The Economist on the Austrian School of Economics’ Relevance in Explaining the Current Crisis

A Buttonwood column in the new issue of The Economist, “Taking von Mises to pieces: Why is the Austrian explanation for the crisis so little discussed?,” discusses the enormous relevance of the Austrian School of economics, including the work of F.A. Hayek, Ludwig von Mises, and Lawrence White in explaining the current economic crisis. The long-standing dominance within the economics profession of the ideas of John Maynard Keynes has led to policies that have produced credit booms and collapses, capital misallocation, high unemployment, de-stablized markets, and widespread economic harm.

We would add that the pioneering work of Independent Institute Senior Fellow Robert Higgs, including his book Depression, War, and Cold War: Challenging the Myths of Conflict and Prosperity, has produced an entire new appreciation for the insights of the Austrians on how the New Deal prolonged and deepened the Great Depression, preventing its end until after World war II when such policies were largely eliminated, and that government interventionism since has produced repeated economic problems. The current recession is perhaps the most dramatic example.

As the article states:

John Maynard Keynes is back. The British economist has modern intellectual champions in Paul Krugman and Robert Skidelsky. For all today’s talk of austerity, a policy of Keynesian fiscal stimulus was adopted by most governments in the immediate aftermath of the credit crisis.

In contrast policymakers seem to show a lot less interest in the economic ideas of the “Austrian school” led by Ludwig von Mises and Friedrich Hayek, who once battled Keynes for intellectual supremacy. Yet the more you think about recent events, the odder that neglect seems.

A one-paragraph explanation of the Austrian theory of business cycles would run as follows. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. Capital is misallocated into wasteful areas. When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up.

Take that analysis piece by piece. Were interest rates held too low? The case seems self-evident for Ireland and Spain, where the European Central Bank was setting a one-size-fits-all monetary policy. Many people would also argue that the Federal Reserve kept rates too low. Some lay the housing boom of 2003-06 at the Fed’s door, others criticise the central bank’s tendency to slash rates whenever the financial markets wobbled.

Was capital misallocated? Again most people would accept that too many houses and apartments were built in Ireland and Spain, as well as individual American states like Florida and Nevada. In some places these dwellings may sit idle for a while, keeping downward pressure on property prices. . . .

Here is the article in full.

David J. Theroux is Founder, President and Chief Executive Officer of the Independent Institute.
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