Essential Austrian Economics: Business Cycles
One of the most contentious ideas of the Austrian School is its explanation
for one of the reasons economies fluctuate between booms and busts.
According to Austrian economists, the ebbs and flows of the economy,
or what we call the business cycle, are often rooted in central banks actively
intervening to change interest rates from what they would otherwise be.
Austrians, like most economists,
see the interest rate as the price that coordinates savings and borrowing.
The link with the business cycle is that when central banks lower interest rates relative to
the actual amount of savings, it artificially stimulates investment that is not sustainable.
Let's explore this with an example: The central bank of ProsperityLand believes
that interest rates are too high and are impeding economic growth, so it intervenes to lower them.
This intervention makes it more attractive for entrepreneurs and
businesses to borrow and expand their business. The lower interest rate signals to entrepreneurs
and businesses that people are saving more today and will, therefore, consume more in the future.
Ivan is a business owner with a profitable company selling chocolates.
Based on the lower interest rate, he decides to build a new factory,
doubling his production capacity. Two years later Ivan opens his brand
new factory - and soon realizes that there has been no increase in demand for his chocolates.
Interest rates weren't really lower—as they would be if people were actually saving more—instead,
they were made artificially lower because of the government's injection
of money into the banking system. Ivan now has the capacity and costs
to produce double what he once produced, but there isn't enough demand for his chocolates.
Ivan's profitable business is now losing money and he still has to
repay the loan for the new factory. Ivan realizes that building the new
factory was not a sound decision. And unfortunately he's now forced to lay
off workers and restructure his business. And this story replays itself throughout the
economy, with countless entrepreneurs like Ivan. The Austrian School's view is that distortions
in interest rates play a major role in business cycle booms and busts.
For more information on Austrian Economics, visit EssentialAustrians.org
For more information on Essential Scholars, visit EssentialScholars.org