Business Cycle Theories: Symptoms v. Causes

0:00My talk is Business Cycle Theories, Symptoms vs Causes. There are a plethora of explanations and solutions from the various schools of economics to the boom bust cycles. Each of the various theories proposes a cause. What was the event or action that causes the boom bust cycle? Furthermore, each of the theories also provides a cure. What can be done to alleviate boom bust cycles? Each of the business cycle theories are at odds with one another, proposing different causes and thereby different cures. Cures. In essence, each theory is in conflict with one another. Obviously, this audience knows which business cycle theory describes the Boehm-Bawerk cycle most accurately and correctly, namely, the Austrian Business Cycle Theory, developed by Ludwig von Mises, pushed forward by F. A. Hayek. Although there are methodological differences between the various schools of thought, I propose that many of the other business cycle theories are in one The theories aren't correct in that they are able to identify symptoms. However, these theories are detrimentally wrong because they could not identify the root cause, thus proposing the wrong cure.

1:11The business cycle theories we are examining are associated with the following economists. F. A. Hayek of the Austrian School, of which Hayek won the Nobel Prize, Milton Friedman of the Chicago School, Hyman Minsky, who has come out of nowhere as of late, our next speaker will delve into the details of Minsky, and undoubtedly our favorite economist of all, last and certainly least, John Maynard Keynes. With each of these economists, we will examine the following. We will touch on how each economist Hayek once proposed that the economy produces sustainable growth. We will briefly describe each of these economists' respective business cycle theories.

1:58And then we will discuss whether or not their theory they propose identifies a symptom or a cause. Sustainable Growth Hayek once said, before we can understand, before we can even ask how things might go wrong, we must first explain how they could ever go right. So in that spirit, let's examine how each economist views the economy going right. According to Hayek, sustainable growth comes from savings through time. As described by Professor Garrison in his capital-based macroeconomics slideshow with that fancy PowerPoint and interlocking graphs and animations, there can either be savings, investing or consumption. But the key to this is time. What is saved today can be used for either investment or consumption tomorrow.

2:46The structure of production lengthens. There is no duex machina aka government intervention or the Fed. Sustainable growth occurs from the market coordinating time and interest. Now, how does Friedman view sustainable growth without the use of duex machina? You got me there. How does Minsky view sustainable growth? You got me there as well. And how about our good friend Keynes? Nada, zilch. Friedman, Minsky, and Keynes do not have an explanation of how things go right, of how the economy produces sustainable growth, but strangely enough, they were able to develop a theory of how things go wrong. But none provide explanations of sustainable economic growth sans a duex machina. So, let's take a look at how things can go wrong. Let's take a look at each of these business cycle theories.

3:41First, the correct business cycle theory from Hayek. The central bank artificially lowers interest rates, not to mention creates fiat money. With cheap money, easily available, consumers are less likely to save and more likely to consume. Furthermore, entrepreneurs attempt to utilize the cheap money by investing. All things being equal, consumers spend on things they otherwise wouldn't spend, and entrepreneurs invest in projects they otherwise In essence, there is overconsumption and overinvestment. This spurs the boom. The structure of production can't decide whether it needs to lengthen or shorten. There is a growing imbalance between savings, consumption and investment. Eventually, the malinvestment and overconsumption of capital becomes readily apparent and the economy busts. According to Hayek, the boom is a crisis and the bust resolves a crisis. The market itself is best suited to coordinate time and interest, Savings, Investment and Consumption.

4:36The ultimate cure would be to eliminate central banking and allow for competing private currencies. Let's take a look at Friedman. In regards to cause, the literature is unclear as to what Friedman thinks is the actual cause. In some sources, he references a large supply shock. In other references, he points to central bank not keeping up with the fluctuating money supply. Friedman thinks the business cycle is a monetary phenomena. Furthermore, the cure to the business cycle, according to Friedman, is with monetary policy. The central bank must fluctuate money supply accordingly. Hence, Friedman and his ilk are nicknamed the monetarists. Minsky on the other hand provides an interesting theory. Minsky's theory is called the financial instability hypothesis. When I first was reading about his proposed cause, I thought I was Minsky suggested that fluctuations in credit and interest rates entice borrowers. He divided borrowers into three types, hedge borrowers, speculated borrowers and ponzi borrowers.

