Accounting for the business cycle: Nominal rigidities, factor heterogeneity, and Austrian capital theory

Accounting for the business cycle: Nominal rigidities, factor heterogeneity, and Austrian capital... An Austrian interpretation of the New Keynesian small menu cost model of the business cycle is proposed. Austrian and New Keynesian business cycle theories share the feature that the cycle is generated by rigidities which prevent the economy from adapting instantaneously to changing conditions. Austrian business cycle theory is capital-based, focusing on credit expansion which artificially lowers interest rates and causes an investment boom and unsustainable business expansion. In contrast, the New Keynesian small menu cost model of the business cycle is based on nominal rigidities which prevent markets from clearing. Small menu costs introduce dichotomous behavior, where firms find it locally optimal to avoid instantaneous output price adjustments in the face of the cost, but this local optimum results in economy-wide output and employment fluctuations which are much greater in relative magnitude. The small menu cost model of the business cycle is extended and reinterpreted in light of Austrian business cycle theory with heterogeneous, multiply-specific capital, thus providing a rigorous formalization of the Austrian business cycle. The Austrian interpretation of this New Keynesian model fortuitously addresses several of its shortcomings. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Austrian Economics Springer Journals

Accounting for the business cycle: Nominal rigidities, factor heterogeneity, and Austrian capital theory

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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 2006 by Springer Science + Business Media, LLC
Subject
Economics; Public Finance; Political Science; History of Economic Thought/Methodology
ISSN
0889-3047
eISSN
1573-7128
D.O.I.
10.1007/s11138-006-9251-1
Publisher site
See Article on Publisher Site

Abstract

An Austrian interpretation of the New Keynesian small menu cost model of the business cycle is proposed. Austrian and New Keynesian business cycle theories share the feature that the cycle is generated by rigidities which prevent the economy from adapting instantaneously to changing conditions. Austrian business cycle theory is capital-based, focusing on credit expansion which artificially lowers interest rates and causes an investment boom and unsustainable business expansion. In contrast, the New Keynesian small menu cost model of the business cycle is based on nominal rigidities which prevent markets from clearing. Small menu costs introduce dichotomous behavior, where firms find it locally optimal to avoid instantaneous output price adjustments in the face of the cost, but this local optimum results in economy-wide output and employment fluctuations which are much greater in relative magnitude. The small menu cost model of the business cycle is extended and reinterpreted in light of Austrian business cycle theory with heterogeneous, multiply-specific capital, thus providing a rigorous formalization of the Austrian business cycle. The Austrian interpretation of this New Keynesian model fortuitously addresses several of its shortcomings.

Journal

The Review of Austrian EconomicsSpringer Journals

Published: Jan 1, 2006

References

  • Information costs, pricing, and resource unemployment
    Alchian, A. A.
  • Production period and cycles: Several interpretations in a Neo-Austrian economic perspective
    Augier, J.; Augier, L.

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