Knowledge shifts and the business cycle: When boom turns to bust

Knowledge shifts and the business cycle: When boom turns to bust Informational cascades can be used to augment the existing Austrian business cycle theory. As first-order users of knowledge know the direct causes of a price change, they transmit this knowledge to second-order users through the price system. Banks with direct knowledge of the sources of the fresh liquidity during a credit-induced boom have knowledge of the boom’s artificial and unsustainable nature. Higher order users lack this direct knowledge and hence continue investing largely ignorant of underlying developments. When first-order users of knowledge sense the boom has run its course, they exit the market, sending a strong signal to higher order knowledge users that the boom has ended—a fragile situation built upon an informational cascade begins collapsing. Simultaneously, the boom is characterized by an influx of capital and knowledge into the financial sector owing to increased profits relative to the real economy stemming from Cantillon effects surrounding the credit injection. As knowledge pertaining to real production has also exited, the bust commences with a misallocated productive structure requiring equilibration to become consistent with consumers’ wants. Actions which inhibit this knowledge from returning to the productive structure will unnecessarily lengthen the time to recovery. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Austrian Economics Springer Journals

Knowledge shifts and the business cycle: When boom turns to bust

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Publisher
Springer Journals
Copyright
Copyright © 2009 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/s11138-009-0095-3
Publisher site
See Article on Publisher Site

Abstract

Informational cascades can be used to augment the existing Austrian business cycle theory. As first-order users of knowledge know the direct causes of a price change, they transmit this knowledge to second-order users through the price system. Banks with direct knowledge of the sources of the fresh liquidity during a credit-induced boom have knowledge of the boom’s artificial and unsustainable nature. Higher order users lack this direct knowledge and hence continue investing largely ignorant of underlying developments. When first-order users of knowledge sense the boom has run its course, they exit the market, sending a strong signal to higher order knowledge users that the boom has ended—a fragile situation built upon an informational cascade begins collapsing. Simultaneously, the boom is characterized by an influx of capital and knowledge into the financial sector owing to increased profits relative to the real economy stemming from Cantillon effects surrounding the credit injection. As knowledge pertaining to real production has also exited, the bust commences with a misallocated productive structure requiring equilibration to become consistent with consumers’ wants. Actions which inhibit this knowledge from returning to the productive structure will unnecessarily lengthen the time to recovery.

Journal

The Review of Austrian EconomicsSpringer Journals

Published: Sep 16, 2009

References

  • Monetary policy as bad medicine: The volatile relationship between business cycles and asset prices
    Bagus, P
  • A theory of fads, fashion, custom, and cultural change as informational cascades
    Bikhchandani, S; Hirshleifer, D; Welch, I

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