The 2008 financial crisis made it clear that prolonged periods of apparent stability can mask the accumulation of structural imbalances in credit and asset markets. Since then, the study of the relationship between credit and real activity has expanded considerably, and international institutions have recognized the need to incorporate these dynamics into macroeconomic analysis (Borio 2014). However, a central question remains unresolved: Through what mechanism does credit expansion translate into more severe subsequent contractions, and why are booms with greater credit intensity followed by disproportionately deep recessions?

This question presents an opportunity for Austrian business cycle theory (ABCT). Developed by Mises ([1949] 1998) and Hayek ([1931] 2008), ABCT offers a specific answer. Credit expansion pushes the interest rate below its natural level, inducing entrepreneurs to undertake investment projects that the real economy cannot sustain. Resources are reallocated toward stages further from final consumption and more capital intensive (the Austrian tradition calls this phenomenon malinvestment), generating structural unsustainability—that is, a distortion that originates in the financial domain but ultimately alters the real configuration of the economy. ABCT thus proposes a qualitative dimension of credit excess that complements the predominantly aggregate focus of the conventional literature, whose hypotheses differ on the specific mechanism but coincide in framing the problem in terms of volumes rather than intersectoral composition.

Despite this potential relevance, the Austrian tradition has had little presence in the contemporary debate on the transmission of credit to the real economy for two reasons. The first is epistemological. Founded on a logical-deductive methodology of praxeological inspiration, the Austrian tradition has historically distrusted econometric work as a means of validation, which helps explain the scarcity of empirical work produced from within the school. The second is methodological. The few empirical works available have aimed to validate the theory as a whole, accumulating identification problems that are difficult to overcome with standard econometric tools. The proposal of this article is that there is a path that addresses both problems at once: testing malinvestment as a transmission mechanism isolated from the rest of the Austrian cycle. This strategy, enabled by a feature of the theoretical framework itself, allows the Austrian tradition to participate productively in the debate without renouncing its specificity.

The article first reviews the conventional debate and the limitations of the Austrian empirical literature, articulating the opportunity that motivates the proposal. It then presents two illustrative methodological decisions, summarizes the evidence from the Spanish cycle, and develops the implications of the approach before outlining a research agenda.

A Debate Without a Structural Mechanism

The macroeconomic literature has documented that credit expansions are associated with deeper subsequent recessions. The macrohistorical analysis of Jordà et al. (2013), spanning fifteen advanced economies and more than a century of data, shows that the volume of credit growth during an expansion is one of the best predictors of the depth of the ensuing contraction. The authors themselves leave open the investigation of the mechanisms underlying this regularity.

The dominant theoretical response has focused on balance-sheet dynamics and financial amplification. The credit channel and the financial accelerator emphasize how the deterioration of balance sheets amplifies monetary shocks and prolongs contractions (Bernanke and Gertler 1995). Minsky’s (1986) financial instability hypothesis adds the endogenous dynamic by which periods of stability favor increasingly speculative financing structures. All these mechanisms address aggregate dimensions of credit excess (volumes of indebtedness, financing structures, balance-sheet composition), while the allocative dimension has received comparatively less attention, with Borio (2014) serving as a notable exception in identifying the misallocation of resources as a characteristic feature of booms.

The aggregate mechanisms that populate this debate operate on volumes (of indebtedness, of investment) or on the structure of financing, but not on the sectoral composition of investment. This is the dimension that ABCT addresses.

The Limitations of the Austrian Empirical Literature

ABCT does answer that question. When the market interest rate is pushed below the natural rate by credit expansion, the system loses what Pérez Asensio (2025) terms double coordination: intertemporal coordination between saving and investment, on the one hand, and financial-real coordination between the viability of the projects undertaken and the resources actually released by consumers, on the other. The artificially low rate induces entrepreneurs to initiate projects in stages further from final consumption and more capital intensive without the real resources those projects require having been released. The resulting productive structure is inconsistent both with the genuine intertemporal preferences of agents and with the available resources and must be corrected when the expansion reverses. The Jordà, Schularick, and Taylor correlation is consistent with this interpretation. The greater the expansion, the greater the accumulated distortion and the deeper the subsequent adjustment.

