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mono Posted: Sat, Oct 16 2010 2:41 PM

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Hello!

I am a bachelor student in Economics, just about to write my thesis. Even though I'm fairly new to austrian philosophy and economics I'm currently thinking about incorporating the austrian business cycle theory into my dissertion. My current idea of issue is "Can low-interest policies induce a real estate property bubble?". The general idea is that I will use the business cycle theory as the foundation for my theory and I will use historical property prices, interest rates, etc to perform an econometric approach on Sweden, England, USA and a fourth country (Spain or another european country).

My question for the forummembers is: Is the austrian business cycle compatible with this kind of economic problem? What do you think about the idea?

I'm greatful for all the help I can get!

Sincerely Mono

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mwalsh replied on Sat, Oct 16 2010 3:13 PM

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First, Welcome to Austrian theory/this forum.

B- ABCT is perfectly compatible, as one reads more into it, ABCT states, and a prioristically proves that when interest rates are artificially lowered via credit expansion in fiat money, there is an artificial and unsustainable boom in a "captial" goods industry.  This is because lower interests rate are a signal that people are now prefering future goods to present goods. 

For business to fufil this new market condition, they must extend the production structure.  If there were shorter, more effiecient production structures, they would already be in use.  This leaves, if they want higher production, they must extend this production structure.  What ABCT does not expalin is which thing people will flock to.

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Sam Silverspring replied on Sat, Oct 16 2010 3:46 PM

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Hey Mono,

That might be a doable since Austrian business cycle theory DOES say that aritificially low interest rates can induce a property bubble (for example, a book that makes that type of argument explicitily is Tom Woods' Meltdown). And if you're capable of doing the econometric work that could show that low interest rates "caused" the bubble, then fantastic! Of course, I'm not big on econometrics (I'm more of a theory guy), so I would not know how to go about using econometrics to validate Austrian theory. But maybe you, or a professor at your school, does know how to go about showing something like that.

Just bear in mind that you will probably have to do a fair bit more independant research than you otherwise would have if there are not other people at your school who are familiar with Austrian economics. I feel I should warn of this because I wrote my undergrad thesis on Austrian economics last year as well, and while I'm glad I wrote on something that I was passionate about, the fact that I chose a topic that very few profs were familiar with meant that I had to put in ALOT more work than somebody who was writing on, say, Financial Economics (we have a lot of good Financial economists at my school). Because of that, I was reeeally burnt out by the end of the year (I don't say this lightly either - I definitely needed some time off after that). So bear in mind that it can really be really intellectually exhausting to engage in independant research without somebody knowledgeable that you can bounce ideas off of.

In that vein, before you commit to that topic, I would go talk to professors at your school and see if they think it is a good idea. If they do not think its a good idea, I would seriously consider rethinking your topic, since your primary goal should be to come up with a workable thesis so you can get your degree.

However, these warnings aside, if you're confident that you can do it (and be sure that you REALLY are confident that you can do it BEFORE you start), then go for it.

Either way, good luck with whatever you decide to write your thesis on!

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mono replied on Sat, Oct 16 2010 4:52 PM

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I wouldn't say econometrics is my strongest field, I also tend to be more of a "theory guy". Nevertheless I've taken taken a course in econmetrics (which is supposed to cover what I need to know to be able to conduct a bachelor thesis) and passed it without any problems. I've gotten an instructor which I've discussed the topic with, and he seemed to be positive about my idea. He is familiar with the austrian school, and the few austrians I know at my university has used or are currently using him as their instructor. On the other hand he's been trying to influence me to take his side of things (monetarism) :). But I do feel that I have an instructor which knows the field and knows how I should set up an econonmetric model to validate my theory.

When it comes about my thesis, I'm not so worried about the theoretical part, more of the econometric. But I thought it would be wise to look around on this forum for suggestions and tips. What literature should I use? Where can I found other works in the same field (from an austrian perspective)?

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chloe732 replied on Sat, Oct 16 2010 5:07 PM

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Mono,

I think Sam Silverspring offers sound advice.  From your original post, I'm not sure if you realize the task in front of you, but if you do, then great.  The econometrics part concerns me.  Such data, I think, is filled with hazards.  Someone else could probably use whatever you come up with to prove that ABCT had no correlation to the housing market.  There's that word; correlation.   The mainstream mind cannot shake it off. 

Seems like you have two tasks: First, to master ABCT, then to somehow use econometrics to demonstrate correlations.  

Have you read through these links yet? 

Austrian Theory of the Trade Cycle - Garrison - EXCELLENT VIDEO, Watch this first.  Can't get the link to work.  Go to You Tube, search Garrison Macro.

Mises Daily Archive - Roger Garrison - Link does not work, go to Mises Daily, search Garrison.

