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IAI Actuarial Core Principles · Business Economics · Main economic schools and their key features

Austrian business cycle theory attributes a boom followed by a bust mainly to which sequence?

Austrian theory says central bank credit expansion holds interest rates below the level reflecting real saving, so firms undertake unsustainable long-term projects. This malinvestment distorts the production structure, and the later bust is the necessary liquidation of those errors.

  1. AArtificially low interest rates from credit expansion distort the structure of production, causing malinvestment that later has to be liquidatedCorrect
  2. BRandom productivity shocks that are efficiently absorbed by markets
  3. CInsufficient government spending reducing the multiplier
  4. DWorkers misperceiving general price changes as relative wage changes
  5. A fall in animal spirits that is unrelated to monetary conditions

Explanation

Austrians such as Mises and Hayek argue that credit expansion pushes market rates below the natural rate, encouraging long-term projects not backed by real saving. When this becomes unsustainable the malinvestments are exposed and the bust is the necessary correction. The other options belong to RBC, Keynesian or Lucas-style misperception views.

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