Monday, November 22, 2010

Were Hayek and Von Mises right?

The Economist seems to think so:
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.

  • 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,
  • 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.


  1. I wonder if you could directly derive it from combing permanent income hypothesis with either hyperbolic time preferences or with some lack of future foreknowledge.

  2. I disagree with the assertion that recoveries are sluggish after recessions. For example, in 1988, unemployment dropped by 3% over a one year period (WSJ 12/3/10) which implies a rapid expansion after a recession. Of course, GDP might not be rising at a similar pace, but can't we glean GDP growth based on unemployment figures? I don't think the last point on this posting holds water.