5:39Easy credit allows more borrowing. These borrowers contributed to the accumulation of insolvent debt. Banks then tighten credit and the economy contracts. This is called the Minsky moment. However, Minsky's cure gave it away that he was no Austrian. He posited that a free-market economy inevitably produces the boom-bust cycle unless government and the central bank step in to regulate. Keynes suggested that economic instability stems from several causes, the fluctuations in aggregate demand, speculation, and just the very nature of man, or what Keynes refers to as animal spirits. and Animal Spirits. Keynes uses the term animal spirits to define a spontaneous urge to action.

6:25Keynes' cure for the bust was to boost aggregate demand via a strong fiscal policy. The government needs to prime the pump through deficit spending in order to get the economy back on its feet. It is the combination cures of both Friedman and Keynes' monetary policy that runs rampant in mainstream economics today. Now, the question remains, are the alleged causes of Friedman, Minsky and Keynes actually just symptoms? But before we get to that, let's get rid of some of the alleged cures. A strong monetary policy, government intervention and strong fiscal policy, advocated by Friedman, Minsky and Keynes respectively, will not work to cure the bust.

7:11Ironically, it is the strong monetary policy, government intervention and fiscal policy itself that leads to the boom and thus the bust. We can't cure the economy with the problem that started it. The economy needs to be given the chance to heal itself. Now to the symptoms. Friedman suggested business cycles are due to supply shocks and money supply. This is actually a symptom. Supply shocks can be seen as what Hayek refers to as the lengthening or shortening of the structure of production. In terms of money supply, Friedman suggested that cause was not enough money going around, but he did not take into account time. Consumers and investors alike need to save. Both these causes are actually just symptoms.

7:58Minsky suggested business cycles are due to easy credit and eager borrowers. This falls under what Austrians call malinvestment and overconsumption. Easy money is being spent or invested where it otherwise would not. The cause is not the eager borrower nor the easy credit. The question is, what caused the easy credit in the first place? In other words, the cause is the central bank. Easy credit and, hence, eager borrowers are merely symptoms of the central bank policy. Likewise, Keynes suggested that animal spirits and loss of aggregate demand is the cause of the boom bust. It is obvious that fluctuations in aggregate demand is a symptom because something had to cause aggregate demand to drop.

8:44It's kind of like saying it's raining because water is falling from the sky. Why is water falling from the sky? Why is aggregate demand fluctuating? It's not the bust we look at, but the unsustainable boom to find the answer to this question. As for animal spirits, individuals will act in their own self-interest according to the information individuals have. If the information is distorted, the individual's actions will be distorted. The economy was distorted by the cause, artificial inflation of the money supply via the central bank. Hence, animal spirits is just a symptom as well. Thus, Keynes, Friedman and Minsky were in one respect right, but in a fundamental respect completely wrong.

9:33Each of the three economists had insight into the various symptoms of the Boehm-Bawerk cycles, but did not take their arguments far enough to understand the root cause. Their solutions only viewed the symptoms of business cycles, malinvestment and misallocation of Resources. Furthermore, their solutions instigate the next recession. Unfortunately, their theories do not understand the root cause of boom-bust cycles. Mises and Hayek's contributions have the explanation which takes into account the symptoms of Keynes Friedman-Minsky and more so the root cause. The Mises-Hayek Business Cycle Theory has the full understanding of the root cause of boom-bust, fiat money and the central control and the symptoms of malinvestment and misallocation of resources.

10:21Furthermore, the series suggests that the solution to thwarting business cycles is abolishing centralized control of money and the money supply. All in all, the Austrians have the theory that understands the cause, the symptoms, and the cure to business cycles.