Austrian Business Cycle Theory Redux: Integrating Sticky Consumption and Sequestered Capital

Abstract

F.A. Hayek’s trade cycle theory was triumphant in the early 1930s, but withered within a decade as critics went unanswered. Hayek challenged others to “prove” theoretically, what he “knew” intuitively about business cycles. In the late 1990s, Roger Garrison responded with a logically sound and pedagogically persuasive model that answered most of Hayek’s critics. In recent years, the Garrison model has been confronted over its conflict with empirical evidence that consumption is sticky, lack of insight into the timing of either booms or busts, and inconsistency with rational expectations. To address these, we first modify Garrison’s model to identify not just the capital usages in the stages of production, but also sequestered pre-production (R&D) capital. With sequestered capital in play, sticky consumption can be logically accommodated, providing answers all three criticisms of Garrison — addressing Hayek’s challenge.

Keywords: Sticky Consumption, Sequestered Capital, Austrian Business Cycle Theory (ABCT), Hayek’s Challenge

JEL Classification: El4, E21, E32