Leland B. Yeager is Ludwig von Mises Distinguished Professor Emeritus of Economics at Auburn University.
The Austrian theory of the business cycle describes how expansion of money and credit can cause recession or depression. Perhaps under political pressure to cut interest rates, the monetary authorities expand bank reserves. Business firms find credit cheaper and more abundant. These signals suggest, incorrectly, that people have become more willing to save and thereby free resources for investment projects. Firms put more resources into interest-sensitive projects that will take relatively long times to ripen into consumer goods and services. Actually, investable resources have not become more abundant through voluntary saving. Competition for resources grows more intense among long-term and short-term capital-goods industries and consumer-goods industries. This becomes especially true as workers employed on the artificially stimulated long-term projects try to spend their increased incomes on current consumption.
Sooner or later, however, the falsified appearances must bow to reality. Shortages or increased prices of resources necessary for completing the capital-construction projects force abandoning some of them, at least partially wasting the resources they embody. A tightening of money and credit may play a part in this return to reality, for continuing to expand them would threaten unlimited inflation. Cutbacks in long-term investment mean laying off workers and canceling some orders for machines and materials and some rentals of land and buildings. The downturn is under way.
Sophisticated Austrians do not claim that this scenario accounts for all recessions and depressions, but it is the one most often recited in Austrian circles. Though conceivable as a scenario, as a general theory it has long seemed implausible to me—incomplete yet unduly specific. However, it suits the Austrians’ methodological and ideological predilections. The Austrians cite observed facts that are compatible with their account; but practically never, to my knowledge, do they present evidence that favorably discriminates between it and rival theories. (I find the “monetary-disequilibrium” or “monetarist” theory in better accord with standard economic theory and with statistical and historical evidence from many times and places.) The Austrian school has much of value to teach the world, but its favorite emphasis in business-cycle theory is an embarrassment that it would well be rid of.
Tyler Cowen now joins the attack on this “old Austrian perspective,” as he calls it. He finds it strange that business investors, despite weeding-out and discipline by profit and loss, should repeatedly be fooled by artificially and unsustainably low interest rates. His long list of further reasons why the Austrian theory is implausible—his protracted flogging of a dead horse—becomes tedious.
Cowen offers his own “new perspective,” his “risk-based” theory, as a modification of the one he rejects. Whereas the Austrian theory requires “volatile inflation” rather than steady inflation, volatile inflation under his theory “produces an immediate contraction and downturn, rather than an expansion of malinvestment.” (By “inflation,” Cowen usually seems to mean money-supply expansion rather than price inflation.) His theory “is not committed to pinpointing the nature of expectational errors from inflation, as does [sic] the traditional Austrian theory.” It does not require that a bust always follow an inflationary boom. “Either increases or decreases in long-term investment may set off downturns.” It does not rely on specific types of misperception, forecast error, or malinvestment; it can accommodate a variety of them.
It is pointless to go on trying to summarize Cowen’s theory. Although it does invoke a tradeoff between risk and expected yield on investments, it is not really a theory. It is a farrago of disorganized lists of how risk, investments of various kinds, sectoral shifts, various misperceptions and errors, and monetary volatility might somehow affect business conditions. Cowen repeatedly speaks of what “may” happen and occasionally of what “may or may not” happen.
All this is vague and iffy. To add complexity—to multiply the factors taken into account—is no virtue in its own right. On the contrary, a good theory penetrates beyond fringe complications to emphasize decisive circumstances and relations. It reveals significant uniformities amidst apparent diversities. The old Austrian account, though wrong as a general theory of cycles, arguably at least helps focus thinking and research on its subject matter. Cowen’s new theory does not rise even to that level; to borrow a phrase from the physicist Wolfgang Pauli, it is “not even wrong.”
One style of argument, for which it would be convenient to have an agreed name, overwhelms the reader with miscellaneous dates, figures, historical details, names, and even personality sketches, as if in hopes that the reader will be so impressed with the author’s erudition as not to notice that all this material fails to make a coherent argument about the points at issue. Cowen employs a variant of this style: he spews forth, almost as if at random, numerous theoretical terms and concepts and numerous summaries of other authors’ articles. Occasionally economists try to make a splash in their own field by importing concepts and techniques from philosophy or engineering or whatever. Cowen, with one foot still in the Austrian school that nurtured him, writes as if—I say no more than “as if”—attempting a similar splash by importing sophisticated terminology (more so than substance) from advanced economics and econometrics. He does not adequately test his theory against its rivals; the many potted summaries of econometric studies in his concluding chapter do not serve that purpose. He himself concludes by claiming no more than that his risk-based approach is compatible with microeconomic theory and with some observed facts and can provide a basis for future research.
Who might appreciate this book? Not the general reader who might be sympathetic to libertarian political philosophy and have an amateur interest in economics, for too many inadequately explained technicalities will repel him. Not the mainstream economist who likes to think of himself as working at the “frontier” of research, for he will find no contribution to the technical topics so blithely mentioned, and Cowen’s lack of rigor will irritate him. (I reject knee-jerk demands for “rigor” and “explicit models”; but Cowen’s loose style will arouse sympathy for such demands.) Nor will Cowen find much resonance among economists of the Austrian school, for his tacit parade of superiority rankles.