Austrian Business Cycle Theory: Dinosaur Economics

dinosaur bones

Just a very quick note so as to weigh in on a debate which, frankly, I don’t really want to weigh in on. It relates to the Austrian Business Cycle Theory (hereafter: ABCT) and its relationship to the natural rate of interest. The natural rate of interest was discredited by Piero Sraffa in the 1920s when he pointed out that there were actually multiple own rates of interest depending on which commodity you took as a numeraire. There have been many Austrian responses to try and iron this out — almost all of them imagine a range of financial market contracts, throw in some implicit “rational expectations” assumptions about how such contracts are priced and then claim that they can reconstruct the ABCT from here.

I don’t think that this is the case, I think that the assumptions they use to make the financial contracts produce the interest rate they wish to produce — because, let us have no doubt, this is a theory that at some base emotional level the Austrians want to be true — contradict other assumptions made elsewhere in Austrian theory; such as the assumption of Knightian uncertainty.

However, even leaving this aside we know that the ABCT will not work because, whatever way you cut it, it rests on the idea of a rate of interest that will bring the economy to full employment equilibrium. The manner in which the theory “works” is that the money rate of interest — i.e. that charged by banks — either falls above or below this full employment equilibrium rate, thus causing either inflationary or deflationary forces to generate. This view, however, is disproved by the Cambridge Capital Controversies which showed that such a rate of interest — which the Austrians take over from Knut Wicksell — cannot exist.

Here I will quote Peter Kriesler summarising the argument made by Colin Rogers in his extensive book on monetary theory, Money, Interest and Capital:

Wicksellian monetary theory relies crucially on the concept of the natural rate of interest which has logical flaws which are now recognized as having been exposed by the Cambridge capital controversies. The natural rate of interest was derived from the interaction of forces within the real sector, and determined the equilibrium monetary rate of interest. The natural rate of interest is derived from Wicksell’s capital theory on the assumption that all forms of capital must earn a uniform rate of return. The natural rate is the price which determines the equilibrium of savings and investment. By applying the results of the Cambridge critique of neoclassical capital theory to Wicksell’s concept of the natural rate of interest, Rogers is able to show that it has no rigorous theoretical foundation. Since, for Wicksell, it is the natural rate which determines the market (or monetary) rate of interest, this leaves Wicksell’s monetary theory also without foundation. (Pp52)

It also leaves the ABCT without foundation as this theory relies on the notion of an interest rate — call it the “natural rate” or the “equilibrium rate” or whatever else you want — that, as Kriesler says, “determines the equilibrium of savings and investment”. But this notion does not stand up to the results of the Cambridge Capital Controversies.

And just to wrap this all up I will quote Austrian economist Robert Garrison on the origins of the ABCT and how it relies crucially on Wicksell’s ideas on monetary theory that I have laid out above:

Grounded in the economic theory set out in Carl Menger’s Principles of Economics and built on the vision of a capital-using production process developed in Eugen von Böhm-Bawerk’s Capital and Interest, the Austrian theory of the business cycle remains sufficiently distinct to justify its national identification. But even in its earliest rendition in Mises’s Theory of Money and Credit and in subsequent exposition and extension in F. A. Hayek’s Prices and Production, the theory incorporated important elements from Swedish and British economics. Knut Wicksell’s Interest and Prices, which showed how prices respond to a discrepancy between the bank rate and the real rate of interest, provided the basis for the Austrian account of the misallocation of Financial capital during the boom. The market process that eventually reveals the intertemporal misallocation and turns boom into bust resembles an analogous process described by the British Currency School, in which international misallocations induced by credit expansion are subsequently eliminated by changes in the terms of trade and hence in specie flow. (My emphasis)

Put a fork in it. The ABCT has been a dead duck for years. Which leads one to wonder why Hayek received the faux-Nobel for it — which he received, ironically enough, joined with Gunnar Myrdal, Wicksell’s student who overturned the Wicksellian monetary theory!


About pilkingtonphil

Philip Pilkington is a London-based economist and member of the Political Economy Research Group (PERG) at Kingston University. You can follow him on Twitter at @pilkingtonphil.
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41 Responses to Austrian Business Cycle Theory: Dinosaur Economics

