Economic theory as a guiding light for government action in this crisis. But which theory? The dominant Keynesian economic theory, or that of the Austrian School? (see the links at the end for background information about each).
Here is an excerpt from the Drobny Global Monitor of 5 March 2009, by Andres Drobny (see his bio at the end). It not only provides a major expert’s perspective on our situation, but also illustrates the complexity and limitations of today’s economic theory — factors often lost in the politicized discussion about the appropriate public policy response to this recession (or depression).
One of the debates out there is whether the governments should keep ‘bailing out’ institutions to prevent a cascade of defaults. Or, just let them go bust, let the ‘haircuts’ fall where they fall, get it over with and then allow firms to restructure and start again. Avoid the Japanese mistake of prolonging the misery.
It is sometimes suggested that the former idea is somehow ‘Keynesian’. And, the latter is often described as ‘Austrian’.
Now, it is true that some Keynesians argue in favor of ‘bailouts’. And, Governments generally seem to be following both a bailout strategy and the more traditional Keynesian idea of fiscal stimulus during a slump. It is also true that some famous Austrians have been known to favor the default strategy. Yet, this discussion misses the point. None of this is actually what the various theories suggest. There’s a profound difference between policy prescriptions associated with a theoretical perspective, and the underlying theories themselves.
And, looking back at the simple principles of Austrian and Keynesian theories provides some clarity of what we are currently living through, how the policy debates fit in, and what is evolving in financial markets. It also helps us assess the increasingly popular ‘bond bubble’ concept that has been circulating this year.