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Great Recession

2011-02-16T00:16:05Z

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The [[financial crisis]], that began in 2007, has been named the '''Great Recession''' due to its impact on the American and worldwide economy.<ref name="Zuckerman_recession">Zuckerman, Mortimer. [http://online.wsj.com/article/SB10001424052748703837004575013592466508822.html "Mortimer Zuckerman: The Great Recession Continues - WSJ.com"], ''The Wall Street Journal'', referenced 2010-07-23.</ref><ref name="Evans-Pritchard_recession">Evans-Pritchard, Ambrose. [http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7871421/With-the-US-trapped-in-depression-this-really-is-starting-to-feel-like-1932.html "With the US trapped in depression, this really is starting to feel like 1932"]. ''The Daily Telegraph'' (London). Referenced 2010-07-27.</ref><ref name="Samuelson_recession">Robert J. Samuelson. [http://www.washingtonpost.com/wp-dyn/content/article/2010/07/11/AR2010071103038.html "The Great Recession's stranglehold"], ''The Washington Post'', July 12, 2010. Referenced 2010-07-27.</ref><ref name="Isidore_recession">Chris Isidore. [http://money.cnn.com/2009/03/25/news/economy/depression_comparisons/ "The Great Recession"], ''CNNMoney.com'', First Published: March 25, 2009. Referenced 2010-07-27.</ref>

==Prelude to the crisis==
Banks increasingly had the incentive to make long-term amortizing loans secured by long-term assets because the threat of bank runs has been taken away by increases in [[Federal Deposit Insurance Corporation|FDIC]] deposit insurance. Deposit insurance started at $2,500 in the [[Great Depression]] and has increased in fits and starts to $250,000 in 2009. With the increase in deposit insurance there is no need to maintain liquidity. So instead of making short-term, self-liquidating business lines of credit, bankers opted for making real-estate loans.

Numbers from the FDIC reflect this shift over the past decade. At the end of the third quarter of 1999, the assets of the nation's banks totaled $5.5 trillion. As of September 30 2009, bank assets had grown to $13.2 trillion. Commercial and industrial loans outstanding only grew from $947 billion a decade ago to $1.27 trillion by September 30, 2009. Meanwhile, loans secured by real estate increased from $1.43 trillion in the fall of 1999 to $4.5 trillion in 2009. And investment in securities doubled, rising from $1.03 trillion to $2.4 trillion.<ref name="French_loans">Doug French. [http://mises.org/daily/3925 "Productive Debt versus Unproductive Debt"], Mises Daily, December 08, 2009. Referenced 2010-07-28.</ref>

Finance was once just a small portion of the US economy, but by 2007 it had mushroomed into being over a quarter of the S&P 500, after being only 5 percent of the index back in 1980 — and this doesn't count the financial affiliates of companies like GE. Finance is the largest sector of the US economy, so college graduates believe the road to riches lies with pushing paper, creating complex financial securities, and jockeying risk-management models.

These products served to grow Wall Street exponentially. All stocks in the S&P in 1957 had a market value of $220 billion. By the end of 2008, that index had a value of $9 trillion, but the real action was in derivatives, which totaled $518 trillion that year, "or about ten times the Gross Global Product." Credit Default Swaps owners jumped on this opportunity to profit and the CDS market grew to $62 trillion at its peak, while the entire market for home mortgages was only $12 trillion. Sold as an insurance to hedge against credit risk, the CDS market morphed into speculation.<ref name="French_finance_industry">Doug French. [http://mises.org/daily/4592 "Turning Bread into Stones"], Mises Daily, July 26, 2010. Referenced 2010-07-28.</ref>

The Washington Post has called the 2000s "[[Lost Decade (Japan)|The lost decade]]". "The U.S. economy has expanded at a healthy clip for most of the last 70 years, but by a wide range of measures, it stagnated in the first decade of the new millennium. Job growth was essentially zero, as modest job creation from 2003 to 2007 wasn't enough to make up for two recessions in the decade. Rises in the nation's economic output, as measured by gross domestic product, was weak. And household net worth, when adjusted for inflation, fell as stock prices stagnated, home prices declined in the second half of the decade and consumer debt skyrocketed."<ref name="WashPost_decade">The Washington Post. [http://www.washingtonpost.com/wp-dyn/content/graphic/2010/01/01/GR2010010101478.html "The lost decade for the economy"], a graphic by Neil Irwin, Cristina Rivero and Todd Lindeman. Referenced 2010-07-30.</ref>

===Predicting the crisis===
<blockquote>''"While I am not going to say that there is no possibility of house pricing declining... the notion of a bubble bursting and the whole price level coming down seems to me as far as a nationwide type of phenomenon really quite unlikely."'' <br />
<small>Federal Reserve Chairman [[Alan Greenspan]], 2003.</small><ref name="Greenspan_bubble">Alan Greenspan. [http://www.access.gpo.gov/congress/senate/pdf/108hrg/86497.pdf "Global Aging: Opportunity or Threat for the U.S. Economy?"] (pdf), Hearing before the [http://aging.senate.gov/ Special Committee on Aging], United States Senate, One Hundred Eighth Congress, First Session, Washington, DC, February 27, 2003, p.10. Referenced 2010-07-24.</ref></blockquote>

A common view from the very beginning of the credit crisis, shared from the upper echelons of the global financial and policy hierarchy and in academia to the general public, was that, ‘no one saw this coming’. However, several economical analysts - especially from the [[Austrian School of Economics]] - warned specifically about a housing-led recession, going against the general mood and official assessment, and well before most observers turned critical from late 2007.<ref name="Bezemer_coming">Bezemer, Dirk J. [http://som.eldoc.ub.rug.nl/FILES/reports/2009/09002/09002_Bezemer.pdf "No One Saw This Coming": Understanding Financial Crisis Through Accounting Models] (pdf), ''Groningen University'', 16. June 2009. Referenced 2010-07-30.</ref><ref name="Mises_Bailout">Mises.org. [http://mises.org/daily/3128 "The Bailout Reader"], ''Mises Daily''', September 2008, section "Who Predicted This?". Referenced 2010-11-11.</ref><ref name="Murphy_Recession">Robert P. Murphy. [http://mises.org/daily/2728 "The Worst Recession in 25 years?"], ''Mises Daily'', October 01, 2007. Referenced 2010-11-11.</ref> For example, in 2004, [[Mark Thornton]]<ref name="Thornton_Housing">Mark Thornton. [http://mises.org/daily/1533 "Housing: Too Good to be True"], ''Mises Daily'', June 04, 2004. Referenced 2010-11-25.</ref> and others warned about a bubble in the housing market.<ref name="Karlsson_Boom">Stefan Karlsson. [http://mises.org/daily/1670 "America's Unsustainable Boom"], ''Mises Daily'', November 08, 2004. Referenced 2010-11-25.</ref>

[[Federal Reserve]], led by then-Chairman [[Alan Greenspan]], identified a housing bubble in 2005 and failed to slow down the expansion of mortgage credit, as transcripts from Open Market Committee meetings that year show.<ref name="Torres_Fed">Craig Torres. [http://www.bloomberg.com/news/2011-01-14/fed-saw-housing-bubble-in-2005-failed-to-alter-policy-of-rate-increases.html "Fed Officials Saw Housing Bubble in 2005, Didn't Alter Policy"], ''Bloomberg'', January 14, 2010. Referenced 2010-11-11.</ref>

==Bubble economy==

===Housing bubble===
Psychology clearly plays a role in stimulating a bubble, but only monetary [[inflation]] enables it. It is difficult not to succumb to the temptation of astronomic profits in a short period of time. Resistance is even more difficult if the means to engage in the bubble are easily available at the nearest bank.

