The Role of Government Policy in the Financial Crisis: Debunking the Austrian School Interpretation

In the wake of the financial crisis in 2008, the debate surrounding its causes has been extensive. A common argument posited is whether the crisis was a logical result of the economic theories of the Austrian school or the result of their imperfect implementation. This question, as posed, oversimplifies the issue and overlooks the primary factors at play. The responsibility for the crisis primarily lies with government policy, particularly in its failure to regulate and adequately contain risk in the financial sector.

Government Failure: Fault Lines in the Financial System

The financial crisis of 2008 was not a natural outcome of the irresponsible implementation of Austrian school economics. Instead, it was the product of a series of regulatory and policy failures. One of the most significant failures was the lack of competition in bond rating services. The government lacked the foresight and will to foster competition, allowing a few major credit rating agencies to essentially have a monopoly. This monopoly significantly influenced investor decisions and created a cascade of risky financial practices.

Another critical factor was the precedent of government bailouts. Historical instances of bailouts had set a precedent that failed entities would receive generous support from the government. This led to an environment where institutions felt they could take on increasingly risky activities, knowing full well the safety net was always there. This practice undermined market discipline and created a false sense of security.

Economic Theorists and Policy Makers

It is important to note that in practice, the authority of economists like Keynes and Piketty is often selectively heeded by policymakers. Their contrarian views might make them more appealing to the authorities but do not necessarily mitigate other risks. Conversely, economists supporting policies that align with government interests are often more influential and listened to. This bias towards economists who cater to policymakers’ preferences can skew the public discourse and overlook the complexity of economic issues.

Market Predictions and Investor Behavior

Before and during the crisis, investors were faced with the task of predicting future economic conditions. They successfully anticipated years of slow growth following 2008. Contrary to popular belief, the subsequent market crash was not an unforeseen event but a natural response to the built-up risks in the financial sector. If there had been no financial crisis, investors would have suspected the market of having “predicted” the absence of a downturn overly confidently.

Histories of financial crises and economic panics often include recoveries as markets rebounded when no structural changes warranted continued pessimism. However, the 2008 crisis was distinct because of the severe misalignment between monetary policy and market needs. Central banks’ efforts to manage the money supply became overly stringent during the neoliberal era, leading to a mismanaged transition.

The Monetary Policy Shift and Its Consequences

Before the neoliberal era, central banks kept inflation high to combat recessions. However, in the neoliberal era, economies shifted towards structural solutions such as austerity, deregulation, and privatization, enabling growth at low inflation levels. In 2008, central banks took this approach too far, neglecting short-term market signals for long-term structural reforms. This contributed to the crisis as it led to an overcorrection and excessive risk aversion, setting off a chain reaction in the financial sector.

To summarize, the financial crisis in 2008 was primarily a result of government policy failures rather than the logical, albeit imperfect, implementation of Austrian school economics. Understanding these policy failures is crucial for developing better regulatory frameworks that can prevent future crises.