Austrian economics and the Real McCoy
Conservative politicians often identify themselves with something that they call “Austrian economics.” This, in their mouths, boils down to the proposition that inflating the money supply will inflate prices. (One exception is the U.S. presidential candidate Ron Paul, a disciple of Ludwig von Mises; Paul has advocated competition among currencies in order to improve them.)
The link of money supply to inflation is not uniquely Austrian. Most economists accept that when the economy produces at full capacity, attempts to spend additional money will raise only prices since long-run output cannot be increased. They also accept that when the economy is below capacity, a boost in spending may induce producers to hire more workers and reopen factories, increasing output. Competition among these firms will hold down prices. In today’s anemic economies, an increase in the money supply may not hitch up prices right away – but just you wait.
What is Austrian macroeconomics? What does it mean for central Asia?
Austrians -- particularly the late Nobel laureate Friedrich Hayek -- focus on how money affects the structure of the national economy. In principle, any industry should expand to the point that a little more expansion will earn the same rate of return as it would in any other industry. An industry that earns a lower rate of return than others has over-expanded. It should release some men and machines to industries where they would be more valuable.
This process is painful for the bloated industry – and for industries that depend on it. When the faulty industry happens to be finance, its sudden curtailment will slow down the economy in general, since any firm must rely on finance to pay for expansion. (In the United States, firms often pay out of their own pockets – i.e., out of retained earnings – rather than borrow from banks or sell shares of stock. But finance still determines American expansion, since the firm will spend its retained earnings on its own project rather than lend to someone else’s only if it anticipates a higher rate of return to the former.) Austrians want to reduce the corpulent industry as quickly as possible – even if this would trigger a national recession – since delay would distort the economy further and make the inevitable adjustment more painful. Do we want a one-year recession now or a 10-year depression later?
Increasing the money supply may obscure identity of the industries that need to slim down, because the new money does not affect all industries at the same time. The first industries to receive the money may interpret it as an increase in demand for their products – and so may expand. Later, when their input prices rise, they will discover that the supposed increase in “demand” was, in fact, an increase in money supply that will eventually raise all prices. Then they will cut back, laying off workers and padlocking factories. Inflation leads to mistakes that touch off a business cycle.
Austrian castor oil
To Austrians, the problem with printing dollars is not that it raises all prices. This would increase the household’s income by as much as it did the cost of its groceries (since the wage is also a price), so the household could buy as many goods as before. The problem is that inflation is not general in its early stages. The fact that most prices do not rise immediately after an expansion of money – which seems the case today -- is small comfort; to the contrary, it may lead to mistakes that induce recession.
For example, global oil prices rose 65% from 2009 ($60 per barrel) to early 2011 ($95), according to the United States Energy Information Administration. Does this increase merely signal the rise in demand for oil that one would expect from a recovering world economy? Or is part of it due to the early effects of a monetary expansion that occurred because national governments fought the 2008-9 crisis by printing money?
Conservative politicians are quicker to accept the Austrian mantle than its implications. It’s easy to blame central bankers for “debasing our money.” It’s not so easy to point out that the Austrian medicine – let bad firms fail – may cost millions of voters their jobs.
Nevertheless, the Austrian model may have anticipated correctly the economic twists and turns around the world for the past five years. The current eurocrisis may have arisen in large part because commercial banks lent to profligate governments that today cannot pay them back.
The Austrian model may also pertain to Central Asia in the long run. To what extent are the region’s economies inefficient because of lingering effects of Soviet policy? In Kazakhstan, has the farm sector contracted to its efficient size? To what extent are monetary policies in the region disguised attempts to prop up faltering industries like banking? The Austrians are politically correct; are they therefore wrong? – Leon Taylor, tayloralmaty@gmail.com
Good reading
F. A. Hayek. The collected works of F. A. Hayek. Volume 5: Good money. Part I: The New World. Edited by Stephen Kresge. The University of Chicago Press. 1999.
References
Paul Krugman. G.O.P. monetary madness. The New York Times. December 15, 2011.
Ron Paul. Mises and Austrian economics: A personal view. Auburn, Alabama: Ludwig von Mises Institute. 1984. Online.
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