Will this Recession Bring New Economic Theories?

This was an interesting question asked by Adam Davidson on “Planet Money” at NPR.com while talking to famed young Economist Daron Acemoglu. Here is what Davidson wrote:

“The Great Depression begat Keynesianism, the crisis of the 1970s/1980s gave broader support to Friedmanism. So, will this crisis give birth to some new theory? Or are we just going to keep refining the big ideas we already have.

I had a great talk with Daron Acemoglu, a big-shot young economist about this. He says that yes, certainly, there will likely be radical new ideas.

He says that in the past few months we’ve learned that many of the fundamental models of economics are wrong. We’ve learned, for example, that it’s impossible to think of a “firm” (one of the core actors in any economic model) as a unified thing. Bear Stearns and Lehman Brothers were firms. By economic theory that means they don’t do things like, um, pursue short term profits that can destroy the firm.

So, he says, we’ll have to develop a more complex view, one that allows for a firm to be made up of lots of individual actors with their own–sometimes catastrophically contrary–incentives and goals.

He also says the pure models of Keynes or Friedman or the Austrian School have proven insufficient to explain the current mess.

Acemoglu says we have no idea what that new theory will be or if there will be many. But we can know, for sure, that dramatic changes are on the way.”

Most of the commentator have came out in defense of the Austrian Business Cycle and I think it is in the correct ways. It is true that the Federal Reserve System lowered interest rates and caused the housing boom. Therefore, to say that the Austrian Business Cycle has something to do with this recession is a good start. In fact, non-Austrians like Jeff Sachs came out and said that the “loose credit” caused this crisis. This recession may move Austrians  back stronger in the mainstream but there are still a few problems with their business cycle.

The main problem that I have learned in my class taught by Dr. Peter Leeson at George Mason University, who is an Austrian, is that why do businesses keep repeating the same cycle. The Austrian Business Cycle shows businesses using the loose credit to their advantage and then when the rate adjusts to the natural rate they all get burned. This is much like an infant putting its hand on a hot stove. The problem is why does the infant continue every 5 to 10 years to put their hand on the stove. Is it because there are different sectors getting burned and the same people never get burned? We will still assume they would learn from others. The answer here is not clear but it is something Austrians could solve with the current crisis.

The rest is here.

~PCCapitalist