The Optimal Austrian Business Cycle Theory

Abstract

Since Hayek’s pioneering work in the 1930’s, the Austrian business cycle theory has been presented as a disequilibrium theory populated by less-than-perfectly rational agents. In contrast, we maintain that (1) the Austrian business cycle theory is consistent with rational expectations and (2) the post-boom adjustment process can be understood in an equilibrium framework. Hence, we offer a new interpretation of the existing theory. In doing so, we also address concerns raised with Garrison’s (2001) diagrammatic approach, wherein the economy moves beyond the production possibilities frontier. Our interpretation might accurately be described as a monetary disequilibrium approach grounded in an implicit general equilibrium framework with positive costs of reallocation.

Keywords: Austrian, boom, business cycle, bust, Friedrich A. Hayek, Ludwig von Mises, macroeconomic fluctuation, structure of production, rational expectations

JEL Classification: B53, E20, E22, E23, E32, E40