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« Ron Paul on the Crisis | Main | The Most Interesting Points Can Not Be Put In Your Footnotes! »


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Why don't economists say it?

Paul Krugman is a deeply dishonest man.

Sometimes it seems as if professions were created in order to protect the most vile members of the clan -- lawyers refusing to ever say a bad word about corrupt lawyers, doctors protecting the criminal and unethical behavior of fellow doctors, Senators never saying a bad word about their corrupt and stupid and unethical peers. It goes on and on.

And the same thing goes on among economists.

I guess you call it "professional courtesy".

Economists don't say let the market alone because they basically don't believe it.

After all, every economist knows that in principle the "real balance effect" would assure that "at some point" falling prices and wages would reach bottom, and spending would start again from a lower price level equilibrium.

But, of course, "no one" would want to put an economy through such a "deflationary" episode. So, naturally, the monetary authority has to be activist to prevent such an episode from every happening.

Every economist knows, of course, that long-run equilibrium and stability require a coordinated relative price and wage structure.

But the structure of relative prices and wages is also considered somehow independent of the general scale of prices. So we can prevent deflation (a general fall in prices) through monetary expansion, yet somehow not influence the relative price and wage structure in the process.

The purpose of Fed activism is to prevent prices in general from falling while at the same time not preventing the market from sorting out the bad loans and investments from the good ones.

Setting aside any ideological and special interest rationales that might result in advocating such activist policy, the fact is the profession as a whole does not have a theory or an understanding of the microeconomic processes that lead to macroeconomic outcomes via the monetary system.

Another way of saying this is that the profession has never read Lecture I of Hayek's "Prices and Production" on the relationship between monetary changes and the relative price structure. And certainly not Mises's expositions on the "non-neutrality of money" in a wide variety of his writings.

So the profession does not say, "let the market alone," because they don't believe it is necessary or desirable.

Richard Ebeling

No one can doubt my credentials as a libertarian. However, I am not so confident about the correct prescription right now. I have sympathy with Tyler Cowen's posts on this one. I want to make simple points. Let us assume the fundamental cause of our present financial mess lies in a combination of excessively low interest rates for a long time, the very existence of the Fannie-Freddie pseudo guarantees, the very unAustrian financial models that confused risk with radical uncertainty (see my Time and Ignorance, for example),and other government-induced problems. Where are we then? Hayek understood that a "secondary deflation" is possible after the initial contraction. What is the character of this? Is it possible that uncertainties may be so large that individual market participants cumulatively overract? I do not know. But I am not closing my mind to the possibility. Obviously the future needs to be restructured in market-friendly ways. For all sorts of "public choice" reasons it probably will not be. But how much worse the future would be if in identifying the correct underlying cause of our problems we do not see that the second-best solution now is some kind of intervention of the kind we are getting. I am just urging my fellow Austrians not to keep repeating the fundamentals but to look at the induced secondary phenomena. If an even greater disaster strikes, the market is down the drain completely.

"Don't let the best be the enemy of the good" is a reasonable sentiment, but it does not apply in this instance I would argue. Because the "good" is not feasible due to both public choice and more traditional Austrian concerns with calculation/knowledge. So instead we have the "worst" substituting for the "best".

The role of the economists in this discussions should be informed by W. H. Hutt's "politically impossible?" We cannot intellectually afford the compromise situation.

I must say that I have not been persuaded by Tyler on this issue --- this freaks me out a bit because I consider Tyler one of the smartest people I have ever met, but I have been unpersuaded by his arguments about "market failure in the housing bubble" and the dampening of "moral hazard" with nationalization at the start of this fiasco and his more recent discussions of the plans of government to solve the financial crisis.

I am a less subtle thinker than Tyler so perhaps I am missing something, but when I read the stuff that supposedly our best economic minds are saying I am often left thinking --- boy that is really BAD economics, and a really naive understanding of politics. I long for the arguments of a Milton Friedman on long and variable lags, and of Gordon Tullock on the role of vested interests. Hell, Murray Rothbard would be fantastic to read now on how the government has destroyed our monetary system.

It is not just an ideological issue, but an economic science issue I would argue. The teachings of economics and political economy tell us something, and it is not that the government should assume ownership and control over the financial sector of an economy.

Even in the midst of a secondary phenomena, government does best when limited to questions of the framework of rules (if even that) and NEVER should become an active player in the economic game. Nothing in the alternative plans being offered is limited to the framework, but instead we are asking the government to be an owner, an actor, and a referee.


