I was searching for rebuttals of the common objection by neoclassical economists made against ABCT: That is, how come entrepreneurs foolishly just respond to the lowering of interest rates hence comitting devastating mistakes rather than possessing some level of rational expectations making them understand that the interest rate is merely being manipulated, hence they should not act upon the lowering of the interest rate.
In my search I found a paper by Roberty Murphy with the title The Rational Expectations Objection to Austrian Business Cycle Theory: Prisoner’s Dilemma or Noisy Signal?. Does anyone of you know about similar rebuttals which could be recommended (I have also read B. Stanley’s Why Don’t Entrepreneurs Outsmart the Business Cycle?) and most importantly: Robert Murphy stresses in the mentioned paper as a note that he “no longer fully endorses the views contained in this paper. Nevertheless, he is making it available for public comment”. Does anyone know which parts of his rebuttal he do not any longer endorse?
Also, it appears to me without any reading on the matter that if entrepreneur A decides to pass up the opportunity of taking extra money available from the government, he will lose ground to competitors who do take it and use it while it is non-neutral. It appears that it’s a prisoner’s dilemma situation.
Furthermore, entrepreneurs aren’t all economists. Entrepreneurs make bad mistakes all the time. If they had to make predictions outside of their field of work (plumbing, computers, home protection), we’d get nowhere.
However, entrepreneurs cannot refrain from participating in the widespread process of discoordination bank credit expansion sets in motion, even if they have a perfect theoretical understanding of how the cycle will develop. This is due to the fact that individual entrepreneurs do not know whether or not a loan offered them originates from growth in society’s voluntary saving.
In addition though hypothetically they might suspect the loan to be created ex nihilo by the bank, they have no reason to refrain from requesting the loan and using it to expand their investment projects, if they believe they will be able to withdraw from them before the onset of the inevitable crisis.
The entrepreneur, then, pursuant to the argument under consideration here, must not only sweep away the fog of years of past interventions, he must also predict what the Fed will do in the future and when it will do it — all while the Fed tries to anticipate what the entrepreneurs will do.
It seems that any entrepreneur who attempts to undertake such investigations would have little time for things such as serving his customers, improving his product and responding to his customers’ preferences.
[…] there would be those who would knowingly borrow at the below-market rates and take the risks associated with the loans. These companies would be those that were undercapitalized, perhaps startups or companies in trouble. In short, they would be the companies that had nothing to lose.
The argument ignores the real effect of these lower interest rates, namely that the portion of the entrepreneur’s wealth and investments that are cash-based now yield a lower return. This acts both as a disincentive for entrepreneurs to own cash, and an incentive for them to risk a larger portion of that wealth elsewhere.
You can also mention Reinhart and Rogoff’s work This Time is Different, that shows how businessmen and economists happily throw away old standards and wisdom and embrace the next boom. (And it’s a rather mainstream account, too - the authors with an IMF background are not Austrians.)
My reponse to the neoclassical argument is simple: the pricing system is too complex to rationally override.
If we had a small economy with just fisherman and fishing pole manufacturers then artifically low interest rates are unlikely to have much of an effect. However, in a complex economy, it’s not easy to see intuitively, entrepreneurs depend on price signals.
Also, as I believe Mises and de Soto mention, how can the individual entreprenuer know that his particular borrowing will lead to his downfall, even if he knows that the system as a whole will suffer significantly. Is an entrepreneuer seriously not going to pursue his dreams based off the abstraction that IRs are artificially low and he may be affected by that somehow? No!
I think the neoclassicals have to at least admit - that the more IR distortion and the more time while the IR is distorted, the more likely it is for a recession/depression. Yes, assuming that some dubious rational expectations are applied, surely, they cannot override the entire complex pricing system. Such an ability would require omniscience.
Humans are not omniscient. They base decisions off what people demand and the ability to supply which comes from price signals. Since at the individual level it is impossible to know the effects without omniscience, it is extremely likely a downturn will follow.
If people were omniscient we would never have a business cycle. Just because there isn’t a sudden shock that isn’t expected doesn’t mean artifically low IRs cannot cause the business cycle. The degree of complexity matters too.