[2][3][4] According to the theory, the business cycle unfolds in the following way: low interest rates tend to stimulate borrowing, which lead to an increase in capital spending funded by newly issued bank credit.
Due to the availability of relatively inexpensive funds, entrepreneurs invest in capital goods for more roundabout, "longer process of production" technologies such as “high tech” industries.
[12][13] The "recession" or "depression" is actually the process by which the economy adjusts to the wastes and errors of the monetary boom, and reestablishes efficient service of sustainable consumer desires.
[12][14] The monetary boom ends when bank credit expansion finally stops, i.e. when no further investments can be found which provide adequate returns for speculative borrowers at prevailing interest rates.
All attempts by central governments to prop up asset prices, bail out insolvent banks, or "stimulate" the economy with deficit spending will only make the misallocations and malinvestments more acute and the economic distortions more pronounced, prolonging the depression and adjustment necessary to return to stable growth, especially if those stimulus measures substantially increase government debt and the long term debt load of the economy.
[10] Austrians argue the policy error rests in the government's (and central bank's) weakness or negligence in allowing the "false" unsustainable credit-fueled boom to begin in the first place, not in having it end with fiscal and monetary "austerity".
The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved".
[19] Nobel laureate Hayek's presentation of the theory in the 1930s was criticized by many economists, including John Maynard Keynes, Piero Sraffa and Nicholas Kaldor.
[20] Sraffa also argued that Hayek's theory failed to define a single "natural" rate of interest that might prevent a period of growth from leading to a crisis.
[25] Austrian School economist Peter J. Boettke argued in the wake of the Great Recession that the Federal Reserve was making a mistake by not allowing consumer prices to fall.
Boettke further argues that government regulation through credit rating agencies enabled financial institutions to act irresponsibly and invest in securities that would perform only if the prices in the housing market continued to rise.
[26][27] Economist Steve H. Hanke identifies the 2007–2010 global financial crises as the direct outcome of the Federal Reserve Bank's interest rate policies as is predicted by the Austrian business cycle theory.
[34][35][36][37] Many have argued that this has especially been true since the 1980s because central banks were granted more independence and started using monetary policy to stabilize the business cycle, an event known as The Great Moderation.
[40] Lionel Robbins, who had embraced the Austrian theory of the business cycle in The Great Depression (1934), later regretted having written that book and accepted many of the Keynesian counterarguments.
[41] The Nobel Prize Winner Maurice Allais was a proponent of Austrian business cycle theory and their perspective on the Great Depression and often quoted Ludwig Von Mises and Murray N.
Henry George, another precursor, emphasized the negative impact of speculative increases in the value of land, which places a heavy burden of mortgage payments on consumers and companies.
[46][47] While White conceded that the status quo policy had been successful in reducing the impacts of busts, he commented that the view on inflation should perhaps be longer term and that the excesses of the time seemed dangerous.
According to the theory, a sustained period of low interest rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment.
[51] In response, historian Thomas Woods argues that few bankers and investors are familiar enough with the Austrian business cycle theory to consistently make sound investment decisions.
[53] Austrian School economist Robert Murphy argues that it is difficult for bankers and investors to make sound business choices because they cannot know what the interest rate would be if it were set by the market.
[55] In a 1998 interview, Milton Friedman expressed dissatisfaction with the policy implications of the theory: Jeffery Rogers Hummel argues that the Austrian explanation of the business cycle fails on empirical grounds.