The Austrian business cycle theory (or ABCT) is an economic theory developed by the Austrian School of economics concerning how business cycles occur. The theory views business cycles as the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings.
The Austrian business cycle theory originated in the work of Austrian School economists Ludwig von Mises and Friedrich Hayek. Hayek won the Nobel Prize in economics in 1974 (shared with Gunnar Myrdal) in part for his work on this theory.
Proponents believe that a sustained period of low interest rates and excessive credit creation result in a volatile and unstable imbalance between saving and investment. According to the theory, the business cycle unfolds in the following way: Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. It is argued that this leads to an unsustainable credit-sourced boom during which the artificially stimulated borrowing seeks out diminishing investment opportunities. This credit-sourced boom results in widespread malinvestments. In the theory, a correction or "credit crunch" – commonly called a "recession" or "bust" – occurs when exponential credit creation cannot be sustained (often coupled with Central Banks increasing the wholesale lending rate). Then the money supply suddenly and sharply contracts when markets finally "clear", causing resources to be reallocated back towards more efficient uses.
The Austrian explanation of the business cycle differs significantly from the mainstream understanding of business cycles and is generally rejected by mainstream economists as inconsistent with empirical evidence. In contrast to most mainstream theories on business cycles, Austrian business cycle theory focuses on the credit cycle as the primary cause of most business cycles. Economists such as Gottfried von Haberler, Milton Friedman, Gordon Tullock, Bryan Caplan, and Paul Krugman have argued that the theory is incorrect.
A modern presentation of this theory can be studied in the book "Time and Money" by Roger Garrison, which presents a graphical framework for capital-based macroeconomics and offers a critique of Keynesian graphical analysis.
Derived from the Wikipedia article.
Real business cycle theory (RBC theory) are a class of macroeconomic models in which business cycle fluctuations to a large extent can be accounted for by real (in contrast to nominal) shocks. Unlike other leading theories of the business cycle, RBC theory sees recessions and periods of economic growth as the efficient response to exogenous changes in the real economic environment. That is, the level of national output necessarily maximizes expected utility, and government should therefore concentrate on long-run structural policy changes and not intervene through discretionary fiscal or monetary policy designed to actively smooth out economic short-term fluctuations.
According to RBC theory, business cycles are therefore "real" in that they do not represent a failure of markets to clear but rather reflect the most efficient possible operation of the economy, given the structure of the economy. RBC theory differs in this way from other theories of the business cycle such as Keynesian economics and Monetarism that see recessions as the failure of some market to clear.
RBC theory is associated with freshwater economics (the Chicago school of economics in the neoclassical tradition).