Is ABCT a neoclassical theory?

In one of Facebook discussions on his wall Peter Boettke wrote that the Austrian Business Cycle Theory is a pre-WW2 neoclassical theory in response to a claim by Daniel Kuehn that the Austrian school is thoroughly neoclassical but is just in denial about it.

Indeed, as I tried to show in my paper on the realistic reconstruction of ABCT in its original versions by Mises and Hayek ABCT has a lot of affinity with Wicksell-style neoclassicism. It relies entirely on the notion of natural interest rate and equilibrium constructs for attempting to explain business cycles.

However, in the same paper, I tried to show that the actual insight underlying the theory does not have much to do with aggregate constructs and is not even primarily about interest rates. In other words, perhaps since Wicksell the thinking about inter-temporal coordination seems to have been focused excessively on interest rates while ignoring the price dynamics for intermediary goods, and focused on them in not exactly the right way.

The main question I ask in the paper is how credit expansion may result in multiple entrepreneurs mistakenly undertaking unsustainable investment projects (which is the central prediction of ABCT) and why they do not do the same mistakes in cases when the increase in credit available for investment comes from an increase in voluntary savings. The difference, in my view, is that in the latter case a fall in demand for some consumer goods causes some intermediary goods used for their production to become sufficiently cheaper to make some investment projects involving those goods ex ante more profitable than before. Those entrepreneurs who have such projects in mind thus have an incentive to go to the banks who now have more money to lend and ask them for money. Since such projects are also more profitable for banks than shorter projects, the supply and demand for credit meet and the credit will tend to be channeled into the right projects. Notice that interest rates do not play any important role in the inter-temporal coordination here at all. They will not even necessarily fall on average.

Not so in the case of fiat-money-based credit expansion. In such case no projects have in themselves become more profitable according to the objective market conditions, and thus the crucial element of the inter-temporal coordination mechanism is absent from the start. Thus, banks need to lower interest rates on the loans involving the newly created money to induce entrepreneurs to borrow. However, the longer investment projects still have the advantage for the banks here, since loaning the same amount of money several times over a period ceteris paribus involves more costs than loaning it to one project for the same period. Thus, the newly created money will tend to be allocated to longer projects. This creates a plausible possibility that the sellers of intermediary goods for which the longer investment projects will compete with the shorter ones will not realize that the market conditions have changed and will not reflect the change in the initial prices. If the sellers of intermediary goods indeed make such mistakes, the entrepreneurs undertaking longer projects will initially think that they will be able to acquire them at much lower prices than is dictated by the market conditions. This will go into calculation of the conditions of the loans. Then, when prices of such intermediary goods finally reflect the distortion, some projects may turn out to be unsustainable. Again, even in this story interest rates play only a secondary role.

The central role is played by potential mistakes of the sellers of intermediary goods. It is those mistakes that are necessary for a cluster of unsustainable investment projects to be undertaken. Without such mistakes, the prices of intermediary goods will tend to reflect the increased demand from the start and will negatively compensate the lowered interest rates. And the mistakes of the sellers that I mentioned cannot be accounted for by equilibrium theorizing. In such theorizing they are precluded by definition.

Thus, you hopefully can see that ABCT in terms of its valuable insights is not a Wicksellian neoclassical theory.


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