…or else their theory may appear inconsistent and impossible to validate. Don’t get me wrong, the Austrian Business Cycle Theory (ABCT) is great and applies sound economics every step of the way. But its application suffers from a deficiency: It is only part of a larger theory. I will explain what I mean by that and the inconsistencies it leads to.
When Austrian Economists talk about the business cycle they are actually referring to what I called the production business cycle. It is that business cycle which causes entrepreneurs to withdraw resources from the production of consumer goods and directs them toward the production of capital goods.
They never consider the idea of a consumption business cycle, at least I was unable to find it anywhere. But I can’t find a reason to dismiss the notion of such a cycle.
What does this lead to? It leads to problems when it comes to explaining historical events. If, say, the recession of 2008 was caused by excessive production of capital goods and a shortage of consumer goods then how can they explain the massive expansion of the production of consumer goods throughout the recent boom:
Click on images to enlarge.
In fact, a much more realistic assumption is that the ratio of consumer vs capital goods is the same for imported/exported goods as it is for all of production, in which case the real ratio would be closer to the blue line or at least somewhere in between blue and green.
In fact the entire problem of an excessive production of consumer goods, of surplus strip malls, of Starbucks locations on every block, or of a glut in homes makes little sense when one tries to apply the concept of over production of capital goods. What makes even less sense when applying this theory is the fact that the production of capital goods throughout this entire period was utterly neglected, factories “shipped off to China”, etc.
The solution to this is simple. What Austrians currently refer to when they say business cycle has to be viewed as the production business cycle. Together with the consumption business cycle it forms a general theory of the business cycles which simply establishes that resources are misdirected as a result of government intervention. From where to where, however, highly depends on the types of loans made and/or subsidized.
This is what I established and outlined in detail in The Business Cycle Revisited, and I am open to feedback and constructive criticism from the Austrian community. :)