  1. Jan says:

    Excellent take on the ABCT Philip!Yes as a Swede and familiar with the Swedish tradition that use to be called Stockholm School,and what turned out be as identical to Keynsianism that you could not really differ it as separate school in the end.You probarly know, Bertil Ohlin a friend to Keynes, coined the term Stockholm School in his , “Some Notes on the Stockholm Theory of Savings and Investment” Economic Journal in 1937.What he basicly wanted to show was that, a Keynsian revolution have been taken place in Sweden at the same time and independently as J.M Keynes formed his ideas in Cambridge.But what is interesting to me is when i see the Austrians so slavishly and very narrow and uncritical interpret the Wicksellian Natural Rate concept. It is so different from how Wicksell´s own adepts treated old Knut´s work.There was from the start a much more open debate and even open rejection and disputes about if there was much use or even existence of some sort of “Natural Rate”.They revolted against their mentor Wicksell in an open and lively but friendly way in discussions,there Wicksell himself was apart to his death 1926.There is almost an anthesis to what seem to be the way in Austria with such as Hayek and Mises,when they dealed with old Wicksell.
    For exampel Erik Lundberg
    in his 1937 “Studies in the theory of economic expansion” and Erik Lindahl in 1939: Studies in the “Theory of Money and Capital” dealed with buisness cycles with in
    a fare more open and variated form and they were Wicksell´s own students.
    But what i could see ,is that Austrians treat Wicksell in a regressive way,fare apart from what Wicksell did with his own theories.Wicksell i guess was never a true “Wickselian” he was very selfcritical,and he himself,seem to struggle with if the Natural Rate was even a useful thought-model,to elaborate with.But Austrian´s in my view is some sort of “Bastard-Wicksellian´s”!I can´t see much of Wicksell in their attempt to use his work!Have a great week Philip!
    By the way i just read this one about the Cambridge Capital Controversy
    Essays in Honour of Geoff Harcourt Volume One
    Edited by
    Philip Arestis, Gabriel Palma
    and Malcolm Sawyer

    • 100%! I read Gunnar Myrdal’s abridged English works at the same time as I read Keynes. They are the same ideas. I also read Wicksell in the original and he is pretty flexible and a good economist. It is the Austrians that tore him out of context and ruined his legacy.

      The Stockholm School was very important and needs more recognition among Post-Keynesians. In fact, in the next week I’m going to do a few posts on Myrdal’s writings and maybe LK will oblige by responding. It’s a discussion worth having.

  2. Meng Hu says:

    What you think about the ABCT is wrong because of your poor understanding of the austrian theory. The CCC is irrelevant to that. What the ABCT is all about is the distorsion of relative prices, through signals in “expected” profits. Go here, if you want to understand why.

  3. Meng Hu says:

    No, you are aware of nothing at all. I didn’t comment much earlier, pointing to my article instead and hoping you’ll say something. Apparently I have over-estimated you.

    But enough with that. You misinterpret the ABCT by saying the interest rate must decline. It’s not always true and Rothbard as well as H de Soto both argue it’s possible within ABCT prediction that the interest would rise during the boom (see my article). What is relevant is the interest rate(s) that happen to be below the equilibrium, and this condition may happen independently of changes in interest rates over time.

    The core of ABCT is about time preference, and you should focuse more about that, rather than on interest rates per se.

    Equally important, is the comment made by Hayek below, in his The Pure Theory of Capital :

    It is evident and has usually been taken for granted that methods of production which were made profitable by a fall of the rate of interest from 7 to 5 per cent may be made unprofitable by a further fall from 5 per cent to 3 per cent, because the former method will no longer be able to compete with what has now become the cheaper method. It is true, however, that it is scarcely possible adequately to explain this, if one thinks only of the direct effect of a change in the money rate of interest on cost of production, and does not proceed to consider the changes in relative prices which ultimately govern the profitability of the various methods of production. It is only via price changes that we can explain why a method of production which was profitable when the rate of interest was 5 per cent should become unprofitable when it falls to 3 per cent. Similarly, it is only in terms of price changes that we can adequately explain why a change in the rate of interest will make methods of production profitable which were previously unprofitable.

    The most important conclusion, then, which emerges from this discussion is that the method of production that will be adopted, or the proportional amount of capital that it will be profitable to use, will depend not on the rate of interest at which money can be borrowed but on the relations between different prices and the shape of the profit schedule (or investment demand schedule) as determined by these price differences. And these relative prices will in turn depend on the relative scarcity of the various kinds of resources compared with the direction of demand. The rate of interest will, in the main, determine only to what point on the schedule investment will be carried, that is, it will determine only the marginal rate of profit, and, through the latter, it will exercise a minor influence on the volume of ontput that it is profitable to produce with a given demand. The volume of investment, however, will depend as much if not more on how much investment it will be profitable to undertake in order to obtain a certain output. And with a high “rate of profit” any given marginal rate of profit will be reached with relatively little investment per unit of output, because with a high rate of profit the investmend demand schedule will be steep, while with a low “rate of profit” the same marginal rate of profit will only be reached with much more investment per unit of output, because the investment demand schedule will be flat. [1]

    And here’s another devastating paragraph, from Hayek’s Profits, Interest, and Investment :

    The remarks of the last section on questions of trade cycle policy have inevitably been cursory and incomplete. There arises, however, in this connection one point which is closely connected with our main problem and therefore needs more systematic consideration, namely the precise role played by the rate of interest. So far our main conclusion with respect to the rate of interest, rather borne out by recent experience, is that we might get the trade cycle even without changes in the rate of interest. We have seen that if the rate of interest fails to keep investment within the bounds determined by people’s willingness to save, a rise in the rate of profit in the industries near consumption will in the end act in a way very similar to that in which the rate of interest is supposed to act, because a rise in the rate of profit beyond a certain point will bring about a decrease in investment just as an increase in the rate of interest might do. This, of course, does not contradict the truism that a high rate of profit, if general, makes for prosperity.

