Crazy Day

Headache, traffic, police, work, it's been one of those days that everyone loves to complain about, but no one wants to hear about. As time goes by, the probability of me actually doing linkapalooza 2 on Austrian Economics grows slimmer by the day, but I found this article in Canada's Financial Post which is a good primer on Austrian economics, and the lens through which Austrian economists view the current financial situation. Nuggets include:

While there isn’t perfect unanimity on this, it is widely acknowledged that a significant part, if not the root, of our difficulties originated with the low-interest-rate policy implemented by the Alan Greenspan-led Fed in 2001-2005. This generated a housing boom, which was further stoked by the financial engineering of Wall Street in securitizing mortgages, by obliging bond rating agencies in evaluating these securities and by portfolio managers eagerly willing to buy them, hungry for extra returns in a low interest rate environment.

For a video illustration on the above, please see:


The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.

Back to the FP article:

Austrian economists hold that downturns are the inevitable aftermath of loose monetary policy, thus opposing explanations typically heard prior to the current crisis that attributed recessions to price shocks, underconsumption or central bank tightening of monetary policy.

As the Austrian tradition points out, the dilemma with easy money is that the central bank sets rates below that which the market would naturally set. The natural rate reflects people’s willingness to trade present for future satisfactions. When the actual rate is established under this, entrepreneurs and firms are issued a false signal that people are willing to defer more consumption into the future than they really are. As a result, excess investments in capital goods industries, such as housing, are made on the expectation that these will pay off in the long-run. The boom ends when monetary conditions are tightened back to natural levels or the passage of time makes clear that the demand was never really there to sustain the investments made. At this point, a crisis takes place in which capital investments get liquidated and resources are shifted such that the economy’s productive capacity more appropriately reflects people’s time preferences.

A negative savings rate, a private debt the size of GDP, and mounting foreclosures and bankruptcies certainly were part of the wake up call that long-term consumer demand was not sustainable.

Still, the Austrians argue that the liquidation process must be allowed to proceed, since any government intervention to mitigate the necessary adjustments will end up sustaining the very pattern of production that caused the crisis in the first place. This was the error that Greenspan committed in dramatically lowering interest rates in 2001, which allowed excess investment in future goods to persist, as resources merely shifted from one capital goods industry to another, from the technology and Internet sectors to housing. No such switch is in the offing now, so any further government intervention is apt to prolong the economic slowdown.

This is the unpopular aspect of Austrian economics, especially among the government must act and government can solve everything folk, like Paul Krugman.