The traditional Austrian claim: Positive rates of nominal money growth induce unsustainable increases in long-term investment.
Traditional Austrian business cycle theories focus on the overexpansion of long-term investment as the relevant intertemporal coordination problem. We find this emphasis in the writings of Mises, Hayek, Rothbard, Garrison, and other presentations of Austrian cycle theory. Competing presentations of the Austrian theory offer differing accounts of exactly how and why these malinvestments cause business downturns, but the initial overexpansion of long-term investment is central to all versions of the theory.1
This chapter examines the signal extraction problems behind the traditional Austrian theory in detail and considers whether entrepreneurs will, in fact, overexpand long-term investment in response to an inflation-induced decline in real interest rates. I will attempt to draw out the underlying expectational assumptions behind the traditional Austrian theory and examine whether these assumptions are plausible and whether they generate the stated conclusions. I also contrast the traditional Austrian theory with the risk-based approaches of the last two chapters; the final section of this chapter explicitly compares and contrasts the two approaches, and asks whether some synthesis or rapprochement might be possible. Similar to the risk-based theory presented above, the traditional Austrian account views investment as the transmission mechanism for the cycle, starts with the assumption of full employment, links the monetary and real sectors of the economy, uses a loanable funds theory of interest, and builds on Wicksellian themes.
1 See the writings of Mises, Hayek, Rothbard, and Garrison, as cited in the bibliography. O’Driscoll (1977, 1980), McCulloch (1981), O’Driscoll and Rizzo (1985), de Long (1990), Skousen (1990), McCormack (1992), van Zijp (1993), Laidler (1994), and Colonna and Hagemann (1994) offer recent treatments of the Austrian theory.