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Origins of Financial Crises
The Critics
Mainstream economists tend to ignore the concerns of the Austrian School. The most common criticism of the School is that it lacks scientific rigour. According to D. Walker, its theories are not developed in formal mathematics, but by using mainly verbal logic and what proponents claim are self-evident axioms.
In fact, as M. Thomas notes in his critique of Boettke’s critique of mainstream economics, the Austrian School advocates a rejection of methods that involve the direct use of empirical data in the development of theories. A final criticism is that, while the School claims to highlight shortcomings of mainstream methodology, it does not offer a viable alternative.
The Austrian School, however, offers up a response to these criticisms.
According to Hayek, the lack of mathematic and econometric justification is a necessity. He believed that economic theories cannot be proven or disproven through the same methods of empirical observation that are commonly applied to the study of natural science.
Ludwig von Mises, another early Austrian economist, explains that we cannot build a theory to predict how humans will act in a “complex” situation from how they will act in “simple” situations. Furthermore, there may be limits to how much we can learn from observing even a “simple situation.”
Only the human actor knows to what ends he acts. Observers may try to understand why an actor behaved in a particular way but this reason must be inferred from a complex set of data, which can only be gathered once. Reproducible experiments are not possible because both the actor and the observer have been altered by the experiment.
Although the Austrian School does not offer a completely viable alternative, it does advocate a laissez-faire approach to the economy.
This conclusion follows from a key tenet of the Austrian School: that the free market price mechanism (i.e. the natural interaction of supply and demand) is the most efficient and effective way of organizing and allocating the economy’s resources. Despite the criticism, there must be something to it if Greenspan himself would say that “the Austrian School have reached far into the future from when most of them practiced and have had a profound and, in my judgment, probably an irreversible effect on how most mainstream economists think in this country.”
What can be done?
Many Austrian School economists support the abolition of the central banks and the fractional-reserve banking system. They would advocate a return to the use of Free Banking, a monetary arrangement in which banks are subject to no regulations beyond those applicable to most other corporations (see the next issue of Arbitrage for my article on Free banking).
Food for thought:
Why do we need inflation?
Do we need inflation or do we need to be protected from it?
What would happen if the money supply were fixed?
Is the free market mechanism the most effective way to control interest rates?
Have central banks become much too involved in trying to manage a process that they don’t really understand?
What would be the government’s response if the economy were to make a move toward the free market control of the business cycle? Would it resist the removal of its power to finance its activities through inflation? Would important government programs suffer because they may not have access to consistent funding?
Arbitrage Magazine
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