Austrian economics in the WSJ

A story about Austrian Economics showed up in the Wall Street Journal yesterday - but not in the newspaper. Fed-channeler Grep Ip wrote this in the Real Time Economics Blog:

Amid Financial Excess, a Revival of Austrian Economics

Does the U.S. risk repeating the mistakes that led to the Great Depression? The Bank for International Settlements’ annual report, released Sunday, suggests that it does, and offers a remedy steeped in the doctrine of Austrian economics.

In the 1930s adherents of the “Austrian school,” named for its Austrian-born proponents Ludwig von Mises, Joseph Schumpeter and Friedrich Hayek, argued the Great Depression represented the unavoidable remediation of misallocated credit and overinvestment in the 1920s. The Austrian school largely failed to become orthodoxy as first Keynesian demand management appeared to end the Depression and later monetarism blamed the Depression on inadequate attention to the money supply.

Austrian economics, however, has enjoyed a minor revival in the last decade, most prominently at the Basel, Switzerland-based BIS, which has few formal banking duties but is an important talking shop (it is sometimes called the “central bankers’ central bank.”) The BIS’s leading “Austrian” is a Canadian, William White, the head of the bank’s monetary and economic department and sometimes-rumored successor to retiring Bank of Canada governor David Dodge. In a 2006 paper Mr. White wrote that under Austrian theory, “credit creation need not lead to overt inflation. Rather…. the financial system … create[s] credit which encourages investments that, in the end, fail to prove profitable.” This leads to an “an eventual crisis whose magnitude would reflect the size of the real imbalances that preceded it [because] the capital goods produced in the upswing are not fungible, but they are durable. Mistakes then take a long time to work off.” He argued that in recent decades, “financial liberalisation has increased the likelihood of boom-bust cycles of the Austrian sort.”
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What does the BIS say central bankers should do? Essentially, relax their single-minded focus on price stability, and tighten monetary policy when “a number of indicators — not just asset prices but also credit growth and spending patterns — are simultaneously behaving in a manner that indicates increasing exposures.” In other words, when easy credit is fueling excesses, raise interest rates to end the party, even if inflation is quiescent.

Duh!

When they write the history books it will all seem so obvious. In the mean time, buckle-up - it's going to be a bumpy ride.

Until there is a major shift in the way that central bankers collectively think, the "ready-the-mops" strategy will be the tactic employed.

As Mr. White has acknowledged, the Fed can rightly argue its practice of leaving bubbles alone and cutting rates to mitigate their bursting appears to have worked well. The post-stock bubble rate cuts may have in turn created a housing bubble whose consequences haven’t fully played out.

At some point in time, maybe in the next decade, someone will actually think that, just maybe, financial bubbles shouldn't be allowed to form - that maybe nipping 'em in the bud would be a better approach.

Think what life would be like if, instead of the Nasdaq bubble inflating and bursting followed by a housing bubble inflating and now in the process of losing air rapidly, we would all be complaining that money has been much too tight for the last ten years and that there are so many good ideas out there for new technology that just can't get funded.

While it is true that many of us might not have inexpensive, super-fast broadband access, YouTube surely wouldn't yet exist, and Google might still be privately held, it is also likely that we'd hear much less talk about the entire global economy sitting on an abyss.

Think about it.