If I may add something to Peter's comments in relation to Mario's post.

I think we need to keep out heads. I recall that Wilhelm Ropke -- who was one of the intellectual "fathers" of the idea of a "secondary depression" that could get out of hand and would serve no "corrective" purpose -- made a point of emphasizing in the introducuton to his 1936 book, Crises and Cycles," that it is easy at moments of great instability to fear the end of civilization or the capitalist system.

But it is necessary to put such moments in historical perspective. And this makes us realize that crises have occurred before, sometimes severe, but it often does not mean that a "turning point" in history has been reached. That it is the "end" of the free society as we have known it.

Such very fears, Ropke was suggesting, can make us do or support rash things that may in fact end up bringing about the very institutional changes we most seriously desire to avoid.

Given that there is no shortage of those on the "left" and the "right" who are happily or reluctantly supporting a huge government intervention into the financial and related markets, it seems to me that Peter's point about W. H. Hutt's argument in "Politically Impossible?" should be our guide.

Our task to to tell the truth as we as "value-free" economists see it. That is, markets work; intervention and monetary manipulation has gotten us into this mess; and this is how and why allowing markets to "do their job" even in difficult times would bring the system back into balance.

And why the most recent interventionist proposals would only run the risk of introducing more difficulties, distortions, and imbalances for the following reasons, "x", "y", and "z".

I recall that Alfred Marshall once pointed out that any economist whose ideas and comments helps to sell newspapers (i.e., supports popular fallacies and delusions) should seriously rethink his ideas on the matter at hand.

Richard Ebeling


Of course the proposals are lousy. But the problem is that framework-institutional reforms are long-run solutions. The issue is whether some drastic action must be taken now to avoid a very deep recession that would be excessive by the standard of the initial distortions. And if you worry about the reactions of our screwed up political system just wait for what will happen then! Look, I am in the bad intellectual situation of urging more discussion and fewer definite conclusions among Austrians on the secondary phenomena. I do not *know* if the secondary situation is as bad as "they" say. If it is, we (the world) are very bad off on the liberty front no matter what. I just want to minimize the harm.


I share Pete's unconvinced sentiment about Tyler's posts. Similar to his calls for moderate intervention concerning other potentially pervasive disasters (global warming, asteroids destroying earth) the argument falls out from the acceptance of the assumption. If we believe that there is a possibility of a total disaster than even a small chance may warrant some form of response, assuming also low costs of intervention.

But I think there has to be some sort of understanding and insight about the nature and scope of such a disaster. How big is big? Maybe I'm just dense but these mortgage and insurance companies going under does not translate into disaster in my mind.

I admit I'm no specialist in these areas but what I understand is that the process would go something like this. The mortgage contracts would be bought out by other firms. Those new firms would likely foreclose on unprofitable mortgages. So there would be some form of shift from larger to smaller housing more strongly felt amongst lower income brackets.

After an initial shift to smaller houses, markets would likely be static - few sales and purchases. Housing prices would fall. Don't get me wrong this sounds unpleasant for a whole host of people (not me I don't own a house but envision buying in the next ten years, it would be great for me).

But how does a housing market problem translate into pervasive economic disaster? The average person on the street doesn't understand the financial crises or the fallacies being promoted about it, precisely because they are relatively unaffected. Gas is expensive, the value of the dollar has gone down (over the past several years), and stocks are falling up and down. But with regard to real goods and services there's no shortages or extreme price spikes.

Am I missing something what's the mechanism that links these particular bailouts with avoiding particular consequences throughout the market (and what are those consequences)?

On the flip side one could argue against Tyler's assumptions that the intervention has low costs. How low is low? Do we know what to do or have the incentives to do just that? Are there unintended and unknowable consequences? It seems obvious that our perceptions of such costs are biased downward.


Yes. I will remain calm. I am completely in favor of pointing out what is wrong with the Paulson (and Dodd) proposals. In particular, I think there should be clear sunset provisions. The question, however, is are they the best policies *given* the present situation? I am not looking forward to living through another "Roosevelt Administration." Where Pete may be right is that this is just the beginning -- perhaps (should I say?) the camel's nose entering the tent.


I see no reason why people would move into smaller houses on net. The housing stock has been built. The over expansion is a sunk cost. The market wouldn't knock down the new houses and force people to move back into the older smaller ones. What would happen in the housing market without intervention is just a reshuffling of who owns which part of the stock. People who can't afford inflated prices that they bought at will have to sell for a loss. People who didn't buy before will buy now at lower prices. Building of new houses will slow dramatically because of lower prices and inventory (which it already has) so it will slow the upward trend of a net improvement of the housing stock but I see no reason it would result in any decrease in the housing stock from existing levels.



