by Mario Rizzo
There has been a lively debate on forecasts of high inflation made by those worried about the Fed’s recent policy of quantitative easing. For details I refer the reader to Daniel Kuehn’s excellent blog. The question to which I address myself is solely “What do these predictions have to do with core Austrian Business Cycle Theory?” This is my answer.
We must start with a few general points. First, I am talking about the Austro-Wicksellian business cycle theory as developed by Friedrich Hayek and Ludwig von Mises and as synthesized by Roger Garrison in his book Time and Money. I cannot take responsibility for versions constructed by others. It is not that I think the others are necessarily wrong (and I mean no disrespect to them), but I do not know with sufficient precision what all these others are saying in the name of “Austrian theory.”
Secondly, the Austro-Wicksellian theory begins with either an endogenous increase in credit through the banking system or with an “exogenous” increase initiated by a central bank. In the latter case, however, the theory itself has little to say about the extent to which increases in base money will manifest themselves in increases in bank credit to producers. (This may not be much of an issue during a boom but may be an issue during a recession or in a recovery.)
Third, the theory is fundamentally one about the “upper turning point” in the cycle – it is a theory about why a credit-induced boom must come to an end. It is not a theory, for better or worse, about the “secondary” factors that develop consequent on the break-up of the boom. These include possible recessionary-problems relating to bank runs (there is an Austrian inspired banking literature, but that is not the cycle theory) or what exactly will get investment expectations to turn around. As to deflation, Lawrence White has argued that the logic of the theory requires the avoidance of deflation in accordance with Hayek’s very early recommendation to keep M V from falling. (Hayek departed from this in the Depression, and later admitted he was incorrect to do so.)
Now to more specific points: Continue reading