'..Austrian business cycle theory explains the Great Depression by the extraordinary credit expansion of the 1920s. Reinflating the money supply, in the Austrian view, disturbs the necessary readjustment as it stabilizes artificially old malinvestments and stimulates additional ones..'<blockquote>'
Explaining Booms and BustsConsequently, the interpretations of the Great Depression (and the Great Recession) by Austrians and Chicagoites differ widely. The Chicago school, following Milton Friedman and Ana J. Schwartz, maintains that the severity of the Great Depression was due to errors committed by the Federal Reserve. More precisely, the Federal Reserve according to Friedman and Schwartz did not expand the monetary base fast enough during the early 1930s. Following the Chicago interpretation, Ben Bernanke (2002) promised Milton Friedman not to commit the same mistake again, which explains the Federal Reserve’s reaction to the Great Recession in the form of Quantitative Easing.
In contrast, Austrian business cycle theory explains the Great Depression by the extraordinary credit expansion of the 1920s. Reinflating the money supply, in the Austrian view, disturbs the necessary readjustment as it stabilizes artificially old malinvestments and stimulates additional ones. Austrians explain the severity of the Great Depression by the size of the credit expansion in the 1920s and the concomitant malinvestments as well as the government interventions introduced in the 1930s such as the Smoot-Hawley Tariff Act or the New Deal in general.
Austrian economists were not blinded by the apparent price stability in the early 2000s. In fact, Mises and Hayek warned against policies of general price level stabilization hailed by Fisher and other monetarists. In times of economic growth such policies require the continuous injection of new money which is the source of intertemporal distortions. Due to their business cycle theory, Austrians were not taken by surprise by the financial crisis in contrast to Chicago economists. The same is true for the years leading to the Great Recession. Thus, Mirowski is just plain wrong with his sweeping statement that the (whole) economics profession did not foresee the financial crisis. It is true that neoclassical economists due to their methodological approach could not develop the theoretical tools necessary to understand the problems of the ongoing credit expansion of the early 2000s. In contrast, Austrian economists had those tools.'
- Philipp Bagus,
Why Austrians Are Not Neoliberals, January 4, 2016</blockquote>
'..First, credit booms tend to undermine productivity growth as they occur, largely through labour reallocations towards lower productivity growth sectors. Second, labour reallocations that occur during a boom, and during economic expansions more generally, have a much larger effect on subsequent productivity if a crisis follows..'<blockquote>'In this paper we have investigated the relationship between credit booms, productivity growth, labour reallocations and financial crises. We have identified two new possible stylised facts. First, credit booms tend to undermine productivity growth as they occur, largely through labour reallocations towards lower productivity growth sectors. Second, labour reallocations that occur during a boom, and during economic expansions more generally, have a much larger effect on subsequent productivity if a crisis follows. This effect dominates that of other variables, including the non-allocational (common) component of productivity growth. In other words, this second stylised fact is consistent with the view that when economic conditions become more hostile, misallocations beget misallocations; they have a long reach. These findings, based on a large sample of over twenty advanced economies and over forty years, are robust to different definitions of credit expansion and to the inclusion of various controls.
These findings have broader implications for the current policy debate and for macroeconomics more generally. First, they shed new light on the secular stagnation hypothesis (Summers (2014)), according to which the United States was facing a structural deficiency of aggregate demand even before the crisis. Our findings suggest a different mechanism, in which the slow recovery after the Great Financial Crisis is the result of a major financial boom and bust, which has left long-lasting scars on the economic tissue (eg BIS (2014), Rogoff (2015)). More specifically, they suggest that what some see as a comparatively disappointing US growth performance in the pre-crisis years,
despite a strong financial boom, was actually disappointing, in part, precisely
because of the boom. And so has been the post-crisis weak productivity growth.
