Do you remember the Austrian economy? In the aftermath of the 2008 financial crisis, a number of conservatives rejected Keynesian economic prescriptions and instead asserted themselves as devotees of the Austrian school, especially Friedrich Hayek.
One wonders how many of these self-proclaimed “Austrians” really knew what they were supporting. Usually, when right-handed people talk about intellectual history, you want to kickstart your fact-checking. For example, Fox News’ Mark Levin has a bestselling book claiming not only that the current American left is in the grip of European Marxists, but more specifically that they are disciples of Herbert Marcuse and the Frankfurt School. – except that he continues to call it the “Franklin School”.
And the idea that there was a titanic intellectual battle in the 1930s between Hayek and John Maynard Keynes is essentially fan fiction; Hayek’s views on the Great Depression did not generate much intellectual interest at the time, and his fame came later, with the publication of his 1944 political tract “The Road to Serfdom”.
Nonetheless, there was an identifiable Austrian analysis of the Depression shared by Hayek and other economists, including Joseph Schumpeter. Where Keynes argued that the Depression was caused by a general deficit in demand, Hayek and Schumpeter argued that we examine the inevitable difficulties in adjusting to the consequences of a boom. In their view, excessive optimism led to allocating too much labor and other resources to the production of capital goods, and a depression was only the economy’s way to reclaim those resources for them.
This view had logical problems: if the transfer of resources from capital goods causes mass unemployment, why did the same not happen when resources were transferred to and from others? industries? It was also clearly at odds with experience: during the Depression and, for that matter, after the 2008 crisis, there was overcapacity and unemployment in just about every industry – no slowdown in some and all. shortages in others.
But this time it’s different. While we don’t hear much about the Austrian economy these days, the pandemic has really produced an Austrian-style reallocation shock, with demand for some things increasing while demand for others plummeting. You can see it even at a macro level: there was a huge increase in purchases of durable goods even as services struggled. (Think about the people who buy stationary bikes because they can’t go to the gym. Hey, I did.)
You can see it even more clearly in the details: record vacancy in the office market, overwhelming shortage of shipping containers.
So we finally have the kind of economic crisis that people like Hayek and Schumpeter mistakenly thought we had in the 1930s. Does that mean we should follow the political advice they gave back then?
That’s the message from an article by Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub and Iván Werning that was prepared for this year’s meeting in Jackson Hole, Wyoming, a major Federal Reserve conference that often produces influential research. . (Fun fact: I’ve been ostracized from Jackson Hole since the early 2000s, when I had the temerity to criticize Alan Greenspan before it was all the rage.) Guerrieri et al. never explicitly mention the Austrians, but their article can nonetheless be interpreted as a refutation of their political prescriptions.
Hayek and Schumpeter were adamantly opposed to any attempt to tackle the Great Depression with monetary and fiscal stimulus. Hayek denounced the use of “artificial stimulants”, insisting that we should instead “allow time for permanent healing through the slow process of adaptation of the production structure”. Schumpeter warned that “any awakening that is simply due to an artificial stimulus leaves some of the work of the depressions unfinished.”
But those conclusions didn’t follow even though you accepted their incorrect analysis of what the Depression was. Why should the need to remove workers from a sector lead to unemployment? Why shouldn’t that just lead to lower wages?
The answer in practice is downward nominal wage rigidity: employers are really reluctant to cut wages because of the effects on worker morale.
However, if wages cannot go down in the sector that is to contract, why can’t they go up in the sector that is to grow? Of course, that would lead to a temporary increase in inflation, but that would be good.
Guerrieri et al. argue, with a formal model in support, that the optimal response to a reallocation shock is indeed a very expansionary monetary policy that causes a temporary spike in inflation. Workers would still be incentivized to change jobs, as real wages would fall in their old job but rise elsewhere. But there would be no need for large-scale unemployment.
Maybe it was obvious from the start – or maybe not, because most of us were so focused on the Austrians’ mistake in diagnosing the problem that we didn’t spend much time thinking about it. to their solution. Now that we finally got the shock that Austrian economists kept imagining, we can see that they were still giving really bad advice.
And in case you were wondering, the Fed, in accepting transitory inflation, is right.