    I hope you can do better than the poor article of yours here. If the only comment you’re capable to make is “the ABCT can be made to say basically anything” I can tell you I’m not impressed.

    If you want, you can invite your best friend (what’s the name already, ah, Lord Keynes ?) to come here. And try to distort the ABCT once again as he has always did and he will always do. Guys like him or you surely never read Hayek’s work. At least, not seriously. To show you the interest rate is not what should be focused on, see what Mises said in Human Action :

    If a bank does not expand circulation credit by issuing additional fiduciary media (either in the form of banknotes or in the form of deposit currency), it cannot generate a boom even if it lowers the amount of interest charged below the rate of the unhampered market. It merely makes a gift to debtors. The inference to be drawn from the monetary cycle theory by those who want to prevent the recurrence of booms and of the subsequent depressions is not that the banks should not lower the rate of interest, but that they should abstain from credit expansion.

    The creation of credit “out of nothing” is what matters. Thus you don’t need to think about the “natural” interest rate(s) or whatever is like. Just thinking about how credit over-supply can distort relative prices and cause entrepreneurs to misinterpret the price signals. I have reviewed virtually all studies on the empirics of ABCT and I can tell the theory should be taken very seriously. And not like the mess you’re making out of it.

    There are more comments from the austrians on the CCC. You have also Huerta de Soto’s argument which says that re-using a method known as less capital-intensive as a part of the new, more capital-intensive production structure is in fact a proof that such effect of reswitching is (or may be) the product of lengthening in production structure through more investments in more capital-intensive structures. In that case, he says, you can’t say the re-use of these less capital-intensive methods should be seen as less capital intensive because they are incorported in the new, more capital-intensive structure. For more details, see my post, again.

    On a final remark, there are non-austrian guys who ridiculize themselves by strawman-ing the ABCT and as a result get the boomerang right back to them, such as this clown of Noah Smith. But you also have more serious guys like Daniel Kuehn who knows more (and probably have read more) about what they are talking about. I hope you’re more in the second category than the first.

    • Just thinking about how credit over-supply can distort relative prices and cause entrepreneurs to misinterpret the price signals.

      Unfortunately for you the money supply is not strongly related to the price index:

      Queue: some evasion that says that the CPI is not the correct measure; that individual prices matter; or that Misean ‘praxeology’ states that empirics don’t matter.

      By the way, a note on style. Your zealous tone makes you sound like a self-important cultist. Tone it down.

    • Meng Hu says:

      I doubt you have read this comment within only 3-4 minutes. Also, after looking at your post, I’m convinced you do not understand what ABCT is all about. And that you also misread my comment. I talked about “relative” prices. You clearly don’t know what it is. Ask austrian scholars and they will tell you (without any doubt) that the ABCT does not predict the prices will be on an increasing trend during the boom. The money supply increase sharply during the 1920s without changes in “overall” prices (and perhaps even a slight drop) but all austrian scholars I have read are well aware of that. I am also very disappointed by you ignoring my link about the empirics of ABCT. The theory is well supported.

      Talking about zealous tone, you’re the one here to say the ABCT is dinosaur economics. Thus, that comment of yours is surprising.

      • Relative prices? Relative to what?

      • Meng Hu says:

        I thought it was obvious. Some prices go up faster than others. Or some prices go up (especially asset prices) but consumer goods do not. Normally, austrian theory predicts the prices of capital goods among industries of early stages (such as mining, manufacturing, etc.) to rise relative to prices among industries in the late stages (such as retailing, wholesaling, etc.). The late stage industries are those said to be closer to the final consumption good. But the ABCT also predicts that at a late stage, the consumer goods will begin to rise as well. That’s because the rise in prices among industries producing capital goods will result in higher wages for workers in these industries and they will end at some point to use the new money to but consumer goods. Of course, it depends on how the authorities react. If they attempt to end the boom through a rise in interest rates before the consumer goods prices go up, I do not expect them to rise, and this will not contradict the ABCT.

      • “Normally, austrian theory predicts the prices of capital goods among industries of early stages…”

        No evidence of this:

        A linear regression yields a flat trendline and a shockingly low R-squared of 0.000006.

        I have literally never seen a theory more completely falsified.

      • Meng Hu says:

        I have linked to the empirical studies of the ABCT. These econometricians agreed we should take the ABCT very seriously. You ignored it once, and you continue to ignore it again.

