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Source link: http://archive.mises.org/8719/the-sort-of-attention-austrians-dream-about/

The Sort of Attention Austrians Dream About

October 7, 2008 by

From the Financial Post:

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.

To the extent that this assessment has been made, it represents an important victory for a school of thought that has long hung on the margins of the economics discipline: the Austrian school of economics, whose most illustrious figures include the Nobel prize winning Friedrich von Hayek and Ludwig von Mises. 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.

But if, to rephrase a well-known Nixon quote, we are all Austrians now, it illogically only extends to the diagnosis of the crisis and not to the school’s market-based cure. For it is just not consistent to simultaneously assign blame to Greenspan’s easy money and then support government intervention to fix the damage, as so many of the business op-ed writers and talking heads on CNBC have.

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.

Read the whole thing

{ 5 comments }

Dennis October 7, 2008 at 10:09 am

Yes, it is wonderful that this excellent article has been published in the “Financial Post.” Hopefully, many individuals will read it and absorb the important lessons.

My only complaint is that the article does not mention the U.S. government’s considerable machinations that strongly encouraged the newly created credit to flow into very low-quality mortgages.

Stanley Pinchak October 7, 2008 at 11:47 am

Dennis,
the direction of the money is secondary. Spreading the knowledge of the ABCT is the most important feature of this article, and for that I am thankful. I think that the explanations of other articles on the bail out have gone into the various governmental interventions which led to such a huge amount of malinvestment in real estate. Adding that information to this article would have made it cumbersome and distracted from the business cycle theory and critique of governmental intervention.

Dennis October 7, 2008 at 1:25 pm

Stanley,

I fully agree that “the direction of the money is secondary” and “spreading the knowledge of the ABCT is the most important feature of this article.”

However, I would add that the curious reader would probably ask why are the problems so concentrated in the real estate and mortgage markets, especially relative to past business cycles. Briefly describing the more recent interventions of the federal government in these markets would answer that question. It would also emphasize the corrupt nature of government.

Libertas est Veritas October 7, 2008 at 3:06 pm

Great article, but one part stuck out for me:

“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.”

This gives the impression that there is such a thing as a correct rate. It should have been pointed out that a central bank can’t know what a market-based rate would be.

David Ch October 8, 2008 at 4:03 am

Great article, but one part stuck out for me:
Libertas wrote:
“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.”

This gives the impression that there is such a thing as a correct rate. It should have been pointed out that a central bank can’t know what a market-based rate would be.

Response: Yes you are right nobody can know what the ‘correct’ rate would be. But you dont need to know what that rate would be. It is enough to observe that the Central bank discount or window rate, whether Fed or elsewhere in the world, will always be BELOW what the ( unknown level of) ‘true’ market rate would settle at.

If the fed rate was indeed higher than the market rate, no bank would use the window and the rate as a policy instrument becomes irrelevant – why pay the Fed more when you you can get it on the ‘open’ market? the Fed has to make it cheap if their policy intervention is to have any influence on the ‘market’ rate, and it can only ever do it by influencing it DOWNWARDS from ( whichever ) level it ‘should’ settle at in a completley free context.

Hope that makes sense

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