The Problem is Structural…

Martin Wolf, a British journalist, recently commented on the Austrian Business Cycle Theory (ABCT) at his Financial Times blog entitled the Martin Wolf Exchange. While he acknowledges that much of what the Austrians say could very well be correct, he disagrees with their view that markets should be allowed to liquidate without government intervention.

But Austrians also say – as their predecessors said in the 1930s – that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing.

The problem here is that while he may agree with Austrians that fractional-reserve banking could be inherently unstable, he misses the real heart of the theory: malinvestments within the capital structure. During the boom stage of the business cycle capital is misallocated into sectors of the economy it otherwise would not have been were it not for the artificially low interest rates that misled entrepreneurs. Roger Garrison, in his book Time and Money, says

…credit expansion sets into motion a process of capital restructuring that is at odds with the unchanged preferences [of consumers] and is ultimately ill-fated.

The problem, then, is structural. It is a structural problem within the production process that ultimately leads to the bust. Now, I realize most mainstream economic theories typically think of capital as a homogeneous “k” where a “structure of production” is ultimately meaningless. But just for a moment take the ABCT on its own terms. If the problem is ultimately structural and not simply a lack of effective aggregate demand than it becomes immediately apparent why government attempts to boost aggregate demand will end in failure. Increasing aggregate demand is not going to help the production process straighten out its  structural problems. In fact, it will probably exasperate it.

I should point out that if Wolf’s concern is for the general population most effected during the “liquidation period” than I can see no serious objection within Austrian economics to providing some sort of short-term safety net. Of course many Austrian economists would object to a government safety net out of hand, but that would be more as “libertarians” than “Austrian economists”. While there are good economic reasons for being wary of the long-term effects of unemployment insurance and other safety nets, used sparingly I can’t see this as halting, in any meaningful sense, the capital restructuring necessary for the economy to get back on its feet.

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