Former Fed chairman [[Alan Greenspan]] would suggest that "irrational exuberance" has the power to escalate asset prices. He could certainly claim exuberance, but there is nothing irrational in investing in higher-yield projects instead of watching your idle savings lose their purchasing power because of inflation.

With extremely low nominal interest rates and negative real interest rates (inflation is estimated at over 10% for 2007 and 2008), the rational behavior was to borrow and invest wherever it is possible. A booming real-estate market seemed to be the obvious choice most of the time. Under these conditions, everyone becomes a brilliant businessman. Entrepreneurial errors seem seldom while credit is abundant.

In the case of the housing sector, people failed to understand that demand for real estate is only sustainable if the ultimate reason for purchasing a property is to actually reside in it. Only [[saving]]s can allow for sustainable economic growth. Through inflation, credit flows excessively and distorts the production structure, allocating resources to projects that should have never existed in the first place and paving the way for the ensuing recession, that is, the adjustment of all the [[malinvestment]]s. Entrepreneurs can and will make mistakes even in the absence of inflation. But it is only through undue monetary expansion that the distortion occurs on a massive scale throughout the economy.

Production and saving cannot keep up with the pace of credit expansion, because production takes time and labor. The creation of additional money out of thin air does not add to the available amount of goods and services in the economy. If more credit is extended to construction companies, it does not mean there will be enough steel, cement, etc. — certainly not at prices that make the developments profitable. As soon as each company starts bidding for the same resource, it will tend to increase in [[price]], rendering some projects unviable. Resources are scarce. Printing more money can never alter this fact.<ref name="Ulrich_housing_bubble">Fernando Ulrich. [http://mises.org/daily/3956 "Rise and Fall in Dubai: An Austrian Perspective"], Mises Daily, December 16, 2009. Referenced 2010-07-28.</ref>

===Government intervention in the housing market===
Government policies intended to promote home ownership, even by people otherwise not able to afford it, date back to the 1930s if not before. Today, many government agencies and government-sponsored companies guarantee or subsidize mortgage loans, either directly or by providing a secondary market. Examples include the [[Federal Home Loan Banks]], the [[Federal Housing Administration]] (FHA), the [[Government National Mortgage Association]] (GNMA, "Ginnie Mae"), and the Department of Agriculture's [[Rural Housing Service]] and [[USDA Rural Development|Rural Development Guaranteed Loan Program]]. Some programs aim to make housing more affordable for particular groups, including military veterans, police officers, teachers, and Native Americans.

Some programs have forged strong links with politicians. The [[Fannie Mae|Federal National Mortgage Association]] (Fannie Mae) and [[Federal Home Loan Mortgage Corporation]] (Freddie Mac), both government sponsored, have been particularly notorious, enjoying cozy relations with members of Congress and an implicit (later explicit) government guarantee of their bonds.

Several much-discussed laws and regulations, including the [[Community Reinvestment Act]] of 1977 and its sequels, pressured financial institutions to make mortgage loans to normally unqualified borrowers, and even to make them in parts of cities where a prudent person would hesitate to walk. Lenders have also been pressured to grant relief to troubled mortgage debtors.

It is not obvious that homeownership is unequivocally desirable. Owning a house puts friction in the way of the owner's moving to a place where he could have a better job. The owner carries the burdens of maintenance, landscaping, and finding plumbers and other repairmen when emergencies arise. These burdens might be left in the first place to managers of rental properties, who would take advantage of professionalism, risk-spreading, and economies of scale. Yet government has gone to remarkable lengths in obeisance to "the American dream."

Tax laws have long privileged owner occupancy over renting. Homeowners may deduct mortgage-interest payments and real-estate taxes in figuring their federal income taxes, and they enjoy favorable tax treatment of gains on the sale of their houses. Federal tax law permits state and local government agencies to offer below-market-rate financing to homebuyers. Owners enjoy tax-free nonmonetary income (implicit rental income) from occupancy of their homes, whereas landlords pay tax on their rental income and pass it and the property tax along to their tenants.

Such policies have effects. Cheap credit during the years of the boom compounded the long-term effects of government action. As one would predict, cheap credit encouraged borrowing, building construction, and bullish speculation in houses. Even financially unqualified homebuyers took advantage of dubiously attractive subprime mortgages, mortgages whose initial teaser rates could later be raised, loans requiring no payment of principal during the early years, and even negative-amortization loans.

Some borrowers and mortgage brokers connived to conceal applicants' inability to meet even the loosened financial standards. Borrowers and lenders were seduced by expectations that the collateral — houses — would keep rising in price indefinitely. Low interest rates spurred savers and institutions to look for better yields even on new or exotic and riskier kinds of investment. Financiers reached for these yields, resorting to complicated and poorly understood financial derivatives and making defective assessments and unclear explanations of risks.<ref name="Yeager_bubble_background">Leland B. Yeager. [http://mises.org/daily/4531 "Pandemic: The Contagious Crisis"], Mises Daily, July 08, 2010. Referenced 2010-07-28.</ref>

===Financial markets===
An advanced economy is a tissue of intricate interdependencies whose unraveling damages finance, production, employment, and consumption. Contagion particularly bedevils financial intermediation, which is the business of banks and other financial firms and the stock market. Lending institutions borrow, normally at shorter-term and lower rates of interest, to relend at higher rates. Banks, for example, owe short-term debt to their depositors and use the funds for medium- and long-term loans and securities.

Financial intermediation tailors types, maturities, and risk/reward characteristics of financial instruments to meet the desires both of ultimate savers and of borrowers and stock-issuing firms. In an advanced economy, this intermediation is essential to channel savings efficiently into factories, farms, machinery, and other capital goods, so promoting economic growth.

By its very nature, intermediation requires firms performing it to operate heavily with borrowed funds. Their excess of assets over liabilities — their capital in this accounting sense (net worth) — amounts to only a very small percentage of either. Even ordinary businesses use borrowed funds to some extent; but financial firms practice this [[Leverage (finance)|leverage]], so called, to a more extreme degree. Their capital, a small percentage of their balance sheets, is vulnerable to being wiped out.