Existing empirical works can be grouped according to the type of variable they employ to detect distortion in the productive structure. A first group is confined to the aggregate plane, examining the response of investment volume to credit expansion through the slope of the yield curve as a proxy for the Wicksellian gap. These works confirm the monetary origin of the cycle but do not test the intersectoral distribution of investment, which is the distinctive feature of Austrian theory (Keeler 2001; Bismans and Mougeot 2009). A second group examines relative prices and quantities of goods across stages, with mixed results (Wainhouse 1984; Lester and Wolff 2013; Luther and Cohen 2014). A third group directly observes factor reallocation through employment shares across stages (Mulligan 2002; Schaffer 2017) or by inferring distortion from the composition of outputs (Young 2012; Alonso-Neira and Sánchez-Bayón 2024). It is with this third group that the present work is most closely aligned. We share with Mulligan (2002) the intuition of observing the labor factor as a proxy for intersectoral reallocation, although we argue, contrary to his approach, that relative wages provide an approximation more faithful to the bidding mechanism between stages than quantities do.

A common feature of these contributions is their ambition to validate ABCT in broad terms by testing the complete cycle with its multiple interacting phenomena. This ambition creates a severe identification difficulty which combines two problems. First, the theory simultaneously predicts malinvestment and overconsumption operating on the same observable variables, with forces that tend to partially offset one another. Second, the test requires assigning to standard sectoral classifications a theoretical construct—that of the intermediate stages—which has no unequivocal empirical translation. The combination of concurrent phenomena and insufficiently disaggregated data places ABCT, by construction, in a difficult empirical position because validating it as a whole requires simultaneously solving problems that are tractable when considered separately.

ABCT as a Natural Candidate

The conjunction of the two preceding diagnoses—a structural gap in the conventional debate and an Austrian tradition that responds to that gap but has not articulated its response in empirically productive terms—defines the opportunity that motivates this article. ABCT can position itself as a complement to the credit channel and to Minsky’s financial instability hypothesis, emphasizing the real allocative dimension that these overlook. Malinvestment incorporates a compositional element that overindebtedness does not capture.

Enabling this participation requires a change in empirical strategy. Instead of attempting to validate ABCT as a whole, we propose testing in isolation the theory’s most distinctive and tractable prediction: intersectoral malinvestment. This strategy exploits a feature of the Austrian framework itself—the Cantillonian nonneutrality of money—to delimit the phenomenon and submit it to empirical testing using current methodological standards.

Two Illustrative Methodological Decisions

The strategy of isolating the mechanism requires two decisions: identifying the temporal window in which to look for the malinvestment signal and selecting an indicator to measure it with. The decisions presented below are concrete proposals rather than the thesis of the article.

The first, the start-up window, exploits the temporal sequentiality of the cycle. Credit expansion generates two simultaneous incentives—malinvestment in early stages and overconsumption in late stages—which produce opposing pressures on the relative prices of factors and are difficult to separate when they operate concurrently. Investment, however, responds to interest rate variations more rapidly and more intensely than consumption, a stylized fact widely documented since Christiano et al. (2005). Within the Austrian framework, this asymmetry is explained by the combination of two theses: the nonneutrality of money formulated by Cantillon ([1755] 1959), which makes the direction of transmission depend on the entry point of credit, and the operative assumption that this entry point lies with producers, canonically adopted by Hayek ([1931] 2008) and Mises ([1949] 1998, 555). There exists, therefore, an initial phase of the expansion during which the observable malinvestment signal dominates and remains relatively isolated. The operative definition rests on three hierarchically ordered planes: the timing of monetary policy, its corroboration by the financial cycle indicators described by Borio (2014), and its validation through statistical tests.

The second decision is the use of relative wages between productive stages as an indicator of reallocation. ABCT is a theory of relative prices, as Hayek ([1931] 2008) notes and Lester and Wolff (2013) emphasize. Relative wages between early- and late-stage sectors therefore constitute a direct indicator of competition for factors, one that is closer to the theoretical mechanism than employment shares, which measure physical displacement rather than the intensity of demand. The only known precedent that tests the wage channel, Schaffer (2017), finds weak results, which he attributes to institutional features of the US labor market. To mitigate the problem of nominal wage rigidities affecting base wages, it is also advisable to employ a harmonized labor cost index, which incorporates flexible components such as overtime and bonuses.

