Thursday, May 7, 2009

Austrians and Economics

Markets good, government bad. Markets never fail. When they fail, it is always the fault of government. Austrians suffer from an extreme anti-government bias that taints all their reasoning. Since government always exists and is always to blame, it is impossible for markets not to fail. Austrians should give up before they start since they can’t use history to establish anything. All we have is assertions that something else will be better, even though that something suspiciously resembles what we had in the past and were not happy with. At best it is assertions and wishful thinking. Wishful daydreams of ancient golden age market utopias. A kingdom for ‘the right monetary policy’. Austrians offer little in the way of explaining, preventing, or responding to business cycles than interest rates and ideology. That summarizes Austrian economics in all its tediousness and answers any question that arises.

There is some truth in credit induced booms and busts. Austrians explain a business cycle, but not the business cycle. There are more reasons than low interest rates for booms and more causes than high ones for busts. In this one it was far more relaxed lending standards than low interest rates. While lower interest rates can, although not necessarily do, relax lending standards, that is not the only way. Higher monetary velocity can as well and the central bank has even less control over that than interest rates or money. It seems evident from experimental work that bubbles are inherent to market processes.

Central banks make mistakes. So do markets, and no, they are not all due to government however fervently Austrians want to believe. The ability to make mistakes also implies the ability to correct them. We live in a more complex world than Austrians admit. While money is predominately created by the central bank, they are not alone in creating credit. While interest rates are powerful, other things such as lending standards and monetary velocity are as well. While one answer for everything may be satisfying to the zealot, it leaves a lot to be desired for the rest of us.

It is possible the central bank can’t really prevent cycles, that the most they can do is redistribute their occurrence, frequency, and magnitude, but if it is possible to make them worse it should also be possible to make them better. While accidents may happen, our actions in response need not be accidental.

Now both markets and government are subject to human foibles and both can error. Even Adam Smith thought interest rate caps prudent to prevent bad lending. Certainly the Fed should have watched the burgeoning of credit and taken steps to limit bad lending which was what made this boom unsustainable, and it should probably be doing more rather than less now to prevent further damage, but those are errors of omission rather than commission.

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