The Poverty of Modern Macroeconomic Theory and Power of Austrian Business Cycle Theory

By Reynolds, Morgan O. | The Quarterly Journal of Austrian Economics, Fall 2010 | Go to article overview

The Poverty of Modern Macroeconomic Theory and Power of Austrian Business Cycle Theory


Reynolds, Morgan O., The Quarterly Journal of Austrian Economics


"I didn't fully understand the subject... I kept failing to understand the relationship of microeconomics to macroeconomics [laughter]."

--Interview with Edmund S. Phelps (1)

"If gold rust, what then will poor iron do?"

--Geoffrey Chaucer, Canterbury Tales

INTRODUCTION

"Madness! Madness!" declares Major Clipton, the physician played by James Donal in the magnificent 1957 movie The Bridge on the River Kwai, after observing the antics of Colonel Saito (played by Sessue Hayakawa) and Colonel Nicholson (played by Alec Guinness). I muttered that same phrase repeatedly in 2008 as I watched the Chairman of the Federal Reserve Ben Bernanke and U.S. Treasury Secretary Henry Merritt (Hank) Paulson create, print, transmit and guarantee trillions in unearned digital dollars for the financial powers-that-be, the insolvent of Wall Street, on an unprecedented scale. Despite popular opinion strongly to the contrary, Washington, D.C. bailed out these "masters of the universe" at the expense of Main Street under the false-flag rubric of preventing "systemic collapse" and nipping "financial contagion" in the bud since "too big to fail" sounded less persuasive. The biggest moochers in history not only have survived on the dole but thrived, instead of being dismembered through long-tested bankruptcy procedures. To say that their balance sheets have not been cleansed of worthless "assets" is to understate the obvious. Prepare for another round of extraordinary "rescues."

It took me less than a day in the nearby University of Arkansas Little Rock library perusing prestigious American Economic Association publications to confirm the persistent, seemingly irreversible pathological condition of contemporary macroeconomics and its well-intended statist economists. While mainstream macro theorists continue their futile if "high-powered" displays in trying to diagnose the ongoing financial bust/downturn as well as other feverish boom/bust episodes, there is no valid excuse for their analytical failure. The business cycle is not that hard to figure out, certainly not at this late date, nearly a century after Ludwig von Mises's breakthrough in his Theory of Money and Credit. (2)

A good rule in controversial areas is Keep It Simple Stupid; state the important facts at the beginning:

1. There is no dispute that the business or trade cycle has gone on for several centuries in major economies of the world, characterized by the same wavelike motion despite intermittent chatter about "a new era," the "new economy," or the "Great Moderation."

2. The business cycle is universally condemned as distinctly unlovely, something to be avoided, "cured" or solved if possible, assuming side effects would not be prohibitively costly. This yearning implies "damping the cycle" to avoid large ups and downs, and therefore would eliminate the intoxication of the boom and bubble in addition to the corrective phase variously known as the crash, "bust," depression and recession.

3. The "puzzling" phenomenon of the business or trade cycle has attracted some of the ablest minds in economics, certainly since John Maynard Keynes, so there is no lack of IQ points sleuthing the problem.

4. The recent boom/bust episode is an especially clear-cut, attention-grabbing archetype of the repetitive features of the cycle. Therefore, it should have tipped off most observers about what is going on, including our mainstream macrotheorists who typically blame "exogenous shocks" for a downturn. The data should almost have led them by the hand to the origin of the business cycle (on 20th Street and Constitution Avenue, NW) but apparently not. This has been the biggest, longest boom in world history ever, globally synchronized as it were, fueled by cheap credit and artificially low interest rates run amok. It has not just been "leverage," it has been an ocean of liquidity and debt come a cropper. …

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