Austrian Business Cycle Theory

Conclusion

IN PART 1, WE EXAMINED ECONOMIC growth and how an economy “goes right.” The “magic” formula for economic growth is not magic. The economy does not grow automatically. It requires the coordination of millions and millions of people every day.

A key aspect to the proper working of an economy is the price system. Prices perform an incredibly valuable economic function. Prices are packets of information. They communicate, to anyone who wishes to look, the relative scarcities of the various goods and services available. When something changes in the economy, prices transmit this information to anyone and everyone. When a new deposit of a resource is located, the lower price informs everyone of this discovery. When a storm disrupts supply lines, higher prices tell users to be more cautious with goods and suppliers to rush more to the affected area. When a business finds a new way to be more efficient, its new prices communicate this new reality to all.

Everyone, from entrepreneurs to consumers to employees, uses prices to integrate their personal plans with the greater whole. Should we invest in project A or project B? Should I buy that product now or look for something else? Should I go to work today or quit and find a new job? Each of these questions is unanswerable without the price system. The entrepreneur can calculate the different rates of return for the projects and decide. The consumer can see that the price is higher than acceptable and look for something else. The employee can see that there is another job that offers a higher wage. Prices are not a perfect reflection of our subjective preferences and are constantly changing, however, they serve the economic function of communicating important knowledge quickly and efficiently. There is no substitute.

In part 2, we saw the effects of manipulating prices. When the government imposed a price cap on the loanable funds market, a political purpose was served. When the central bank chose the path of monetary expansion, it decided that it could accelerate the growth of the economy. As economists, we need to ask, “Are these policies enhancing or detracting from the market’s ability to efficiently and effectively serve consumers? Do these policy changes enhance an economic function? Do the new prices that result from price caps or expansionary monetary policy communicate new scarcity ratios between goods and services? Do they reflect new tastes and preferences? Have expectations about the future changed?” If the new prices do not reflect the underlying economic reality, they are disruptive and lead away from economic stability.

Governments often intervene in markets. When small-scale interventions occur, the effects tend to be limited in both time and place. However, when the intervention is systemic and persistent, it leads to the ultimate disruption of the economy—a business cycle. The best way to avoid such a calamity is by not starting down the path of monetary expansion. Knowing how business cycles get started helps to give us the strength to resist the siren song of easy money. In this vein, let us close with Rothbard.

The time is ripe—for a rediscovery, a renaissance, of the [ABCT]. It can come none too soon: if it ever does, the whole concept of a Council of Economic Advisors would be swept away, and we would see a massive retreat of government from the economic sphere. But for all of this to happen, the world of economics, and the public at large, must be made aware of the existence of an explanation of the business cycle that has lain neglected on the shelf for all too many tragic years.

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Rothbard (1996, 91).