The Austrian theory of the business cycle continues its comeback

Except no one seems interested in calling it by that name.  Here is the new NBER working paper by David López-Salido, Jeremy C. Stein, and Egon Zakrajšek, “Credit-Market Sentiment and the Business Cycle”:

Using U.S. data from 1929 to 2013, we show that elevated credit-market sentiment in year t – 2 is associated with a decline in economic activity in years t and t + 1. Underlying this result is the existence of predictable mean reversion in credit-market conditions. That is, when our sentiment proxies indicate that credit risk is aggressively priced, this tends to be followed by a subsequent widening of credit spreads, and the timing of this widening is, in turn, closely tied to the onset of a contraction in economic activity. Exploring the mechanism, we find that buoyant credit-market sentiment in year t – 2 also forecasts a change in the composition of external finance: net debt issuance falls in year t, while net equity issuance increases, patterns consistent with the reversal in credit-market conditions leading to an inward shift in credit supply. Unlike much of the current literature on the role of financial frictions in macroeconomics, this paper suggests that time-variation in expected returns to credit market investors can be an important driver of economic fluctuations.

The paper is here, here are ungated copies.  Here are some other related “Austrian” papers.

The resurrection of both Austrian and “risk-based” theories shows how alive and well macro has been of late, but at least in blog land you don’t hear that much about them…


In case anyone needed proof that economists are basically getting paid to spew nonsense, this is it.

But hey, the Cathedral cannot be without its priests

Eh, people who talk about "the Cathedral" are spewing nonsense for free. At least economists say something interesting and empirically demonstrable once in a while.

The idea of the cathedral is a useful and helpful concept. Even if you just think of it in terms of mainstream journalists are drawn from a fairly homogeneous class background and must profess certain ideas to rise.

Tithe is not free.

People who chuffer about 'the Cathedral' are generally alt-right cranks with an affinity for vulgar Austrian notions. Daniel's an outlier.

From the paper :

"Our emphasis on the role of credit-market sentiment in the business cycle is thus closer in spirit to the narrative accounts of Minsky (1977) and Kindleberger (1978), who emphasize the potentially destabilizing nature of speculative movements in asset prices."

The focus on "Minsky moments" , balance-sheet recessions , etc. , has been common in the Post-Keynesian literature all along. That the mainstream of macro took so long to catch on - and only because of a crisis that made the importance of credit and debt glaringly obvious - is hardly worthy of "alive and well" sorts of praise. More like " showing a somewhat stronger pulse , and occasional traces of EEG activity ".

This paper is indeed excellent , though , and I wonder if it might have had significant influence on the Fed's recent decision to raise rates in the face of widespread skepticism about the move. Private sector debt has gone from growing well below the level of ngdp growth to slightly above as of Q2 2015. If the Fed has finally learned that debt can't sustainably grow faster than gdp , and it only took the twin debacles of the 80s and 2000s for them to do so , I guess we can conclude that they're " alive and well ".

( Total nonfinancial debt has been growing just about exactly with gdp growth over the last several years. You can plug item "c" in place of item "b" on the formula line to see this. )

+1 I really enjoy Kindleberger. You need to read it and his critique of Austrian economics.

Two brief comments: First, the authors (in particular Stein) don't seem to have an ax to grind - Stein was appointed to the Fed by Obama and has since been a paid consultant (at Blue Mountain Capital) in addition to his duties at Harvard. Second, the authors measure economic activity by reference to real business fixed investment (and real GDP and unemployment). I will have to read the entire working paper closely, but by using real business fixed investment (rather than "investment"), the authors are giving weight to a phenomenon that so far gets little attention from economists - investment in productive capital vs. investment in speculative (financial) assets. [As the authors indicate in the two sentences preceding the one quoted by commenter Marko about speculative movements in asset prices: "By contrast, many of the modern theoretical models of the “financial accelerator” that have followed the seminal work of Bernanke and Gertler (1989) and Kiyotaki and Moore (1997) are set in a simple efficient markets framework, in which the expected returns on all assets are constant, and there is time variation only in the cashflows associated with financial intermediation—that is, the process of intermediation is more effient at some times than others, say because of greater availability of collateral".] I have not read the entire paper, so this comment is speculative. [Sorry, I couldn't help myself.]

Sounds kind of like the underwriting cycle in insurance.

This post ( by Dietz Vollrath on the declining capital per worker raises a few related questions. First, according to Vollrath, the recent (since 2000) uptick in the marginal product of capital (MPK) is attributable almost entirely to the increase in capital's share in output. Hence, the long-term (since the 1960s when MPK spiked) trend of a declining MPK is continuing. Vollrath: "The steady decline in the MPK over time is consistent with declining {n} [population growth] (because capital’s marginal product is lower when there are fewer people around), declining {g} (slower productivity growth), and higher {s} (more savings). In this story we are transitioning from the immediate post-war era of relatively rapid population and technological change, to a new era of relatively low population and technological growth." Was the high MPK in the 1960s an aberration? Vollrath: "MPK has been declining from 1960 until now, matching the decline in the [SPX] earnings yield from roughly 1970 until today. . . . The earnings yields suggests that what is abnormal about the figure for MPK is the high values in the 60’s and 70’s, not the low values now." [The earnings yield spiked following WWI and WWII and again in the late 1970s to early 1980s, and has a "normal" level over time of about 6%.]

Quality spreads move in lock step with capacity utilization. So this study may be saying that widening credit spreads are causing problems when in truth the quality spreads are just reflecting the point that the economy is already weakening.

Quality spreads are just as good a leading indicator, if not better than maturity spreads.

Maybe no one is calling it Austrian because it isn't unless we now refer to any reference to debt as being Austrian. One might as well call it Keynesian as it refers to sentiment, aka, animal spirits.

Credit cycle theory is the only business cycle theory outside academia and always has been. While academia went off on the fruitless RBC/New Keynesian sidetrack, the investment world stayed with credit cycle theory. The "comeback" is only within academia.

There's good reason not to call all credit cycle theory "Austrian." The term Austrian has become too tied up with von Mises and his cultic following, in which the central bank is seen as the sole driver of the credit cycle. Also "Austrian Business Cycle" is usually taken to be about the interaction between credit signals and the length of the production cycle.

This credit cycle theory seems more of the Keynesian variety with its heavy use of the word "sentiment," as if human sentimentality waxes and wanes over the course of a business cycle.

^^ indeed, these are obviously not Austrian business cycle theories (which rely on changes in kapital structures with a k) and it is disappointing to see them framed as such.

Are not "Austrian" business cycle theories micro based? Would that not mean macro is not alive and well, but rather on a downward trajectory?

No, because these are not Austrian business cycle theories.

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