(1) The version of Mises in The Theory of Money and Credit (trans. J. E. Batson; Mises Institute, Auburn, Ala. 2009 ), pp. 349–366. The first version presumably appeared in the original German edition, the Theorie des Geldes und der Umlaufsmittel (The Theory of Money and Credit; Munich and Leipzig, 1912) and the 2nd German edition published in 1924. An English translation appeared in 1934.Hülsmann has a pertinent discussion of the flaws in the original theory of Mises in The Theory of Money and Credit:
(2) Mises’s version in Monetary Stabilization and Cyclical Policy (1928) that can be found in Mises 2006 , p. 99ff.
(3) The version in Mises’s Nationalökonomie, Theorie des Handelns und Wirtschaftens (Geneva, 1940).
(4) The version in Human Action: A Treatise on Economics (Auburn, Ala., 1998 ), pp. 568–583.
“In light of his theory of interest, Mises now clarified the relationship between interest and changes in the quantity of money. The Austrian (Misesian) theory of the business cycle asserts that intertemporal misallocations result from inflation-induced reductions of the interest rate. But what was the precise meaning of ‘reduction’? Mises did not mean to assert that simple changes of the interest rate would induce a business cycle. The fact that today’s interest is lower than yesterday’s does not by itself mean that a misallocation has occurred.Hülsmann is entirely correct about the non-existence of Wicksell’s natural rate of interest. Mises’s exposition of the ABCT in The Theory of Money and Credit (trans. J. E. Batson; Mises Institute, Auburn, Ala. 2009 ) and Monetary Stabilization and Cyclical Policy (1928) both use the Wicksellian unique natural rate of interest concept. It follows that both these expositions are severely flawed.
In his Theory of Money and Credit, Mises had based his analysis on the Wicksellian distinction between the natural rate of interest and the money rate. But this distinction was untenable in light of Mises’s work on economic calculation and on the non-neutrality of money. There is no such thing as a natural rate of interest, defined as the rate of interest that would prevail in a barter economy. And even if there were such a ‘natural’ rate of interest, it would still be irrelevant for the analysis of a monetary economy. Money is not just a veil over a barter economy.
It affects all economic relations. Prices, incomes, allocation, and social positions in an economy using money are completely different from what they would be in a society with no common medium of exchange. And so the interest rate in a monetary economy is necessarily different from what it would have been in the same economy if the market participants had decided to forgo the benefits of money. Even if one could hypothetically compare ‘natural’ and money interest rates—which is not the case—it would not follow that intertemporal misallocations would ensue whenever the ‘natural’ rate was higher than the money rate.
In Nationalökonomie, Mises gave a new exposition of his business cycle theory. He came up with a new benchmark to identify pernicious reductions of the monetary interest rate. The relevant benchmark was no longer the Wicksellian natural rate that would exist if the economy were a barter economy. It was rather the monetary interest rate that would exist in the absence of credit expansion. Any increase in the supply of credit on the market will reduce the interest rate, but if the increase comes from printing paper money or banknotes (rather than from savings) then the artificially lower interest rate falsifies the entrepreneurial profit calculus. In light of the decreased interest rate, a greater number of business projects appear to be profitable and are launched. But the material factors of production necessary for the physical completion of the greater number of projects do not exist.
Credit expansion does not mean expansion of the real factor endowment of the economy; it merely means expansion of the money supply through the credit market. It follows that it is physically impossible to sustain the new structure of production that resulted from the credit expansion. The boom must eventually end in a bust.” (Hülsmann 2007: 779–781).
But Mises’s new version of his business cycle theory in Nationalökonomie (and developed in Human Action) still has major flaws, as follows:
(1) it assumes an economy with no idle resources and no international trade. In reality, capitalist systems have historically had many periods where there are significant idle resources, like labour, raw materials, capital goods and other factor inputs. If an economy with significant idle resources has investment via fractional reserve banking or central bank creation of excess reserves, how will the inflationary pressures imagined by ABCT happen if productive resources simply do not need to be freed in the stages close to consumption? Such factor inputs will be available or quickly made available through increasing capacity utilization in the relevant industries, or even imported from overseas. Versions of ABCT dispensing with a Wicksellian natural rate of interest fail to explain why the cycle effects would happen if factor inputs were not scarce and available through international trade. And even when resources become scarce the theory still has problems.
