Tyler Cowen’s “Risk and Business Cycles”

by Mario Rizzo

I am happy to report that Tyler Cowen’s book, Risk and Business Cycles: New and Old Austrian Perspectives  is now available, as of July 15th, in a reasonably-priced paperback edition from Routledge. (I am sure that Amazon will be making it available soon.)

This is not an orthodox Austrian approach. In fact, Cowen criticizes that version. However, the “new Austrian” inspired version he presents seems especially relevant in view of the widespread, but not uiversal, agreement that the pre-recession period of very low interest rates contributed to the search for yield and greater risk taking. As the title indicates, Cowen’s theory emphasizes the importance of low interest rates on risk-taking.

This book appears in the Routledge series, “The Foundations of the Market Economy” edited by Larry White and me. Tyler’s book is well worth reading as are many books in this series (now approaching thirty books).

Now you can afford to buy it.

11 thoughts on “Tyler Cowen’s “Risk and Business Cycles”

  1. Is there any central point that Tyler has when criticizing the original version of ABCT?

  2. Cowen’s critique is the most thorough critical analysis of ABCT. Compared with Wagner’s, Yeager’s, Leijonhufvud’s, Caplan’s and Tullock’s is probably the most interesting, and surely the most complete.

    Here are his key points (there are other critiques, but I prefer these because they appear more relevant):

    1. Why do consumption and investment comove during the boom and bust?
    2. Why are interest rates so effective in causing malinvestment?
    3. Why do entrepreneurs commit non-random, but biased, errors during the boom?
    4. Why do central banks play a key role in miscoordination, whereas the market may be inherently unstable on its own terms?
    5. Why does finance play no role in Austrian theorizing?

    I wrote my assessment of these critiques in the post linked below.

    His pars construens is much worse than the critical part, however. He tries to build an efficient investment frontier along which the economy moves due to monetary policy, and higher growth is traded off with higher instability. In my opinion, it is the INEFFICIENCY of risk taking during booms that is the key aspect of business cycle theory, the economy trades off risk for nothing.


  3. Re: #2, The discounted cash flow analysis in Alfred Rappaport’s book _Creating Shareholder Value_ (2nd ed.) has Austrian implications. When a central bank causes interest rates to fall below their free market levels, this induces investors to (over)value investments with sub-market discount rates. Any investment based on long-dated cash flows (real estate, private equity, stocks, bonds, etc.) might become overvalued this way. As the markets become more overvalued, the process can feed on itself (extroardinary popular delusions, the madness of crowds, and all that) causing further overvaluation. Think of stocks and venture capital in the late 90s, and real estate and private equity more recently.
    Of course, discount rates are not the only factor in investment valuation, but they are an important one.
    Austrians should read this book and think about its implications for business cycle theory. (Their are other books on investment valuation that might be worthwhile too.)
    Re: #3. See #2.
    Re: #4. George Selgin studied historical business cycles and claimed that a large share of them were caused by central bank policy. I think others have come to similar conclusions. I don’t think the market is necessarily inherently unstable, at least not to the degree central monetary planning is.
    #5. Is this true? If it is, see Rappaport, and start working….

  4. The July 24 issue of The Economist’s “Economics Focus” column (p. 76) has an article on “Agents of Change.” It seems that America’s only native criminal class (Congress) had a hearing about “dynamic stochastic general equilibrium”–there outta be a law–models used by the Fed in its monetary central planning. In June the NSF had a confab on “agent-based models,” which make no assumptions about general equilibrium, efficient markets, etc. The latter have non-linear feedback institutions, which include the herding and panics that lead to bubbles and busts.
    A couple of economists think they can construct an ABM for the entire global economy. Cost to taxpayers, undertermined.
    They might consider pulling a handfull of Austrian books off the shelf. Cost to taxpayers: nada.

  5. Re: #1, in response to Pietro M’s criticism of the early Austrian view of forced savings (the doctrine that, at full employment, a rise in loan-fueled investment implied a necessary reduction in consumption): in fairness to Mises, Hayek, et al., they wrote at a time when consumers didn’t have the loan options they have now, options that could boost their consumption as they increased their indebtedness. To pick one example, today Mr. and Mrs. Consumer can use their home equity as an ATM; they couldn’t do this in 1930.

  6. That’s more or less what I wrote on my blog post, which I haven’t posted here because it was too long. I’m not convinced of Cowen’s critiques, I just consider a full blown response to be lacking.

    Let’s expand on capital consumption: many analyses (like Woods’s on “Money in crisis”) are based on accounting, not real factors. Mises didn’t provide a justification, although he claims in Human action that unused capacity plays a key role. Hayek talked about “double shifts” in “Profits interest and investment”, and dedicated a paper on the issue, Garrison talks about pro-cyclical labor supply and “triangles pulled at both hands” (which, however, is more a metaphore than an explanation). He also wrote a very interesting paper comparing Mises and Hayek on the topic. Probably the best paper I read on the topic is one by Machlup on the meanings of capital consumption.

    Such a theory is key to answer criticisms regarding lack of comovement, anticyclical consumption, etc. Sraffa, Cowen, Tullock all insisted on the issue. However, except for Garrison who insisted on it at length, it seems to me quite a neglected topic. Besides, there is some focus on accounting effects and not on the real issue: what exactly is an unsustainable expansion beyond the production frontier? What does really happen in the economy?

    I have Rappaport’s book but I haven’t read it yet. I think you suggested it on Coordination Problem months ago.

    Regarding point 1, however, overconsumption was taken into account by Mises in Human Action, it’s a microfoundation which was missing. There is no need of consumer’s loans: higher real wages or higher employment or higher working hours are sufficient to boost consumption.

  7. Hayek also emphasized the importance of low interest rates on risk taking.

    See _The Constitution of Liberty_, among other writings by Hayek.

    I recently sent Cowen a few quotes from Hayek on that topic.

    Cowen replied saying Hayek’s remarks on this topic were terrific.

  8. Let me say that again.

    Changes in risk taking are explicitly part of Hayek’s account of the trade cycle.

    And Cowen is now informed of that fact.

  9. Note well.

    Cowen takes on Rothbard. He clearly does not engage Hayek.

    For example in Hayek central book on the trade cycle, he explicitlynsays that the private economy can create trade cycle without a central bank playing any role.

    And ther is a bit of “finance” in Hayek”s first and central book on the topic.

    Hayek mostly takes the institutional background of finance for granted, and had his plate well full with other fish to fry.

    Pietro list these criticisms of “Austrian” macro:

    “4. Why do central banks play a key role in miscoordination, whereas the market may be inherently unstable on its own terms?
    5. Why does finance play no role in Austrian theorizing?”

  10. Hayek in important places identifies changes in profits as the central causal element in malinvestment, and NOT interest rates.

    More evidence that Cowen is a critic of Rothbard but can’t be thought of as someone who has actually engaged Hayek’s work on any serious level.

    Pietro on Cowen’s criticism of “Austrian” macro:

    “Why are interest rates so effective in causing malinvestment”

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