macro: Horwitz on How Microeconomics Explains the Current Crisis

Can microeconomics explain the current crisis?  Steven Horwitz explains how it does in an outstanding explication of microeconomic explanation and its application to our current macroeconomic problems (pdf):

The Austrian approach to macroeconomics can already be seen as being fundamentally microeconomic. What matters for growth is the degree to which microeconomic intertemporal coordination is achieved by producers using price signals, especially the interest rate, to coordinate their production plans with the preferences of consumers.  However, this coordination process can be undermined through economy-wide events that might well be called “macroeconomic.” In particular, the very universality of money that makes possible the coordination that characterizes the market process can also be the source of severe discoordination. If there is something wrong with money, the fact that it touches everything in the economy will ensure that systemic “macroeconomic” problems will result. When money is in excess or deficient supply, interest rates lose their connection to people’s underlying time preferences and individual prices become less accurate reflectors of the underlying variables of tastes, technology, and resources. Monetary disequilibria undermine the communicative functions of prices and interest rates and hamper the learning processes that comprise the market.

More:

The Austrian theory predicts that excess credit will flow to long-term production processes. In this case, that was housing, as the lower interest rates from the Fed’s expansion artificially reduce the price of housing and led to the sequence of events we have outlined. As noted in the prior section, the Austrian theory does not attempt to predict the specific path inflation will take, only that it will generally conform to the pattern whereby it ends up in long-term investments as a result of lower interest rates. That in this case it went into housing is a particular feature of this cycle that is completely consistent with the more typical features the theory identifies. Inflation by the government central bank, along with other government interventions and policies, account for both the typical and unique features of this cycle and are the direct causes of the current recession.

As I said, just outstanding.  Read the whole thing.

3 comments to macro: Horwitz on How Microeconomics Explains the Current Crisis

  • Don Lloyd

    “When money is in excess or deficient supply, interest rates lose their connection to people’s underlying time preferences and individual prices become less accurate reflectors of the underlying variables of tastes, technology, and resources.”

    Money cannot be in excess or deficient supply as any amount of money is just as good as any other – standard Austrian theory. The problems arise from the non-uniform flows of new money, benefitting some at the expense of others, debtors at the expense of creditors, etc. The only people how generally benefit from new money are those who produce it, just like counterfeiters.

    The problem with credit expansion is that virtually all the new borrowers are those who were too uncreditworthy to obtain loans when loanable funds were in more limited supply. Credit expansion means that everyone’s idiot brother-in-law gets his hare-brained scheme funded. This hurts everyone as he bids up the price of resources and then wastes them as his business collapses.

    Regards, Don

  • Sorry Don, but “any amount of money is just as good as any other” is NOT “standard Austrian theory.” Mises explicitly refers to excesses and deficiencies in the money supply as does Hayek. Both understood that not all increases in the supply of money are inflationary and problematic in the ways you are arguing.

    I know your view is the standard *Rothbardian* view among Austrians, but it is hardly “standard Austrian theory.” It’s also wrong as a matter of sound economics. I’m happy to provide chapter and verse to Mises and Hayek if you’d like.

  • Don Lloyd

    Steve,

    Thank you for the reply. I don’t think that we should have any disagreement, as all of the effects come from a CHANGE in the supply of money and credit. It doesn’t matter what the absolute supply of money is, as long as all the dynamic effects of any previous changes in the supply of money have decayed away and there is no reason to believe that future changes are affected. If you said that ALL of the possible gold had been recovered, then the absolute supply of a 100% gold standard money would have the significance that a future increase in the aupply of money would not be possible.

    Regards, Don

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