'''[[Securitization]]''' means bundling loans into packages that provide the backing for bonds issued by the bundlers. Ideally, these "[[Collateralized debt obligation|collateralized debt obligations]]" enable their buyers to enjoy the convenience of not making individual mortgage loans and also, normally, the relative safety of diversification. The bundlers receive their shares of these benefits from an interest-rate spread between what they earn on the loans and what they pay on their own obligations.

The process can be carried to further stages as the first-level bonds are cut into "tranches" according to the estimated riskiness of their backing. The different tranches can then serve as backing for a further level of bonds, and even further levels. The results are called CDO2s (collateralized debt obligations squared). Many of them received the highest ratings by the three government-privileged bond-rating companies, S&P, Moody's, and Fitch, so becoming approved holdings even for conservative investors such as pension funds, and building confidence among other investors also.

Yet these ratings, especially of unfamiliar debt instruments, proved overoptimistic. At the beginning of the chain, some of the underlying mortgage borrowers may not have been creditworthy — and in recent years, many of them certainly were not. While the process may achieve the apparent safety of diversification, it also makes risk assessment more difficult and obscures how participants along the chain share the risk of default on the underlying mortgages. Unforeseen defaults can spread and magnify damage along the whole ingenious chain.<ref name="Yeager_bubble_background" />

'''[[Credit-default swaps]]''' can be described as an insurance that investors buy to compensate for a loss if a particular debtor defaults on its obligation (a loan, mortgage, government debt, etc). The investor pays the CDS spread (the "insurance premium") and if the debtor defaults on its debt, the investor receives the insured sum. The CDS spreads indicate the confidence in the underlying bond.

Investors can buy CDSs even if they do not own any debt from the company that they refer to. These are the infamous naked credit-default swaps (already banned in Germany, there are plans to extend this ban to the rest of the EU). From a free-market point of view, betting on defaults of financial institutions is as legitimate as betting against a certain soccer team in the World Cup.<ref name="Bagus_CDS">Philipp Bagus. [http://mises.org/daily/4502 "The Social Function of Credit-Default Swaps"], Mises Daily, June 29, 2010. Referenced 2010-07-28.</ref>

Generally, the option of insurance means more certainty and that people will be more eager to lend money. However, if many are buying a specific "insurance", it will increase the spreads,and indicate distrust of the market. The institution in question may find it hard to borrow more money (this in fact happened to the [[2008–2010 Icelandic financial crisis|banks from Iceland]], and led to higher interest rate payments for the [[2010 European sovereign debt crisis#Greek government funding crisis|Greek government]]). Speculators can in this way warn the public that a company - or a government - won't be able to pay its debts. They may also bring about the collapse of unstable companies sooner.<ref name="Mera_CDS">Xavier Méra. [http://blog.mises.org/13177/second-thoughts-on-sovereign-credit-default-swaps/ "Second Thoughts on Sovereign Credit-Default Swaps"], Mises Economics Blog, July 6, 2010. Referenced 2010-07-28.</ref><ref name="Bagus_CDS" /> The default-swap issuer can also go broke - and with greater likelihood than a regular "insurer", because of the relative complexity and novelty of the transactions. For an example see the insurer [[American International Group|AIG]], which had to be rescued by the government.<ref name="Yeager_bubble_background" /> (As Treasury Secretary [[Timothy Geithner]] said: "Despite regulators in 20 different states being responsible for the primary regulation and supervision of AIG’s U.S. insurance subsidiaries, despite AIG’s foreign insurance activities being regulated by more than 130 foreign governments, and despite AIG’s holding company being subject to supervision by the Office of Thrift Supervision (OTS), no one was adequately aware of what was really going on at AIG."<ref name="Geithner_AIG">Secretary Timothy F. Geithner. [http://oversight.house.gov/images/stories/Hearings/Committee_on_Oversight/TESTIMONY-Geithner.pdf "Written Testimony"] (pdf) for the House Committee on Oversight and Government Reform, January 27, 2010. Referenced 2010-07-28.</ref>)

The whole tissue of economic interrelations rests on '''trust'''. Confidence can be justified, excessive, or abnormally weak. Confidence can rise or fall in waves of herding: understandably, people without enough information to make judgments on their own regard others' behavior as guided by information that they possess. A boom reinforces confidence. People are inclined to fall for dishonest schemes. A bust saps confidence. People and institutions, including banks, become more cautious in doing business with one another.

The stock market, swinging widely, both registers and magnifies the state of confidence or fear. Loss of stock and house values makes consumers hesitant to spend money, depriving businesses of sales in a further fall of dominos.

'''[[Moral hazard]]''' is a danger: past rescues breed expectations of more in the future. So soothed, firms run greater risks than would otherwise be prudent (just as fire insurance soothes homeowners to be less obsessively cautious than they would be without it). Against a long background of bank and hedge-fund rescues, the rescue of [[Bear Stearns]] in March 2008 further bolstered expectations. These were disappointed when [[Lehman Brothers]] was allowed to fail in mid-September. The crisis deepened, arousing hopes that the authorities had learned a lesson and would not allow a similar major collapse. The economy faces a [[Catch-22 (logic)|catch-22]]: damned by immediate damage if a rescue goes unattempted, and damned by the longer-run moral hazard if a rescue ''is'' undertaken.

Moral hazard presents a major short-run versus long-run contrast. Rescue of a troubled bank may seem the best thing to do immediately, but it reinforces expectations of further rescues, inviting repeated trouble later.<ref name="Yeager_bubble_background" />

===Regime uncertainty===
The December 2009 regular survey on Small Business Economic Trends by the [[National Federation of Independent Businesses|NFIB]] showed that capital expenditures and near-term plans for new capital investments remained stuck at 35-year lows. The same survey revealed that only 7% of small businesses saw the next few months as a good time to expand. Only 8% of small businesses reported job openings, as compared to 14%-24% in 2008, depending on month, and 19%-26% in 2007. The weak economy was the most prevalent reason given for why the next few months are "not a good time" to expand, but "political climate" was the next most frequently cited reason, well ahead of borrowing costs and financing availability. The authors stated: "the other major concern is the level of uncertainty being created by government, the usually source of uncertainty for the economy. The 'turbulence' created when Congress is in session is often debilitating, this year being one of the worst. . . . There is not much to look forward to here."<ref name="NFIB_Small_business">William C. Dunkelberg, Holly Wade. [http://www.nfib.com/Portals/0/PDF/sbet/SBET200912.pdf "NFIB Small Business Economic Trends"] (pdf), December 2009. Referenced 2010-08-15.</ref>

Business investment in the third quarter of 2009 was down 20% from the low levels a year earlier. Job openings were at the lowest level since the government began measuring the concept in 2000. The pace of new job creation by expanding businesses was slower than at any time in the past two decades and, though older data are not as reliable, likely slower than at any time in the past half-century. While layoffs and new claims for unemployment benefits have declined in recent months, job prospects for unemployed workers have continued to deteriorate. The exit rate from unemployment was lower now than any time on record, dating back to 1967.

