This post has been brought forward for those people who asked me today about money, bank credit and economic cycles while I was telling for the EU and local elections.

As the Austrian Theory of the Trade Cycle gains interest for its coherent explanation of our present predicatment, it also gains opponents. Here, Robert Murphy answers Australian economist John Quiggin:

The Mises-Hayek theory of the business cycle — and of our recent housing bubble in particular — is gaining more and more adherents in the “real world.” To give anecdotal evidence: Five years ago, when I’d write a Mises Daily article, the fan mail would pour in from college students. But now, I get questions from hedge-fund managers and others working in the financial sector. Austrian economics is no longer a hobby; this is serious stuff.

I am not here to tell you the Mises-Hayek theory of the business cycle is a work of art that has no flaws. If I said that, then I would be living up to Quiggin’s caricature. What I will say is that the Austrian explanation of the boom-bust cycle makes more sense than any other explanation I’ve seen. In particular, most rival schools of thought say that the way to fix an economy plagued by overconsumption and reckless lending is to have the government borrow obscene amounts of money and to have politicians take over financial accounting. And it’s the Austrians who allegedly cling to dogma in the face of overwhelming counterevidence?

via Correcting Quiggin on Austrian Business-Cycle Theory – Robert P. Murphy – Mises Institute .

Why should we care? Because we are all in this economic mess together: understanding how we came to be here is the beginning of our route out.

See also The Importance of Capital Theory:

Once we understand how our present problems are due to a Fed-induced distortion in the capital structure, it becomes clear that the worst recommendation is for the Fed to cut interest rates and pump in ever more “liquidity.” It was artificially cheap credit that fueled the housing boom in the first place. Greenspan brought the federal funds target rate down to a ridiculous 1 percent — meaning the interest rate was actually negative, once we adjust for price inflation — and held it there for a year. He did this in order to (apparently) obviate the need for a harsh recession in the “real economy” after the dot-com crash. But in fact he sowed the seeds for our present crisis. If Bernanke continues shoveling in hundreds of billions to needy bankers, five years from now Americans (and the rest of the world) may look back fondly on the present the way the 2001 downturn now seems like a minor inconvenience.

It is worth remembering that Alan Greenspan once blamed the Great Depression on the actions of the Federal Reserve in that it pumped excess credit, “triggering a fantastic speculative boom”.

There are issues here that we should all strive to understand. That understanding is not out of reach: Rethinking economics — primer.

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