Second, the findings suggest that when considering the macroeconomic implications of financial booms and busts it is important to go beyond the current focus on aggregate demand effects. True, credit growth during a boom boosts aggregate demand and output. And deleveraging, balance sheet repair and tighter credit constraints depress spending during a financial bust. But supply-side effects during the boom and the bust, operating in particular through resource misallocations, are also important. Thus, our findings help explain the usefulness of financial cycle proxies, notably credit and property prices, in the measurement of potential output in real time during the boom-proxies that, in contrast to traditional methods sometimes based on inflation, could indeed identify that output was running ahead of potential in the pre-crisis years (Borio et al (2013)). And they also provide a complementary explanation for hysteresis effects – one linked to the allocation of credit and real resources rather than simply to protracted aggregate demand weakness, although the two may of course interact. All this highlights the importance of supply-side policies.
Third, the findings enrich our understanding of the medium- to long-run effects of monetary policy and of its effectiveness in addressing financial busts (Borio (2015)). If loose monetary policy contributes to credit booms and these booms have long-lasting, if not permanent, effects on output and productivity, including through factor reallocations, once the bust occurs, then it is not reasonable to think of money as neutral over long-term policy horizons. This is at least the case if a financial crisis erupts. After all, financial booms and busts linked to crises have had a length of between 16 and 20 years (eg Drehmann et al (2011)), and our results confirm that misallocations take time to develop and have very long-lasting effects. Nor is it surprising if monetary policy may not be particularly effective in addressing financial busts. This is not just because its force is dampened by debt overhangs and a broken banking system – the usual “pushing-on-a-string” argument. It may also be because loose monetary policy is a blunt tool to correct the resource misallocations that developed during the previous expansion, as it was a factor contributing to them in the first place.'
- BIS,
Labour reallocation and productivity dynamics: financial causes, real consequences, December 2015</blockquote>
'It has implicity indicted the US Federal Reserve and fellow central banks for perverting the machinery of interest policy to conjure demand that may not, in fact, be needed, and ensnaring us in a self-perpetuating "debt-trap" with a diet of ever looser money.'<blockquote> The world's monetary watchdog has thrown down the gauntlet. It has challenged the twin assumptions of secular stagnation and the global savings glut that have possessed - some would say corrupted - the Western economic elites.
It has implicity indicted the US Federal Reserve and fellow central banks for perverting the machinery of interest policy to conjure demand that may not, in fact, be needed, and ensnaring us in a self-perpetuating "debt-trap" with a diet of ever looser money.
The Bank for International Settlements (BIS) - the temple of monetary orthodoxy in Switzerland - has been waiting for this moment, combing through the archives of economic history to mount an unanswerable assault.
The BIS believes it has found
the smoking gun in a study of recessions in 22 rich countries dating back to the late 1960s. The evidence suggests that the long malaise of the post-Lehman era - and the strange episode that preceded it - can be explained almost entirely by the destructive effects of boom and bust on productivity growth.
Credit bubbles are corrosive. They gobble up resources on the upswing, diverting workers into low-productivity sectors and building booms. In Spain the construction share of GDP reached 16pc at the height of the "burbuja" in 2007, when teenagers abandoned school en masse to earn instant money erecting ghost towns.
Parasitical wastage creeps in. "Financial institutions' high demand for skilled labour may crowd out more productive sectors," said the paper, acidly.'
- Ambrose Evans-Pritchard,
Is the whole theory of secular stagnation a hoax? January 6, 2016</blockquote>
<blockquote>“An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: The Santa Claus principle liquidates itself.”
“Contrary to a popular fallacy there is no middle way, no third system possible as a pattern of a permanent social order. The citizens must choose between capitalism and socialism.”
- Mises (
The EU Bail-In Directive: Dark Clouds are Gathering, January 9, 2016)
Claudio Grass: The Swiss Vote on Fractional Reserve Banking, January 8, 2016</blockquote>
Context<blockquote>
Banking Reform'..subjective knowledge treats knowledge as being tacit, private, subjective, and decentralized..''..Credit, inflationism and resulting central bank-induced monetary disorder.'</blockquote>