by Larry Sechrest
Mainstream macroeconomists may--and do--disagree with such an assessment, but Austrian macroeconomists rightly consider the Misesian/Hayekian theory of the business cycle to be one of the signal achievements of the entire Austrian school of thought. This Austrian business cycle theory (ABCT) offers a unique perspective on the destructive array of private sector incentives created by central bank manipulations of the supplies of money and credit.
ABCT is essentially a theory of unsustainable economic expansions, that is, macroeconomic expansions that must unavoidably be followed at some point by macroeconomic contractions. At the center of this scenario is the phenomenon of malinvestment. Thus, in order to explain ABCT one must be able to convey in what malinvestment consists. In the past, Austrians have usually done this either entirely by means of verbal explication or with the assistance of certain unconventional constructions such as Hayekian triangles. These figures relate the stages of production to the magnitude of ultimate output and thus can reveal the effects of a change in market interest rates on the structure of production. However, to grasp the significance of such triangles one must also comprehend certain distinctively Austrian ideas such as "roundabout production" and the average production period.
Students of economics who are not already familiar with the Austrian School are thus not likely to find Hayekian triangles to be very enlightening. Something more familiar to such students might prove more helpful.
Pursuing that line of thought, the present paper will offer an interpretation of malinvestment in more conventional terms, using such frameworks as the familiar Capital Asset Pricing Model (CAPM) seen so often in finance classes. In addition, the everyday observation about the disproportionate effects of interest rate changes on the present values of assets with different maturities will be shown to be congruent with Hayekian triangles, thus removing the latter from the realm of the exotic. Finally, the important role of the “subsistence fund" in understanding malinvestment will be illustrated. First of all, however, the basics of ABCT will be briefly reviewed.