macro: Two From Roger Garrison on The Greenspan Bust

From Roger Garrison, “Mainstream Macro in an Austrian Nutshell”:

Of all the losses suffered during the current recession, one of the most notable (and well deserved) is the loss in reputation suffered by today’s macroeconomics textbooks. J. Bradford DeLong admits as much — even of his own textbook — in a recent lecture on our current financial crisis. While the events that have unfolded over the past year have required some outside-the-box theorizing by mainstream macroeconomists, the economists of the Austrian school can offer a straightforward, fill-in-the-blank explanation by drawing on the theory first articulated by Ludwig von Mises and then developed by Friedrich A. Hayek ..

A true-to-Hayek nutshell version of the Austrian theory is not difficult to produce: The central bank is central to our understanding of the current crisis. The Federal Reserve under the leadership of Alan Greenspan kept interest rates too low during 2003 and 2004 and then ratcheted the rates steeply upward. Time-consuming investments that were initiated while cheap credit made them artificially attractive were then made prohibitively costly to carry through. Macroeconomically, that sequence translates into an Austrian style boom and bust. The background against which the story unfolded was a long running, politically motivated sequence of housing policies whose dubious goal was to increase home ownership beyond what mortgage markets themselves would allow. The actual effect of the various policies was to desensitize both lenders and borrowers to the risk of default, causing mortgage markets and hence housing markets to play leading roles in this particular boom-bust episode. The Austrian theory couldn’t be more tailor-made for understanding our current situation …

From Roger Garrison, “Interest-Rate Targeting During the Great Moderation: A Reappraisal”:

The focus on the Federal Reserve as a basis for declaring the boom unsustainable and hence the crisis inevitable is not to downplay the significance of housing related legislation in our understanding the particulars of this cyclical episode. It was the legislation that set the stage on which the dynamics of the boom and bust played themselves out. Key features of the institutional and legislative environment were the Government Sponsored Enterprises Fannie Mae and Freddie Mac (created in 1938 and 1970) and the Community Reinvestment Act of 1977 (during the Carter administration) as amended in 1995 (during the Clinton administration).  Increasingly lax policies of the Federal Housing Administration (created in 1934) figure in as well.

Many business cycle theorists and historians have noted that each cyclical episode differs from all the earlier ones while there seem to be unmistakable similarities. The perspective provided here suggests that it is the central bank that is central to our general understanding of business cycles and that the particulars of any given episode are reflections of the times. But even with changing particulars, there is a general pattern. Policy-induced booms tend to ride piggyback on whatever economic developments are underway. In the 1920s, it was innovations—the mass production of automobiles; the development of chemicals, including cosmetics; rural electrification and hence the mass marketing of home appliances and the introduction of processed foods; in the 1990s, it was the many facets of digital revolution; in this most recent episode, it was the overriding of the creditworthiness criteria for mortgage lending and the securitization of government-guaranteed mortgages. In each of the different episodes, the easy money policies of the Federal Reserve leveraged — over-leveraged — these developments, which otherwise would have been kept in bounds by market forces.

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2 Responses to macro: Two From Roger Garrison on The Greenspan Bust

  1. Roger says:

    I love Garrison’s works, but I’m curious as to why he doesn’t mention the Ricardo Effect. Hayek placed a lot of emphasis on it, especially in “Profits, Interest and Investment,” but modern Austrians, except O’Driscoll, don’t even mention it. Any idea why?

  2. yonason says:

    I don’t see where you think it was so complicated that no one could see it coming. Plenty of reasonable Conservatives saw it, and tried to fix it, even Bush and McCain. But their efforts were blocked by the very people who forced Banks into unsafe practices. It was government, not business, that caused the problem.

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