        Although you show me graph with M3 against producer prices, I was already aware that most studies do not support such a relationship. My link summarized these studies. But they show that most investments are made in producer goods but except from the Wainhouse study, they have not necessarily have larger growth than consumer goods. The ABCT is not necessarily falsified because you have to factor out the external influences over time. When more investment are made in these industries, as the empirics show, you should expect a subsequent change in relative prices of the same direction and magnitude. I don’t see it, and you don’t see it either.

        If you click on my link, look for Anker’s table 4.3. It appeared that relative price is not meaninful predictor but “spread” and “dep” variables are meaningful. The spread was defined as the difference between long and short-term rates (the first is a proxy for the natural rates and the second is the market rates). The ABCT predicted the larger the spread the larger the consequences. Such prediction was borne out. DEP variable was the ratio of consumption/investment expenditure. And it, too, supports the ABCT. So, although these econometricians agreed the PPI/CPI ratio do not follow the ABCT prediction, the mechanisms were fully consistent with the ABCT, and they rightly conclude the data supports the theory. Why then, the PPI/CPI ratio do not follow the expectation of ABCT ? Perhaps because of external confounding factors that may hidden the PPI/CPI ratio to change accordingly to the theory. However, I can easily think of how austrian scholars can counter your argument; they would merely say that the PPI/CPI ratio would be lower than what has been observed in the data, regardless of its trend over time, if there was no money over-expansion.

      • Meng Hu says:

        “But they show that most investments are made in producer goods but except from the Wainhouse study, the capital good prices did not necessarily have larger growth than consumer goods prices.”

        My sentence seems terrible, but I corrected it anyway.

      • Evasive garbage. I’m done with this. Thanks for the chat.

        The theory either says nothing that we don’t already know or it makes incorrect predictions that have to supplemented by ceteris paribus conditions.

        If you want to get my attention come up with a firm prediction and I’ll check it against the data. Otherwise you’re just talking waffle.

      • Meng Hu says:

        I show you the data, in fact, support the theory and what you say is “evasive garbage” without even bothering to look at the article ? It’s not serious, you know that. Also, if you’re right about the idea that mainstream economists say the same things as the austrians, I told you before to cite these scholars. I can cite you austrian scholars if you ask me to do so. And I would expect you to do the same to support your claim. Because I will not accept it without proof.

      • I did cite: Minsky. And he’s not mainstream. He’s a Keynesian. Tobin’s Q open up the possibility for something similar. The list goes on.

        If you want to continue make a firm prediction based on the ABCT that cannot be made without it. Otherwise you’re not serious.

      • Meng Hu says:

        Specifically, I asked you to cite the “sentences” and “parapraphs” where your economists said stuff like “time preference” and “relative price”. You did not do that.

        Concerning the ABCT prediction, I don’t know what to say anymore. I show the links, I told you about the empirical studies but all you have to offer is a hand-waving argument. I will not persist. I know from my stats you have not clicked on the link, because the number of views for that article I linked to is zero, today.

        There are other great studies I can recommend such as :

        Carilli, & Dempster (2008). Is Austrian Business Cycle Theory Still Relevant?
        Young, Andrew T., (2012). The time structure of production in the US, 2002-2009.

        But I’m afraid you’ll not change your mind even if I prove you wrong.

      • I’m not asking for studies. It’s easy to fit a model to data. Any jackass with Eviews can do that.

        I’m asking YOU to make a firm prediction that I cannot make without ABCT. It’s a very simple thing to ask. If you can do this and the results are good I will embrace ABCT. If not, I will not.

        Very simple.

      • Meng Hu says:

        “I’m not asking for studies”

        You’re interested in empirics and yet not interested in empirical studies. Something must be wrong with you.

        For “my” prediction (which will not be specifically mine, but more broadly, the prediction that every austrians will make) it’s like what I said before. You can’t have a business cycle without monetary over-expansion. If you can, the ABCT is falsified. I don’t have any examples of booms without monetary over-expansion.

      • Studies in economics often come to opposite conclusions. If you don’t know that you’re not very experienced.

        Now, you’re beginning to make a prediction. Define ‘boom’ and define ‘monetary overexpansion’ very precisely. Thank you.

      • Meng Hu says:

        “Studies in economics often come to opposite conclusions. If you don’t know that you’re not very experienced.”

        Funny, because this is exactly my opinion about you. I suppose I should ask you to cite some evidence of boom without monetary over-expansion. But you would have asked me to define these terms first.

        By monetary (or credit) over-expansion, I meant a growth in credit supply that exceeds people’s willing to save, by defering/delaying consumption.

