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Knowledge shifts and the business cycle: When boom turns to bust

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  • David Howden

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Abstract

Informational cascades can be used to augment the existing Austrian business cycle theory. As first-order users of knowledge know the direct causes of a price change, they transmit this knowledge to second-order users through the price system. Banks with direct knowledge of the sources of the fresh liquidity during a credit induced boom have knowledge of the boom's artificial and unsustainable nature. Higher-order users lack this direct knowledge, and hence continue investing largely ignorant of underlying developments. When first-order users of knowledge sense the boom has run its course, they exit the market, sending a strong signal to higher-order knowledge users that the boom has ended – a fragile situation built upon an informational cascade begins collapsing. Simultaneously, the boom is characterized by an influx of capital and knowledge into the financial sector owing to increased profits relative to the real economy stemming from Cantillon effects surrounding the credit injection. As knowledge pertaining to real production has also exited, the bust commences with a misallocated productive structure requiring equilibration to become consistent with consumers' wants. Actions which inhibit this knowledge from returning to the productive structure will unnecessarily lengthen the time to recovery.
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Suggested Citation

  • David Howden, 2010. "Knowledge shifts and the business cycle: When boom turns to bust," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 23(2), pages 165-182, June.
  • Handle: RePEc:kap:revaec:v:23:y:2010:i:2:p:165-182 DOI: 10.1007/s11138-009-0095-3
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    Citations

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    Cited by:

    1. David Howden & Jason XingBin Li, 2015. "An Austrian Analysis of China's Unsustainable Boom," Economic Affairs, Wiley Blackwell, vol. 35(3), pages 443-452, October.
    2. Howden, David & Gabriel, Amadeus, 2015. "The Interest Rate Brake on Maturity Transformation," MPRA Paper 79793, University Library of Munich, Germany.
    3. Philipp Bagus & David Howden, 2011. "Monetary equilibrium and price stickiness: Causes, consequences and remedies," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 24(4), pages 383-402, December.
    4. Philipp Bagus, 2011. "The Eurosystem: Costs and Tragedies," Chapters,in: Institutions in Crisis, chapter 7 Edward Elgar Publishing.
    5. Philipp Bagus & David Howden, 2012. "Monetary equilibrium and price stickiness: A rejoinder," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 25(3), pages 271-277, September.
    6. Bagus, Philipp & Howden, David, 2011. "Unanswered Quibbles with Fractional Reserve Free Banking," MPRA Paper 79594, University Library of Munich, Germany.
    7. David Howden, 2014. "Knowledge flows and insider trading," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 27(1), pages 45-55, March.
    8. Philipp Bagus & David Howden, 2012. "Still unanswered quibbles with fractional reserve free banking," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 25(2), pages 159-171, June.
    9. Bagus, Philipp & Howden, David, 2010. "The Term Structure of Savings, the Yield Curve, and Maturity Mismatching," MPRA Paper 79592, University Library of Munich, Germany.
    10. Bagus, Philipp & Howden, David, 2013. "Some Ethical Dilemmas with Modern Banking," MPRA Paper 79599, University Library of Munich, Germany.
    11. Bagus, Philipp & Gabriel, Amadeus & Howden, David, 2014. "Causes and Consequences of Inflation," MPRA Paper 79608, University Library of Munich, Germany.
    12. Malte Tobias Kähler, 2011. "From German Rules to European Discretion: Policy’s Slippery Slope," Chapters,in: Institutions in Crisis, chapter 9 Edward Elgar Publishing.
    13. Howden, David, 2013. "The Rise and Fall of the Icelandic Economy," MPRA Paper 79603, University Library of Munich, Germany.
    14. García Iborra, Rafael & Howden, David, 2016. "Uses and Misuses of Arbitrage in Financial Theory, and a Suggested Alternative," MPRA Paper 79802, University Library of Munich, Germany.
    15. repec:kap:revaec:v:30:y:2017:i:4:d:10.1007_s11138-016-0368-6 is not listed on IDEAS
    16. Gabriel A. Giménez-Roche, 2011. "Institutional Illusion and Financial Entrepreneurship in the European Debt Scheme," Chapters,in: Institutions in Crisis, chapter 1 Edward Elgar Publishing.
    17. repec:kap:revaec:v:30:y:2017:i:2:d:10.1007_s11138-016-0343-2 is not listed on IDEAS

    More about this item

    Keywords

    Informational cascades; Overshooting; Business cycle; Inflation; D82; E31; E52;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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