Wednesday, 29 July 2015

Mises’s Contribution to Understanding Business Cycles

Included in The Theory of Money and Credit were at least the rudiments of another magnificent accomplishment of Ludwig von Mises: the long-sought explanation for that mysterious and troubling economic phenomenon — the business cycle. Ever since the development of industry and the advanced market economy in the late eighteenth century, observers had noted that the market economy is subject to a seemingly endless series of alternating booms and busts, expansions, sometimes escalating into runaway inflation or severe panics and depressions. Economists had attempted many explanations, but even the best of them suffered from one fundamental flaw: none of them attempted to integrate the explanation of the business cycle with the general analysis of the economic system, with the “micro” theory of prices and production. In fact, it was difficult to do so, because general economic analysis shows the market economy to be tending toward “equilibrium,” with full employment, minimal errors of forecasting, etc. Whence, then, the continuing series of booms or busts?

Ludwig von Mises saw that, since the market economy could not itself lead to a continuing round of booms and busts, the explanation must then lie outside the market: in some external intervention. He built his great business cycle theory on three previously unconnected elements.