According to the Michigan Survey of Consumers, 37% of households planned to postpone purchases because of uncertainty about jobs and income, a figure that has not budged since the second quarter of 2009, and one that remained higher than any previous year back to 1960.<ref name="Becker_Uncertainty">Gary S. Becker, Steven J. Davis and Kevin M. Murphy. [http://online.wsj.com/article/SB10001424052748703278604574624711732528426.html "Uncertainty and the Slow Recovery"], ''The Wall Street Journal'', January 4, 2010. Referenced 2010-08-15.</ref> In 2009, companies were holding more cash — and a greater percentage of assets in cash — than at any time in the past 40 years.<ref name="McGinty_cash">Tom McGinty and Cari Tuna. [http://online.wsj.com/article/SB125712303877521763.html "Jittery Companies Stash Cash"], ''The Wall Street Journal'', November 3, 2009. Referenced 2010-08-15.</ref><ref name="Higgs_cash">Robert Higgs. [http://www.independent.org/blog/index.php?p=3890 "More Evidence of Current Regime Uncertainty?"], ''The Beacon'', blog of the The Independent Institute, Nov 7, 2009. Referenced 2010-08-15.</ref>

The chairman of China’s [[sovereign wealth fund]] said in late 2008 that China had no plans for further investments in Western financial institutions. "Right now we do not have the courage to invest in financial institutions because we do not know what problems they may have." Mr. Lou said that the sheer pace of new initiatives and new rules issued by Western regulatory agencies was disconcerting and made it even harder for him to choose worthwhile investments. "If it is changing every week, how can you expect me to have confidence?" he asked.<ref name="Bradsher_China">Keith Bradsher. [http://www.nytimes.com/2008/12/04/business/worldbusiness/04yuan.html?_r=2&adxnnl=1&adxnnlx=1228594043-/gsxRDJZWxAxLLCcUhx8oQ "China Shuns Investments in West’s Finance Sector"], ''The New York Times'', published: December 3, 2008. Referenced 2010-08-15.</ref><ref name="Higgs_China">Robert Higgs. [http://www.independent.org/blog/index.php?p=635 "Regime Uncertainty in 1937 and 2008"], ''The Beacon'', blog of the The Independent Institute, Dec 6, 2008. Referenced 2010-08-15.</ref>

The chairman of the [[Business Roundtable]], an association of top corporate executives that has been [[Barack Obama|President Obama's]] closest ally in the business community, accused the president and Democratic lawmakers in June, 2010, of creating an "increasingly hostile environment for investment and job creation." ... "By reaching into virtually every sector of economic life, government is injecting uncertainty into the marketplace and making it harder to raise capital and create new businesses."<ref name="Montgomery_stifle_growth">Lori Montgomery. [http://www.washingtonpost.com/wp-dyn/content/article/2010/06/22/AR2010062205279.html "Business leaders say Obama's economic policies stifle growth"], ''Washington Post'', June 23, 2010. Referenced 2010-08-15.</ref>
{{Main|Regime uncertainty}}

==Burst of the bubble==
Some consider the [[Bankruptcy of Lehman Brothers|bankruptcy of Lehman Brothers]] to cause the financial panic of late 2008.<ref name="Jones_Lehman">Sam Jones. [http://ftalphaville.ft.com/blog/2009/03/12/53515/why-letting-lehman-go-did-crush-the-financial-markets/ "Why letting Lehman go did crush the financial markets"], ''Financial Times'' on Mar 12 2009. Referenced 2010-07-30.</ref> According to others, the main risk indicators only took off after Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke's [[Troubled Asset Relief Program|TARP]] speeches to Congress on Sept. 23 and 24.<ref name="Cochrane_TARP">John H. Cochrane and Luigi Zingales. [http://online.wsj.com/article/SB10001424052970203440104574403144004792338.html "Lehman and the Financial Crisis"], ''The Wall Street Journal'', September 15, 2009. Referenced 2010-07-30.</ref><ref name="Taylor_responses">John B. Taylor. [http://www.stanford.edu/~johntayl/FCPR.pdf "The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong"] (pdf), November 2008, referenced 2010-07-30.</ref>

Still others point out, that the previous bailouts (esp. Bear Stearns in March 2008) produced in the markets an expectation, that the government will bail out large financial institutions and its decision to let Lehman Brothers to fall has surprised and shocked them.<ref name="Suster_Lehman">Matěj Šuster. [http://www.libinst.cz/komentare.php?id=574 "Pád Lehman Brothers a finanční panika"] ("Fall of Lehman Brothers and financial panic", in ''[[Czech language|Czech]]''), ''[http://libinst.cz/stranka_en.php?id=2 Liberalni Institut]'', 2009-09-20. Referenced 2010-07-30.</ref> (It has been noted, however, that there is a significant relationship between lobbying and bailout money, as well as a greater chance of getting bailouts depending on a bank’s ties with either the Federal Reserve or key members of Congress.<ref name="Mitchell_corruption">Daniel J. Mitchell. [http://www.cato-at-liberty.org/2009/12/22/university-of-michigan-study-confirms-link-between-financial-bailout-and-corruption/ "University of Michigan Study Confirms Link between Financial Bailout and Corruption"], ''Cato Institute'', December 22, 2009. Referenced 2010-07-31.</ref>)

===Unemployment===
Total employment peaked in 2007 at 137.6 million persons on nonfarm payrolls, fell slightly in 2008, and then dropped precipitously in 2009 to 132.0 persons, for a two-year loss of 5.6 million jobs. In 2009, total employment was approximately equal to its magnitude in 2001, even though the labor force had grown substantially in the interim.

The loss of employment has occurred entirely in the private sector: employment fell from 115.4 million persons in 2007 to 109.5 million persons in 2009, a decline that took private employment back to its level at the end of the 1990s. As private employment has collapsed since 2007, however, the government payroll has actually grown slightly from 22.2 million persons in 2007 to 22.5 million persons in 2009, which puts this class of employment roughly 1.7 million persons above its magnitude in 2000.<ref name="Higgs_unemployment">Robert Higgs. [http://www.independent.org/blog/index.php?p=4728 "Pity the Poor Private-Sector Workers"], ''The Independent Institute'', Jan 9, 2010. Referenced 2010-07-31.</ref>

The government employees also enjoyed increased compensation. The growth in six-figure salaries has pushed the average federal worker’s pay to $71,206, compared with $40,331 in the private sector.<ref name="Higgs_federal">Robert Higgs. [http://www.independent.org/blog/index.php?p=4383 "The Federal Bureaucracy-Plutocracy"], ''The Independent Institute'', Dec 12, 2009. Referenced 2010-07-31.</ref><ref name="Cauchon_Feds">Dennis Cauchon. [http://www.usatoday.com/news/washington/2009-12-10-federal-pay-salaries_N.htm "For feds, more get 6-figure salaries"], ''USA TODAY'', 2009-12-10. Referenced 2010-07-31.</ref>

This situation bears a resemblance to the employment situation during the [[Great Depression]], when private nonfarm hours worked fell steeply from 1929 to 1932 and did not get back to the 1929 level until 1941, notwithstanding (or perhaps because of) the millions of persons added to government payrolls during the New Deal period. In both cases, the possibility that government employment crowds out private employment, rather than stimulating it, cannot be dismissed out of hand.

