Austrian Business Cycle Theory Reaching Mainstream Economists

It is good to know that the Austrian Business Cycle Theory has finally reached mainstream economists. The response varies. Thanks to 2008 global financial crisis. To me this is an indication of the fulfillment of a foresight.

Beginning 2010, I have been encountering in the web that existing economics will undergo transformation. Mainstream economists can no longer afford to ignore the voice of the Austrian school.

A paper written by Jerry H. Tempelman is an example of the influence of such voice. His topic is the “Austrian Business Cycle Theory and the Global Financial Crisis: Confessions of a Mainstream Economist”. He wrote it in 2010.

The paper is structured around three parts: the identity of those who oppose the business cycle theory, the summary of the theory, and the influence of the theory on several mainstream economists. I just want to follow this order in sharing my own understanding of Tempelman’s paper.

Opponents of Austrian Business Cycle Theory

Milton Friedman tops the list of those who oppose the Austrian Business Cycle Theory. For Friedman, the theory does not provide an accurate explanation of economic recession. It lacks verifiable evidence in actual practice.

Unfortunately, Friedman was not able to witness the 2008 global financial crisis. He passed away in 2006. He was no longer there to witness the specific fulfillment of the theory.

Allan Greenspan is another key personality that opposed the Austrian school. He is a Keynesian. Due to his influence, the voice of William R. White, an Austrian influenced economist was ignored.

Prior to 2008 crisis, White predicted an economic crisis that would result from real estate bubble. His warning was not seriously taken. He actually identified central banks as primary responsible for the crisis due to monetary easing policies. The response to White changed when his prediction happened.

Overview of Business Cycle Theory

Tempelman acknowledged that among several schools of economics, the Austrian school is now considered the most reliable source of interpretation of the 2008 global financial crisis with its business cycle theory. He gave an overview of this theory. It is good that he distinguished between two types of economic booms – sustainable and unsustainable. I find it very helpful.

An economic boom is considered sustainable if it is an outcome of escalation in investment funded by growth in saving. On the other hand, it is unsustainable if the resulting escalation in investment is derived from credit expansion by monetary authorities. This kind of economic boom will certainly end in bust.

Ordinary people find it difficult to identify the dynamics that follow after credit expansion. They include lending money at low interest rates, distortion of vital economic information, negative impact on entrepreneurial decision, and unproductive use of capital. The end of the process is economic decline.

The Austrian Business Cycle Theory described above was proven true in the 2008 economic crisis. The credit expansion and mal-investment that characterized the years prior to 2008 was the primary cause for the decline both in financial market and the total global economy.

The Influence of Business Cycle Theory on Mainstream Economists

The names of mainstream economists mentioned in the paper include William Dudley and Paul Krugman. The Economist is also mentioned. Other mainstream economists using different methodology and whose economic researches are classified as “on the cutting edge” are also identified.

Tempelman noted William Dudley’s analysis of the Federal Reserve has many features common in the Austrian school. Paul Krugman also voiced out his criticism of the Fed for its ability to create boom and bust, an idea borrowed from the Austrian school. The Economist even cited the analysis of Ludwig von Mises criticizing the Fed’s monetary stimulation policy. The economic website also recognized that numerous qualities from Austrian business cycle theory characterized the economic decline both in the US and Japan.

Mainstream economists who utilized different methods include Taylor (2007), Jarocinski and Smets (2008), Smithers (2009), and Vogel (2010). All of them, though they used different approach arrived to a conclusion almost similar to the ideas of the Austrian school. Taylor for instance identified the correlation between the Fed’s monetary policy and the boom in the housing industry. Jarocinski and Smets confirmed this findings using “Bayesian vector auto-regression”. Furthermore, Smithers identified the connection between the irresponsible action of central bankers and global financial crisis. Finally, Vogel observed a sequence of events leading to financial crisis. It all started with the Fed’s monetary policy followed by 2001 economic recession leading to house bubble, which collapse finally resulted to the global crisis.

Tempelman mentioned three among cutting edge mainstream economic research. The first type of research focused on financial leverage and liquidity. Someone mentioned in the paper that a growing body of literature has been focused on this important subject. The works of Tobias Adrian and Hyun Song Shin (2009) is just one example of this type of research. Again the works of these scholars appear to be an echo of the message of Austrian business cycle theory.

Another type of research resonates the voice of the Austrian school is simply focused on liquidity. Brunnermeier (2009) argues that the face of macroeconomics will certainly change and a new economics will emerge considering the contribution coming from the macro, the micro, and financial economics.

The third type of cutting edge research concentrates on behavioral interpretations of business cycle. This one is considered complementary to Austrian Business Cycle Theory.


Tempelman wrote that since 2008 crisis, Federal Reserve officials have shown some “positive signs” acknowledging the mistake of their monetary policy. They admitted that low interest rates for too long does not really help, but has made the crisis more severe.

Some ideas for monetary reform are now considered. Unfortunately, in spite of the accuracy of the Austrian school, its proposal is still considered too radical and therefore rejected. The proposal includes closure of central banks, return to gold standard, free banking, and monetary competition.   

Personal Response

Immediately after the crisis, central banks escaped public blame. All fingers are pointing to free market capitalism. That’s the power of mainstream media. Statist interventionism is doing its best to find a scapegoat.

Thanks to alternative media and bloggers. Thanks also to the influence of Ron Paul. Central banks now are exposed. In time, the role of statist interventionism on the global crisis will also become part of mainstream consciousness.

Regarding the paper, I observe that despite the fact that core features of Austrian Business Cycle Theory were fulfilled in 2008 crisis, mainstream economists are still hesitant to acknowledge the direct influence of the Austrian school in their economic interpretation. This is my personal impression after reading the paper. I think this observation also applies to Templeman’s position. Even though he was in favor of the Austrian school, somehow he remains reserve in the way he presented his material.

As a whole, I appreciate the fact that the Austrian Business Cycle Theory is making an impact among mainstream economists. How I wish that such impact would lead to a thorough study of the Austrian school of economics and the abandonment of the Keynesian economic framework. I also wish to see the fulfillment of George Reisman’s vision in our generation: the spread of Austrian economics literature into the library of universities worldwide. I believe that such education would enable economists to see the real colors of dominant ideologies behind our present political and economic turmoil around the world. I am hopeful that the exposure of the schemes of socialism and statist interventionism would lead to a new appreciation of genuine free market capitalism. And this would mean a better future for global economy based on personal liberty, honest money, and private property.

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