The Austrian Theory of the Business Cycle Is a MICROECONOMIC PROCESS as the Price of Time Is Severed from the Preferences that Underlie It

It is the unobservability of the natural rate that is central to understanding the Austrian theory of the business cycle. Because the natural rate of interest is a theoretical construct and not a phenomenon observable on any real market, we cannot know with certainty that any given market rate of interest is accurately reflecting the underlying natural rate. It is in this sense that the Austrian theory of the business cycle is ultimately a microeconomic process; the problem begins with a price that becomes severed from the preferences that are supposed to underlie it. The whole theory elaborates the microeconomic results of that mistaken price signal. Because the price in question is the price of time, and all economic production involves time, the effects of that erroneous price are much more pervasive than those of any other price. It is that pervasiveness that makes the Austrian cycle theory ‘macroeconomic.’ It is not, however, macroeconomic in the sense of explaining some relationship among aggregates. This confusion arises with some frequency, especially when the theory is referred to as an overinvestment theory. The problem is not that there is too much investment (per se) but that the wrong kind of investment is taking place. That distinction is not readily visible through the eyes of modern macroeconomics since Keynes, which has understood investment only in terms of some aggregate measure rather than as part of an interconnected capital structure where the composition of investment is just as important as its overall level.

—Steven Horwitz, Microfoundations and Macroeconomics: An Austrian Perspective, Foundations of the Market Economy (London: Taylor & Francis e-Library, 2003), 126.