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How the Austrian School Explains Modern Financial Crises

How the Austrian School Explains Modern Financial Crises

Learn why setting interest rates centrally is not the solution to financial crises.

Max Rangeley, editor at the Cobden Centre and entrepreneur on May 31, 2023, spoke at the Austrian Central Bank. Titled “How the Austrian School Explains Financial Crises,” he used a preponderance of data to support an Austrian school alternative to setting interest rates. He demonstrated that the price-fixing of the past—on goods like food and rent—failed and thus countries overwhelmingly rejected price-fixing on everything. That is everything but interest rates. As a result, we have seen bigger and bigger bubbles in financial markets. He summarizes this by saying “Very rarely would you have economists in this day and age suggesting that the price of food or consumer goods or fuel should be set by government committees rather than by the market. So in essence, the Austrian school applies this to interest rates as well.”

He started with the hypothesis that interest rate price fixing will result in lower quality of debt, as the pool of savings is smaller relative to available credit. The lack of free market activity in interest rates sends false price signals, which extended over a long period of time, can capitulate to disastrous financial crises. Put simply, “a mismatch between demand and supply…disturb[ing] the interest-temporal coordination of the economy.” Global aggregate debt has doubled from even the levels of the 2008 financial crisis, largely due to a decade of near-zero percent interest rates. Using debt, PE, stock market, GDP radio, and other indicators, Rangeley demonstrated that the data correlated strongly to a negative consequences of artificially low-interest rates. This correlation matched the hypothesis made at the beginning, leading the data to suggest a causal relationship.

Aside from the market instability, long periods of elevated housing prices can affect house ownership among the younger generations. Rangeley demonstrated that this has effects as far-reaching as birth rates. He also spoke about the “fallen angels” bonds that are included in investment grade portfolios. These are some of the most dangerous assets due to their recent downgrades.

The proposed solution to all this is allow the market to set interest rates independent from the Government. Drawing on the example of Ludwig Erhart’s lifting price controls and saving West Germany’s economy, a market alternative might be able to save ours. He suggested this is best done before the bubble bursts again and the cycle begins larger and more dangerous.

In the inflation-ridden times we are living in, not surprisingly, the Q&A started with concerned members of the audience asking about exactly that­—inflation. Somewhat surprisingly, Rangeley suggested it was important to not get too caught up in inflation as the only worry, suggesting it might even come down more than expected. He also spoke on AI, predicting the third wave of AI—contextual adaptation—will have the largest productivity effect, but to keep in mind that the internet didn’t affect productivity as much as expected. The last few questions centered around implementation. There were concerns about both whether it was realistic to believe central banks would give up power, as well as questions on the “fairness” of such systems potentially causing pain. The bottom line is that the pain that will be caused by future bubbles will be much more significant than the institution of market interest rate price setting. Central banks are naturally concerned about their power being taken away, but Rangeley predicts the next bubble will galvanize support for the Austrian approach. The bubbles will only grow if this is not stopped.

At the conclusion of the event, Rangeley thanked the Austrian National Bank for allowing him to speak, highlighting the importance of such viewpoints in the halls of these institutions.

Authors

  • Leo Koerner

    Leo Koerner is a student at Harvard University working towards his Bachelors in the Classics department. Leo is summer intern 2023 at the Austrian Economic center.

  • Burkley McCarthy

    Burkley McCarthy is a student at Wabash College. Burkley is summer intern 2023 at the Austrian Economic center.

The views expressed on austriancenter.com are not necessarily those of the Austrian Economics Center.

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