Empirical Evidence on the Austrian Business Cycle Theory

Presented at the Atlantic International Econoimc Association meetings, October 1996.

Review of Austrian Economics, December 2001, 14, 4, pp. 331-351.

The Austrian theory of the business cycle, as originally presented by Mises and Hayek implies several hypotheses that are distinctive, especially in terms of relative prices and resource allocation. A monetary shock will systematically alter the relative prices of raw materials, capital goods, retail goods and services, resulting in reallocation of labor and capital resources through the cycle. The relative price of current and future consumption as expressed in the term structure of interest rates is the guide for resource allocation, although its information is distorted by the monetary shock. The pattern of sectoral shifts provides the framework for the cyclical behavior of real income. Business cycle theories demonstrate their power of explanation by hypothesis testing or by simulating business cycle behavior, in comparison to actual cycles. Relatively few empirical tests have been conducted of the Austrian theory of the business cycle, given the methodological proscription. The theory will be briefly restated in a form that identifies testatble hypotheses. Since Burns and Mitchell, stylized "facts" of cycles have become the behavior that needs to be explained. Measures of interest rate term structures that are appropriate to the Austrian theory are offered here to express the divergent price signals received by investors and consumers. Data for eight U.S. business cycles are standardized for the time period of the cycle and offered as an alternative to the NBER cycle format. Are there consistent relative price signals that might guide the cycle process? Do macroeconomic variables respond to the price signals in an identifiable way? Are the responses large enough to explain business cycle behavior? While a formal, testable model is not proposed, evidence suggests that a ratio of short-term to long-term interest rates exhibits cyclical patterns. An error correction model of short-term interest rates implies that both the gap between short-term and long-term rates and the level of aggregate income affect short-term rate adjustment. Preliminary empirical evidence about the business cycle process supports the Austrian notion that resource use and aggregate income respond to changes in interest rates.

James P. Keeler
Kenyon College

April 2002
KEELER@KENYON.EDU

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