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The Economist: " Why Is The Austrian School Explanation For The Crisis So Little Discussed?"

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It was in this last week's edition.

http://www.economist.com/node/17522368?story_id=17522368

Good article, by a very influential international magazine.

And about time too! Pseudo Keynesians have had too much leeway already.

Buttonwood

Taking von Mises to pieces

Why is the Austrian explanation for the crisis so little discussed?

Nov 18th 2010 | from PRINT EDITION

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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.

Related topics

* John Maynard Keynes

* Government and politics

* Economics

* Economic crisis

* Economic policy

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.

Economists who would not describe themselves as Austrian have reached conclusions that chime with Hayek. Carmen Reinhart and Kenneth Rogoff, in their book “This Time is Different”, argued that past financial crises have been followed by long periods of sluggish growth. Hyman Minsky, an American economist who died in 1996, said that the financial cycle led to economic volatility. Long booms tended to result in excessive risk-taking and “Ponzi finance”, where investors buy assets with borrowed money in the hope of quick capital gains. Minsky’s reputation has soared since the start of the credit crunch.

Nassim Nicholas Taleb is a very popular financial author thanks to his books “Fooled by Randomness” and “The Black Swan”. One of his principal ideas is the difficulty of forecasting given the role of chance and extreme events. That echoes the views of Hayek, who wrote that “the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

The Austrians may have said smart things about the boom, but what about the bust? One criticism is that the Austrians offered a “counsel of despair”, suggesting that the authorities do nothing while a crisis blows itself out. At least the monetarists propose cutting rates and expanding the money supply and the Keynesians promote deficit spending.

But Lawrence White, an economist at George Mason University in Washington, DC, argues that this is an unfair characterisation. “Hayek was not a liquidationist,” he says, referring to the philosophy of Andrew Mellon, President Herbert Hoover’s Depression-era treasury secretary, who wanted to “purge the rottenness out of the system”. Hayek believed the central bank should aim to stabilise nominal incomes. On that basis Mr White thinks the Fed was right to pursue the first round of quantitative easing, since nominal GDP was falling, but wrong to pursue a second round with activity recovering.

Mr White is one of the few current economists to promote the Austrian approach. This may be because economists divided into Keynesians and monetarists in the 1970s. You might think that the Austrians would find common cause with the monetarists. But Milton Friedman rejected their analysis, stating in 1998 that: “The Austrian business-cycle theory has done the world a great deal of harm.” Efficient-market theorists disliked the Austrians because they appeared to assume that businessmen could act irrationally.

The libertarian streak of the Austrians still has its fans. Glenn Beck, a lachrymose Fox News pundit, turned Hayek’s “The Road to Serfdom” into an unlikely bestseller earlier this year. Being associated with Mr Beck will not persuade many academics to take Austrian economic ideas seriously. Given the repeated credit booms and busts of the past 40 years, that may be a pity.

Edited by Tired of Waiting

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I am not sure Keynes wasn't basically right, except the conclusions were extended too far. That is Austrian economics explains perfectly well the reasons behind the crisis.

To coin my own analogy - excessive debt is like cancer, keynsian stimulus is like radiotherapy, and its use should therefore be strictly and conservatively prescribed.

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"When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up."

with a poor deceitful summary that includes the above sentence, you see why its ignored.

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I am not sure Keynes wasn't basically right, except the conclusions were extended too far. That is Austrian economics explains perfectly well the reasons behind the crisis.

To coin my own analogy - excessive debt is like cancer, keynsian stimulus is like radiotherapy, and its use should therefore be strictly and conservatively prescribed.

I agree. If governments accumulated surpluses in good times, to be use in bad times, then OKish. The problem is that governments are never Keynesian in good times! Only when TSHTF... :rolleyes: (That is why I wrote "pseudo" Keynesian in my OP.)

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"When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up."

with a poor deceitful summary that includes the above sentence, you see why its ignored.

Sorry, I didn't get that.

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"When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up."

with a poor deceitful summary that includes the above sentence, you see why its ignored.

