1. Austrian Business Cycle Theory and the financial
crisis
The global financial crisis is, without doubt, the most important
economic event of our time. Its depth, extent and duration have led many people
to put into question the free market and capitalism. This, of course, has
resulted in a very heated debate about its causes (and possible solutions). On
one side are those who call for more regulations, institutional improvement and
implementation of Keynesian policies and, on the other side, those who argue
that the current crisis is the fault of governments and Central Banks because
they, and not the market, created the “financial bubble” that eventually had to
burst. In the view of this group, the crisis is not sample of the failure of
neoliberal capitalism but rather of the interventionist paradigm, the
unregulated free market is still the perfect way to organize the economy and if
there are problems is not because the market doesn’t work but because the State
has not allowed it work. Among those who advocate this position are obviously
the Austrian economists. In fact, this view is at present strongly promoted by
prominent Austrians such as Ron Paul and Peter Schiff, who claims to have
predicted the crisis.
The theoretical basis of these economists to support their position is
on the Austrian Business Cycle Theory. According to this theory, originally
proposed by Ludwig von Mises and Friedrich von Hayek, crises are the result of “distorting
action” generated by the State to intervene in the market. So, as the
coordination capacity of the market is destroyed, is necessary a painful
process of “adjustment” to restore the “spontaneous order” and, consequently,
the crisis comes.
This is in a very general and abstract level. However, the most
interesting formulation of the Austrian Business Cycle Theory is about the
crises caused by “credit bubbles”. Here the “spontaneous order” is the correspondence
between actual savings and investments of private agents. In this context, the
State, through the Central Bank intervenes in the market to “stimulate” the
economy by relaxing credit conditions. To do this is applied a monetary policy
that determines a rate of interest below the “natural rate of interest”, that
is, the one that would be configured under conditions of absolute free market. In
this new “artificial economy”, consumers have access to more loans and
entrepreneurs make more investments with respect to what would occur merely on
the basis of actual savings and then the bubble begins to emerge. At some
point, as already said, this bubble has to burst and the economy will have to “adjust”
itself, and the crisis occurs. All this does not happen through the fault of
free market but rather through the fault of the State intervention.
Like most economists, Austrians developed their analysis of the
mechanism of causation of the crisis taking as main reference the U.S. economy.
Specifically, they argue that the financial crisis was caused in 2001 when,
precisely in the context of economic depression and loss of confidence after
the attack on the Twin Towers, the U.S. Federal Reserve, to “stimulate” the
economy, reduced the interest rates from 6.5% to 1.75% and then to a minimum of
1% in 2003. Also in June 2002 the U.S. government announced would guarantee to
the companies Fannie Mae and Freddie Mac to help create liquidity in a
secondary market for mortgages so that the vast majority of families can access
the “American dream” of own home. This, argue the Austrians, was what created
the credit bubble which would trigger the financial crisis in 2008.
This is the Austrian view of the crisis. The liberal Spanish economist
Jesus Huerta de Soto, the most famous representative of the Austrian School in
Spanish-speaking countries, puts it this way: “Economic depression is not a
crisis caused by the market economy. This is something we have to remove of our
mind definitively. The crisis is not a crisis of the market, it is a crisis of
state intervention, state intervention which produced the current banking
system and credit expansion, which has deceived entrepreneurs, which has
distorted the production structure (...). Therefore, in a free market economy does
not have to exist economic depressions”. (1)
The implicit assertion that “the market is always and necessarily perfect, and the State always and necessarily is at fault” is too radical and deserves to be examined. And this is the subject of this article: make a critical analysis of the Austrian Business Cycle Theory in the context of the current financial crisis.
To be continued...
References:
1) Jesús Huerta de Soto, “Una
interpretación liberal de la crisis económica”, Estudios de Economía Política, Unión Editorial Press, Madrid, 2004, p. 157.
You can contact the author of this article in: “Dante Abelardo Urbina
Padilla” (Facebook) and dante.urbina1@gmail.com
(email)