Agreed, these are the ins and outs of this particular market that I don't regularly think through and am glad others do. Your description though slightly different from mine, is similar to mine in so far as it doesn't involve the full scale catastrophe hypothesized by Tyler and others. Have I followed you right?

Is it worthwhile to just make the point that the so called disaster is not that disastrous after all? Do the housing market adjustments screw up the rest of the economy?

In my head I've been trying to think of who the like minded thinkers and writers are on these topics that we should be turning to. I suppose the cycle theorists would be on that list: Garrison. And also the real estate guys: Stringham and Powell. Who am I missing, and what are they saying?

The housing market has not for various reasons reached its bottom. Therefore, the mortgage-backed securities, which are bundles of mortgages or derivatives thereof, are of radically uncertain value. (The latter is the proximate and the former a more remote cause of the financial crisis.) To have a clear idea of what these securities are worth, there must be equilibration in the housing market and greater transparency in the securities market. Both will take time. In the meanwhile, we have the here and now.

Pete is being consistent with his earlier criticisms of Lachmann (Boettke and Sullivan chapter in Koppl and Mongiovi 1998). He says Lachmann, the radical subjectivist, caved in when he called for a period of activism back in 1935. Lachmann, Pete said "forgot his own analysis," and called for "constructivist" programs to help ease out of the depression; Lachmann "failed to consistently take his own subjectivist lessons to heart. If the world is truly kaleidic...." (pp. 178-79). Pete cites O'Driscoll and Rizzo to fortify his argument.

I replied in print somewhere (at least I think it was in print, I can't remember where) that in the depth of the collapse, etc., Lachmann didn't "forget" his own analysis but adopted a "pragmatic" stance for the short run.

This is what Mario is now calling for. At the very least, Mario is quite consistent with Lachmann even on this issue!

Just remembered -- I replied in a review I wrote up of the Koppl and Mongiovi compilation. I don't remember where my review was published.

Reading the above posts, I'm once again reaffirmed why the free market approach is not vaible politically in its current form. Every single post although logically and theoretically correct leaves out three things: time, numbers, and specifics.

How big will the drop be if we do nothing? How long until the market can recover. What companies can make it through the crisis? What amount of companies will default without intervention?

To just say we should use laissez-faire, is absolutley useless in a real D.C. policy debate. Unless you can answer the above questions with specific numbers, dates, and company names, your prescriptions are useless.

This is Congress not a philosophy seminar.

"How big will the drop be if we do nothing? How long until the market can recover. What companies can make it through the crisis? What amount of companies will default without intervention?"
Vedran, please answer the above questions with specific numbers, dates, and company names IF (when?) the government steps in and does everything Paulson and Bernanke want it to do. Does anybody know? Nope. Do you seriously think that even the $700 billion bailout will put an end to the current financial crisis and no more companies will go out of business? Wasn't the Bear-Stearns bailout supposed to do that already? Followed by the Fannie-Mae/Freddie-Mac takeover by the government that was also supposed to put an end to any further instability? And what happens to the federal government's ability to issue debt in the future if it adds another trillion dollars worth of debt almost overnight, after already adding potentially multiple trillions just in the last month or two? Will the Chinese and others continue to just dutifully buy up our bonds? Will the Fed have to monetize the debt to make all of this workable and what will the consequences of that new inflation be? To pretend that the way of Laissez Faire is full of uncertainty while the intervention is certain to bring stability is simply intellectually disingenuous.


You're absolutely right. You can't solve a knowledge problem like that. But that doesn't change the importance of numbers in a policy debate. Bad numbers are still better than no numbers.

Sure, their predictions will most likely be wrong....probably very wrong. But the point is that they have numbers today and we do not. Their figures will come out wrong in the future, but unfortunatley policy is being decided today.

If we can't answer how long a problem will last or how big, we don't sound relevant or that we know what we're talking about. At the very least, we need ballpark figures. We don't have any

Miss American Empire

"Hell, Murray Rothbard would be fantastic to read now on how the government has destroyed our monetary system." --Peter Boettke

If it turned out anything like America's Great Depression, it would certainly be worth the effort to both write and read. If there are any Austrians of his expository talent about these days it would make a wonderful project for them.

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