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New evidence on the structure of production: Real and Austrian business cycle theory and the financial instability hypothesis

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  • Mulligan, Robert F.
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    Abstract

    This article develops the relationships among real business cycle (RBC) theory, Austrian business cycle (ABC) theory, and Minsky's financial instability hypothesis (FIH). In RBC models, recessions are caused on the supply side by random technology shocks which are independent of monetary policy. However, in ABC models, credit expansion results in negative productivity shocks, as the marginal return on investment is lowered and the production structure is extended by commitment to more capital-intensive activities. Thus, ABC theory helps resolve several problems with RBC theory. The FIH describes a process of endogenous overleveraging which unsustainably overvalues assets and exposes the financial sector to greater risk. This paper argues that the overleveraging described by the FIH is compatible with the unsustainable expansion of production described in ABC theory, and further argues that credit expansion would both provide additional funds to finance overleveraging, as well as encourage the process by making it cheaper with lower interest rates.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0167268112002995
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

    Volume (Year): 86 (2013)
    Issue (Month): C ()
    Pages: 67-77

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    Handle: RePEc:eee:jeborg:v:86:y:2013:i:c:p:67-77

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    Web page: http://www.elsevier.com/locate/jebo

    Related research

    Keywords: Production structure; Hayekian triangle; Real business cycle model; Financial instability hypothesis;

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    References

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    1. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
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    8. Hyman P. Minsky, 1992. "The Financial Instability Hypothesis," Economics Working Paper Archive wp_74, Levy Economics Institute.
    9. Israel M. Kirzner, 1997. "Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach," Journal of Economic Literature, American Economic Association, vol. 35(1), pages 60-85, March.
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    12. Carilli, Anthony M & Dempster, Gregory M, 2001. " Expectations in Austrian Business Cycle Theory: An Application of the Prisoner's Dilemma," The Review of Austrian Economics, Springer, vol. 14(4), pages 319-30, December.
    13. Steve Keen, 1995. "Finance and Economic Breakdown: Modeling Minsky's "Financial Instability Hypothesis"," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 17(4), pages 607-635, July.
    14. Israel M. Kirzner, 1984. "Economic Planning and the knowledge Problem," Cato Journal, Cato Journal, Cato Institute, vol. 4(2), pages 407-425, Fall.
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    Cited by:
    1. Mulligan, Robert F., 2014. "Multifractality of sectoral price indices: Hurst signature analysis of Cantillon effects in disequilibrium factor markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 403(C), pages 252-264.

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