With the aftermath of the financial crisis there has been little mention of the Austrian school of economics led by Frederick von Hayek. The Economist Buttonwood column last week mentioned the fact that when you actually look at the Austrian theory of business cycles there are a lot of similarities with that of the last couple of years. Below are the main characteristics of the Austrian beliefs followed by what happened during the financial crisis:
1. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. The Fed and ECB definitely kept rates at levels that encouraged borrowing.
2. Capital is misallocated into wasteful areas. Too many houses, apartments were built in Spain and Ireland as well as in the US. The vast majority are lying empty or still unfinished which keeps downward pressure on house prices
Maybe this lack of exposure for the Austrian school in media circles is because their panacea for the crisis is to do nothing and let the market run its course. This is in contrast to the monetarists who propose tax cuts and lower interest rates and the Keynesians who would support deficit spending. As a politician you can’t be seen to do nothing especially leading up to an election. Remember US President Jimmy Carter during the 1970’s, when the best thing was to let the economy run its course through the cycle instead he increased government spending and inflation hit 14% and interest rates 21.5%. Ronald Reagan won the election (as did Margaret Thatcher in the UK) and economic policy changed drastically.