Explanation of the Austrian Business Cycle: Part 2

This was originally posted here by me.

As Dr. Peter Leeson has put it in a lecture that I attended the Austrian business cycle is often referred to as being the “Hang-over Theory.” This is where the withdrawal symptoms kick in and stage five begins with the short-term investments bidding back labor and capital from the previous long-term investment. Shortly thereafter, we see prices go up and interest rates rise to their true state. This is when the housing boom began to bust. This completes the Austrian business cycle with failures and layoffs. This is where the legislators have tried to come in and fiscally stimulate the economy with rebate checks totaling at $168 billion. This is as housing sales continue to fall due to the busting of the bubble that was created by artificially low interest rate. It has been reported that housing sales are down 20.1% in the past year[1]. Kevin Logan, who is a senior market economist at Dresdner Kleinworth said, “There is less incentive to purchase when prices are falling. With banks restructuring the availability of credit, it is more difficult to get a loan.” He makes a valuable observation that the banks are loaning less money out than they were but this is due to the adjustment in the interest rate. This is not because of some “restructuring.” As Mises states in “Human Action” that “The banks fare faced with an increase in demand for loans.” Mises continues to describe the problem within that “The banks believe that they have done all that is needed to stop “unsound” speculation when they lend on more onerous terms” and that they actually continually feed into the problem.

After all of this the constant need is to do it all over again. Most people see the boom as being the good part of this cycle when actually that is the bad part. The good part is when the mal-investments readjust correctly. Just this year the Fed is trying to halt the economy from going into a recession by doing just that. The Fed cut the rate to 3%, which was not more than a week after they cut the rates the first time[2]. Now the short-term interest rates have fallen to 2.25%, while inflation is running around 2%.[3] What the next bubble is can be a very hard thing to spot. The Federal Reserve should not continually mess with the market of loanable funds. This in itself is wishful thinking as Mises points out that terminology often betrays us in economics. In this case he says that the bad artificial interest rate is characterized as “good business, prosperity, and upswing.” While the readjustment period that is actually good for the economy in the long run is called “crisis, slump, bad business, and depression.” This is obviously the root cause of how people turned their backs on capitalism in the 1920s and 30s. It was easy to blame capitalism for the bust, when it actually was the Federal Reserve policies.


[1] “Times Online” http://business.timesonline.co.uk/tol/business/economics/article3888223.ece

[2] “Aggressive Activism; American interest rates. (The Fed cuts again).” The Economist (US) (Feb 2, 2008)

[3] See footnote 12.

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3 CommentsLeave a comment

  1. […] Read the rest of this great post here […]

  2. […] basically claims the Austrian Business Cycle as the winner. You can find an explanation here and here from me: “The particular asset varied from one boom to another. But the basic underlying […]

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    Anyways, I’m certainly pleased I stumbled upon it and I’ll be book-marking it and checking back frequently!


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