Expectations in Austrian Business Cycle theory: An application of the prisoner's dilemma

Abstract

The standard account of Austrian Business Cycle theory posits that central bank manipulations of interest rates fool bankers and investors into believing that there has been an increase in the real supply of loanable funds available for capital investment. However, reliance on "foolishness" ignores the entrepreneurial emphasis within the Austrian tradition and fails to produce the strongest possible case for Austrian Business Cycle theory. We use the prisoner's dilemma framework to model the profit maximizing behavior of bankers and the investors under uncertainty when the market rate of interest is below the underlying rate of time preference. © 2001 Kluwer Academic Publishers.