Professors Herbener & Manish, I’ve been studying Austrian Business Cycle Theory for a while now and while I feel like I have a good grasp on the basics I still feel like I’m missing something. Could you explain the effects of bank credit expansion from the perspective of price spreads throughout the structure of production? How does this unsustainable credit expansion distort investment/consumption and why? Is resulting price inflation usually the reason this credit expansion must come to a stop or are there other reasons? I’ve mostly read Rothbard but I’ve heard Hayek analyzes ABCT more in depth…could you recommend any works by Hayek that analyze this process more in depth specifically looking at the effects on price spreads?
In brief, credit expansion suppresses the rate of interest below its market level. But the rate of interest is the price spread between the stages of production, i.e., it is the spread between the buying prices of inputs and the selling prices of output. As Rothbard shows in Man, Economy, and State, the lowering of the rate of interest shifts investment toward the higher stages of production and away from the lower stages. The capital structure is lengthened out. This boom is self-reversing because the people’s time preference do not support the lengthening out of the capital structure. People prefer to have resources devoted to the pattern of investment that existed before the boom, i.e., more to lower stages and less to higher stages than is brought about artificially during the boom. The bust corrects the malinvestments made in the boom.
I would urge you to read Rothbard’s treatment of economic growth in Man, Economy and State in order to gain a thorough understanding of ABCT. Once you understand how the process of inter-temporal coordination occurs on the market, i.e., how entrepreneurs respond to changes in time preferences and allocate resources in a temporal pattern that yields the right consumer goods at the right time, a distortion of this process (which is what ABCT is in essence) will be easy to grasp. The relevant material in MES is Ch. 6 (on the rate of interest) and p. 517-527 in ch. 8.