June, 2008

Austrian Trade Cycle Theory and Rationality

  • Brian Simpson

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This paper shows that Austrian trade cycle theory is fully consistent with rational expectations. It also compares and contrasts rational expectations with an alternative theory of rationality and show that Austrian trade cycle theory is consistent with this alternative theory of rationality. It achieves the above by first providing an exposition of Austrian trade cycle theory. The paper then proceeds to show that one would have to associate omniscience with rationality to claim that Austrian trade cycle theory is inconsistent with rationality. It also shows that because the central bank manipulates the money supply in an erratic manner, it is impossible to use Austrian trade cycle theory to predict exactly when the current cycle will end and the next cycle will begin. Further, this paper shows that even if all businessmen and entrepreneurs had rational expectations, the trade cycle would still occur. Finally, the paper shows that because of the nature of the monetary and banking system we have today, the trade cycle must necessarily occur, and that it is supporters of the current system who have irrational expectations. 

Find article New Perspectives on Political Economy.