Monday, May 30, 2011

Kirzner on Austrian Business Cycle Theory

In “An Interview with Israel M. Kirzner,” Austrian Economics Newsletter (vol. 17.1, 1997), Kirzner makes some very fascinating remarks on Austrian business cycle theory (ABCT). In the extract below, AEN (Austrian Economics Newsletter) stands for the interviewer:
AEN: You’ve never thought of providing a systematic critique of the Austrian business cycle theory, for instance?

KIRZNER: No, I’ve never had too much interest in the Austrian business cycle theory. I’ve never felt that the Hayekian business cycle theory was essentially Austrian. In fact, Mises, who was the originator of this whole idea in 1912, didn’t see it as particularly Austrian either. There are passages where he notes that people call it the Austrian theory, but he says it’s not really Austrian. It goes back to the Currency School and Knut Wicksell. It’s certainly not historically Austrian. Further, I would claim that, as developed by Hayek, there are many aspects of it that are non-Austrian. I don’t believe that to be an Austrian you have to buy into the Hayekian view of business cycles.

AEN: Are there any aspects of Hayek’s business cycle theory that you regard as Austrian?

KIRZNER: I recently wrote a paper to accompany the facsimile German edition of Prices and Production. I identified what seemed to me to be elements of Hayek’s later work on coordination, miscoordination, and knowledge. I argued that the germs of his later ideas can be traced to this volume, especially his description of the upswing stage of the cycle. This is a phase during which some decisions are out of sync with other decisions. Current investors are making decisions which anticipate the decisions of others down the road, which are in fact not there. Leaving the exact mechanism aside, that is the kind of thing Hayek taught us to look for in analyzing the market process. In that respect, it's Austrian.

AEN: And the rest of the theory?

KIRZNER: Otherwise, the Austrian theory of the business cycle is a macro theory. It’s an equilibrium theory. And it treats capital in an objective sense rather than a subjective sense. It treats time as somehow embedded in the capital goods themselves. So I’ve always had a certain reserve about that particular theory, however brilliant it may be. I think the way Hayek developed it was not quite consistent with the way Mises laid it out in 1912.

AEN: Do you accept the idea that interest-rate manipulation by the central bank can cause distortions in the structure of production?

KIRZNER: Certainly the Austrian cycle theory showed brilliantly how this can happen. But it’s one thing to develop a theory which could explain a downturn. It’s quite another to claim that historically every downturn is to be attributed to that particular theory. That does not necessarily follow. If one were asked, does this theory necessarily explain each and every cycle, I would say no.

Mises used to poke fun at those who criticize the Austrian theory of the business cycle as being too simple. He said that still doesn’t tell what’s wrong with it. That’s correct, as far as it goes. Perhaps many market aberrations are of this kind. But that can only be a question of historical understanding. We must be able to look at every case to see just what is happening.
A number of points emerge from this:
(1) Kirzner never felt “that the Hayekian business cycle theory was essentially Austrian.”

(2) Hayek’s version of ABCT contains “aspects” that are “non-Austrian.”

(3) Austrians do not even need to adhere to ABCT, as it is not some fundamental idea of Austrian economics.

(4) Hayek’s development of ABCT was not “quite consistent with the way Mises laid it out in 1912.”

(5) Kirzner did not even think that all recessions could be explained by ABCT.
You have to wonder, then, what Kirzner would think of modern Austrians desperately trying to use ABCT to explain every recession that has ever happened. And, moreover, for the moderate subjectivist Austrians who agree with Kirzner, a question occurs: what recessions in their mind aren’t explained by ABCT?


The commentator Iain below alerts me to another issue. Kirzner argues that “the Austrian theory of the business cycle is a macro theory. It’s an equilibrium theory.”

How strange it is, then, to see Austrians denying the validity of macroeconomics or macro concepts, particularly when Roger Garrison, one of the leading neo-Austrian moderate subjectivists in the tradition of Hayek, has devoted himself to creating an Austrian macroeconomics (Garrison 1984 and 2002). Furthermore, Steve Horwitz notes how Hayek’s work in the 1930s was essentially in macroeconomic theory and what its legacy was:
“Hayek’s ‘pre-Keynesian’ macroeconomics was not left to die on the vine. Although not much discussed in self-consciously Austrian books, there is an Austrian macroeconomics that is alive and well. There are three distinct issues that Austrian macroeconomists have been pursuing in the post-revival years. First are the extensions of the Mises–Hayek theory of the trade cycle ... . Second is the recent interest in the idea of ‘free banking’ .... Third, and arguably even less explicitly Austrian, is the work of Leland Yeager, Axel Leijonhufvud, and Robert Greenfield that has tried to revive interest in the pre-Keynesian monetary disequilibrium theorists...” (Horwitz 2000: 2).
J. E. King gives a further explanation of ABCT and macroeconomic and equilibrium theory:
“In the 1930s, however, Hayek had formulated an influential theory of the trade cycle, which he explained as the result of mistaken government policy. Excessive monetary expansion in the upswing pushed the rate of interest below its ‘natural’ value, encouraging a short-lived boom in investment that extended the average degree of ‘roundaboutness’ of production beyond its sustainable level. In the ensuing depression the appropriate capital structure was restored by means of a decline in the level of investment expenditure. Hayek interpreted the reduction in output and employment in the downswing as the unavoidable consequence of the initial policy error (Hayek 1931). His analysis of money and capital was heavily criticized at the time [Sraffa, 1932; Kaldor 1937]. It not only proved to be vulnerable to the Cambridge capital critique ..., but also appeared to rely upon concepts of equilibrium (the ‘natural rate of interest’, for example) that were inconsistent with the broader principles of Austrian economic theory” (King 2002: 229–230).
It appears that Kirzner in the comments above is pointing to precisely this issue.


