An Austrian Explanation of the Recession

The only economic theory which anticipated the recession is the Austrian school. While it has gotten more press recently, most people do not have an understanding of Austrian theory. Steven Horowitz has published a working paper for  the George Mason Mercatus Center which explains the current recession in Austrian terms. It is concise and easy to understand even for laymen. An excerpt:

Modern neoclassical macroeconomics has taken on the air of what John Kenneth Galbraith decades ago termed “the conventional wisdom.” In particular, since Keynes, the economics profession has taken for granted a broad vision of macroeconomics that looks for the explanations of both booms and busts in the movements of various aggregate variables. The whole sub-discipline of “macroeconomics” is premised on the belief that the standard microeconomic tools are not of much use in understanding the dynamics of growth and business cycles. Even with the rational expectations revolution purporting to set macroeconomics back on microfoundations, the language of aggregate supply and demand, over-simplified versions of the Quantity Theory of Money, and the aggregative analytics of the Keynesian cross and simple models of functional finance still fill the textbooks and inform most policy debates. As we find ourselves in a significant recession that none of these models foresaw, nor seem to be of much help in extracting ourselves, other approaches to macroeconomics have an opportunity to fill the explanatory vacuum. The Austrian school is uniquely positioned to fill that gap, as Austrians have long rejected the fundamental assumptions of modern macroeconomics and have developed an alternative approach to business cycles and economic growth that sheds a great deal of light on the current recession as well as suggesting ways to prevent future boom-bust cycles.

Austrians and Modern Macroeconomics

For Austrians, the start of economic analysis is the human actor trying to figure out what his ends are and how best to deploy his means to achieve them, but doing so in a world where his knowledge is fragmentary and often inarticulate and where the future is clouded by genuine, structural uncertainty. From the start, these preclude the use of standard neoclassical assumptions about rationality and self-interest. Austrians are not interested in describing the Horwitz – The Microeconomic Foundations of Macroeconomic Disorder 2 equilibrium outcomes of fully-informed individuals and firms maximizing their utility and profits respectively. Such pictures of the world are useful, at best, as contrasts to the ways in which real-world humans attempt to peer through the fog of uncertainty to better deploy their means for their desired ends, whether that is a single person engaging in economizing behavior or a firm searching for profits. All human action is, for the Austrians, speculative and entrepreneurial in that there is no assurance of success and genuine error and regret are possible (unlike neoclassical models where the best decision possible given the data at hand is assumed to be made).

If you are really interested in getting past the noise of the political debate and understanding the causes of the recession – and therefore the cure – read this essay in full.

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