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Malinvestment

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  • Randall G. Holcombe

    (Florida State University)

Abstract

In the Austrian business cycle theory, monetary expansion lowers the interest rate and sends misleading relative price signals to investors, who then make investments that turn out to be unprofitable. One criticism of the theory is that if malinvestment is predictable, investors should understand their businesses well enough to see and avoid the temptation to be lured into unprofitable investments. A broader understanding of the Austrian school's framework explains why malinvestment takes place. The economy is a complex order, and while the theory explains that malinvestment will rise during the expansionary phase, it cannot identify which investment projects will eventually become unprofitable, nor can investors themselves tell ahead of time. Furthermore, applying the fallacy of composition, it may be that one investor could profitably invest based on those price signals, but all investors cannot. Monetary expansion lowers the informational content of prices, making it more likely that unprofitable investments will take place. Even if investors become more cautious, the percentage of investment projects that eventually will prove unprofitable will rise.

Suggested Citation

  • Randall G. Holcombe, 2017. "Malinvestment," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 30(2), pages 153-167, June.
    • Handle: RePEc:kap:revaec:v:30:y:2017:i:2:d:10.1007_s11138-016-0343-2
    DOI: 10.1007/s11138-016-0343-2
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    References listed on IDEAS

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    More about this item

    Keywords

    Business cycles; Investment; Monetary policy; Fractional reserve banking; Austrian school of economics;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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