Hayek: understanding the financial crisis


Given all the wasted ink spilt over this financial crisis, it was a breath of fresh air to read Philip Booth on The Telegraph website putting the case that the financial crisis shows why we should admire Freidrich Hayek. He is absolutely spot-on in arguing against the trend of a lot of reporting.  Austrian or Hayekian economics has indeed been strengthened by the facts and nature of the financial crisis.

A key point that has been missed by most commentators is that prior to the crisis an abundance of regulation was already in place. The simple truth is that the financial markets were not free. Booth is right to critique the type of regulation present and question the standardization of regulatory institutions use of highly quantitative risk models. This type of regulation forced our eggs firmly into one basket.

It should be made clear that Booth is not against institutions per se, but against government led institutions that distort the market and give people false expectations. As Booth states:

Hayek argues that unregulated markets develop institutions that ensure that trust and reputation become valuable commodities. But who cares about trust and reputation when we believe that everything will be looked after by the regulators or by deposit insurance?

And as for booms and busts:

Hayek suggests, too, that booms and busts are the product of poor monetary policy. Central banks hold interest rates too low. People consume too much and invest in business projects that would not be profitable at higher levels of interest rates. Resources then get misallocated. And then the whole things goes bang and we get a recession (in this case accompanied by a banking crisis).

Someone needs to explain these ideas to print journalists. Except the US Wall Street Journal, most are doing a very poor job of explaining what has gone wrong. I would suggest the journalists go back to school, though I would be surprised if many school libraries are stocked with the works of the Austrian economists.