From Mises Boot Camp

1. BusinessCycles
Jonathan Newman
Mises Boot Camp 2015

2. Whatisa businesscycle?
• What it is not: Business fluctuations
• Changes happen all the time and are necessary for a functioning market
economy (production, consumption, preferences, resources)
• Entrepreneurs have the task of dealing with and anticipating these
changes by putting resources on the line in such a way to satisfy
consumer demands.
• Good choices mean growth, bad choices mean decline
• But, bad entrepreneurs suffer losses and good entrepreneurs gain profits

3. Whatisa businesscycle?
• General boom and general bust
• We see patterns in economic data like this

4. Whatisa businesscycle?
• General boom and general bust
• We see patterns in economic data like this

5. Whatisa businesscycle?
• General boom and general bust
• We see patterns in economic data like this

6. Whatisa businesscycle?
• General boom and general bust
• We see patterns in economic data like this

7. Whatisa businesscycle?
• General boom and general bust
• We see patterns in economic data like this

8. Whatisa businesscycle?
• General boom and general bust
• We see patterns in economic data like this

9. Whatisa businesscycle?
• General boom and general bust
• We see patterns in economic data like this

10. Whatisa businesscycle?
• General boom and general bust
• Consumer prices vs. factor prices
• Rothbard, America’s Great Depression p. 9: “capital-goods industries
fluctuate more widely than do the consumer-goods industries”

11. Whatisa businesscycle?
• General boom and general bust
• Consumer prices vs. factor prices
• Rothbard, America’s Great Depression p. 9: “capital-goods industries
fluctuate more widely than do the consumer-goods industries”

12. Whatisa businesscycle?
• General boom and general bust
• Theory must account for these phenomena:
• The “shape” or stages of the cycle: boom then depression
• The cluster of entrepreneurial errors
• The more dramatic fluctuations in capital-goods industries compared to
consumer-goods industries
• Suspects:
• Money
• Credit

13. Whatisa businesscycle?
• General boom and general bust
• Theory must account for these phenomena:
• The “shape” or stages of the cycle: boom then depression
• The cluster of entrepreneurial errors
• The more dramatic fluctuations in capital-goods industries compared to
consumer-goods industries
• Suspects:
• Money
• Credit

14. Whatisa businesscycle?
• General boom and general bust
• Theory must account for these phenomena:
• The “shape” or stages of the cycle: boom then depression
• The cluster of entrepreneurial errors
• The more dramatic fluctuations in capital-goods industries compared to
consumer-goods industries
• Suspects:
• Money
• Credit

15. Whatisa businesscycle?
• General boom and general bust
• Theory must account for these phenomena:
• The “shape” or stages of the cycle: boom then depression
• The cluster of entrepreneurial errors
• The more dramatic fluctuations in capital-goods industries compared to
consumer-goods industries
• Suspects:
• Money
• Credit

16. Whatisa businesscycle?
• General boom and general bust
• Theory must account for these phenomena:
• The “shape” or stages of the cycle: boom then depression
• The cluster of entrepreneurial errors
• The more dramatic fluctuations in capital-goods industries compared to
consumer-goods industries
• Suspects:
• Money
• Credit
• Nick Cage?

17. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

18. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

19. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

20. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

21. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

22. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

23. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

24. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

25. Malinvestment
• Investment in unprofitable lines of production induced by
artificially low interest rates
• Profits anticipated ex ante
• Profits/losses realized ex post
• Need to explain how interest rates influence production
• Good candidate because…
• Explains boom (increased investment)
• Explains bust (liquidation)
• Explains cluster of errors
• Related to money and credit
• Related to capital markets

26. StructureofProduction
• Factors of production are employed together to make
consumer goods
• Requires laborers using land and capital
• Complex, heterogeneous, interwoven, “latticework”
• Takes time (stages)
• What does it look like?

