Sorry if this has been asked and answered before, but I couldn’t find much with the search function.
Are business cycles ALWAYS a result of the expansion of credit ala Austrian Business Cycle, or are cycles a somewhat natural function of the market? The only reason I ask this is because someone I was discussing this with (who agrees that it is the primary cause of them) said that cycles would still occur in absence of government interference. He makes the claim that malinvestment is literally a social phenomenon where entire societies are influenced by investment trends (and speculators follow and drive up prices) and ‘jump on the bandwagon’. He claimed there’s a reason every major recession comes before a major f’uck up in the financial world that is always aimed at a single sector of the market (be it the internet, mortgages, Asian manufacturers in the 80s, etc). Because people, as individuals, based on market rumors, widespread speculation, bandwagon jumping, whatever, make these bad decisions that become a society wide phenomenon.
What does mises.org have to say about this? Like I said, in general the guy believes in laissez faire capitalism and the like, but is he correct in his assertion that the cycles are natural?
Follow up questions: Why do “crashes” tend to happen in a single market (housing, tech, etc.)? How does an Austrian address this?
How would one address the claim that there is simply not enough time for people to realize the gravity of their (usually undiverse) malinvestments and to allow the feedback mechanism of the market to be effective? In other words, most “financial crashes” happened in the space of a few days, hours even, up to which point, everyone believed their money was sound no matter how long or how fast credit was poured into the market in the first place.
I think the key thing to realise with an Expansionary Monetary Policy is that it allows a flawed “investment trend” to go on unrealised for longer. In the absense of an EMP, the bubble would pop far sooner leading to far fewer malinvestments.
These various “investment trends” merely determine which particular sector the bubble will manifest itself.
Yes, but understanding why means understanding Austrian Business Cycle Theory.
Briefly, when the central bank begins to expand the money supply (through credit), it causes the interest rate to be lower giving the illusion of an increased supply of real savings. This allows for many investment projects to appear viable that would not appear viable with a more realistic picture of the supply of savings. Inflation begins to kick in and the money supply needs to continue expanding in order to maintain the new found momentum. Eventually, the rate of monetary expansion becomes anticipated and needs to be increased in order to avoid widespread realisation of the true level of savings, which leads to increased inflation. Utlimately, either inflation will escalate out of control or the central bank will need to put the brakes on (take the “heat” out of the economy). Then the shortfall in savings becomes realised and the bust kicks in.
Thus we can see how an EMP can sustain investment bubbles for longer than would otherwise have been the case.
To add, with this new found abundance of credit comes increased consumer demand for consumption and as a result malinvestment. New consumer demand for consumption creates increased investment in consumer products and high orders of production. It makes less credit available for investment in low orders of production or in capital goods to support the higher orders of production (at some time later the future). The trend will not be sustainable. For example, the cheap money gets builders to start building houses. That’s where all the new money flows. The brick and shingle manufacturers don’t get the same investment signals and don’t invest in producing more cap goods. Three months later when the house is nearly completed the builders later find out that there are aren’t enough bricks and shingles to complete the houses. Bricks and shingles will now cost substantially more due to short or non-existent supply The house will become more expensive and perhaps become a profitless venture for the builder. The recession / depression to correct the situation is to tear down one or more houses to free up resources to finish the remaining houses. It became apparent to the builder, after the fact, that they had malinvested. It was due to the errorneous economic signals (interest rates) given by the central bank.