The 2000s may prove to have been America’s second "lost decade" (the 1930s having been the first), an interval of little or no net economic gain, owing to destructive government policies that produced only unsustainable booms followed by inevitable busts, along with such huge, frequent, and unsettling changes in government policies that private planning, especially for long-term investment, has become too risky for private investors to bear — a situation called [[Uncertainty#Regime uncertainty|regime uncertainty]].<ref name="Higgs_unemployment" />

==After the fall==
Since the summer of 2008, the U.S. Treasury and the Fed initiated a new wave of spending, lending, and subsidizing programs ostensibly aimed at stemming the recession that began early in that year and deepened quickly in its last quarter and in the first quarter of 2009. Among the most notable of these programs have been attempts to prop up the real estate market and the residential construction industry, where the Fed’s easy-money policies in the first half of the present decade induced lenders to make millions of mortgage loans to home buyers who would not have qualified for such loans if traditional underwriting standards had been applied.

Rather than terminating the government policies that had encouraged the foolish behavior of real estate buyers, sellers, and lenders, the government has undertaken to continue and even to compound the selfsame policies that in large part caused our present economic troubles. For example, Fannie and Freddie, now effectively government owned and operated firms, continue to extend loans as if promising borrowers were superabundant.

Moreover, the [[Federal Housing Administration]], a government agency created in 1934 to insure conventional mortgage loans, has greatly expanded the volume of its business, and according to a [http://www.nytimes.com/2009/11/20/business/20limits.html?_r=1 report] in the New York Times, the FHA "is underwriting loans at quadruple the rate of three years ago even as its reserves to cover defaults are dwindling." The Mortgage Bankers Association affirmed on November 19, 2009 that "more than one in six F.H.A. borrowers was behind on payments." The FHA has backed 37 percent of all residential mortage loans made in 2009. Reporter Patrice Hill observes that "these loans are exposing taxpayers to the same kinds of soaring default rates and losses that brought down Fannie Mae and Freddie Mac as well as destroyed many banks and the private market for mortgage loans."<ref name="Higgs_housing">Robert Higgs. [http://www.independent.org/blog/?p=4069 "Government Responds to Economic Woes by Making More Bad Mortgage Loans"], ''The Independent Institute'', Nov 22, 2009. Referenced 2010-07-30.</ref>

Households across a majority of large U.S. cities received more foreclosure warnings in the first six months of 2010 than in the first half of 2009. In all, 154 out of 206 metropolitan areas with at least 200,000 residents posted an annual increase in foreclosure activity between January and June. The threat of foreclosures is spreading well beyond the top tier of metropolitan areas located in California, Florida, Nevada and Arizona, which have borne the brunt of the fallout from the housing crisis. "The face of foreclosure is driven much more now by unemployment than in the past," said the speaker of a foreclosure listing firm. The number of households facing foreclosure in the first half of the year climbed 8 percent versus the same period last year, but dropped 5 percent from the last six months of 2009.<ref name="Veiga_foreclosures">AP Real Estate Writer Alex Veiga. [http://news.yahoo.com/s/ap/20100729/ap_on_bi_ge/us_foreclosure_rates "Foreclosure activity up across most US metro areas"], ''Yahoo News'' / ''Associated Press'', Jul 29, 2010. Referenced 2010-07-31.</ref>

===Impact on Investment===
In 2006, gross private domestic [[investment]] reached its most recent peak, at $2.33 trillion (in constant 2005 dollars), or 17.4 percent of GDP. After remaining almost at this level in 2007, this measure of investment fell substantially during each of the next two years, reaching $1.59 trillion, or 11.3 percent of GDP, in 2009.

The greater part of gross investment consists of what the statisticians call the capital consumption allowance, an estimate of the amount of money that must be spent simply to offset wear and tear and obsolescence of the existing capital stock. In a country such as the United States, with an enormous fixed capital stock built up over the centuries, a great amount of funds must be allocated simply to maintain that stock. In recent years, the private capital consumption allowance has ranged from $1.29 trillion in 2005 to $1.46 trillion (in constant 2005 dollars) in 2009. Thus, even in the boom year 2006, about 60 percent of gross private domestic investment was required merely to maintain the economy’s productive capacity, leaving just 40 percent, or $889 billion in net private domestic investment, to augment that capacity.

From that level, net private domestic investment plunged during each of the following three years, taking the greatest dive between 2008 and 2009, when it fell to only $54 billion (in constant 2005 dollars), having declined altogether by 94 percent from its 2006 peak! Only 3.5 percent of all private investment spending in 2009 went toward building up the capital stock. Thus, net private investment did not simply fall during the recession; it virtually disappeared. Without substantial net private investment, brisk economic growth is unthinkable beyond the very short run.<ref name="Higgs_Divergence">Robert Higgs. [http://www.independent.org/blog/index.php?p=7882 "The Great Divergence: Private Investment and Government Power in the Present Crisis"], ''The Independent Institute'', on Sep 18, 2010. Data taken or derived from the National Economic Accounts prepared by the Commerce Department’s ''Bureau of Economic Analysis'' (Tables 1.1.5, 1.1.6, and 5.2.6 - see a [http://www.bea.gov/national/nipaweb/SelectTable.asp?Selected=N list of tables] for information. Referenced 2010-09-20.</ref>

==End of the crisis?==
In September, 2010, the [[National Bureau of Economic Research]] concluded, that the recession has ended in June 2009. It defines a recession as following:
<blockquote>"A recession is a period of falling economic activity spread across the economy, lasting more than a few months, normally visible in real [[GDP]], real income, employment, industrial production, and wholesale-retail sales. The trough marks the end of the declining phase and the start of the rising phase of the business cycle."</blockquote>

According to the Bureau, the recession lasted 18 months, which makes it the longest of any recession since World War II. Previously the longest postwar recessions were those of 1973-75 and 1981-82, both of which lasted 16 months.