27. StructureofProduction
• Factors of production are employed together to make
consumer goods
• Requires laborers using land and capital
• Complex, heterogeneous, interwoven, “latticework”
• Takes time (stages)
• What does it look like?
Böhm-Bawerk

28. StructureofProduction
• Factors of production are employed together to make
consumer goods
• Requires laborers using land and capital
• Complex, heterogeneous, interwoven, “latticework”
• Takes time (stages)
• What does it look like?
Böhm-Bawerk Hayek

29. StructureofProduction
• Factors of production are employed together to make
consumer goods
• Requires laborers using land and capital
• Complex, heterogeneous, interwoven, “latticework”
• Takes time (stages)
• What does it look like?
Böhm-Bawerk Hayek

30. StructureofProduction
• Factors of production are employed together to make
consumer goods
• Requires laborers using land and capital
• Complex, heterogeneous, interwoven, “latticework”
• Takes time (stages)
• What does it look like?
Böhm-Bawerk Hayek Rothbard

31. StructureofProduction
• Factors of production are employed together to make
consumer goods
• Requires laborers using land and capital
• Complex, heterogeneous, interwoven, “latticework”
• Takes time (stages)
• What does it look like?
Böhm-Bawerk Hayek Rothbard
Garrison

32. Timepreference
• We all prefer a given satisfaction sooner rather than later
• Variety of rates of time preference, and so there is an
opportunity to trade
David
$1200 F
$1000 P
$1100 F
:
$1000 F
Jeff
$1100 F
$1000 P
$1050 F
:
$1000 F
interest
rate
loans
S
D

33. Productionandtheinterestrate
• Since production takes time, the costs of production
(purchasing, renting, and hiring factors) precede revenues
from the sale of output
• Therefore anticipated future profits are compared to returns
that could be earned by lending at interest
• Suppose Nick could earn 5% interest by lending, but has an idea for a
product he thinks he could produce and sell for a 7% return.
• Nick increases his demand for factors, engages in production, and puts
his product on the market.
• No matter the outcome (profit or loss), Nick has pushed up the price of
factors because the interest rate was lower than his anticipated rate of
profit.
• What about the opposite?

34. Saving andgrowth
• We save more at a lower rate of time preference because we
discount the future less.
• When we save, a few things happen:
• First, and most obvious, we decrease consumption. Fewer resources are
consumed in the present.
• The supply of loanable funds increases. More people are willing to part
with more of their money in the present in exchange for the promise of
future returns.
• The interest rate falls, and production is restructured for longer lines of
production.
• Factor price relationships change as earlier stages see a greater increase
in demand than later stages. Late stage factor demand will decrease as
consumers consume less to save more.

35. Saving andgrowth
• We save more at a lower rate of time preference because we
discount the future less.
• When we save, a few things happen:
• First, and most obvious, we decrease consumption. Fewer resources are
consumed in the present.
• The supply of loanable funds increases. More people are willing to part
with more of their money in the present in exchange for the promise of
future returns.
• The interest rate falls, and production is restructured for longer lines of
production.
• Factor price relationships change as earlier stages see a greater increase
in demand than later stages. Late stage factor demand will decrease as
consumers consume less to save more.

36. Saving andgrowth
• We save more at a lower rate of time preference because we
discount the future less.
• When we save, a few things happen:
• First, and most obvious, we decrease consumption. Fewer resources are
consumed in the present.
• The supply of loanable funds increases. More people are willing to part
with more of their money in the present in exchange for the promise of
future returns.
• The interest rate falls, and production is restructured for longer lines of
production.
• Factor price relationships change as earlier stages see a greater increase
in demand than later stages. Late stage factor demand will decrease as
consumers consume less to save more.

37. Saving andgrowth
• We save more at a lower rate of time preference because we
discount the future less.
• When we save, a few things happen:
• First, and most obvious, we decrease consumption. Fewer resources are
consumed in the present.
• The supply of loanable funds increases. More people are willing to part
with more of their money in the present in exchange for the promise of
future returns.
• The interest rate falls, and production is restructured for longer lines of
production.
• Factor price relationships change as earlier stages see a greater increase
in demand than later stages. Late stage factor demand will decrease as
consumers consume less to save more.

