The Business Cycle: Mises vs Keynes

Resolution: Austrian economics has a better explanation of the business cycle than Keynesian economics. My burden of proof is to show that my explanation is better than my opponent’s, and Con’s is to show that his explanation is better than mine.This round will only be for me and Con to give an exposition for our own theories—we will address each other’s theories in the next 2 rounds.Theory:The Austrian theory of the business cycle starts with the expansion of the money supply. This generally happens when a central bank, such as the Federal Reserve, prints money out of thin air and gives it to banks. This expansion is then compounded by fractional-reserve banking, which is when banks are only required to keep a fraction of the reserves they’d need to redeem all of their deposits (so, if you put $100 in a bank account, they can loan out $90, even though they already promised to give you your $100 back whenever you want it. Then that $90 can end up in another bank account, and the process repeats itself, making a $100 increase in the money supply much greater than $100). Of course, the banks don’t just do nothing with this money—they invest it and loan it out. This is where the problem starts.But first, let’s see how money and loaning work without any artificial increases in the money supply. Loans are, necessarily, backed up by savings—people choosing to consume less now so that they can consume more later. Businesses respond to this by borrowing money from these savings to invest in consumer goods for the future. They may build “producer’s goods,” like machines and factories, and then use those to make consumer goods. An increase in savings lowers the interest rate for loans, sending a signal to the market—a signal saying that people are consuming less now so that they can consume more later. Businesses respond to this signal by borrowing more money and using it to build producers goods to make the consumer goods for the future. Resources are directed away from direct production of consumer goods (because people are consuming less now, so that they can save money), and toward the production of consumer goods in the future (because people are going to spend their savings in the future on goods). Everything works out great.An artificial increase in the money supply distorts this signaling and allocating process. Central bank money printing has the same effects on interest rates that a true increase in savings has—it lowers them. It sends the same signal to the market that an increase in savings would—it signals that businesses should invest in consumer goods for later. So, businesses do just that—investing in building much more housing, for example, than would normally be built. The problem is that no actual increase in savings has occurred—people aren’t delaying consumption now so that they can consume more later. So the signal is wrong, and resources are allocated to the wrong place, creating the “boom” phase of the business cycle. The investment in future consumer goods would have paid off if it had been the result of actual savings—because people actually had savings to spend on those goods in the future. But if the investment was because of a fake signal, an artificially lower interest rate, then the investment was wasted—building a bunch of houses that it turns out people didn’t want to buy, for example. The “boom” created by the money printing turns out to be a waste of labor and resources creating goods that people didn’t want. Once this becomes apparent, which it eventually must, the cycle enters the “bust” phase. People that invested in the future of the boom industry, whether it’s housing, dot-com, or whatever, lose much of their money. People working in the boom industry and industries relying on that industry lose their jobs, as the market tries to correct for the overinvestment in that industry by stopping using resources on it.Evidence: One indication that the Austrian theory is the correct one is that Austrians can, and have, used it to correctly predict bubbles and busts. Austrian economists, such as Peter Schiff, have said throughout the entire housing bubble that the growth was illusionary and that it would end in a severe recession—the mainstream Keynesian economists just laughed at them. [1] Austrians have known that Fannie and Freddie were distorting the housing market and unsustainable for years. [2] [3] They've warned about the housing bubble for years, while mainstream economists, including the ones that are supposed to be stabilizing the economy through the Federal Reserve, denied it. [4] [5] Austrians warned that Greenspan's money printing after the 2001 crash would inflate a housing bubble and create an even worse crash further down the road—while everyone else ignored them. [6] [7] Sources:[1] http://tinyurl.com...[2] http://mises.org...[3] http://mises.org...[4] http://mises.org...[5] http://tinyurl.com...[6] http://mises.org...[7] http://mises.org...