        By boom, it’s more complicated. But if you are thinking about what are the characteristics of a boom, here’s Huerta de Soto (1998 [2008]), page 352, footnote 68 :

        Lionel Robbins, in his book, The Great Depression (New York: Macmillan, 1934), lists the following ten characteristics typical of any boom: first, the interest rate falls in relative terms; second, short-term interest rates begin to decline; third, long-term interest rates also drop; fourth, the current market value of bonds rises; fifth, the velocity of the circulation of money increases; sixth, stock prices climb; seventh, real estate prices begin to soar; eighth, an industrial boom takes place and a large number of securities are issued in the primary market; ninth, the price of natural resources and intermediate goods rises; and last, tenth, the stock exchange undergoes explosive growth based on the expectation of an uninterrupted increase in entrepreneurial profits (pp. 39–42).

      • You must more clearly define boom so that I can test your hypothesis. I need something I can see in the data. Might it be fair to say that a boom is always followed by a bust? So, a boom is the period of growth prior to a recession?

      • Meng Hu says:

        Yes. According to the ABCT, a boom is the symptom of credit over-expansion. Because it generates mal-investment, the bust is the final, necessary outcome to be expected.

      • Now, you are aware that the money supply is FAR larger than the total savings of the economy, right? So, I’m assuming that we are talking about growth rates here. Correct?

        So, let’s be crystal clear.

        The ABCT says that when the money supply grows at a faster pace than the growth rate in private savings a boom will take place that will then be followed by a recession.

        Is this a fair characterisation? If not could you give me a suitably modified version.

      • Meng Hu says:

        The above statement should be re-written as follows :

        The ABCT predicts that monetary expansion will cause a lower savings/consumption ratio, and this will in turn cause an increase in the ratio investment/consumption expenditure, and a rise in GDP followed by a drop in GDP.

        However, if you’re going to make a blog article on that, I would not recommend you to cite me. I’m not an austrian scholar. I happened to espouse the ABCT because i’m fairly convinced by its strength. So, you should better read and cite scholars like Carilli & Dempster (2008) or Bismans & Mougeot (2009) or Mulligan (2006) or Keeler (2001).

        With regard to the private saving growth rates, I don’t think it was the kind of variables the econometricians have used to proxy the divergence between people’s willing to save and the credit supply changes. For example, Carilli & Dempster (2008) use the savings/consumption ratio as proxying the natural interest rates. But others, such as, Keeler (2001) used the “spread” in interest rates (divergence between market and natural interest rates). Carilli & Dempster prefer their own variables. Perhaps the best thing is to use both, if possible. But if you want to know, the savings/consumption ratio is the variable proposed by Rothbard as to be the appropriate “time-preference-based” determinant.

        Here’s for example Keeler’s exposition of the ABCT :

        According to Austrian business cycle theory, a cycle caused by a monetary shock should exhibit the following patterns: 1) the liquidity effect lowers market interest rates below the natural interest rate, and creates a steeper yield curve at a lower position; 2) investment flows and capacity utilization are systematically increased for more capitalistic production processes in the expansion; 3) short-term interest rates adjust to long-term interest rates with a mechanism related to the cycle; and 4) the expansion phase entails the contraction phase as resource allocations are reversed.

        And here’s Carilli & Dempster reply to Keeler’s use of the spread (or interest rate gap) :

        There is also a potential theoretical concern, one that is shared by other attempts at econometric analysis of ABCT, due to the use of the term structure (the long–short spread) as a proxy for the divergence between market and natural interest rates. This term structure approach implicitly assumes that differences between current short- and long-term rates are driven solely by expectations of future short-term rates, the so-called Expectations Theory of the term structure. Most research in term structure theory indicates that this assumption is a poor one—other factors, such as liquidity preference and price risk (which are themselves sensitive to monetary policy changes), seem to play an important role in the structure of interest rates. These factors, along with central bank management of the long–short spread, distort the influence of personal time preferences on the term structure. Therefore, any result based on the assumptions of a purely expectations-driven term structure and money-neutral long-term rates is suspect. The important point here is that the measure of the natural interest rate should be materially independent of monetary policy actions.

        The same authors defend their use of savings/consumption ratio as follows :

        To illustrate, consider a monetary inflation (reserve increase) that not only lowers effective market rates, but also decreases the natural rate proxy. If the latter effect is transitory, which is the case according to ABCT because the natural rate is a pure reflection of time preference, the endogenously determined lag structure will eliminate the distorting influence of these monetary effects on our proxy, so that the estimated relationships reflect the direct influences of reserves on the underlying (and unobservable) interest rate gap.

        So, as i said, the ideal is to examine both variables and see if you get something different. But the most ideal seems to be the consumption/saving ratio. Also, these authors wrote about ABCT prediction, the following :

        ABCT does more than posit that a market rate below the natural rate will lead to changes in GDP; it also predicts that movements in GDP, after a manipulation of the interest rate gap, will be upward at first and then downward as “malinvestment” makes itself apparent. We have demonstrated that reserves cause the interest rate gap, which in turn causes changes in real GDP, for at least one of our two natural rate specifications. We now seek to determine whether GDP growth has a turning point endogenous to the interest rate gap, regardless of manner in which the gap is produced. If the ABCT story holds, we would expect to see an interest rate innovation (an increase in the gap) have a positive impact on GDP in the near term and a negative impact in later periods.


