Why the Austrian Business Cycle is Not a Tarot Card

Many, if not most people, tend to look for a one-size-fits-all solution or supposed elixirs to the world’s problem. That’s one of the key reason why many are seduced by analysis or reasoning premised on mathematical or statistical models or on pattern seeking formulas.

Readers of this blog recognize that I use much of the Austrian Business Cycle Theory (ABCT), but not as a standalone way to evaluate markets and events. It is important to know of the limitations of every theory, and this applies to the ABCT as well.

Professor Steve Horwitz explains, (italics original, bold emphasis mine)

Both critics and adherents of the ABCT misunderstand it if they think it is some sort of comprehensive theory of the boom, breaking point, and length/depth of the bust. It isn't. As Roger Garrison has long insisted, the theory by itself is a theory of the unsustainable boom. It is a theory that explains why driving the market rate of interest below the natural rate through expansionary monetary policy produces a boom that contains endogenous processes that will cause that boom to turn to a bust. Again, it's a theory of the unsustainable boom.

ABCT tells us nothing about exactly when the boom will break and the precise factors that will cause it. The theory claims that eventually costs will rise in such a way that make it clear that the longer-term production processes falsely induced by the boom will not be profitable, leading to their abandonment. But it says nothing about which projects will be undertaken in which markets and which costs (other than perhaps the loan rate) will rise, and it tells us nothing about the timing of those events. We know it has to happen, but the where and when are unique, not typical, features of business cycles.

Once the turning point is reached, ABCT tells us little to nothing about how the bust will play out. Yes, we know that further inflation and interventionist attempts to prevent the necessary reallocation of resources will make matters worse, but the theory by itself doesn't tell us a priori how this will play out in any given historical circumstance. The ABCT is not a theory of the causes of the length and depth of recessions/depressions, but a theory of the unsustainable boom.

In short, the ABCT explains the cause and effects of tampering with interest rates. Yet there are many other influences to people's incentives to act, which is not limited to interest rate signals.

And in looking for specifics or exactitudes, like ‘timing’ and which ‘particular projects or costs’ will be affected, would be similar to looking for answers from the tarot card. Obviously ABCT does not work that way.