Wednesday, April 15, 2009

How government caused the financial crisis

A few weeks ago I reviewed Thomas Woods' new book, "Meltdown: A Free-Market Look at How the Stock Market Collapsed, the Economy Tanked, and Bailouts Will Make Things Worse" which takes a fairly orthodox Austrian-school economics approach, arguing that the financial crisis was not only the creation of government, but it fits rather neatly into the Austrian business-cycle model, which holds (roughly and colloquially) that government central banks tend to inflate the money supply, which causes misallocation of investment which leads to a bubble that inevitably bursts. The essence is that boom-bust cycles are not an inherent feature of unregulated free-market capitalism, as most people believe, but are caused by the government intervention inherent in having central banks.

Now John Taylor, who is now at Stanford and the Hoover Institution, having also spent time in government, in Treasury under Bush 43, on the Council of Economic Advisers under Ford, Carter and Bush 41, and with the Congressional Budget Office, has published a short little book. He is widely respected -- almost revered -- as a technical whiz. He is generally a monetarist, having refined Milton Friedman's advice that if we're to have a Fed it should expand the money supply at a steady, predictable, formulaic rate into a more nuanced formula universally called the "Taylor rule."

The title of the book says it all: "Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis." He argues that the Fed deviated from the Taylor rule from 2002 through 2006, expanding the money supply (cutting the interest rate) much more drastically than his rule would dictate, spoiling the Great Moderation that had prevailed from abut 1980 and creating the housing bubble and financial bubble.

So from two different theoretical perspectives, Woods and Taylor get almost the same conclusion: the Fed was the main (though not the only) culprit. Woods would abolish the Fed while Taylor would have it act more sensibly (which it certainly hasn't been doing). Both agree that what they're doing now is more of the same poison.

Just for a different take, here's a link to leftist Nation editor and trust-fund baby Katrina Vanden Heuvel's book, "Meltdown: How Greed and Corruption Shattered Our Financial System and How We Can Recover," which argues that it was capitalist greed and more government regulation is the answer.

No comments: