The Austrian Theory of the Business Cycle in the Light of Modern Macroeconomics

T he Austrian theory of the business cycle has many critics. Some believe that this part of the Austrian contribution is so misdirected as to constitute an "embarrassing excrescence" (Yeager [1986, p. 378]); others simply doubt that there can be a single theory that provides a general account of cyclical activity (Leijonhufvud [1984, 1986]; see also Sirkin [1972] and Lachmann [1978]); and still others deny the existence of some of the most salient features of business cycles. Defending—or even discussing—the Austrian theory of the business cycle, then, requires some careful groundwork. There are a number of expositions of the Austrian theory in the literature, which for the most part are complementary (e.g., Hayek [1967, 1975b], Mises [1966, pp. 538-86], Mises et al. [1983], O'Driscoll [1977], Robbins [1934], and Rothbard [1975]), but because business cycles remain a live issue inside as well as outside the Austrian school, there is no—and can be no—canonical version. Gordon Tullock, who took an exposition by Murray Rothbard to be canonical, has identified perceived shortcomings of the Austrian theory in an article entitled "Why the Austrians Are Wrong About Depressions" (Tullock, [1987]). The present article was initially motivated by Tullock's basic objections as well as by his "nit picks," as he calls them. But even his title is evidence of a misunderstanding. The Austrian theory is not primarily about depressions; it is about artificial booms and about the market process that brings them to an end. The theory sheds light on the kind of readjustments needed on the eve of the bust, but the issue of the depth and length of the ensuing depression as measured by the massive unemployment of labor is dealt with by the Austrians in ways that are similar to several other schools of thought.