What causes Recessions?

Economists have always been puzzled and in debates over what causes business cycles, as in booms and busts. The Economist has even mentioned that mentioning the word causes recessions, so I hope my post title is okay.

I am going to go over a few of the theories and then talk about the theory that I think it being proven true in this business cycle. That doesn’t mean I am completely sold by it but it will be the one I use to try to look back in history later in my Economic career.

The first theory is the Marxist theory because it is one of the most easily summarized ones. It basically says that boom/bust periods are inherent in a free market capitalistic society and therefore he created socialism to try to combat that.

The second theory is called the "Real Business Cycle Theory." It basically says that technology shocks cause the cycles. Booms are when we have lots of technological innovation and recessions happen when new innovations are poor or not happening.

The third theory is the one Keynes came up with and our government is currently using his solution. He believes that sometimes capitalism doesn’t work and the markets need to be fixed by government. He wanted a fiscal plan to push consumption and the demand curve out.

The last theory is the Austrian one and I believe that this one is showing true in our current situation. I hope that I will have time to research it back in history.

The idea is that the central bank lowers the interest rate and entrepreneurs believe that people are saving more, which means they want long term investment. Therefore, business shift investment because now it is cheaper to with the interest rate being lower. When the interest rate adjusts and raises because it wasn’t more saving it was just fake central bank movement. As people shift their investments back to the correct areas this is the recession period. The fed then attempts to lower rates again and does it all over again.

It is often called the "hangover theory" if you think of a drug addict that when they use, it feels really good but the only good part is when they have withdrawal symptoms but the fed instead feeds it more drugs.

It can be applied to today by looking back at 2001, when the fed dropped the interest rate and people shifted investment to housing. The interest rate rose and people failed, which was just the market moving resources back to where they should have been. What is the fed doing?

Cutting rates…

Are the Austrians finally getting their day to shine?

Published in: on March 23, 2008 at 2:41 am  Comments (1)  

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One CommentLeave a comment

  1. […] My work on the Austrian Business Cycle can be found here. […]

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