38. Saving andgrowth
• We save more at a lower rate of time preference because we
discount the future less.
• When we save, a few things happen:
• First, and most obvious, we decrease consumption. Fewer resources are
consumed in the present.
• The supply of loanable funds increases. More people are willing to part
with more of their money in the present in exchange for the promise of
future returns.
• The interest rate falls, and production is restructured for longer lines of
production.
• Factor price relationships change as earlier stages see a greater increase
in demand than later stages. Late stage factor demand will decrease as
consumers consume less to save more.

39. Saving andgrowth

40. Saving andgrowth
• Result: greater production in the long run
• Saving today frees up resources for productive uses which
yields more output tomorrow

41. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

42. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

43. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

44. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

45. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

46. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

47. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

48. Artificialcreditexpansion
• Central bank can expand credit without an economy-wide
increase in savings
• Newly created money enters the economy through credit
markets and so represent an increased supply of loanable
funds
• Interest rate falls, but not because of a decrease in time preference
• At the lower interest rate, saving decreases
• Consumption and borrowing increase
• Firms take the new funds and try to invest in new, longer lines of
production
• Factor prices are bid up across the board.Wages increase, employment
increases, consumption increases, investment spending increases.
• In short, we have a general boom.

49. Artificialcreditexpansioncauses
overconsumptionandmalinvestment
• Consumers did not show they preferred future output to
present output, in fact, they decreased saving at the lower
interest rate.
• The credit expansion does not represent an increase in real
resources available for consumption or investment.
• Factors of production become increasingly scarce
• Prices are bid up higher than entrepreneurs expected
• Costs increase: expected profits turn into losses
• Entrepreneurs were led to believe consumers had saved, real
resources were available for production, and that longer
production would be profitable.

50. Artificialcreditexpansioncauses
overconsumptionandmalinvestment
• Consumers did not show they preferred future output to
present output, in fact, they decreased saving at the lower
interest rate.
• The credit expansion does not represent an increase in real
resources available for consumption or investment.
• Factors of production become increasingly scarce
• Prices are bid up higher than entrepreneurs expected
• Costs increase: expected profits turn into losses
• Entrepreneurs were led to believe consumers had saved, real
resources were available for production, and that longer
production would be profitable.

51. Artificialcreditexpansioncauses
overconsumptionandmalinvestment
• Consumers did not show they preferred future output to
present output, in fact, they decreased saving at the lower
interest rate.
• The credit expansion does not represent an increase in real
resources available for consumption or investment.
• Factors of production become increasingly scarce
• Prices are bid up higher than entrepreneurs expected
• Costs increase: expected profits turn into losses
• Entrepreneurs were led to believe consumers had saved, real
resources were available for production, and that longer
production would be profitable.

52. Artificialcreditexpansioncauses
overconsumptionandmalinvestment
• Consumers did not show they preferred future output to
present output, in fact, they decreased saving at the lower
interest rate.
• The credit expansion does not represent an increase in real
resources available for consumption or investment.
• Factors of production become increasingly scarce
• Prices are bid up higher than entrepreneurs expected
• Costs increase: expected profits turn into losses
• Entrepreneurs were led to believe consumers had saved, real
resources were available for production, and that longer
production would be profitable.

53. Artificialcreditexpansioncauses
overconsumptionandmalinvestment
• Consumers did not show they preferred future output to
present output, in fact, they decreased saving at the lower
interest rate.
• The credit expansion does not represent an increase in real
resources available for consumption or investment.
• Factors of production become increasingly scarce
• Prices are bid up higher than entrepreneurs expected
• Costs increase: expected profits turn into losses
• Entrepreneurs were led to believe consumers had saved, real
resources were available for production, and that longer
production would be profitable.

