Murray N. Rothbard, in his book For a New Liberty: The Libertarian Manifesto, wrote a chapter that is highly relevant to the situation we face today. Unfortunately, if Rothbard’s analysis of the business cycle using Austrian economics is correct — and I believe it is — what’s going on presently in Washington, and what president-elect Barack Obama is planning, will do much more harm than good.
The chapter’s title is “Inflation and the Business Cycle: The Collapse of the Keynesian Paradigm.” In it, Rothbard explains the flaws in the Keynesian theory of the business cycle. This theory — in spite of its defects — is pretty much what our present and future administrations are following as they attempt to manage our economy. In fact, Steven Pearlstein’s column in yesterday’s Washington Post is titled Keynes on Steroids, and it contains this whopper: “Nixon’s Keynesian conversion, however, looks positively quaint compared with the fiscal and monetary stimulus that is about to be brought to bear on the U.S. and global economy. I doubt even Keynes himself could have imagined the scale and scope of what’s ahead.”
The Austrian school of economics has a different theory of the business cycle, and a different prescription for what government should do to get the country out of recession. It’s not a prescription that our leaders are likely to follow. In fact, everything they are doing, and are preparing to do, directly contravenes the Austrian prescription. Here’s what Rothbard wrote near the end of chapter 9 of For a New Liberty: The Libertarian Manifesto (I’ve added some emphasis):
What then are the policy conclusions that arise rapidly and easily from the Austrian analysis of the business cycle? They are the precise opposite from those of the Keynesian establishment. For, since the virus of distortion of production and prices stems from inflationary bank credit expansion, the Austrian prescription for the business cycle will be: First, if we are in a boom period, the government and its banks must cease inflating immediately. It is true that this cessation of artificial stimulant will inevitably bring the inflationary boom to an end, and will inaugurate the inevitable recession or depression. But the longer the government delays this process, the harsher the necessary readjustments will have to be. For the sooner the depression readjustment is gotten over with, the better. This also means that the government must never try to delay the depression process; the depression must be allowed to work itself out as quickly as possible, so that real recovery can begin. This means, too, that the government must particularly avoid any of the interventions so dear to Keynesian hearts. It must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. For doing so will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease. The government must never try to prop up wage rates or prices, especially in the capital goods industries; doing so will prolong and delay indefinitely the completion of the depression adjustment process. It will also cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries. The government must not try to inflate again in order to get out of the depression. For even if this reinflation succeeds (which is by no means assured), it will only sow greater trouble and more prolonged and renewed depression later on. The government must do nothing to encourage consumption, and it must not increase its own expenditures, for this will further increase the social consumption/investment ratio—when the only thing that could speed up the adjustment process is to lower the consumption/savings ratio so that more of the currently unsound investments will become validated and become economic. The only way the government can aid in this process is to lower its own budget, which will increase the ratio of investment to consumption in the economy (since government spending may be regarded as consumption spending for bureaucrats and politicians).
Thus, what the government should do, according to the Austrian analysis of the depression and the business cycle, is absolutely nothing. It should stop its own inflating, and then it should maintain a strict hands-off, laissez-faire policy. Anything it does will delay and obstruct the adjustment processes of the market; the less it does, the more rapidly will the market adjustment process do its work and sound economic recovery ensue.
Will our government follow Rothbard’s recommendation to do “absolutely nothing”? Absolutely not.