Excess capacity in high order goods and a defict in capacity in lower order goods.

Misalocation of capital means other areas were starved of capital.

The UK has an excess capacity on the consumptive side of the economy and a deficit on the productive side.

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"When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up."

with a poor deceitful summary that includes the above sentence, you see why its ignored.

That is a pretty poor explanation. It's not excess capacity, it's poor/inefficient use of capital resources.

A bad investment is one which uses a lot of resources to generate little or no (or negative) lifetime return. Austrian economics argues that artificially cheap money distorts prices such that lots of bad investments seem like good ones at the time, but when reality reasserts itself they are proven to be bad ones. By that point it is too late as the resources have already been committed and cannot be easily reallocated to where they would actually be useful.

What should Britain have been building instead of new build flats in northern cities? German-style high tech factories? Trouble is we will never know as prices were distorted and price discovery was impossible.

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I agree. If governments accumulated surpluses in good times, to be use in bad times, then OKish. The problem is that governments are never Keynesian in good times! Only when TSHTF... :rolleyes: (That is why I wrote "pseudo" Keynesian in my OP.)

Unless of course their was no boom, if their is no boom then you don't have to save. And when someone announces boom/bust has been abolished, well it's different this time isn't it...

You also have the problem that those on the right will get upset during the good times if govts have a surplus and demand tax cuts ensuring there is no surplus. Again it's different this time.

The other problem if you do have a surplus to spend during the bust invariable it will get wasted and spent propping up businesses of friends. Which probably won't be in the overall interest of the economy. Votes aren't won by letting failed businesses collapse.

Edited by interestrateripoff

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Keynes would have wept at how he has been misunderstood by these champagne socialistas.

+0.5

however, he did single-handedly oversee the keynsian concensus in the post war era that saw us suffer economically for years, only finally put to bed by Maggie T

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Keynes would have wept at how he has been misunderstood by these champagne socialistas.

I think that he would be bringing defamation of character suits.

I have a new collective noun for certain economists : KrugmanFlowers are Austrians during the boom and Keynesians during the bust. They are always on the "right side" of the popular view at any point in the cycle. They are without logic, integrity or backbone.

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I think people look at Keynes in the same rose-tinted way that some now look at Bernanke.

I have read numerous economic histories that point out that there were numerous other financial disasters looming pre-Keynes but that the Economists in the various central banks did nothing - well, they did something in allowing Capitalism to worh through in its natural way, allowed the bust to disappear and allowed new organisations to grow up... but because such measures worked the men behind the solutions have been forgotten.

OK, time for an analogy... imagine a forest full of trees... some trees are rotten... but new trees can't grow up because of lack of space and lack of light.. Oh, I can't be bothered... Too cold...

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It is completely scandalous that there are no Austrian-school economists in any government. Considering the damage done by the bunch of economists who helped get us into this mess, it is incomprehensible that they should still be in their jobs at all (yes Merv, I'm looking at you). Fundamentally, I think most economists (and I am one by education and interest) just didn't have the ******ing balls to say what was wrong - better to get political favour by agreeing with the politicians that the party could never end or that there was a new paradigm. These cowards should have been removed some time ago and the Austrians brought in. If not, and things carry on, we might well get the equivalent of another Austrian with a funny moustache instead. 

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Excess capacity in high order goods and a defict in capacity in lower order goods.

Misalocation of capital means other areas were starved of capital.

The UK has an excess capacity on the consumptive side of the economy and a deficit on the productive side.

it was the last part of the sentence I was specifically vexed with.

Its the application of Keynesian cures late in the cycle causes the YEARS of recovery.

the point about Keynes, was that instead of allowing a credit boom, Governments would extract a surplus of actual funds via taxation. these funds would then be used to stimulate the economy in the inevitable BUST after the BOOM. No extra borrowing or deficits required.

the time to stop the BOOM and missallocation of credit is during the BOOM....Keynes and Mises seem to be in agreement here, Mises wanting to exclude government, Keynes wanting to include it.

Austrians are referred to as the "evil Austrians" by Nulabour....I dont suppose the Tories even know what they are.