54. Artificialcreditexpansioncauses
overconsumptionandmalinvestment
• Consumers did not show they preferred future output to
present output, in fact, they decreased saving at the lower
interest rate.
• The credit expansion does not represent an increase in real
resources available for consumption or investment.
• Factors of production become increasingly scarce
• Prices are bid up higher than entrepreneurs expected
• Costs increase: expected profits turn into losses
• Entrepreneurs were led to believe consumers had saved, real
resources were available for production, and that longer
production would be profitable.

55. Artificialcreditexpansion

56. Depression
• Firms attempt to liquidate malinvested capital
• Wages decrease and workers are laid off
• Credit markets dry up
• Prices readjust to reflect consumer demands
• Inputs and outputs
• Depression is a recovery phase as people try to find profitable
uses for capital and labor

57. Contrasting business cycle theories
Austrian Keynesian
Shape Boom-bust
Cause Expansionary monetary policy
Cause #2 Malinvestment
Cure Markets
Cure, restated Let consumer demand dictate
prices and resource allocation
Prevention Don’t give money production
authority to non-market
institutions

58. Contrasting business cycle theories
Austrian Keynesian
Shape Boom-bust Bust-boom
Cause Expansionary monetary policy
Cause #2 Malinvestment
Cure Markets
Cure, restated Let consumer demand dictate
prices and resource allocation
Prevention Don’t give money production
authority to non-market
institutions

59. Contrasting business cycle theories
Austrian Keynesian
Shape Boom-bust Bust-boom
Cause Expansionary monetary policy Instability of investment spending
Cause #2 Malinvestment
Cure Markets
Cure, restated Let consumer demand dictate
prices and resource allocation
Prevention Don’t give money production
authority to non-market
institutions

60. Contrasting business cycle theories
Austrian Keynesian
Shape Boom-bust Bust-boom
Cause Expansionary monetary policy Instability of investment spending
Cause #2 Malinvestment Fall in aggregate demand
Cure Markets
Cure, restated Let consumer demand dictate
prices and resource allocation
Prevention Don’t give money production
authority to non-market
institutions

61. Contrasting business cycle theories
Austrian Keynesian
Shape Boom-bust Bust-boom
Cause Expansionary monetary policy Instability of investment spending
Cause #2 Malinvestment Fall in aggregate demand
Cure Markets Expansionary monetary policy and
fiscal policy
Cure, restated Let consumer demand dictate
prices and resource allocation
Prevention Don’t give money production
authority to non-market
institutions

62. Contrasting business cycle theories
Austrian Keynesian
Shape Boom-bust Bust-boom
Cause Expansionary monetary policy Instability of investment spending
Cause #2 Malinvestment Fall in aggregate demand
Cure Markets Expansionary monetary policy and
fiscal policy
Cure, restated Let consumer demand dictate
prices and resource allocation
Let the government dictate prices
and resource allocation
Prevention Don’t give money production
authority to non-market
institutions

63. Contrasting business cycle theories
Austrian Keynesian
Shape Boom-bust Bust-boom
Cause Expansionary monetary policy Instability of investment spending
Cause #2 Malinvestment Fall in aggregate demand
Cure Markets Expansionary monetary policy and
fiscal policy
Cure, restated Let consumer demand dictate
prices and resource allocation
Let the government dictate prices
and resource allocation
Prevention Don’t give money production
authority to non-market
institutions
Give the government control of
money production and a blank
check for spending

64. Conclusion
• We can successfully explain business cycles using
malinvestment concept
• Investment in unprofitable lines of production induced by artificially low
interest rates
• Theory must account for these phenomena:
• The “shape” or stages of the cycle: boom then depression
• The cluster of entrepreneurial errors
• The more dramatic fluctuations in capital-goods industries compared to
consumer-goods industries
• Original suspects:
• Money
• Credit