Friday, August 7, 2009
Misconceptions about Austrian Business Cycle Theory
I'm very happy that ABCT is being talked about and debated these days, however, those who are critical of it (Brad DeLong, Paul Krugman, et al), get one thing wrong. The length and depth of the recession need not be explained by sectoral reallocation alone. DeLong has been particularly willful on leaving out this point. The ensuing panic caused by such misallocations (what Hayek called the secondary downturn), may and sometimes does have a much larger impact. In terms of MV=PQ, when people rush to hold cash and less risky assets, V drops. If M is not increased to counterbalance, this deflation can lead to a decline in Q, as P will not adjust immediately. This part of the recession occurs completely independently of the sectoral shifts.
The critics should acknowledge this, or at least acknowledge that Austrians acknowledge that magnitudes between boom and bust need not be symmetrical. Friedman dismissed the link between the bust and the preceding boom. Austrians link the two, but there need not be a 1-to-1 ratio in magnitudes.