(2) Like all versions of ABCT, it assumes that credit flows primarily or exclusively to producers engaged in capital goods investments. It is obvious that this is a grossly simplistic and unrealistic assumption in the modern world. Credit today is a complex composite of flows to create consumer loans, loans to speculators on assets or primary commodities, and loans for capital goods investments. When booms in business cycles are primarily driven by credit flows to speculators who blow asset bubbles, the dynamics of the boom are different from those of booms in (allegedly) unsustainable high-order capital goods investments, as assumed by ABCT.
As a concrete example, in the 2000s the economic effect of subprime loans (such as liar’s loans or NINJA loans), where people used their houses as ATMs, was an asset bubble in housing, from which exotic CDOs were created. These effects – essentially caused by consumer loans – are clearly very different from the alleged distortions of capital structure imagined in the ABCT. Even if we assume that alleged unsustainable capital structure distortions occurred, they would be swamped by effects coming from consumer credit expansion and debt deflation.
(3) Underlying Mises’s new theory is still the mistaken time preference theory of interest rates.
(4) As Robert Vienneau has argued, there is no necessary reason why lower interest rates would cause production to be re-oriented to higher-order capital goods anyway, and even classifying capital structure into well-defined higher orders is dubious in itself (see Vienneau 2006 and 2010).
(5) The development of any boom in the business cycle is dependent on a myriad of factors, and whatever future profit any particular capital goods project will deliver can only be a matter of subjective expectation in the present. A rise in interest rates may decrease the demand for credit and raise the burden of servicing debt, but, if there is a mutual expectation that a particular investment might deliver future profit by the bank and business, it is normal for businesses to refinance their investment loans or have the loans rolled over by banks.
(6) In the real world, even when inflationary booms occur, the causes of recession and depression are often very different from the ridiculously simple Austrian business cycle theory. The business cycle after WWII down to the 1980s was rather different from the pre-1933 business cycle. The post-war world saw downturns that were mostly “inventory recessions.” Recessions from the 19th-century to the 1930s often (though not always) conformed to a pattern of bursting asset bubbles, financial crises, bank runs and debt deflation. The Austrian trade cycle theory says nothing about asset bubbles in financial markets or real assets like housing. In the 1990s and 2000s, many nations have experienced asset bubbles and the debt deflation-type of recession once again (or balance sheet recession), after neoliberal economics introduced lax and ineffective forms of financial regulation.
Hülsmann, J. G. 2007. Mises: The Last Knight of Liberalism, Ludwig von Mises Institute, Auburn, Ala.
Mises, L. von. 1912. Theorie des Geldes und der Umlaufsmittel, Duncker & Humblot, Munich and Leipzig.
Mises, L. von. 1924. Theorie des Geldes und der Umlaufsmittel (2nd edn), Duncker & Humblot, Munich.
Mises, L. von. 1934. The Theory of Money and Credit (trans. H. E. Batson from 2nd German edition of 1924), J. Cape, London.
Mises, L. 1940. Nationalökonomie, Theorie des Handelns und Wirtschaftens, Éditions Union, Geneva.
Mises, L. von. 1953. The Theory of Money and Credit (enlarged, new edn), Yale University Press, New Haven.
Mises, L. 1998. Human Action: A Treatise on Economics. The Scholar’s Edition, Mises Institute, Auburn, Ala.
Mises, L. von. 2006 . The Causes of the Economic Crisis and Other Essays Before and After the Great Depression, Ludwig von Mises Institute, Auburn, Ala.
Mises, L. von, 2009 . The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.
Vienneau, R. L. 2006. “Some Fallacies of Austrian Economics,” September
Vienneau, R. L. 2010. “Some Capital-Theoretic Fallacies in Garrison’s Exposition of Austrian Business Cycle Theory,” September 4