It’s no accident that Austrian economics is newly popular. It provides the best explanation for the business cycle we just lived through.
But the resurgent popularity of Austrian economics may actually be hampering the ability of the Federal Reserve to reflate the economy with low interest rate policies. Businesses, now aware of the dangers of a low inflation- sparked economic bubble, may simply be refusing to fall for the age-old boom-bust trap.
The Austrian theory of business cycles is rather straightforward:
1) In a market economy, lower interest rates are a sign that more wealth is available in society for new business projects. Either society is more wealthy—and therefore saving more without lowering spending—or its members are saving more—delaying current consumption in favor of future consumption, and incidentally providing loanable funds for projects that will be sold for future consumption.
2) In either case, the low interest rates are a sign of additional savings—and therefore a sign that more money will be available for future consumption. Businessmen respond to this by starting or expanding business lines aimed at future consumption—that is, projects that take time and larger amounts of money to complete.
3) Many of the projects seem profitable only because low interest rates make them cheap to fund and the assumption of future consumer spending out of increased savings promises demand for their products. For businesses, this is a kind of paradise: they get to borrow cheaply and sell to wealthier people in the future.
4) Low interest rate-fueled business expansion spreads through the economy. The cost of labor and materials goes up, which provides people with more money to spend or save. Retail businesses expand as well as the higher-order long-term manufacturing, investment and research & design projects. This creates what looks like a benign cycle: expansion fueling expansion.
Read more at CNBC
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