Central bank precipitates cycle by  i.
Increased Investment unsustainable.
Eventually, a recession results.
Explains all the salient features of cycle.
D. Ricardo
F. Hayek

5. How should gov’t. address Business Cycles?
von Mises & the Austrians
Stop inflating money in the first place!
Don’t bail out troubled firms!
Don’t inflate to get out of the depression!
Don’t encourage more consumption!
F. Hayek
What are & have we been doing?

6. Capital Structure and the ABCT
Lessons:
To consume, you must produce.
To consume more you must save.
Adding more money doesn’t create more resources and distorts the capital structure.
When the false promise of this money is revealed, long-run investment plans collapse and resources are wasted.
In the real world, the Fed pumps money into the financial sector, not real resources. A boom ensues that cannot persist.
L. von Mises

7. Interest & Time in the ABCT
Interest rates:
Usually referred to as the “time value of money.”
It is a (real) price signal.
It coordinates production across time.
It changes as our time preferences change.
We prefer more goods now; time preference rises; savings falls; interest rates rise. Or…
 time preference = want more current consumption and less future consumption.
 time preference = want less current consumption and more future consumption.

8. Interest and the Loanable Funds Market
S’LF
SLF = (real) saving
interest i’ i*
DLF = investment
LF’
LF*
Loanable funds
If our time preference rises and we want more current consumption, SLF falls and i rises.
If our time preference falls and we want more future consumption, SLF rises and i falls.

9. Interest & Coordination in the ABCT
Time preference rises …
We save less.
Interest rates rise.
Investment plans most sensitive will be scrapped.
Consumption goods prices rise.
Resources reallocate from Investment to Consumption.
Disruption depends on how fast preferences change.
Time preference falls …
We save more.
Interest rates fall.
Investment plans most sensitive will be started.
Consumption goods prices fall.
Resources reallocate from Consumption to Investment.
Disruption depends on how fast preferences change.

10. The ABCT & the Unsustainable Boom
The Fed MS to i and I (and employment)
But, there has been no change in time preferences.
Investment competes with Consumption for resources.
Initially slack resources get used.
Eventually, C and I will bid up resource costs.
Inflation results, I falls and the Fed further MS.
Effects can only be temporary.
Fed actions will keep investment plans going even though inflation is pushing up interest rates as well. But, this only gets worse until the Fed halts its actions & ...

11. The Austrian Business Cycle Theory The Madness of Monetary Policy
L. von Mises
ECO 473 – Money & Banking – Dr. Dennis Foster