The Great Recession |
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Fixing the Problem
How do we get out of this recession?
There are two schools of thought regarding this: the Keynesians and the Austrians.
Keynesian Economics
Keynesians believe in active government intervention in the economy - usually through interest rates policies but also debt spending during downturns. Ideally, Keynesians advocate spending when the chips are down and pulling bad when the going gets good. Stimulus packages are an example of Keynesian government involvement; additionally, lowering interest rates also decreases lending costs. It's important to note that the US government pursued a very activist and interventionist government policy during the 1930's and the Great Depression really only ended after the WWII when taxes and regulations were reduced.
Austrian Economics
Austrians believe the government should intervene in the economy as little as possible. Austrians prefer: low taxes, a gold backed dollar, no government stimulus programs - really, hands off and let the economy function.
Austrian are particularly concerned about the Boom/Bust cycle. According to the Austrians, government involvement in the economy with such things as artificially low interest rates, subsidies and backstops creates an artificial economic boom (usually debt based). This overstimulation eventually peters out and the boom is followed by a bust - usually, the bigger the boom, the bigger the bust.
The real estate boom of the early 2000's would be a classic example of a boom/bust cycle. The combination of record low fed funds rate (1%), the GSE's (Fannie & Freddie) purchase of sub-standard loans, and deregulation of the financial industry led to an artificial debt-based boom in real estate which saw house prices double in the years 2002-2006. Unfortunately, the housing boom was built upon a rickity financial foundation which has been unwinding since late 2007 and probably won't completely unwind until sometime after 2012.
So what's the Austrian solution for an economic downturn? Do nothing. It sounds awful, but Austrian's believe the only way to cure the excess of a bubble is to let the system clean itself out (clear out the malinvestment) and start from a fresh base. Austrians simply let entities that need to go bankrupt, go bankrupt.
Restarting From a Fresh Base
Since the United States went off the gold standard in 1971 there has been a tremendous amount of monetary and credit inflation which greatly accelerated in the 2000's. Because of the extent of the credit inflation (in 2005, The Economist called the real estate bubble the biggest asset bubble in history !), it will probably take many years to unwind the debt . After the mal-investments and debt has been purged from the system, here are suggestions for establishing a more stable economic base:
And a controversial change to the banking system - replace Fractional Reserve Banking with Full Reserve Banking. With Full Reserve Banking, there would be two types of bank accounts:
It's not to say fractional reserve banking is a failure, but full reserve banking is meant to remove the the money multiplier effect and the inherent boom / bust cycle that seems to result from fractional reserve banking. On the other hand, we've had several hundred years of progress with fractional reserve banking, so it's probably not the worst thing in the world...
Additional Sources
05/18/2010