        Unrelated to this, but now that I look at your graph again, I think what you did is wrong. The ABCT posited that (net of external influences) the ratio PPI/CPI should increase at the beginning of the boom. But you looked at the trend of PPI, not the trend of PPI/CPI ratio. That being said, it’s not a relevant variable anymore. Most studies show that this variables do not follow the prediction but that the pattern of expenditure and the interest rate gap are both consistent with the ABCT.

        I do not know what data you’ll use, but you should remember that a lot of econometricians have already tested the ABCT within the USA. I’m not sure whether you’ll be able to dig up some new data that they haven’t examined already. For example, your graph was from the FRED, a data that has been used by Carilli & Dempster (2008) and they conclude in favor the austrians. Thus, you should really verify the data and what has been done before. However, outside the USA, there are less empirical studies (except the ones done by Bismans & Mougeot) especially in less developed countries (I know of one studies one in South Africa if my memory is correct but I was not able to access the paper). At the very least, if you use different statistical methods than the others, that can be worth the try.

        Here is a list of studies I recommend you to read, to know more about how others have attempted to test the ABCT.

        Bismans, F., & Mougeot, C. (2009). Austrian business cycle theory: Empirical evidence. The Review of Austrian Economics, 22(3), 241-257.
        Carilli, A. M., & Dempster, G. M. (2008). Is the Austrian business cycle theory still relevant?. The Review of Austrian Economics, 21(4), 271-281.
        Keeler, J. P. (2001). Empirical evidence on the Austrian business cycle theory. The Review of Austrian Economics, 14(4), 331-351.
        Luther, W. J., & Cohen, M. (2014). An Empirical Analysis of the Austrian Business Cycle Theory. Atlantic Economic Journal, 42(2), 153-169.
        Mulligan, R. F. (2006). An empirical examination of Austrian business cycle theory. Quarterly Journal of Austrian Economics, 9(2), 69-93.
        Sechrest, L. (2009). Evidence regarding the structure of production: An approach to Austrian business cycle theory. The Review of Austrian Economics.
        Young, A. T. (2012). The time structure of production in the US, 2002–2009. The Review of Austrian Economics, 25(2), 77-92.

        I have cited Sechrest because he uses the austrian “measure” of money supply. Just in case, if you want to use it, here’s what Sechrest says about it :

        As suggested by Salerno (1987: 1-6; 2004) and Rothbard (1978: 143-56; 1983: 254- 62), the Austrian conception of money is here taken to include currency held by the public, demand deposits, other checkable deposits, U.S. government deposits, and deposits due to foreign banks and foreign official institutions. Ideally, overnight repurchase agreements, overnight Eurodollar accounts, and U.S. savings bonds should also be included but are excluded due to the fact that government data 1) combine term repurchase agreements and term Eurodollars with the overnight categories and 2) no longer include numbers for the stock of savings bonds.

        I think it’s all.

      • LOL! A “lower savings to consumption ratio”!? You do realise that household income can only go to two places: savings and consumption, right? So, a “lower savings to consumption ratio” simply means “lower savings”.

        Anyway, the data doesn’t show it. High money supply growth is often accompanied by higher savings.

        I find it rather amusing that you are convinced of the validity of theory when you have clearly not bothered looking at the statistics. You should think about that for a moment. As yourself WHY you think that this theory is correct despite the fact that you have not examined the evidence. I think you are taking the argument on authority.

  4. Meng Hu says:

    About time preference, to be sure, the key thing is that entrepeneurs act as if there are more savings than what is actually available, and make investments on a greater scale than what they would have done otherwise. That will cause mal-investment because the increase in credit supply is unlikely to be matched by changes of preference in the same direction, i.e., willing to save by delaying consumption, especially when the decline in interest rate comes so quickly, just within a few years. ABCT does not of course predict “what” will be booming in the process, but just that money is the leading condition of every booms. Without money, even the “animal spirit” theories so dear to J.M. Keynes does not work. Very soon, the bank credit will become costlier, and this will prevent the boom to emerge. See what Fritz Machlup had to say on this matter :

    If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, the boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted.

    Keynesianism, not austrianism, is the dinosaur.

    • And why do you assume that the credit markets would price in risk properly if the central bank stepped back? There are many historical examples where this did not occur. Speculative bubbles did not start when central banks came into being. They have been around far longer than that. Do you have an explanation that works within the ABCT to accommodate these phenomena?

    • Meng Hu says:

      You say : “Speculative bubbles did not start when central banks came into being”

      But I’m afraid you continue to mischaracterize the ABCT. Try to cite any austrian scholars saying stuff like that. I can tell you that you will fail terribly. I’m not aware of them saying things like that. There were bubbles (probably not as serious as the ones we have today) not because of central banks but because of bank regulation. Central bank is an emanation of bank regulation.

