Monetary Misperception, Rational Expectations and the Austrian Theory of the Business Cycle

Abstract

Salter and Luther (2016) argue that the Austrian theory of the business cycle (ABCT) can be interpreted as one where consumers and entrepreneurs with rational expectations make erroneous investment decisions driven by misperceptions regarding real vs. nominal shocks. Although we are sympathetic to their individual points, in this paper we criticize their overall stance on two grounds. First, we argue that their Lucasian approach to the boom treats money as a mere veil, ignoring the “driving force of money” that Mises emphasized. Second, we criticize their analysis of the bust on the grounds that their model lacks a capital structure. Although their discussion of the intertemporal PPF is arguably an improvement on Garrison’s treatment, we argue that by neglecting the time structure of production their model is unable to generate a bust similar to the traditional ABCT that involves a significant reallocation of resources and that leaves the economy permanently poorer.

Keywords: Austrian Business Cycle Theory, Rational Expectations, Capital Structure, Money Neutrality

JEL Classification: B53, E13, E14, E32