Illustrative Evidence: The Spanish Credit Cycle

Spain experienced one of the most pronounced credit expansions in the euro area during the first decade of the 2000s, with an identifiable monetary impulse: The reduction of the European Central Bank’s main refinancing rate to 2 percent in June 2003 ushered in strongly expansionary conditions for an economy with above-average inflation and, therefore, a particularly negative real differential relative to the natural rate.

The empirical design we propose, developed in Pérez Asensio (2025), constructs a measure of relative wages as the year-on-year variation in the log ratio of harmonized labor cost indices between construction (early) and retail trade (late), using quarterly data from the Spanish National Statistics Institute (2001–25). The monetary stance is approximated by the year-on-year variation in the European term spread. The design consists of an autoregressive distributed lag model that incorporates a dummy variable for the start-up window (2003Q2–2004Q1) interacting with the monetary variable.

The results support the malinvestment hypothesis within the start-up window. A sustained monetary easing of 1 percentage point is associated with a long-run propensity of +4.47 percentage points in the growth rate of the wage ratio, significant at the 1 percent level (Wald: F = 21.98; p < 0.001). This “start-up premium” is robust to an alternative monetary proxy (the natural-rate gap of Holston et al. 2017), which mitigates concerns about the known limitations of the term spread as an indicator of monetary stance. It is also robust to the exclusion of the COVID-19 period and to temporal placebo tests. Outside the start-up window, the effect is economically marginal and indistinguishable from zero, consistent with the attenuation of the signal by overconsumption forces in subsequent phases. The scope of the evidence is deliberately limited—one country and one cycle—but sufficient for its intended purpose: demonstrating that the strategy of isolating the mechanism is empirically viable.

Implications if Malinvestment Were Incorporated into the Debate

If the preliminary evidence were confirmed across a broader set of episodes, incorporating malinvestment into the conventional debate would have three implications. First, it would offer a microstructural foundation for the regularity identified by Jordà et al. (2013) that the dominant aggregate mechanisms do not provide. The depth of the postboom recession would depend, beyond balance-sheet and leverage factors, on the magnitude of the structural distortion accumulated during the boom and subsequently unwound when the cycle reverses.

Second, it would have implications for the design of macroprudential policy. If the composition of investment during the boom is a relevant predictor of structural vulnerability, indicators of sectoral distortion, such as wage differentials between stages, could complement the aggregate credit-to-GDP indicators that dominate the Basel III framework. Such indicators would operationally measure the breakdown of the double coordination conceptualized in this article and serve as early signals of the structural distortions underlying the severity of recessions following intense credit booms.

Finally, it would open a path of theoretical dialogue between the Austrian tradition and conventional macroeconomics that has been largely closed for decades. ABCT would cease to be perceived as a framework irreconcilable with the dominant toolkit and could instead participate in dialogue across traditions, offering theoretical elements that address the allocative dimension. An appropriate empirical strategy could be sufficient to make the distinctive predictions of Austrian theory visible without making concessions about its foundations.

Research Agenda

Realizing this potential requires a research program that has not yet been undertaken systematically. The next step is to extend the analysis to multiple economies and cycles. The countries of the European periphery, for example, offer natural comparisons, sharing a common monetary policy while exhibiting different real rate gaps. This could be complemented by the systematization of the start-up-window approach through exogenous monetary policy surprises or economy-specific natural-rate estimates that strengthen causal identification.

Conclusions

This article proposes a path by which the Austrian tradition can participate in the contemporary debate on the transmission of credit to the real economy. The proposal consists in isolating intersectoral malinvestment from the rest of the Austrian cycle and submitting it to empirical testing using the econometric tools of the conventional debate itself. The main contribution transcends the evidence presented here, which is deliberately modest, as well as the specific methodological decisions that produce it, and lies in the overall strategic movement: demonstrating that the failure of double coordination discussed here is susceptible to partial testing and that its allocative dimension can be understood as the Austrian response to the question that Jordà et al. (2013) leave unresolved. The research program outlined here allows the Austrian tradition to engage with the mainstream on its own terms, contributing from the allocative side to the understanding of the credit cycle.