Classical economists failed to foresee 2008-2009 GFC. Austrian economists saw it coming.
February 17, 2017
One of the great failures of Classical Economics (the School of Economics that dominates most government Treasuries and central banks) was to have not foreseen/forecast the 2008-2009 Global FInancial Crisis. By contrast, many of those of the Austrian School of Economics could see it coming, as clear as the hand in front of your face. Why such a difference?
Classical School economists believe that debt can be ignored, because one person's debt is another person's asset, thus cancelling each other out from a Macro perspective.
By contrast, Austrian School economists believe that debt is critical in understanding the business cycle.
" This mainstream economist’s understanding of Austrian business cycle theory is roughly as follows. An economic expansion is sustainable if it is the result of an increase in investment that is funded by an increase in saving. In contrast, an economic boom that is merely the result of credit expansion is not sustainable.2 When credit creation by monetary authorities exceeds a society’s structural saving rate, financial intermediaries end up lending money at interest rates that are below the rate where supply and demand clear in the market for loanable funds. As a result, the information embedded in market prices (including interest rates) is distorted, affecting entrepreneurial decisions and causing a misallocation of capital across the economy. Specifically, too many capital goods and not enough consumer goods end up being produced relative to ultimate consumer preferences. Eventually, as the lack of underlying demand for these capital goods becomes apparent, production capacity is idled, and the boom that was fed by the credit expansion turns to bust. Thus, credit expansion during an economic downturn will not help bring about a sustainable boom but will merely postpone it, as it causes a delay in the structural adjustments, such as business closures and other eliminations of unproductive uses of capital, that need to be made to bring about a sustainable economic expansion.
With the benefit of hindsight, the preceding paragraph would appear to be a summary description of what has happened to the financial system and the macroeconomy in recent years. The 2002–2007 expansion was characterized by both monetary accommodation and a boom in residential real estate. The boom proved unsustainable, and was followed by a spectacular bust in both the financial markets and the broader economy. "
Indeed, predictions by Austrian or Austrian-inspired economists such as William R. White, Economic Adviser and Head of the Monetary and Economic Department of the Bank for International Settlements from May 1995 to June 2008, have been uncanny not just in their accuracy but in their specificity. Just before the onset of the crisis, White (2006, p. 1) pointed out that “persistently easy monetary conditions can lead to the cumulative build-up over time of significant deviations from historical norms—whether in terms of debt levels, saving ratios, asset prices or other indicators of ‘imbalances.’” To be sure, a financial crisis of sorts had also been forecast by many non-Austrian economists, such as Nouriel Roubini and Stephen Roach. But their predictions tended to focus more on macroeconomic imbalances such as the current account deficit or the federal government debt. White and other Austrians, on the other hand, were more precise in predicting that a crisis would be triggered by a collapse of an asset bubble, specifically the real estate bubble. "
After the Global Financial Crisis George Soros ( https://en.wikipedia.org/wiki/George_Soros ) and global economic leaders (including 3 Nobel laureates in Economics including Jo Stiglitz) came to accept that mainstream economics was broken - because of the lack of ability to foresee the Global Financial Crisis. As a result George and other, formed the Institute of New Economic Thinking ( https://www.ineteconomics.org/ ) to find some better approach to economic thinking to help economists in the future, to solve economic problems better than economists were able to do in the lead up the Global Financial Crisis. Some worthwhile links:
Introduction - Institute for New Economic Thinking. Many of the world's leading economists including Nobel laureates, played a role in setting up the Institute of New Economic Thinking. https://www.youtube.com/watch?v=KoqLu5CKx-o
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