Governments however didnt ( as a rule) build up surpluses in the BOOM, they just added new methods to borrow, PFI, pension promises and the rest of the unfunded liabilities.

then, when the BUST hits they get all Keynesian and try to stimulate...no funds available though.

Austrian Economics predicts and accounts for all this behaviour, but the leaving it all alone is not something a Big Government can bring itself to contemplate...I cite the Jeremy Vine show today talking about the snow....WHAT ARE THE GOVERNMENT DOING ABOUT THE SNOW? asks Vine and callers, wheeling in a Minister to explain himself.

We live in a time where ENTITLEMENT is rife..in salaries, house values and now to a weather free world....all courtesy of the all powerful, all seeing, all caring, Government.

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It is completely scandalous that there are no Austrian-school economists in any government. Considering the damage done by the bunch of economists who helped get us into this mess, it is incomprehensible that they should still be in their jobs at all (yes Merv, I'm looking at you). Fundamentally, I think most economists (and I am one by education and interest) just didn't have the ******ing balls to say what was wrong - better to get political favour by agreeing with the politicians that the party could never end or that there was a new paradigm. These cowards should have been removed some time ago and the Austrians brought in. If not, and things carry on, we might well get the equivalent of another Austrian with a funny moustache instead. 

Unfortunately, there just aren't that many Austrian economists around. I studied economics at a British university for a little while and all we were fed was pure Keynesian junk.

The whole profession needs a revolution, but I suspect it won't happen until the current experiment in global Keynesian economics returns a big fat crash as its result. So far the experiment is "working" in the sense that the ATMs are open and there is food on the shelves. Economists wouldn't want to set the bar too high you know, by aiming for something like "low unemployment" or "90% of full time workers able to provide food and shelter for a family of 4 on their income alone."

Edited by Dorkins

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Douglas Carswell does.

sadly, he is describing FRB in the first minute or so, which we dont use here..we have Capital Ratios, and the £100 deposit is not Bank capital but a bank liability.

Interesting he reckons 70% of people think the deposit belongs to them and not the bank though.

and anyway...Who He?

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We live in a time where ENTITLEMENT is rife..in salaries, house values and now to a weather free world....all courtesy of the all powerful, all seeing, all caring, Government.

As an exercise, watch the BBC news and, whenever the phrase "The Government" is used, mentally substitute "Big Brother".

It usually fits right in.

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I agree. If governments accumulated surpluses in good times, to be use in bad times, then OKish. The problem is that governments are never Keynesian in good times! Only when TSHTF... :rolleyes: (That is why I wrote "pseudo" Keynesian in my OP.)

The problem is/was for a long time now, we've never actually had any good or boom times. Unless you believe Blair/Brown/Darling of course. Pseudo Keynesian for a Pseudo Boom!

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Unless of course their was no boom, if their is no boom then you don't have to save. And when someone announces boom/bust has been abolished, well it's different this time isn't it...

You also have the problem that those on the right will get upset during the good times if govts have a surplus and demand tax cuts ensuring there is no surplus. Again it's different this time.

The other problem if you do have a surplus to spend during the bust invariable it will get wasted and spent propping up businesses of friends. Which probably won't be in the overall interest of the economy. Votes aren't won by letting failed businesses collapse.

I agree. When I wrote above that some countercyclical policy would be OKish I was thinking in similar lines, that moderate cycles have a positive side, a clearing/stimulating effect on an economy. Though too much of it is too disruptive, and too painful.

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.....

The whole profession needs a revolution, .....

Profession? Its junk science. Every politician twists the theoretic to get what they want. The theoretic only works if you "assume that...." All economics starts with "if we assume that...." Its all bunk.

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The problem is/was for a long time now, we've never actually had any good or boom times. Unless you believe Blair/Brown/Darling of course. Pseudo Keynesian for a Pseudo Boom!

Nonsense. that last chappy who was Pm for a while had Golden rules, with indefinite start and moveable end dates...that was Keynesian, until it wasnt. then he had abolished boom and bust,...till he hadnt.

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