An Empirical Analysis of the Austrian Business Cycle Theory

28 Pages Posted: 11 Jan 2014  

William J. Luther

Kenyon College

Mark Cohen

Kenyon College

Date Written: January 9, 2014

Abstract

The Austrian economists Ludwig von Mises and Friedrich A. Hayek developed a unique theory of the business cycle. In their view, an unsustainable boom ensues when the rate of interest prevailing in the market falls below the natural rate. The boom is characterized not only by an increase in aggregate production but also by a distortion of the structure of production. Similarly, the recession that follows is characterized by a decline in aggregate production as the structure of production is repaired. Hence, the Austrian account of macroeconomic fluctuation stresses the misallocation and reallocation of resources in addition to the overproduction and underproduction of more conventional business cycle theories. In a recent article, Lester and Wolff (2013) attempt to consider the empirical relevance of the Austrian view. We argue that the authors’ use of the Federal Funds Rate as an indicator of monetary policy is inappropriate in that it fails to distinguish a low market interest rate from a market interest rate that is low relative to the natural rate. Using an estimate of the natural rate provided by Selgin et al. (2011), we attempt to improve upon their analysis.

Keywords: Austrian, boom, business cycle, bust, federal funds rate, Friedrich A. Hayek, interest rate, Ludwig von Mises, macroeconomic fluctuation, monetary policy, natural rate of interest, neutral rate of interest, producer price index, productivity rule, recession, stage of process, structure of production

JEL Classification: B53, E32, E52, E53

Suggested Citation

Luther, William J. and Cohen, Mark, An Empirical Analysis of the Austrian Business Cycle Theory (January 9, 2014). Available at SSRN: https://ssrn.com/abstract=2377057 or http://dx.doi.org/10.2139/ssrn.2377057

William J. Luther (Contact Author)

Kenyon College ( email )

Gambier, OH 43022
United States

HOME PAGE: http://www.wluther.com

Mark Cohen

Kenyon College ( email )

Gambier, OH 43022
United States

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