From bust, or to say, the financial

From an
Austrian perspective, two drivers behind the financial crisis were the pressure
on interest rates by monetary authorities and the use of mathematical equations
in attempt to lessen risks.

Firstly, Austrians
use the Austrian Business Cycle Theory to provide an explanation for the financial
crisis (Maier & Koumparoulis, 2012). The theory entails that economic
growth is sustainable if follows from greater investment funded by higher
saving, but is unsustainable if follows from credit expansion, as was the case
prior to the financial crisis. This conclusion
can be explained as follows. In a freely functioning market economy, the
interest rate provides a signal that coordinates the plans of savers and investors.
The natural interest rate ensures that just enough is invested now to be able
to produce in future the consumption goods that consumers demand in the future.
When monetary authorities engage in credit expansion, interest rates fall below
the natural interest rates. Consequently, the information embedded in interest
rates is misleading, and savers and investors are provided by inconsistent signals.
It gives consumers the signal to consume more now and at the same time spurs
additional investments. Investors build up additional capacity for providing
additional products in the future but the demand for these products will not be
there because consumers spend more now than in the future. This inconsistency implies
that capital is malinvested throughout the economy. There will be temporary
higher growth due to the boost of investment and consumption, but eventually,
as the shortage of underlying demand for capital goods comes forward, capacity utilization
decreases, and the boom that was launched by credit expansion ends in a bust,
or to say, the financial crisis of 2008/9.

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Secondly, according
to Austrians, one mistake was to view economics as a science on the order of
physics, one that can be reduced to quantities, numbers, and mathematical
formulas (Veryser, 2013). The Austrian School distrusts mathematical modeling
and understands economics as a science of individual human action. Austrians believe human actions
played a significant role in fueling the financial crisis. Bankers kept on borrowing
more mortgages with the view that in time, the value of real estate would
increase. They thought that with time they would gain high interest rates while
consumers looked forward to higher returns. They were speculating huge profits
from the mortgage loans and did not consider the corresponding risks. This
pushed the value of the mortgages beyond their real value. Bankers expected consumers
to invest in the loans, but due to the rising prices of goods, people preferred
to spend, leading to overconsumption. Thus, there was much speculation rather
than relying on real economic calculations. From an Austrian perspective, the improper
speculations by humans contributed to the financial crisis. If the
entrepreneurs did proper economic calculations and had strong cost allocation
systems and, none of the consequences faced would have risen (Maier &
Koumparoulis, 2012).

Next consider
the monetary policies used in response to the financial crisis. These policies
were based on Keynesian models which prescribe expansionary policies to remedy the
weak aggregate demand in times of economic stagnation (Tempelman, 2010). Central
banks indeed responded to the financial crisis by lowering the short-term
nominal interest rates to zero, as well as resorting to more unconventional policies
by targeting long-term interest rates via the purchase of government securities
and by supporting needy sectors of the credit markets (Tempelman, 2010). These followed
policies are at odds with recommendations made by Austrians. In the Austrian
view, expansionary monetary policy is assumed to set up another unsustainable
boom. For Austrians, the real solution is simple: allow the marketplace to work
to realize a restructuring of the economy. The resources that have been
malinvested should be reallocated to other areas (Hoogduin, lecture December
19, 2017). It is only after the economy experienced this that growth can start
afresh based on an analysis of the future consumer behavior. Thus, credit
expansion doesn’t bring sustainable economic growth, but merely postpones it,
as it delays structural adjustments such as business closures and other
eliminations of unproductive uses of capital. Refusing to allow markets to
restructure only sets the stage for a bigger crisis.