I noticed there was some confusion about the cause of business cycles before the Federal Reserve in another thread, so I decided to post my response here, in a separate thread, to explain the Austrian school POV:
Originally Posted by
travisAlbert
Throughout the late nineteenth century, there were several recessions, depressions, and market crashes. Many non-Austrian economists are critical of Austrian economists because their theory of the business cycle fails to explain the "business cycles" prior to the creation of the federal reserve.
Austrians have explained pre-Fed business cycles, especially in America. Jesus Huerta de Soto did so in his
Money, Bank Credit, and Economic Cycles as did Murray Rothbard in his
History of Money and Banking: The Colonial Era to WWII.
The gist is this: there were two central banks, the First Bank of the United States and the Second Bank of the United States which acted in coordination with the Treasury Department during the end of the end of the 18th century and about 40 years into the 19th century to expand the supply of credit. Afterwards, the federal government along with state governments took various actions to promote credit expansion. For example, they effectively bailed banks out by allowing them to suspend specie payments without declaring bankruptcy, as would be required under common law and in free markets, allowing banks to practice fractional reserve banking and therefore expand credit, creating bubbles.
An alternative viewpoint would be that of Schumpeter (somewhat of a renegade Austrian), who believed that fractional reserve banking was natural to the free economy and that its creation of bubbles and busts were helpful in the establishing needed technological infrastructure for sustainable economic growth. Schumpeter also believed that monopolies could be good since they encouraged technological innovation and had several other good qualities (e.g. they solved certain coordination problems and their profits fueled greater saving and investment).
This isn't the view of the majority of Austrians, who use theory to predict that fractional reserve banking, and therefore credit expansion, cannot exist in a free market. History seems to back this up, since fractional reserve banking first came into wide existence when banks with fractional reserves became backed by government. Today's Austrians also disagree with Schumpeter about most forms of monopoly, pointing out that monopolies cannot form in a true free market, except in the case of the "first mover" who cannot keep his monopoly for long.
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