In the most recent issue of National Review Gary Wolfram, Professors of Economics and Public Policy at Hillsdale College wrote this in regard to Mises and Hayek’s Austrian business-cycle theory.
""This theory emphasizes the role of the interest rate in bringing together the plans of producers and consumers. The interest rate is the price of loanable funds — in effect, the price of money — and, like the price of any good or service, it gives producers information about consumers’ behavior and the actions of other producers. For example, if consumers wish to save — to put their money in banks, which lend it out — they will increase the supply of loanable funds, putting downward pressure on the interest rate. Producers can then borrow that money cheaply and invest in capital goods such as machinery, factories, and housing — which they can use to create goods for consumers to buy in the future with the money they have saved. Thus do producers and consumers arrive at the equilibrium interest rate, which matches producers’ plans to invest in capital goods with consumers’ desire to save.
Central banks, by artificially expanding the supply of loanable funds in order to generate a temporary boom, drive down the market interest rate and distort these signals. At a lower interest rate, producers are inclined to borrow money and invest it in capital goods, on the assumption that consumers are saving to purchase more goods and services in the future. In fact, consumers are not saving; they are continuing to consume goods in the present.
Those artificially low interest rates eventually must rise, usually when the government raises the interest rate to combat the inflation it created by lowering it. As a result, the cost of the labor and capital needed to produce capital goods rises beyond what producers expected, so they begin to lay off workers and abandon capital investments. The end result is that producers have used up resources in order to produce future goods for which there is not a sustainable demand. This is what Hayek calls “malinvestment,” and it is the fundamental cause of the boom-bust cycle.""
This makes perfect sense which is exactly why no one will seriously advance it. (Ron Paul’s desire to audit the Fed was the motivation behind the article, but an audit goes no where near far enough.)
At present the interest rate is more political than sensible. It is policy driven, affected by the governments desire to do something that natural economic forces would otherwise resist. The most recent example was the governments desire to get people into homes they could not afford, a program started by democrats, and coddled by them up until the dam broke at which point it was someone else’s idea.
Since then the democrats have duplicated that failed policy, magnified it, and applied it to everything else.
While the left will of course claim otherwise at the end of the day there is but one response. Removing the political motivation to tinker with the interest rate and the money supply would prevent either party from fomenting future disasters. It would also deal a death blow to bail outs. We need to lose the Fed.
Now for the astute observer, the party that balks the most at such an idea is probably most guilty for the politicization of monetary policy, prolonging and aggravating the boom bust cycle, and most certainly has the bigger role in the Housing bubble.
I know who I think that is. But I’ll be more than happy to forget about it if they agree to close up the Fed. But then, that would really screw up that big banking bill they have that actually empowers the fed even further. That’s more power to the one agency most likely to screw up monetary policy.
Which party wrote that bill? Oh, yeah democrats.
Cross posted at NHInsider
