A professor of mine brought up an objection to Austrian Business Cycle Theory, saying that as long as entrepreneurs know what inflation will be then they can build that into their economic models and there will be no disruption of the relative price system or systematic misallocatins of capital. I feel like this isn't necessarily true, as inflation takes time to ripple throughout the economy and during this time the price system must surely be disrupted. I feel like I read a paper on this somewhere but I can't find anything on it, does anyone have a source that might help me out with this? Thanks.
Well, actual inflation can't be predicted perfectly.
This is going to be the strongest boom ever. Its effects have already happened, and they happen during busts--they're just going to be redistributed.
Inflation spreading throughout the economy will only cause intratemporal misallocation of resources and therefore not the business cycle. Your professor is also missing the point, inflation only concerns the ABCT insofar as new money enters the economy through the loan market thus pushing the interest rate down and causing intertemporal discoordination.
Now, what your professor might be getting at is that if entrepreneurs are aware of this the business cycle could be avoided. Whether or not he is correct is a subject of debate within the school with Mises, Rothbard, Shostak and to my knowledge Huerta de Soto on one side and Huelsmann, Lachmann (and I think Salerno) on the other. But it certainly isn't a criticism that's been ignored.
"You don't need a weatherman to know which way the wind blows"
Bob Dylan
Inflation cannot be properly predicted. If it could it would not be effective. Prices would immediately rise on the expectation of price inflation and the recipients of the new money will not obtain the high (often speculative) profits or purchasing power as originally intended by creating the inflation.
It's like people saying they predict really high future price of natural gas. If they were confident in the accuracy of their prediction then everyone would be either investing to produce more of it (when the shortage comes, profiting by supplying more of it at the higher price) or by buying many futures contracts today at low prices, to sell at higher prices in the future. Or you would be buying tankers full of the stuff and storing it to sell at the higher future price. In either of these cases, if the masses took action then the price of nat gas would immediately sky rocket even though the current demand doesn't support it. But having said that, it is not the masses, but rather the few that make such accurate predictions and profit from the prediction. Being able to profit from a venture comes from the ability of only a few (or one single person) to predict a future demand (or situation) that exceeds supply. If everyone foresaw the same opportunity to profit from a venture then many would invest and this would reduce or avoid profitability.
As Mises said, the ABCT is subject to change, because one cannot predict and/or create models of human behaviour. Even that entrepreneurs can never now that inflation will be (are they clairvoyants??), what can happen is that newly created money is loaned to banks, and they do not want to give loans with this newly created reserves, so the inflationary process stops right there, and no ABCT takes place. Even though, in that case, it is very likely that the government will put pressure on banks to give loans to the people.
If the government, with its thousands of Ivy League economists, can't predict inflation, what makes you think that the Mexican restaurant down the street from me can?
To paraphrase Marc Faber: We're all doomed, but that doesn't mean that we can't make money in the process. Rabbi Lapin: "Let's make bricks!" Stephan Kinsella: "Say you and I both want to make a German chocolate cake."
It is certainly not true that entrepreneurs can "know" what inflation will be, but it is true that they will anticipate the inflation and try to account for it. But that will not eliminate the business cycle! Let me give you my take on it.
I believe Hayek has pointed this out very clearly: The anticipation of the inflation, actually forces the central bank to accelerate the inflation in order to sustain the boom! Your professor actually gave the reason why the boom cannot continue forever. Let me elaborate:
First, your professor should acknowledge that the expansion of credit by the central banking system causes artificial low interest rates. It is obvious that the amount of credit being loaned out does not match the amount of real savings by individuals. Therefore, the interest rate does not reflect the true time preference of the consumers. Your professor needs to explain how growth is possible without real savings, that is, consumers sacrificing current consumption for future consumption.
Second, your professor should acknowledge that the boom phase is a result of an increase in aggregate demand in capital goods caused by the credit expansion. It is not a result of a lower shift in pure time preference when wealth is diverted from consumption into savings. This means that the consumer never gave up some of his resources to allow for investment in a more productive production structure.
Third, so if it is artificial credit expansion that is causing the boom, then this is nothing but a shell game. Your professor is right; there will be anticipation of inflation, which is why there will be a demand for more inflation in order to sustain the boom. If the rate of inflation is constant, entrepreneurs will anticipate the inflation and charge higher prices now to account for the future inflation. They would be justified for doing this because they will realize that their profits are not real profits as soon as they will discover that prices for their Capital have gone up more then what they previously earned. So to keep the shell game going, inflation must accelerate and always be 1 step ahead of the anticipation of the entrepreneurs. Accelerated inflation will eventually lead to hyperinflation if not halted. So a bust is unavoidable if we are to avoid the destruction of the system.
Your professor is not very familiar with the Austrian Business Cycle. I don’t know where these “economists” get the “hutzpah” of just disregarding or criticizing something that they just don’t know about.