Roger Garrison's account of his important lecture series at the London School of Economics can be found in HTML format at Garrison's Auburn web site. Here is a cut from the article:
On the day after the Hayek Memorial Lecture, I received a number of e-mails, some with questions about Hayek's macroeconomics and some just expressing appreciation. Most surprising and gratifying, however, was a message from Derek Scott, who had listened to the lecture from the balcony. Mr. Scott is an LSE alum and now economic advisor to Tony Blair. I was unaware that he was in the audience. He was clearly taken by the Hayekian ideas, describing the lecture as "a breath of fresh air." "I only wish that more people looked at the world through similar eyes," he wrote. The Prime Minister's advisor inquired about further lectures in the same vein and about the possibility of meeting with me at LSE. As an alternative, he invited me to pay a visit to No. 10 Downing. I phoned him immediately and arranged for a meeting on the following Thursday morning. As plans developed, Toby Baxendale was included in the visit.
Toby and I arrived at the Whitehall gate to Downing Street just before 10 o'clock on the morning of June 12. We were admitted through the gate and then passed through a security checkpoint. Walking from security towards No. 10, we noticed a rather large gathering of photographers postioned just opposite the Prime Minister's front door. The presence of the media reminded Toby that June 12 was the day of Blair's cabinet "reshuffle"�which added a little excitement to our visit and, as things turned out, marked a significant change in the organization of the British government (SEE INSERT). Just inside the shiny black door, we waited for our host to come and collect us. He appeared shortly and led us to a spacious room on the second floor. There Mr. Scott served coffee and the three of us talked for the better part of an hour. The primary focus was on current economic conditions in the US and the aggressiveness of the Federal Reserve. The artificial quality of the Fed-led boom that characterized the late 1990s had been made clear in my lecture at LSE. But what was the Federal Reserve doing now? And what would be the likely consequences?
I had hinted in my lecture that trying to re-ignite an artificial boom is not a winning strategy. The US economy is still trying to recover from the excesses of the previous expansion. Some needed liquidation has taken place; more liquidation is undoubtedly in order. But the Federal Reserve's interest-rate aggressiveness retards the liquidation process: If a business firm has expanded his operation or otherwise committed capital to a venture that in retrospect seems marginal or even sub-marginal, why should it actually liquidate the investment if it has the option of carrying it forward at exceedingly low interest rates? The small interest costs may be more than offset by hopes�even by slim hopes�for improved market conditions. Toby could easily supply a reinforcing perspective from the business world: "Many businesses are overextended and just trying to hold on."
Given the uncertainty about future market conditions and the compounding uncertainty about Federal Reserve policy, business firms are unlikely to commit themselves to still more investment projects. Keynes's idea that businessmen don't respond to a reduction in the interest rate, though not a general truth, is actually true during a period of liquidation. Hangovers are not cured by the imbibing of more spirits. Hence, it does no good to provide more spirits at bargain-basement prices. The injections of credit by the Federal Reserve, not surprisingly, are stimulating consumption spending instead of investment spending. Cheap credit in the current circumstances also bolsters the demand for housing, creating a bubble in real estate. Homeowners refinance their mortgages and spend the windfall largely on consumption goods. (Ironically, some critics of the Mises-Hayek theory have seen this development as evidence against the Austrian view�since it seems to be consumption and not long-term investment that's getting a boost from low interest rates. Of course, the consumption binge, induced by the Federal Reserve in vain hopes of re-igniting the boom, is neither a refutation of Hayek nor a symptom of genuine recovery.)
What struck me during the visit at No. 10�and I hope it struck Mr. Scott, too�is that the story as told by an academic economist and as told by a real live entrepreneur/businessman were in perfect harmony. I've become aware over the years that this is a characteristic of Austrian economics that cannot be matched by other schools of macroeconomic thought. Hayek's ideas ring true in the financial and business community in ways that the "rational expectations" of new classicism or the "menu costs" of new Keynesianism do not. Credit expansion gives us an artificial boom. Rock-bottom interest rates after the bust forestalls a genuine recovery. The Federal Reserve's near-phobic resistance to any price or wage decreases reflect its resolve not to repeat the blunders of the 1930s. But avoiding a deep depression has gotten translated into precluding a timely correction. The Fed, in effect, is trading depth for duration. The shallow recession drags on.
We made it clear that in the final analysis the Austrian theory suggests banking reform and not just some alternative policy prescription for adjusting interest rates. The reform measure currently on the table in Britain would be a dramatic one. Britain could join the Eurosystem, the Bank of England relinquishing key powers to the European Central Bank. Mr. Scott put into perspective for us the recent choice by Tony Blair to postpone for now making any decision to abandon the pound for the euro. The implications of Austrian theory about the advisability of Britain's adopting the euro are mixed. Generally, Austrian economists favor reform in the direction of decentralization. Clearly, expanding the Eurosystem to include Britain would be a move in the opposite direction.
But, Austrian economists also favor putting monetary decisions in the hands of those least likely to use it for narrow political purposes. In recent years, the Bank of England has constrained itself to rule-following behavior�certainly more so than has the Federal Reserve. But in the past it has not been above using its discretionary powers to serve the interests of an incumbent administration. Nor is there any firm institutional check against such politicisation in the future. It is worth pointing out that relinquishing control of monetary matters to the European Central Bank would effectively eliminate political business cycles�or, at least, ones with British origins. And without an accommodating central bank, the British treasury, like the treasuries of the other euro-using countries, would be put on a shorter leash. The down side of Britain adopting the euro is the inherent problems of centralization. As is well known by seasoned Fed watchers, blunders committed by a central bank can have dramatic and far-reaching consequences. So, while the European Central bank is relatively well insulated from the narrow political interests of its euro-using members, those member nations are continuously exposed to the potential ineptness or miscalculation that tends to characterize any organization not subject to the discipline of the marketplace. In the end, this consideration, an implication of socialist-calculation debate, may be an overriding one.
A breakfast meeting between Toby Baxendale and Derek Scott subsequent to our June 12 meeting at No. 10 and after I had departed for the United States evidenced a continuing interest in Hayekian ideas and their implications for policy prescription and institutional reform.
Posted by Greg Ransom
