Malinvestment

Malinvestment In the Austrian business cycle theory, monetary expansion lowers the interest rate and sends misleading relative price signals to investors, who then make investments that turn out to be unprofitable. One criticism of the theory is that if malinvestment is predictable, investors should understand their businesses well enough to see and avoid the temptation to be lured into unprofitable investments. A broader understanding of the Austrian school's framework explains why malinvestment takes place. The economy is a complex order, and while the theory explains that malinvestment will rise during the expansionary phase, it cannot identify which investment projects will eventually become unprofitable, nor can investors themselves tell ahead of time. Furthermore, applying the fallacy of composition, it may be that one investor could profitably invest based on those price signals, but all investors cannot. Monetary expansion lowers the informational content of prices, making it more likely that unprofitable investments will take place. Even if investors become more cautious, the percentage of investment projects that eventually will prove unprofitable will rise. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Austrian Economics Springer Journals

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Publisher
Springer Journals
Copyright
Copyright © 2016 by Springer Science+Business Media New York
Subject
Economics; Public Finance; Political Science; History of Economic Thought/Methodology
ISSN
0889-3047
eISSN
1573-7128
D.O.I.
10.1007/s11138-016-0343-2
Publisher site
See Article on Publisher Site

Abstract

In the Austrian business cycle theory, monetary expansion lowers the interest rate and sends misleading relative price signals to investors, who then make investments that turn out to be unprofitable. One criticism of the theory is that if malinvestment is predictable, investors should understand their businesses well enough to see and avoid the temptation to be lured into unprofitable investments. A broader understanding of the Austrian school's framework explains why malinvestment takes place. The economy is a complex order, and while the theory explains that malinvestment will rise during the expansionary phase, it cannot identify which investment projects will eventually become unprofitable, nor can investors themselves tell ahead of time. Furthermore, applying the fallacy of composition, it may be that one investor could profitably invest based on those price signals, but all investors cannot. Monetary expansion lowers the informational content of prices, making it more likely that unprofitable investments will take place. Even if investors become more cautious, the percentage of investment projects that eventually will prove unprofitable will rise.

Journal

The Review of Austrian EconomicsSpringer Journals

Published: Apr 11, 2016

References

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