A New Approach to Austrian Business Cycle Theory

Abstract

The most prominent previous versions of Austrian Business Cycle Theory (ABCT) are analyzed with the conclusion that, while containing interesting insights, were excessively aggregative and based on confusing constructs. This work develops a more realistic version of ABCT centered on the actual mistaken investment projects that should lie at the heart of the cycle and the errors that lead to them. The resulting theory is then illustrated by means of a computer model in order to verify the logical coherence of the core mechanism and unearth the potential tacit assumptions. Finally, a methodology is proposed for applying it to particular historical episodes, and the U.S. Great Recession and the run-up to it are considered in its light. There is considerable evidence from those events suggesting that there was a cluster of ABCT-described projects in non-residential construction and a cluster of associated troubled loans. While the cluster appears to be insufficient in itself to explain the scale of the U.S. Great Recession, the finding is still significant given that the bulk of excess credit during the preceding phase was not allocated to it.