ABC in a Nutshell

According to Mises and Hayek, an expansion in bank credit pushes the money rate of interest below the “natural” rate. People prefer goods in the present to the same goods in the future, a matter obvious to anyone except for a few philosophers. The rate at which people favor the present, in the Austrian view, chiefly determines the rate of interest.

As just suggested, though, an increase in bank credit plays havoc with the process of setting the interest rate. Since more money is available, the price of money goes down. Investors, faced with lower interest rates, increase their investments in higher stages of production. Unfortunately, those investments eventually collapse. Because the “natural rate” — the rate of time preference — has not changed, consumers do not want the shift to investment goods that has taken place. Hence, these investments must be liquidated, and the boom collapses.

via Hangover Theory: How Paul Krugman Has Misconceived Austrian Theory – David Gordon – Mises Institute.

That is far and away the most succinct description of Austrian Business Cycle theory I have ever seen. The term “higher stages of production” could perhaps better be described as “longer term projects”.

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