The committee did not conclude that economic conditions since that month have been favorable or that the economy has returned to operating at normal capacity. Rather, the committee determined only that the recession ended and a recovery began in that month.<ref name="NBER_recovery">National Bureau of Economic Research. [http://www.nber.org/cycles/sept2010.html "Business Cycle Dating Committee, National Bureau of Economic Research"], referenced 2010-12-06.</ref>

[[Frank Shostak]] holds, that the NBER's definition does not provide an explanation of what a recession is all about. The main reason why the NBER's definition is confined to describing manifestations rather than the underlying causes of a recession is because mainstream thinkers do not hold that such causes can be known. They are of the view that the sources of recessions are various random shocks emanating from various factors such as a sudden change in people's psychology or various unexpected political and other events. In short, these causes are of an unexpected nature.

In a [[Free market|free unhampered environment]] it is conceivable that the economy would be subject to various shocks, but it is difficult to envisage a phenomenon of recurrent [[Business cycle|boom-bust cycles]].

Shostak points out, that movements in GDP mirror past money pumping. And since a loose monetary policy will start an exchange of 'nothing for something', a rebound in the GDP rate of growth is actually likely to reflect a weakening in the wealth-formation process, which is bad news for the economy. A fall in the growth momentum of [[money supply]] is likely to undermine the rate of growth of GDP in the months ahead. This will be seen by most experts as bad economic news. On the contrary, Shostak suggests that the expected downturn is actually going to be good news for the wealth generating process.<ref name="Shostak_NBER">Frank Shostak. [http://mises.org/daily/4741 "How Useful Is the NBER's Dating of Business Cycles?"], ''Mises Daily'', September 26, 2010. Referenced 2010-12-06.</ref>

===Housing===
Foreclosures were at a record high in 2010, and more than 1 million people lost their homes, even as notices started leveling off during the end year. In total, there were nearly 2.9 million foreclosure notices filed during the year, according to report released Thursday by RealtyTrac. That was a record high, but just 1.7% above 2009. It probably would have been higher had notices not plunged in November and December as banks halted tens of thousands of foreclosures in the face of the "robo-signing" scandal,<ref name="Christie_repossessed">Les Christie. [http://finance.yahoo.com/news/1-million-homes-repossessed-cnnm-3351544913.html?x=0&sec=topStories&pos=3&asset=&ccode= "1 million homes repossessed in 2010"], ''YAHOO! Finance'', January 13, 2011. Referenced 2011-01-13.</ref> where loan servicers had employees sign thousands of documents a month without verifying the information.<ref name="Luhby_robo-signer">Tami Luhby. [http://money.cnn.com/2010/10/28/real_estate/robosigner/index.htm "I was a robo-signer"], ''CNNMoney.com'', October 28, 2010. Referenced 2011-01-13.</ref>

Amherst Securities analyst Laurie Goodman says that as many as 11 million mortgage borrowers are in potential danger of default. Rick Sharga at RealtyTrac, predicted 4 million to 5 million, less than half as many but still disastrous.<ref name="Christie_repossessed" /> According to Case-Shiller Home Price Index home prices are diving again,<ref name="S_P_Weaken">David R. Guarino, David Blitzer. [http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldocumentfile&blobtable=SPComSecureDocument&blobheadervalue2=inline%3B+filename%3Ddownload.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1245281640766&blobheadervalue3=abinary%3B+charset%3DUTF-8&blobnocache=true "U.S. Home Prices Weaken Further as Six Cities Make New Lows According to the S&P/Case-Shiller Home Price Indices"] (pdf), ''S&P Indices'', December 28, 2010. Referenced 2011-01-13.</ref> spelling trouble for more homeowners given high unemployment and diminished job prospects.<ref name="French_Vibes">Douglas French. [http://blog.mises.org/15318/a-million-foreclosed-homes-with-bad-vibes/ "A Million Foreclosed Homes With Bad Vibes"], January 13, 2011. Referenced 2011-01-13.</ref>

In 2010, nearly 11 percent of all housing units have been vacant all year round and renting apartments became ever more popular.<ref name="Olick_Empty">Diana Olick. [http://www.cnbc.com/id/41355854/ "Nearly 11 Percent of US Houses Empty"], ''CNBC'', 31 Jan 2011. Referenced 2011-02-02.</ref>

===Recovery of unemployment===
As of 2011, jobs recovery has been very slow and dominated by low-paying jobs. Growth has been concentrated in mid-wage and lower-wage industries. By contrast, higher-wage industries showed weak growth and even net losses. In the first seven months of 2010, 76% of jobs created were in low- to mid-wage industries -- those earning between $8.92 to $15 an hour, well below the national average hourly wage of $22.60.

But jobs losses continue in higher-wage industries severely hit by the bursting of the housing bubble -- construction and financial services. Recoveries in those sectors helped lead the economy out of earlier downturns, but they're still suffering more than a year and a half after the official end of the Great Recession. High-wage sectors -- made up of jobs that pay between $17.43 and $31 an hour -- accounted for nearly half the jobs lost during the recession, but have produced only 5% of the new jobs since hiring resumed, study showed.

Even in some of the higher-wage industries that are hiring, it's lower-wage occupations within the sector where the jobs are being added. Professional and business services sectors gained a healthy 366,000 jobs in 2010. Workers in that sector earned $27.23 an hour, on average, in 2010. But almost all of the new jobs -- 308,000 -- came in temporary help services, where the average hourly wage was only $15 an hour. Temporary jobs accounted for nearly one in four jobs created by all types of businesses last year.<ref name="Isidore_Jobs">Chris Isidore. [http://money.cnn.com/2011/01/31/news/economy/low_wage_job_growth/index.htm?hpt=C2 "Jobs are back! But the pay stinks"], ''CNNMoney.com'', January 31, 2011. Referenced 2011-02-02.</ref>

==References==
{{Reflist}}

==Links==
* The [[Wikipedia:Late-2000s recession|Late-2000s recession]] on Wikipedia
* [http://video.google.com/videoplay?docid=-2757699799528285056 Real Estate Roller Coaster] (video), history of home values, 1890-2006
* [http://mises.org/daily/3128 The Bailout Reader] by Mises.org, September 2008
* [http://mises.org/daily/4059 Illusions of the Age of Keynes] by Doug French, January 2010
* [http://www.independent.org/blog/index.php?p=5142 Anatomy of the Current Recession] by Robert Higgs, February 2010
* [http://mises.org/daily/4787 Bank Failures in Slow Motion] by Doug French, October 2010
* [http://mises.org/books/walkaway_french.pdf Walk Away: The Rise and Fall of the Home-Ownership Myth] (pdf) by Douglas E. French, 2010
* [http://www.anarcocapitalista.com/JHSLSE10.htm Financial Crisis and Economic Recession] by Professor Huerta de Soto, October 2010
* [http://mises.org/daily/4989 Can Austrian Theory Explain Construction Employment?] by Robert P. Murphy, January 2011

{{DEFAULTSORT:Great Recession, The}}
[[Category:History]]
[[Category:Issues]]
[[Category:Financial crises]]