Garrison, R. W. 1984. “Time and Money: The Universals of Macroeconomic Theorizing,” Journal of Macroeconomics 6: 197-213.

Garrison, R. W. 2002. Time and Money: The Macroeconomics of Capital Structure, Routledge, London.

Hayek, F. A. von, 1931. Prices and Production, G. Routledge & Sons, Ltd, London.

Horwitz, S. 2000. Microfoundations and Macroeconomics: An Austrian Perspective, Routledge, London and New York.

Kaldor, N. 1939. “Capital Intensity and the Trade Cycle,” Economica n.s. 6.21: 40–66.

King, J. E. 2002. A History of Post Keynesian Economics since 1936, Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.

Sraffa, P. 1932. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.


  1. Those questions have been answered, and I'll look for the links to the corresponding papers.

    Also, Kirzner is still alive, his thoughts on modern Austrians aren't hidden.

    A few quips: Points 2-4 seem to be coming off as objective facts, versus notes relating to an interview with Kirzner.

    With 2, I'd also say that the way you're using non-Austrian is misleading. The aspects may not be exclusive to Austrian-economics but that doesn't mean they aren't considered a part of Austrian economics. Methodological individualism, for example, isn't an exclusively-Austrian methodology, yet it is one of the pillars of the Austrian school.

    And 3, I don't think that is what Kirzner is saying at all. One doesn't need an orthodox reading of ABCT to believe that the ABCT can explain certain recessions is a better way of saying it.

  2. Anonymous,

    Thank you for your comment, and perhaps you can also give your answer:

    What recessions in your opinion aren’t explained by ABCT?

    Cna you think of any? I have yet to meet an Austrian who will answer that question.

  3. "Otherwise, the Austrian theory of the business cycle is a macro theory. It’s an equilibrium theory."

    I think that this is a significant point and I'm surprised you did not raise that as worthy of comment. This is a significant admission and proves post-Keynesian critiques of "Austrian" economics right.

    For example, the "Austrian" theory of the business cycle, "not only proved to be vulnerable to the Cambridge capital critique . . . , but also appeared to reply upon concepts of equilibrium (the 'natural rate of interest', for example) that were inconsistent with the broader principles of Austrian economic theory." (J.E. King, A history of post Keynesian economics since 1936, p. 230)

    And I should note that von Hayek admitted as much when Piero Sraffa destroyed his arguments back in the early 1930s.

    Still, given that I have pointed this out for some time it is nice to see it confirmed by a leading light of the school...

    An Anarchist FAQ

  4. Iain, very nice point, and, yes, I should have picked up on that.

  5. "not only proved to be vulnerable to the Cambridge capital critique"
    Why? The overall "lengthening" of the capital structure remains an empirical question, even if some reswitching happens.

    Bob Murphy on reswitching and Hayek:

  6. "What recessions in your opinion aren’t explained by ABCT?"

    If by 'recession' you mean a sudden decrease in employment and investment, then non-ABCT scenarios could include wars, natural disasters, breakdown of society, etc. Bob Murphy explains a possible "non-ABC" scenario could happen in Ron Paul becomes president, here.

    Is this the kind of answer you were looking for?

  7. FWIW, Kirzner has said that the two most important books in Austrian Economics written between O'Driscoll and Rizzo's 1985 book and 2003 or so when IK retired were my book and Roger Garrison's. So perhaps Roger and I addressed a number of his concerns?

  8. "If by 'recession' you mean a sudden decrease in employment and investment, then non-ABCT scenarios could include wars, natural disasters, breakdown of society, etc. "

    I want actual examples of downturns in the business cycle over the past 150 years in any country you like that you think are not caused by ABCT.

    If an Austrian can provide no real world examples, then my suspicion is that the person in question is just another Austrian ideologue who actually explains all real world recession by ABCT.

    E.g., do you think post-WWII US inventory recessions were caused by ABCT? That the Volcker-induced US recessions of 1980 and 1981-1982 were really just caused by ABCT when they were obviously caused by Volcker's experiment with monetarism?

  9. I think you are using 'downturns in the business cycle' and 'recessions' interchangeably, when I think I just demonstrated that they are not (theoretically) equal. {Sidebar: Recessions aren't caused by ABCT; rather, ABCT, like any other theory, can only be used to explain them.}

    As for your question on actual examples, the easiest is to point to Japan right now. Unemployment has gone up, and production fell sharply, although it seems to be picking up. I don't think a lot of Austrians would disagree with me about this.

    I don't feel comfortable speaking about your post-WWII and Volcker examples as I don't know enough about the history there.