This week’s quote(s) highlights why an explanation of a general boom-bust pattern of economic must be a monetary theory of the trade cycle. The first key is to clearly distinguish between fluctuations, which are a normal and indispensable part of the market process, and cycles, which are extra-market; the result of interventions into the market order. Hayek makes similar observations if Monetary Theory of the Trade Cycle and refers to explanations of fluctuations as opposed to true cycles, which rely on external shocks as essentially a non-economic explanation of observed changes in business conditions. The real business cycle research thus actually attempts to explain fluctuations, not cycles. One way to interpret their results is that the research provides some historical evidence that much of what appears to be the ebb and flows of economic activity is actually market adjustments to shocks. However, much is left unexplained (30%?). That which is left unexplained is the boom and bust of the cycle, best understood through the lens of ABCT.
All quotes are from AGD (Scholar’s edition, 4-9).
Cycles and Fluctuations: Error and the Role of the Entrepreneur
It is important, first, to distinguish between business cycles and ordinary business fluctuations. We live necessarily in a society of continual and unending change, change that can never be precisely charted in advance. People try to forecast and anticipate changes as best they can, but such forecasting can never be reduced to an exact science. Entrepreneurs are in the business of forecasting changes on the market, both for conditions of demand and of supply.
The more successful ones make profits pari passus with their accuracy of judgment, while the unsuccessful forecasters fall by the wayside. As a result, the successful entrepreneurs on the free market will be the ones most adept at anticipating future business conditions.
Stabilizing fluctuations would be irrational.
It is, therefore, absurd to expect every business activity to be “stabilized” as if these changes were not taking place. To stabilize and “iron out” these fluctuations would, in effect, eradicate any rational productive activity.
We may, therefore, expect specific business fluctuations all the time. There is no need for any special “cycle theory” to account for them. They are simply the results of changes in economic data and are fully explained by economic theory.
There is thus a necessary role for monetary shocks. Only monetary shocks can create the cluster of errors and thus the cycle; boom, crisis and depression.
In considering general movements in business, then, it is immediately evident that such movements must be transmitted through the general medium of exchange—money. Money forges the connecting link between all economic activities.
It is not legitimate to reply that sudden changes in the data are responsible. It is, after all, the business of entrepreneurs to forecast future changes, some of which are sudden.
In the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors at the same time. The “boom-bust” cycle is generated by monetary intervention in the market, specifically bank credit expansion to business.