Bank of England

2011-02-05T21:05:02Z

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The '''Bank of England''' is the [[central bank]] of the [[United Kingdom|United Kingdom]]. Its development and that of the English banking system has become the model for many other countries.<ref name="Smith_banking_England">Smith, Vera C. [http://www.econlib.org/library/LFBooks/SmithV/smvRCB2.html "The Rationale of Central Banking and the Free Banking Alternative"], Chapter II - The Development of Central Banking in England, online version, referenced 2009-07-30.</ref>

==History==
Banking in the modern sense originated in about the middle of the seventeenth century, when merchants took to depositing their balances of coin and bullion with the goldsmiths. The goldsmiths began to offer interest on deposits, since they could re-lend them at higher rates, and the receipts they gave in acknowledgment of the deposits began to circulate as money. And so arose a number of small private firms, all having equal rights, and carrying on the issue of notes unrestricted and free from Government control.<ref name="Smith_banking_England" />

===Early history===
[[Wikipedia:Charles II of England|Charles II]] relied to a very large extent for his financial needs on loans from the London bankers. He ran heavily into debt and in 1672 suspended [[Wikipedia:Exchequer|Exchequer]] payments and so the repayment of bankers' advances. The King's credit was ruined by this for several decades. To substitute for these sources of income, [[Wikipedia:William III of England|William III]] and his government founded with a Scottish financier [[Wikipedia:William Paterson (banker)|William Patterson]] the 'Governor and Company of the Bank of England', as a minor declaration in the many clauses of the Tunnage Act of 1694 (thus, the Bank in its early years was called the "Tunnage Bank."<ref name="French_Bubbles">Doug French. [https://mises.org/resources/3628 Early Speculative Bubbles and Increases in the Supply of Money] ([http://mises.org/books/bubbles_french.pdf pdf]), Second Edition, 2009. Referenced 2011-01-09.</ref>) The Bank was founded with a capital of £1,200,000, immediately lent to the Government. In return the Bank could issue notes to the same amount.<ref name="Smith_banking_England" />

The Bank of England went bankrupt after two years of operation, in 1696, and survived because of government granted suspension of payments. The English Crown remained its main customer and granted additional privileges, such as legal protection against the competition of other banks.<ref name="Hulsmann_Bank_of_England">Jörg Guido Hülsmann. [http://www.mises.org/books/moneyproduction.pdf "The Ethics of Money Production"], online version, Chapter 15. Fiat Monetary Systems in the Realm of the Nation-State p.199-203, referenced 2009-07-30.</ref>

The extensions of its charter often "coincided with the grant of additional loans to the State",<ref name="Parliament_finance">Great Britain. Committee on Currency and Foreign Exchanges, Great Britain. Committee on Finance and Industry. [http://books.google.ca/books?id=EkUTaZofJYEC&pg=PA25&lpg=PP1&dq=British+Parliamentary+reports+on+international+finance "British Parliamentary reports on international finance"], online version, referenced 2009-08-02.</ref> and the initial limits on the activities of the Bank and the sums it could borrow to the crown were over time repealed. The accumulating privileges gave the Bank of England a position of prestige and influence in the financial world, and smaller banks had difficulties to compete in the same lines of business. In London was the majority of private note issues abandoned by about 1780. The smaller banks began to keep balances with the Bank of England, which was already beginning to acquire the characteristics of a Central Bank.<ref name="Smith_banking_England" />

The modern form of [[central bank]]ing was established by the [[Wikipedia:Bank Charter Act 1844|Peel Act of 1844]]. The Bank of England was granted an absolute [[monopoly]] on the issue of all bank notes in England. These notes, in turn, were redeemable in gold. Private commercial banks were only allowed to issue demand deposits. This meant that, in order to acquire cash demanded by the public, the banks had to keep checking accounts at the Bank of England. In effect, bank demand deposits were redeemable in Bank of England notes, which in turn were redeemable in gold. There was a double-inverted pyramid in the banking system. At the bottom pyramid, the Bank of England, engaging in fractional-reserve banking, multiplied fake warehouse receipts to gold—its notes and deposits—on top of its gold reserves. In their turn, in a second inverted pyramid on top of the Bank of England, the private commercial banks pyramided their demand deposits on top of ''their'' reserves, or their deposit accounts, at the Bank of England.<ref name="Rothbard_BoE">[[Murray N. Rothbard]]. [http://mises.org/books/fed.pdf The Case Against the Fed] (pdf), referenced 2010-05-10.</ref>

===Later history - a timeline===

{| border="0" cellspacing="0" cellpadding="5" align="center"
|'''Year:'''
|'''Events:'''<ref name="Hulsmann_Bank_of_England" /><ref name="Smith_banking_England" /><ref name="BoE_history">Bank of England website. [http://www.bankofengland.co.uk/about/history/index.htm History], referenced 2009-08-03.</ref>
|-
|1694
|Foundation of the bank and a loan to the government
|-
|1696
|Suspension of payments
|-
|1697
|
* Renewal of charter, loan to the government
* Limited liability privilege
* Extension of note issue
* Monopoly cashier of payments to the government
|-
|1709
|
* Renewal of charter and a loan
* Monopoly on joint stock banking with more than six partners
|-
|1713
|Renewal of charter and a loan
|-
|1742
|Renewal of charter, loan to the government without interest
|-
|1751
|Monopoly administrator of the public debt
|-
|1764
|Renewal of charter for a fee paid to the government
|-
|1781
|Renewal of charter and a loan to the government
|-
|1793
|Legalization of short-term loans to government beyond statutory limitations, loan to the government
|-
|1795
|Authorization of £5 notes
|-
|1797
|
* Authorization of £1 and £2 notes
* [[Bank run|Run]] on the bank, suspension of payments, a loan to the government
|-
|1800
|Renewal of charter and a loan to the government
|-
|1812–19
|Bank of England notes are legal tender, further loans to the government
|-
|1821
|Resumption of payments in gold after wars with [[Wikipedia:Napoleonic Wars|France]]
|-
|1825
|Lending to country banks in crisis, re-issue of £1 notes
|-
|1826
|
* Joint stock banks permitted outside of London
* Bank of England authorised to set up branches
* Prohibited issue of notes lower than £5
|-
|1833
|Bank of England notes become legal tender for sums above £5
|-
|1839
|Liquidity crisis, received credits from the [[Wikipedia:Banque de France|Banque de France]] (£2,000,000) and from the Hamburger Bank (£900,000);<ref name="Hulsmann_Modern_Banking">Jörg Guido Hülsmann. [http://www.mises.org/books/moneyproduction.pdf "The Ethics of Money Production"], online version, Chapter 10. Legal-Tender Laws p.143, referenced 2009-09-19.</ref>
|-
|1844
|[[Wikipedia:Bank Charter Act 1844|Peel Act]], monopoly of note issue in Great Britain, loan to the government
|-
|1914–25
|
* Bank of England notes are legal tender
* Suspension of payments, loans to the government
|-
|1931
|Abandonment of the [[Gold standard]]
|-
|1946
|Nationalisation
|}

===The Scottish Exception===
The Bank of England does not have a monopoly on the issue of banknotes in Scotland (or Northern Ireland). The reason was the [[Wikipedia:Acts of Union 1707|union]] of Scotland and England after the foundation of the bank, and so could the Scottish banks develop separately. The [[Wikipedia:Bank of Scotland|Bank of Scotland]] was a privately held bank, with a monopoly held from 1695 to 1716, its charter was not renewed. Another charter was granted in 1727 to the [[Wikipedia:Royal Bank of Scotland|Royal Bank of Scotland]].

