Steven Horwitz, professor of Economics at St. Lawrence University and blogger at The Austrian Economists, gave a presentation in March of 2009 on the causes of the current recession – specifically, how many of those causes have their origins in the New Deal.
Before talking about how we did get here, let me say a quick word about what didn’t cause this mess. Those who wish to blame greed for the crisis need to explain how and why it is that greed seems to causes crises only at specific times, despite the fact that it is omnipresent as a feature of human nature and market economies. As the economist Larry White has noted, if we saw a bunch of planes crash all on the same day, we wouldn’t blame gravity. It’s always there. Something else must be at work. I would argue that the key is the set of institutions through which greed or self-interest is channeled. That is, good institutions can cause self-interest to generate desirable unintended consequences, and bad ones can cause undesirable ones. So perhaps we should be looking at institutions and policy. Those who wish to blame deregulation or the supposed “laissez-faire” philosophy of the Bush Administration are going to have to identify the deregulation in question, which will be a challenge given that the last deregulatory legislation in the financial industry was in 1999 under Clinton. These folks will also have to explain how the enormous growth in the Federal Register and domestic spending over Bush’s two terms reconciles with his supposed belief in laissez-faire. Answer: it doesn’t.
The two key causes of this crisis are expansionary monetary policy on the part of the Fed and a series of regulatory and institutional interventions that channeled that excess credit into the housing market, creating a bubble that eventually had to burst. In other words, the boom (and the inevitable bust) are the product of misguided government policy, not unbridled capitalism.
The Fed drove up the money supply and drove down interest rates very consistently since 9/11. When central banks do so, they make long-term investments relatively cheaper than short-term ones, thus the excess funds flow toward such goods. Historically, these were producer goods in capital industries, but in this particular case, a set of other government interventions and policies pushed those funds toward housing.
Too much of the discussion about the stimulus and recovery has been focused on the “macroeconomics” of GDP and overall rates of unemployment, and not nearly enough on the required microeconomic adjustments that are necessary. Part of the curative process of the recession is not just an overall retrenchment from inflation, but a sectoral reallocation of resources away from the artificially large longer-term asset sectors toward where real consumer demands lie. Unfortunately, no one person or group knows what those are, which is why we need to rely on the competitive discovery process of the market to figure it out, rather than government allocators who both lack the necessary knowledge and have, as we’ve seen, every reason to use such resources to serve their political self-interest.
The Obama Administration’s 2009 budget is also connected to the current mess. According to the president, the reason we got into this mess is that we apparently spent too much on housing, the financial sector, and debt in general and not enough on the core issues of the environment, health care, and education. For the life of me, I cannot see how such a theory can explain anything of what’s happened the last six months, but it does serve to create a rationale for a budget that contains a whole bunch of new initiatives that don’t obviously seem to be related to the Great Recession. At a time when the US government has taken on a whole bunch of new debt with the bailouts and the stimulus, one would think that the next year’s budget should show more restraint and focus on issues central to economic recovery. As many commentators have noted, it’s hard to both argue that too much debt got us into this mess and that more will get us out.
There are indeed parallels between this recession and the Great Depression, but they are not what much of the public commentary would lead you to believe. What we are living through today is a recession whose causes are significantly the unintended result of institutional changes made during the Great Depression and whose proposed solutions reflect the same failed understanding of the causes that motivated Great Depression “solutions” that largely ended up doing more harm than good. History is indeed repeating itself, and not in a good way.
The preceding paragraphs are my personal favorites from the presentation, but I strongly encourage a full reading as it very explicitly lays out the “how” and “why” of our current economic predicament.