      The so-called “free bankers” such as L. White and G. Selgin, for the most renowned, tell us that, at about early times, you have so many times some examples of banks with privileges. If they do not always have the monopoly of issue, there were regulation against private banks (through taxes out of banknote issuing, and so on). Sometimes, the “Central banks” at that time have not been considered officially as central banks and yet they act closely as if they were central banks. I will try to search for these passages again, but I remember clearly from which they come from: “The Experience of Free Banking” (edited by Kevin Dowd; 1992).

      • So what is required to prevent bubbles then according to Austrian theory? Government regulation?

      • Meng Hu says:

        This should be read -> “If they do not always have the monopoly of issue, there were at least regulation against private banks that tend to reduce their competitiveness (through taxes out of banknote issuing, and so on) compared to the privileged banks”

        Also, can you cite specifically what were the bubbles you are referring to ? That will help me to answer it.

      • Meng Hu says:

        You’re faster than lightning !

        So, for your question, it depends. Most austrians say that it’s only with 100% reserve banking that you can avoid crises. But there are other austrians (such as White and Selgin, and Horwitz etc.) who believe in the theory of Free Banking. See Selgin’s book here. Of course, I’m not asking to read all of it. But I believe the chapter 5 is the best one to introduce yourself with Selgin’s idea of “money holding” by the public. The chapters 3 and 4 are also important, after you read 5th. It’s not a huge book, hopefully.

        You have also the empirics of the experiences of Free Banking. Here. It works pretty well, as far as I can see. The only element of doubt was from Sweden, and the episode of banking was a success (people had confidence in the banking system and there were no wide-scale banking crises) but some scholars believed it was due to Sweden having central banks, and others said that the Bank of Sweden (Riksbank) did not act as lender of last resort, etc.

        Furthermore, I don’t think austrians say that regulation automatically lead to bank crises; it depends what kind of regulation. For example, consider Selgin’s argument here, from The Theory of Free Banking: Money Supply under Competitive Note Issue :

        Canadian experience also contradicts the view that free banking is inferior to central banking. During the 19th century Canada had a much more liberal banking policy than the U.S., and its banking system performed much better than the U.S. banking system of the same era. Canadian laws allowed plural note issue, permitted branch banking, and encouraged the growth of an elaborate clearing system. After 1841 the only serious restrictions on banking freedom had to do with capital and note issue. To receive a charter and limited-liability status a bank had to have $500,000 (Canadian) or more of paid-in capital soon after opening. Note issue was limited to the amount of this paid-in capital, but this restriction had no effect until the severe currency drain of 1907. In 1908 the law was changed to allow an emergency circulation exceeding capital by 15 percent during crop moving season.


        These conditions set the stage for the great money panics of 1873, 1884, 1893, and 1907. Each of these crises came at the height of the harvest season, in October, when it was usual for large amounts of currency to be withdrawn from interior banks to finance the movement of crops. The crises provided the principal motive for creating the Federal Reserve System, which ended the era of plural note issue. Yet the crises would never have occurred (or would have been less severe) had it not been for government regulations that restricted banks’ powers of note issue in the first place.

      • ABCT does not appear to be saying anything that is not already known by other economists.

        Low interest rates cause asset speculation. Duh.

        As to the solutions, they’re Utopian and would probably not work anyway.

      • Meng Hu says:

        And why is it utopian ? I thought i told you the episodes of Free Banking point out that the free banks perform relatively well. Of course, governments do not want free banking because they have nothing to gain, and that is, after all, among the first reason why free banking have been banned in the past. They wanted seigneuriage and profits; they could have expanded their public spending more easily this way.

      • Meng Hu says:

        You say -> “ABCT does not appear to be saying anything that is not already known by other economists.”

        Considering this, I should disagree. I hear more often than not that crises result from “random events” or “over-optimism”. Or worse, they say they might be the result of a mere emergence of new technologies and innovations. Some even believed that inequality can cause the business cycles. I have never heard the mainstream saying things like “time preference” or “relative prices”. Unless you cite them, that is.

        Austrians are the only ones who focuse on credit over-expansion and distortion of production structure (towards lengthening, if money supply keeps increasing).

      • No they’re not. Read Minsky. Although he is a bit more subtle on the question of causality than the ABCT which seems vulgar in its ideas as to causality.

  5. Meng Hu says:

    I’m really disappointed, more than you think. I wanted to give up. I don’t even understand why you call yourself researcher. All this talk for nothing. What’s the purpose for all these questions of yours if it was just for you to say “No you’re wrong the facts don’t tell this” ? The least you should do is to collect the data, perform time series regression, test for unit root (ADF and PP), and then transform by detrending or differencing, and then use multiple regression, with your stationary variables, eventually with ECM if cointegrated. All this with the appropriate variables/proxies of natural interest gap, RGDP/NRGDP, ratio investment/consumption expenditure, job (re)allocation, etc. This is how I expected you to test “my” hypothesis, as you said you’ll do. Your answer is not what a scientist should be given.

