Article by Hetzel on the 2008-2009 Recession

by Liberty and Power

I recently read a somewhat technical but quite good article by Robert L. Hetzel on"Monetary Policy in the 2008-2009 Recession," from the Spring 2009 issue of the Federal Reserve Bank of Richmond Economic Quarterly. Like Scott Sumner, whose blog alerted me to this article, Hetzel argues that a minor recession (brought on possibly by the housing shock) was turned into a major panic by monetary policy that was too tight! Hetzel thus agrees with David Henderson and me in exonerating Greenspan of much blame for the crisis. He also alludes to something that has been ignored by many commentators: how Milton Friedman's research on the Great Depression, which emphasized the demand-side impact of the bank panics, is quite different from Ben Bernanke's, which emphasized the supply-side impact. This difference implies significantly different policies: a general increase in liquidity in the case of Friedman versus targeted (and until last October, sterilized) bailouts in the case of Bernanke. Hetzel goes on to distinguish between credit-cycle views of recessions versus quantity-theory views (like Friedman's). Credit-cycle views are all the rage now, among economists and non-economists alike, including Bernanke and many at the Fed, but Hetzel blames such mistaken theories for remedies that aggravated both the Great Depression and the current recession. In the process, he resurrects strong historical evidence from Friedman and Schwartz's monetary history demonstrating the falsity of credit-cycle explanations for the Great Depression. Despite some inevitable disagreements and reservations, I think Hetzel's article is well worth study.

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Jeffrey Rogers Hummel - 8/17/2009

In response to your question, I would say that Austrian business cycle theory is the premier credit view. No other modern, formal business cycle theory that I know of predicts a self-reversing boom, with Fed distortions of interest rates as the causal factor. A quick perusal of the Basu and Frenald article suggests to me that it is an attempt to integrate real business cycle theory with inflexible prices, using some of the ideas that have been developed in post-Solow model growth theory. Austrians may be able to pull insights from the article, but I don't think overall it is congenial with Austrian business cycle theory.

I should add that I have been a long-time critic of Austrian business cycle theory, although I think it contains some valuable insights not found in mainstream theories. But the Austrians themselves seem unaware that there are at least four distinct variants of Austrian business cycle theory: (1) the traditional variant of Ludwig Mises, Friedrich Hayek, and initially Lionel Robbins; (2) the Murray Rothbard variant, which adds on enthusiasm for deflation as well as extreme hostility to fractional reserve banking, per se (this seems to be the version most common among Ron Paul supporters); (3) the Roger Garrison variant, which has implicitly embraced a short-run aggregate supply curve and mainstreamed its labor-market story (Garrison claims to be fleshing out nascent insights of Mises); and (4) the George Selgin-Steve Horwitz variant, which integrates Austrian theory with both Keynesian notions of velocity shocks and the monetarist (Leland Yeager) view of monetary disequilibrium (Selgin and Horwitz seem to be building on passages in Hayek).

Bill Woolsey - 8/13/2009

I thought the Hetzel paper was interesting and more or less consistent with a monetary disequilibrium perspective.

How do "Austrian" economists, of various degrees of sophistication, relate what Hetzel calls the credit view with the ABCT?

I often read things by educated laymen (say, Paul supporters who read the Mises Insitute blog,) that sound more like Hetzel's credit view than my understanding of the ABCT.

On the St. Louis Fed site, there is a paper "What do we know (and not know) about potential output," by Basu and Fernald.

While the technical parts may be a bit slow going for most readers (I am still trying to decide how much effort I want to put into deciphering it.), there is plenty of explantion of what they are trying to do and what they think they are showing, which is interesting.

Most importantly, they describe and cite the literature regarding fluctuations in potential output combined with sticky prices that result in deviations of real output from that changing potential output. For those with an Austrian approach, their key point is that it is important to treat consumer goods and capital goods industries separately (though it has nothing to do with monetary induced malinvestments, but rather with differential changes in technology between those sectors of the economy.)

This approach provides hope that the mainstream might come to understand the need to avoid monetary disequilibrium without adopting some futile notion that the goal is to stablize output.