I am puzzled by the resurgence of Austrian Business Cycle theory among Sachs, Krugman, Baker and many others who you would not ordinarily associate with the theory. Sachs, for example, writes:
…the US crisis was actually made by the Fed… the Fed turned on the monetary spigots to try to combat an economic
slowdown. The Fed pumped money into the US economy and slashed its main
interest rate…the Fed held this rate too low for too long.
Monetary expansion generally makes it easier to borrow, and lowers
the costs of doing so, throughout the economy. It also tends to weaken
the currency and increase inflation. All of this began to happen in the
What was distinctive this time was that the new borrowing was concentrated in housing….the Fed, under Greenspan’s leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash.
What is puzzling about this is two-fold. First, there is no standard model that I know of (say of the kind normally taught in graduate school) with these kinds of results. Second and even more puzzling is that the foul-weather Austrians don’t seem to draw the natural conclusion from their own analysis.
If the Federal Reserve is responsible for what may be a trillion dollar crash surely we should think about getting rid of the Fed? (n.b. I do not take this position.) The true Austrians, like my colleague Alvaro Vargas Llosa, have long taken exactly this position. So why aren’t Sachs, Krugman et al. calling for the gold standard, a strict monetary rule, 100% reserve banking, free banking or some other monetary arrangement? Each of these institutions, of course, has its problems but surely after a trillion dollar loss they are worthy of serious consideration.
Nevertheless, I haven’t heard any ideas, from those blaming the crash on the Fed and Alan Greenspan, about fundamental monetary reform. (Can Sachs, Krugman et al. really believe that it was Greenspan the man and not the institution that is to blame? That seems naive.)
Instead, the foul weather Austrians seem at most to call for regulatory reform. But that too is peculiar. Put aside the fact that banking is already heavily regulated, have these economists not absorbed the Lucas critique? In short, suppose that whatever regulation these economist want had been put in place in earlier years. Would the crash have been avoided or would the Fed have simply pushed harder to lower interest rates? After all, the Fed lowered rates for a reason and if the regulation reduced the effectiveness of monetary policy in creating a boom well then that just calls for more money.