The Poverty of Modern Macroeconomic Theory and Power of Austrian Business Cycle Theory

Reproduced by kind permission of the Quarterly Journal of Austrian Economics

ABSTRACT: This paper contrasts mainstream analysis of the recent boom/bust episode and its massive interventions with Austrian business cycle theory (ABCT). Mainstream economists remain lost in the Keynesian jungle, and economists in the vein of Irving Fisher, Milton Friedman and Martin Feldstein have not helped. The blinkered approach favored by the economics profession ignores the business cycle theory pioneered by Ludwig von Mises and deepened by successors like Murray Rothbard and Jesus Huerta De Soto. Defying standard economic theory, economists implicitly believe that artificially low interest rates (wrong prices) and debt piled on debt unbacked by real savings do no harm to resource allocation and employment. Attempts to hasten economic growth via monetary policy must prove self-defeating by seducing businesses to overinvest in higher stages of production and underinvest in lower stages. The recession is the realignment of the production structure with consumer wants. “Without a sound capital theory, macroeconomics is incomprehensible,” as Larry J. Sechrest wrote.

Download (PDF).

More from Morgan Reynolds
Dynamic Duo interview with Jesus Heurta de Soto
On October 21, 2008, I conducted a radio interview with professor Jesús...
Read More
7 replies on “The Poverty of Modern Macroeconomic Theory and Power of Austrian Business Cycle Theory”
  1. says: Tom E. Snyder

    Thank you for posting this excellent article. I will use it in my economics class.

  2. I am not impressed by this Morgan Reynolds paper. I’ll run through some of it.

    p.12. He deplores the fact that the “too big to fails” have not been put through normal bankruptcy procedures. Well, so do we all. This is not a sentiment unique to Austrian economics.

    p.13. He claims the credit crunch was caused by years of artificially low interest rates which lead to “malinvestments” (favourite Austrian word). Obviously low interest rates had something to do with the credit crunch, though plain simple old fraud (by politicians and bankers) was also a factor.

    Moreover it is easy to overdo the effect of artificially low interest rates: the bulk of the cost of machinery, factories, office blocks, etc consists of a range of expenses OTHER THAN interest rates. E.g. depreciation, running costs like fuel consumption and so on. Thus if interest rates are say 2% lower than they should be, I doubt that on its own is catastrophic.

    p.15 – 25 consists of little more than describing the worst symptoms and most headline grabbing excesses of the credit crunch. Again, most of us are agreed on what these excesses were and how deplorable they were. That does not distinguish Austrian from other ideas.

    p.25. At last we come to (allegedly) the fundamental explanation for booms and busts, namely the well known Austrain idea that it is RELATIVE price distortions that are the root cause.

    One problem here is that we live (quite happily) in an economy where there is a gross distortion of the price of numerous commodities: commodities which make up a sizeable proportion of GDP. I am referring to the “price” of state education, health care and a dozen items. In contrast to these hugely underpriced items, others and way over market price: whiskey or petrol for example. No harm comes of this, does it? So price distortions per se are obviously not a huge problem, though clearly if price distortions exist for no good reason, that needs seeing to.

    p.28. There is a typical bit of “Austrianese” here. “Credit expansion does not bump up total investment…” and this is backed by a quote from Rothbard: “Clearly bank expansion cannot increase capital investment by one iota. Investment can still come only from savings.”

    Rothbard and Reynolds (and Austrians in general) confuse two issues here. It is obvious that capital investment can only come from “savings” in the sense of “foregone consumption” (at given GDP). However, it is not the sole purpose of money creation or bank expansion in a recession to boost ONLY capital investment. The purpose is to boost OVERALL economic activity. The PORTION of the overall increase that devoted to capital investment is a decision that we wicked Keynsians are happy to leave to each individual business.

    To summarise, we wicked Keynsians claim that in a recession, the economy can be expanded, and in this expanded economy, some individuals or firms will forgo current consumption and invest the proceeds. Thus in an indirect way, money creation and bank expansion WILL NORMALLY bring extra investment.

    1. says: Current

      FWIW Ralph a lot of Austrian Economists don’t agree with Rothbard and Reynold’s view on many of these things either.

  3. says: vimothy

    Apologies for abusing your forum in this way, but is “currrent” about? I’d like to talk to him about some issues relating to MMT/Neo Chartalism and an old thread at LvMI…

  4. says: Current

    It would be better if we didn’t tangle up the Cobden centre’s blog threads.

    I’ll give you my email address is, but since I don’t want any spam the format is a bit wierd. Replace the words below you think need replacing…

    rthorpe cinnamon-whirl robertthorpeconsulting famous-late-nineties-bubble


Comments are closed.