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Gold Standard and Boom Bust Cycles

July 31, 2021

GOLD STANDARD AND BOOM BUST CYCLES

According to the Austrian Business Cycle Theory (ABCT), the boom-bust cycle emerges in response to a deviation in the market interest rate from the natural interest rate, or the equilibrium interest rate. It is held that the major cause for this deviation is increases in the money supply. Based on this it would appear that on a gold standard without the central bank an increase in the supply of gold is also going to set in motion boom-bust cycle.

An increase in the supply of gold is likely to result in the lowering of market interest rates. This in turn is likely to cause the market interest rates to deviate from the equilibrium interest rate. Consequently, following the ABCT an increase in the supply of gold is going to set in motion the boom-bust cycle.

According to Robert P. Murphy “More Than Quibbles: Problems with the Theory and History of Fractional Reserve Free Banking” in the QJAE Volume 22 Spring 2019, Ludwig von Mises held that an increase in the supply of gold could trigger boom-bust cycle.

Whilst suggesting that the gold standard could generate business cycles whenever an increase in the supply of gold causes the market interest rate to deviate from the natural interest rate, or the equilibrium rate, Mises however, viewed this possibility as remote.

Mises regarded the gold standard as the best monetary system as far as keeping the expansion in credit under tight control. Murphy quotes Mises on this,

Even a rapid increase in the production of the precious metals can never have the range which credit expansion can attain. The gold standard was an efficacious check upon credit expansion, as it forced the banks not to exceed certain limits in their expansionist ventures…

…click on the above link to read the rest of the article…

The Era of Boom and Bust Isn’t Over

January 31, 2020

The Era of Boom and Bust Isn’t Over

At the 2020 World Economic Forum in Davos, Bob Prince, co-chief investment officer at Bridgewater Associates, attracted attention when he suggested in a news interview that the boom and bust cycle as we have come to know it in the last decades may have ended. This viewpoint may well have been encouraged by the fact that the latest economic upswing (“boom”) has been going for around a decade and that an end is not in sight as suggested by incoming macro- and microeconomic data.

But would that not reject the key insight of the Austrian business cycle theory (ABCT), which says that a boom, brought about by artificially lowered market interest rates and injections of new credit and money produced “out of thin air,” must eventually end in a bust? In what follows, I will remind us of the key message of the ABCT and outline the “special conditions” which must be taken into account if the ABCT is applied to real-world developments. Against this backdrop, we can then form a view about how the next crisis might look.

What the ABCT Says

The ABCT is actually a “theory of crisis,” and it explains the broader consequences if and when central banks, in close cooperation with commercial banks, increase the amount of money in the economy through credit expansion—that is, an increase in bank lending that is not backed by real savings. The increase in the circulation of credit supply initially lowers the market interest rate below its “natural level,” or, “the originary interest rate level,” to use the Austrian school’s term.

…click on the above link to read the rest of the article…

Can Expectations Undo the Validity of the Mises’s Business Cycle Theory?

July 15, 2019

CAN EXPECTATIONS UNDO THE VALIDITY OF THE MISES’S BUSINESS CYCLE THEORY?

According to Ludwig von Mises’s Austrian Business Cycle Theory (ABCT), the artificial lowering of interest rates by the central bank leads to a misallocation of resources due to the fact that businesses undertake various capital projects that prior to the lowering of interest rates weren’t considered viable. This misallocation of resources is commonly described as an economic boom.

Once the central bank reverses its stance this sets in motion an economic bust. It follows then that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are revealed as such once the central bank tightens its interest rate stance.

Critics of the ABCT maintain that there is no justification that businessmen should fall prey repeatedly to an artificial lowering of interest rates. Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates. Consequently, correct expectations will undo or neutralize the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates.[1]  Hence critics are questioning the validity of the ABCT.

Even Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle. In his reply to Lachmann he wrote,

It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.[2]

Do Expectations Matter?

 …click on the above link to read the rest of the article…

Expectations and the Austrian Business Cycle Theory

May 9, 2018

EXPECTATIONS AND THE AUSTRIAN BUSINESS CYCLE THEORY 

According to the Austrian Business Cycle Theory (ABCT) the artificial lowering of interest rates by the central bank leads to a misallocation of resources because businesses undertake various capital projects that prior to the lowering of interest rates weren’t considered as viable. This misallocation of resources is commonly described as an economic boom.

As a rule businessmen discover their error once the central bank—that was instrumental in the artificial lowering of interest rates—reverses its stance, which in turn brings to a halt capital expansion and an ensuing economic bust. From the ABCT one can infer that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are only exposed once the central bank tightens its interest rate stance.

Critics of the ABCT maintain that there is no reason why businessmen should fall prey again and again to an artificial lowering of interest rates. Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates. Correct expectations will undo or neutralise the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates. Hence, it is held, the ABCT is not a serious contender in the explanation of modern business cycle phenomena.

According to a prominent critic of the ABCT, Gordon Tullock,

One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.[1]

…click on the above link to read the rest of the article…

Expectations and Business Cycles

December 16, 2015

Expectations and Business Cycles

According to the Austrian Business Cycle Theory (ABCT) the artificial lowering of interest rates by the central bank leads to a misallocation of resources because businesses undertake various capital projects that prior to the lowering of interest rates weren’t considered as viable. This misallocation of resources is commonly described as an economic boom.

As a rule businessmen discover their error once the central bank—that was instrumental in the artificial lowering of interest rates—reverses its stance, which in turn brings to a halt capital expansion and an ensuing economic bust.

From the ABCT one can infer that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are only exposed once the central bank tightens its interest rate stance.

Critics of the ABCT maintain that there is no reason why businessmen should fall prey again and again to an artificial lowering of interest rates.

Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates.

Correct expectations will undo or neutralise the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates.

Hence, it is held, the ABCT is not a serious contender in the explanation of modern business cycle phenomena. According to a prominent critic of the ABCT, Gordon Tullock,

One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.[1]

…click on the above link to read the rest of the article…

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