Maybe a new approach to the Austrian Business Cycle Theory, some disorganized thoughts

This approach is loosely based on the guido-hulsmann concept of “cluster of errors” and on general ideas about capital heterogeneity taken from Lachmann.

  • Interest is just another price. Let’s consider just flow of money and changes in relative prices instead.
  • Monetary policy is just one possible cause of relative prices misalignment.
  • The base interest rate is not very important, if there’s a big flow of money to one specific sector that’s what matters. There will be an unsustainable boom there.
  • Of course if there’s a general reduction in interest rates that means there’s a general flow of money to multiple sectors (those with lengthier production processes) or even disequilibria inside sectors towards more roundaboutness in an unsustainable manner (to talk about sectors is an oversimplification, these things don’t exist in fact).
  • The standard ABCT formulation gives too much importance to the banking sector, as if it had a role in the economy much more important than anything else. That may not be the case. And even without banks at all still boom-bust cycles would happen if a new flow of printed money is directed somewhere (anywhere).

This new approach solves:

  • Critiques of the theory like “oh, entrepreneurs are rational, they will know the monetary policy and don’t overinvest” because now we can make it clear that they will follow relative prices.
  • The problem with talking about one single interest rate, as in the real world there multiple interest rates – or in fact multiple interest rates for each agent at each point on time.
  • The problem with hayekian triangles. We can ignore these now because the concept of a general lengthening of a general production process is not the characteristic of the cycle anymore. That is just one possible example of cycle – one that’s probably very rare.
  • Garrison’s powerpoint fundamental problem: it ignores the fundamental insight from Solow’s growth model according to which economic growth can’t be explained by considering just aggregate savings/investments.

Networks of circles of production

Instead of thinking in triangles1 we can think in networks of circles of variable sizes.

If we imagine there’s a circle which represents one kind of good produced and for some reason there’s an stimulus for the production of that good (for example, a governmental program that uses newly-printed money to subsidize loans for that specifically) that circle will get bigger. In the process of getting bigger it will also make bigger the circles that were already around it, and the biggerness will gradually spread.

That means new investment is being made on each of these industries, malinvestiment. People and resources are migrating from other, more distant circles, to these circles nearer the epicenter of malinvestment.

Representing the cycle that way we’re free to oversimplify as you can just say: the real world is like this, but with many more circles and more complex relationships between them. You can also alternate between considering the circles sectors, industries or individual companies.

No sequential “steps” of production, just plans

Instead of imagining production princesses with discrete sequential steps we should also consider actually just plans.

Entrepreneurs predict there will be demand and predict there well be suppliers with reasonable prices for them to complete a plan. The plan can be arbitrarily divided into production and sale of a good, but actually often these parts are not so simply detached from each other.

In the network of circles the plan can be visualized as one circle looking around and seeing the other circles and estimating their future behavior.

The boom stops and the bust happens when the predictions fail. They fail because the unsustainable stimulus that was causing some of the circles to increase continuously stops.