The Austrian Theory of Business Cycles: Old Lessons for Modern Economic Policy?

IMF Working Papers, January 1, 2002

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Reviews the "Austrian" theory of the business cycle first proposed by Friedrich Hayek in the 1920s.
Key claim: credit creation by monetary authorities pushes investment beyond society's long-term willingness to save, creating a mismatch between supply and demand that inevitably causes recession.
Additional claim: expansionary policies in recession generally only postpone necessary structural adjustment, making the subsequent correction more severe.
Modern followers identify Austrian features in recent business cycles, including Japan in the 1980s and 1990s, and the more recent U.S. slowdown.

Credit expansion as the proximate cause of unsustainable investment booms.
Mismatch emerges between the structure of production and consumers' time-preferences (long-term willingness to save).
Recessions are the necessary correction of malinvestment induced by monetary expansion.
Expansionary policy during downturns can:
- Postpone structural adjustment.
- Amplify or deepen the eventual correction.

Caution against using expansionary monetary policies to counteract recessions when those recessions are driven by prior credit-induced misallocations.
Implicit recommendation to allow structural adjustments to proceed rather than artificially prolonging maladjusted investment structures through policy measures.

Subject: Business cycles, Consumption, Credit, Labor, Monetary expansion
Keywords: economic activity, economist, interest rate, investment, recession, WP

The Austrian Theory of Business Cycles: Old Lessons For Moden Economic Policy? - WP/02/2
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