Originally Posted by
Danan
Friedman and others basically found out (by using econometrics) that recessions always follow after a contraction of the money supply. They argued that therefore, if this could be prevented, we wouldn't experience these recessions.
Austrian economists view it quite differentely and yet very similar in some sense. Most of them would actually agree that an increase in the money supply theoretically could have "prevented" the Great Depression from occurring in that time, at least in the short run. In fact, if an increase in the money supply had no positive effect on economic growth, the whole Austrian business cycle theory would be meaningless. However, the main difference is that while Friedman and other neo-classicals, Keynesians and monetarists view the whole economy as producing a single homogeneous output Y (by using homogeneous capital K and homogeneous labour L) in order to create practical mathematical models, Austrians beliefe that this simplification is hiding one of the most crucial properties of the economy, the capital structure.
They belief that while a recession is not desirable, it's the necessary correction of malinvestments, mainly caused by artificially low interest rates. Shortly after the Fed (and FDIC, etc.) was created it started to increase the money supply, causing interest rates to drop, giving more incentives to invest in long term projects like mining, housing, etc. And while this may sound like a desirable thing, it's actually bad, because in contrast to a decline in interest rates based on more savings, there was not enough purchasing power available at the time these investments turned into consumer goods, because nobody cut back on consumption at any point before. The result was a huge amount of failing businesses, causing chain reactions. So therefore, ironically I believe Austrians actually agree with Keynes, that too low aggregate demand is what we are experiencing during crises. But they argue that other schools of thought have the causation backwards. There is not enough aggregate demand to match the artificially pumped up producing of the wrong goods in the past, and the suggestion to lower interest rates, increase the money supply and/or increase public spending during crises is trying to cure the drug addict by giving him more drugs. It may delay the pain, but it will not cure the disease.
All this is mainly caused by the fact, that Y=KL hides fundamental truths about the economy. The common motto of neo-classical economists is that, "A map in a scale of 1:1 is useless." I don't disagree, but I would add that a map in the size of a thumbnail is just as useless.
The sad thing is that properties like capital structure are immensly hard to measure objectively. And even if we could, adding them into economic models seems almost impossible, because of the complexity we would arrive at.
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