Saturday, 31 January 2015

A Graphical Introduction to the Austrian Business Cycle Theory

By Gaurav Mehra

Business cycles, simply put, are the fluctuations of economic growth about an economy’s long-term trend. Identifying the symptoms of business cycles is simple enough but identifying their cause is a much more formidable task. Indeed, many theories have tried and many have failed to provide convincing causational links. Many economists and politicians have even come to accept business cycles as an inherently pernicious trait of capitalism. This article attempts to explain, to the best of its author’s ability, a relatively forgotten and anti-conventional theory that aims to explain business cycles; the Austrian Business Cycle Theory (ABCT). Named after its origin in the Austrian School of economic thought, this theory places emphasis on the rate of interest. Specifically, the theory argues that when the rate of interest is set arbitrarily by monetary authorities different from where the market would have it, there is an adverse affect on the structure of production which serves as one of the main catalysts behind the booms and dreaded busts of the business cycles.