    When you ask proof, I give references and links. You ignore them. When it’s me who is asking, I get nothing in return, except a handwaving argument. And I’m still waiting for you to quote a passage of Minsky, because this guy never said anything about time preference and interest rate gap, but instead the Minsky’s thesis was about high risk-taking in banking behavior; so either you’re lying or you’re grossly misinformed about Minsky. You can read “Austrian persistence? Capital-based business cycle theory and the dynamics of investment spending” from Montgomery (2006) and you’ll see the particularity of the austrian theory, and how it differs drastically from others.

    Because you’re helpless, it’s probably my last comment. Here’s the list of evidence.

    Concerning the savings you’re talking about, I suspect the link here answers your question, and as you can see, the data shows you’re wrong. There is no increase in savings. So either you’re uninformed (an irony for a researcher) or you were lying. Or is it just my vision ?

    Now, here some others. Callahan & Garrison (2003) in proving the ABCT in the face of the dot-com, have (among other things) cited Brenner (2002) :

    Between 1950 and 1992, the personal savings rate had never gone above 10.9 per cent and never fallen below 7.5 per cent, except in three isolated years. But, between 1992 and 2000, it plummeted from 8.7 per cent to -0.12 per cent

    Callahan, G. & Garrison, R. W. (2003). Does Austrian Business Cycle Theory Help Explain the Dot-Com Boom and Bust?. The Quarterly Journal of Austrian Economics, 6 (2), 67-98.

    Other studies (Carilli & Dempster, 2008) use econometrics to show that the ratio of savings/consumption Granger-cause changes in output, specifically, an expansion following by a recession. Here a list of other studies using the same approximation of interest rate gap (ratio saving/consumption) and came to conclusion similar to Carilli & Dempster.

    Selleby, K., & Helmersson, T. (2009). Empirical Testing of the Austrian Business Cycle Theory: Modelling of the Short-run Intertemporal Resource Allocation.
    Russell, L. A., & Langemeier, M. R. (2014). Austrian Business Cycle Theory: Evidence from Kansas Agriculture. Paper presented at the Texas Tech University Free Market Institute Friday.

    And here, 2 data analyses on, respectively, Iceland and New Zealand. The data show you that consumption increases during expansion, and of course, savings decline.

    Davidson, R. R., (2013). Austrian Business Cycle Theory: An Application to New Zealand’s Recent Boom and Bust. Dissertation.
    Ragnarsson, R. H. (2012). Austrian Business Cycle Theory: Did Iceland go through an Austrian Business Cycle?.

    Mulligan (2005) conducted ECM analysis, the results displayed in table 4. You have a positive and significant coefficient for consumption index, meaning that credit expansion permanently increases real consumption expenditures. That is consistent with a pattern of decline in savings. Again, you lose and I win.

    Mulligan, R. F. (2005). The Austrian Business Cycle: A Vector Error-Correction Model with Commercial and Industrial Loans. Journal of Private Enterprise, 22(1), 51-91.

    Still related to this topic, Wainhouse (1984) use Granger causality test, and several assumptions are evaluated, the first of them was that changes in supply of savings will be independent of changes in supply of bank credit. He was able to prove it’s indeed the case. If the ABCT is wrong, then, savings would have caused credit. More recently, Richard Whittle (2012) shows that it is M0 but not savings that is responsible for GDP changes. Again, it’s well within the prediction of the austrian theory.

    Whittle, R. (2012). Austrian Business Cycles: From Theory to Empirics.

    Sechrest (2004) shows that, compared to money supply growth, savings predict less well commercial and industrial loans, industrial production and business equipment production (r=0.70 vs r=0.95). Then the ABCT is true in that the savings is not sufficient alone to account for entrepreneurial behaviors.

    I have written another article on the empirics of the ABCT. I reviewed all the new studies here. And I counted them : 32 empirical studies/analyses in total on the ABCT. An interesting analysis that I read recently is that one here, for the US :

    Neira, M. A. A., Bagus, P., & Ania, A. R. (2013). An Empirical Illustration of the Austrian Business Cycle Theory: The case of the United States, 1988-2010. Investigación Económica, 72(285).

    You can see that the structure of production, approximated by the ratio of production in diverse sectors of the economy, moves in a manner coherent with the theory. If you reject the empirics, then so be it. That’s not my problem. But you can’t argue against that if you’re honest with yourself.

  6. Meng Hu says:


    Wait a minute. You’re the one to ask proof that savings move (during expansion) in a manner consistent with the ABCT. I show you the proof here. If you disagree, let’s talk about it, and explain yourself, clearly. If you refuse to engage in the argumentation, I don’t know what I can do. I listed all the materials, and expect you to show me that empirics contradict the ABCT. Because that’s what you say. And that is wrong.

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