Business Cycle


Welfare cost of business cycles - Mathematical representation and formula



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Welfare cost of business cycles - Mathematical representation and formula

  • An alternative, more accurate solution gives losses that are somewhat larger, especially when volatility is large.Latty (2011) A note on the relationship between the Atkinson index and the Generalised entropy class of decomposable inequality indexes under the assumption of log-normality of income distribution or volatility, https://www.academia.edu/1816869/A_note_on_the_relationship_between_the_Atkinson_index_and_the_generalised_entropy_class_of_decomposable_inequality_indexes_under_the_assumption_of_log-normality_of_income_distribution_or_volatility



Welfare cost of business cycles - Risk aversion and the equity premium puzzle

  • However, a major problem related to the above way of estimating \theta (hence \lambda and in fact, possibly to Lucas' entire approach is the so-called equity premium puzzle, first observed by Rajnish Mehra|Mehra and Edward Prescott|Prescott in 1985



Welfare cost of business cycles - Risk aversion and the equity premium puzzle

  • In a survey of the implications of the equity premium, Simon Grant and John Quiggin note that 'A high cost of risk means that



Welfare cost of business cycles - Risk aversion and the equity premium puzzle

  • recessions are extremely destructive'.



Austrian Business Cycle Theory



Austrian Business Cycle Theory

  • According to the theory, the business cycle unfolds in the following way: Low interest rates tend to stimulate borrowing from the banking system



Austrian Business Cycle Theory

  • Austrian business cycle theory states that distortions in the availability of credit are the cause of business cycles. A modern presentation of this theory can be found in the book Time and Money by Roger Garrison, which presents a graphical framework for capital-based macroeconomics and offers a critique of Keynesian graphical analysis.



Austrian Business Cycle Theory

  • The Austrian explanation of the business cycle differs significantly from the mainstream economics|mainstream understanding of business cycles and is generally rejected by mainstream economists.



Austrian Business Cycle Theory - Malinvestment - boom

  • According to ABCT, a period of malinvestment is induced when there is a period of excessive business lending by banks, and this credit expansion is later followed by a period of liquidation, (i.e



Austrian Business Cycle Theory - Malinvestment - boom

  • Austrians argue that a boom taking place under these circumstances is actually a period of wasteful malinvestment. Real savings would have required higher interest rates to encourage depositors to save their money in term deposits to invest in longer term projects under a stable money supply. According to Mises's work, the artificial stimulus caused by bank lending causes a generalized speculative investment bubble which is not justified by the long-term factors of the market.



Austrian Business Cycle Theory - - bust

  • Mises wrote that a financial crisis|crisis (or credit crunch) arrives when the consumers come to reestablish their desired allocation of saving and consumption at prevailing interest rates.[http://mises.org/story/2810 Manipulating the Interest Rate: a Recipe for Disaster], Thorsten Polleit, 13 December 2007 Mises conjectured that 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.



Austrian Business Cycle Theory - - bust

  • Austrians argue that continually expanding bank credit can keep the borrowers one step ahead of consumer retribution (with the help of successively lower interest rates from the central bank). In the theory, this postpones the day of reckoning and defers the collapse of unsustainably inflated asset prices.[http://www.goldensextant.com/SavingtheSystem.html Saving the System], Robert K. Landis, 21 August 2004



Austrian Business Cycle Theory - - bust

  • Austrians argue that the monetary boom ends when bank credit expansion finally stops – when no further investments can be found which provide adequate returns for speculative borrowers at prevailing interest rates. They further argue that the longer the false monetary boom goes on, the bigger and more speculative the borrowing, the more wasteful the errors committed and the longer and more severe will be the necessary bankruptcies, foreclosures, and depression readjustment.



Austrian Business Cycle Theory - Government policy error

  • Austrian business cycle theory does not argue that fiscal restraint or austerity will necessarily affect economic growth.America's Great Depression, Murray Rothbard Rather, they argue that 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 worse, prolonging the depression and adjustment necessary to return to stable growth






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