Austrian Theory of Business Cycles - Garrison

Evidence that the Fed Caused the Housing Boom - Robert Murphy

The Bailout Reader

The Fed's Role in the Housing Bubble - See the related links in this blog post by Robert Murphy

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Sam Silverspring replied on Sun, Oct 17 2010 12:18 PM

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Here's a paper on empirical evidence for Austrian Business Cycle Theory:

http://www.ingentaconnect.com/content/klu/raec/2001/00000014/00000004/00360453?crawler=true

Also, if I recall correctly, Lionel Robbins book The Great Depression has a nice list of empirical things you should see if the Austrian story of the business cycle is true. The list may be reprinted in Huerta de Soto's Money, Bank Credit, and Economic Cycles (which, by the way, you definitely should read; not only does it have a fantastic theoretical breakdown of austrian business cycle theory, but it points out a number of historical examples of business cycles that appear to be consistent with Austrian theory).

Good luck with your paper! It shounds like you have a good supervisor, so it should be fun! :)

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Esuric replied on Sun, Oct 17 2010 6:09 PM

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The Austrian theory of cycles is theoretically sound and can explain real-estate bubbles without a problem (both residential and commercial real-estate consists of long-term durable goods). In fact, Knut Wicksell, in 1898, explicitly stated that we should expect real-estate bubbles as a potential consequence of credit expansion and artificially reduced interest rates:

Knut Wicksell:

An abnormally large amount of investment will now probably be devoted to durable goods (a result of an artificially reduced rate of interest). There may result a relative overproduction of such things as houses and a relative underproduction of other commodities (pp.96).

Here are the potential problems/difficulties:

1. The theory is quite complex and is often misunderstood.
2. You can't empirically prove that interest rates were "too low." This is because (a) interest rates are only "low" when they are pushed below the equilibrium or "natural rate", and (b) expanding the supply of money does not, in itself, suppress market interest rates below this natural position (only when monetary growth exceeds the demand for money as money will the natural rate of interest exceed the market rate of interest).

Key points that you should mention (in my opinion):

1. The theory deals with both the demand side and the supply side.
2. The heterogeneity of capital (the fact that it has to be ordered and that it forms a structure). In other words, merely increasing the "total stock of capital" does not necessarily yield long-term economic growth (closely tied to point #6).
3. Savings must equal investment in the long-run and the consumption/savings trade-off. Monetary expansion does not act as a real substitute for real savings (you can't produce factories and machinery with green pieces of paper). Closely related to the notion of "forced savings."
4. The role that the price mechanism plays in forming entrepreneurial expectations and economic calculations (key).
5. Inflation as a microeconomic phenomenon that affects the relative prices of economic goods. In other words, there is no uniform rate of inflation (closely tied to point #4).
6. The time structure of production: the fact that production is a temporal process and that goods have to be allocated temporally (this is the role of the interest rate, according to Austrian economics).
7. Mention the fact that recessions always hit investment sectors first and more dramatically than the consumer goods industries (which we shouldn't expect if recessions were caused by "inadequate aggregate demand").

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chloe732 replied on Sun, Oct 17 2010 7:24 PM

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Esuric,

Once again, a superb post.  Your ability to organize these concepts and express them clearly is second to none.

Would you add the cluster of entrepreneurial error to your list?  All home builders, all supporting industries, across all regions of the U.S., and really across the western world, experienced the boom / bust simultaneously.  This is related to your point #4, I believe.

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Paul replied on Sun, Oct 17 2010 10:50 PM

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I would just suggest that you do not use the four countries as 'proof' of ABCT, but emphasize that their financial situations are best understood according to ABCT. You'll have to explain this a bit in the methodology.

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mono replied on Sun, Feb 13 2011 6:02 AM

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I'm sorry about the late response to all of your post. But I do want to thank you all for the insightful comments, it really helped! As of right now I'm done with my thesis, and just waiting for the grade to show up in the school database. When it comes to the essay I changed the topic slightly. Instead of exploring property bubbles, I did research on house price appreciation. Since it's kinda tricky to get all the aspects of a bubble into the econometrics, and that I didn't want to do any forecasting, I thought it best to alter the question.

I feel I learned alot during these latest months, especially about austrian economics, but also about how to think about economics issues. The thesis worked out fine, though I was too lengthy and technical in the theoretical part of the essay, which brought my grade down a bit. But on the other hand, none of my fellow students at this level knows anything about ABCT (on how familiar the teachers are with ABCT I don't know), which I kinda thinks justifies the lenghtiness a bit. Even though I got the grade VG (swedish scale is between U, failure, G, pass, VG pass with distinction), which made me really happy, especially considering all the effort I put into it. 

As of the resultats, I found support that low interest policies influence house price appreciation and hence forth ABCT.

Just wanted to check in again, and thank you all! 

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John James replied on Sun, Feb 13 2011 8:11 AM

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Couple of things...

I realize some links have already been posted, but this is the most comprehensive collection of ABCT material on the site:

Austrian Business Cycle Theory learning materials

And second, where do you go to school that a bachelor's degree requires a dissertation?

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mono replied on Sun, Feb 13 2011 9:39 AM

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Thank you, I will check it out!

Of course it's just a language error, no dissertation is needed.