The private banks, however, could operate freely as long as the shareholders accepted unlimited liability for the debts of their banks. Banking was soon dominated by a number of companies of considerable size and financial strength. The system was distinguished by keen competition between the banks and a strict practice of regularly clearing each other's notes (exchanges were made twice a week and balances immediately settled). They quickly adopted branch organisation, and there was, as compared with other countries, a much more rapid growth of deposit banking and development of loan technique. The highly developed Scottish banking, free from legislative interference, has inspired many proponents of free banking.<ref name="Smith_banking_Scotland">Smith, Vera C. [http://www.econlib.org/library/LFBooks/SmithV/smvRCB3.html "The Rationale of Central Banking and the Free Banking Alternative"], Chapter III - The Scottish System, online version, referenced 2009-08-03.</ref>

==References==
{{Reflist}}

==External links==
* [http://www.bankofengland.co.uk/ Bank of England], home page and the [http://www.bankofengland.co.uk/about/legislation/1694act.pdf founding document] (pdf)
* [http://en.wikipedia.org/wiki/Bank_of_England Bank of England] on Wikipedia
* British History Online, [http://www.british-history.ac.uk/report.aspx?compid=46422 Statutes of the Realm, Volume 6]. 
* John H. Clapham, ''The Bank of England: A History, 1694–1914'', ([http://www.archive.org/details/bankofenglandvol030839mbp archived])
*[http://www.anarcocapitalista.com/JHSLSE10.htm Financial Crisis and Economic Recession, The Fatal Error of Peel's Bank Act] by Professor Huerta de Soto

[[Category:Central banks|England]]

Austrian Business Cycle Theory

2011-02-05T21:01:21Z

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The [[business cycle]] describes regularly occurring booms and busts observed in the economy and the '''Austrian Business Cycle Theory''' (sometimes called the "hangover theory"<ref name="Cochran_ABCT">John P. Cochran. [http://mises.org/daily/630 "The Hangover Theory?"], Mises Daily, Friday, March 16, 2001, referenced 2009-11-14.</ref> or simply '''ABCT''') is an explanation of this phenomenon from the [[Austrian School]]. Originally developed by [[Ludwig von Mises]] in the 1912 ''[[Theory of Money and Credit]]'' it was elaborated on by [[Friedrich Hayek|Hayek]] and others.<ref name="Rothbard_business_cycle">[[Murray N. Rothbard]]. [http://mises.org/pdf/austtrad.pdf "The Austrian Theory of the Trade Cycle and other essays"] (pdf), "Economic Depressions: Their Cause and Cure", p.58-81, referenced 2009-10-27.</ref> In one classical rendition:

Banks expand credit well beyond their own assets and by the funds of their clients, often supported or encouraged by the setting of low interest rates by a central bank. This additional credit flow into the economy from increased borrowing for capital projects stimulates economic activity. Projects which would not have been started before, seem now profitable, creating [[malinvestment]]. They increase demand for production materials and for labor and their prices rise, which, in turn, leads to an increase in prices of consumption goods. If the banks would stop the extension of credit, the boom would be rapidly over. To prevent the sudden halt of this boom (and the resulting collapse of prices), the banks must create more and more credit, and the prices will rise even more.

But this expansion of credit cannot continue forever. There is no additional capital or labor; there is only more money (and debt). The means of production and labor which have been diverted to the new enterprises have to be taken away from others. Society is not sufficiently rich to permit the creation of new enterprises without taking away from others. As long as the expansion of credit is continued this will not be noticed, but it can't be pushed indefinitely. The inflation and the boom can last only as long as the public thinks that the prices will stop rising in the near future. When the public becomes aware, that there the inflation will not end, and that prices will continue to rise, panic sets in. Eventually, people may give up the currency and rush to exchange money for goods, buying things they have no use for, just in order to get rid of the money (the so-called "[[flight into real values]].")<ref name="Mises_business_cycle">[[Ludwig von Mises]]. [http://mises.org/pdf/austtrad.pdf "The Austrian Theory of the Trade Cycle and other essays"] (pdf), "The Austrian Theory of the Trade Cycle", p.23-32, referenced 2009-10-27.</ref>

==History==
The regularly occurring booms and and busts were observed from approximately late eighteenth century, along with the start of the [[Industrial Revolution]]. Sudden economic crisis, when some king made war or confiscated the property of his subject were known; but there was no sign of the modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions.<ref name="Rothbard_business_cycle" />

The Austrian cycle theory began with the eighteenth century Scottish philosopher and economist [[David Hume]], and with the eminent early nineteenth century English classical economist [[David Ricardo]]. These theorists observed another crucial institution developing in the mid-eighteenth century, alongside the industrial system. It was the institution of banking, with its capacity to expand credit and the money supply (first, in the form of paper money, or bank notes, and later in the form of demand deposits, or checking accounts, that are instantly redeemable in cash at the banks). It was the operations of these commercial banks which held the key to the mysterious recurrent cycles of expansion and contraction, of boom and bust, that had puzzled observers since the mid-eighteenth century.

The English "[[British Currency School|Currency School]]" has tried to explain the boom by the extension of credit resulting from the issue of banknotes without metallic backing. But the school did not see that current accounts which could be drawn upon at any time via checks, play exactly the same role in the extension of credit as bank notes. Because of the legislation inspired by the Currency School (like the [[Robert Peel|Peel]]'s [[Bank Act of 1844]] and similar laws in other countries), to prevent other economic crises, the issue of banknotes without metallic backing was restricted, but the expansion of credit through current accounts was unregulated. From this it was wrongly concluded that the English School's attempt to explain the trade cycle in monetary terms had been refuted by the facts.

The Currency School has also restricted its analysis to the case where credit is expanded in only one country while the banking policy of all the others remains conservative. The internal rise in prices would encourage imports and paralyse exports. Metallic money would drain away to foreign countries. As a result the banks would face increased demands for repayment of the instruments they have put into circulation (such as unbacked notes and current accounts), until they have to restrict credit. Ultimately the outflow of specie checks the rise in prices. The Currency School analyzed only this particular case; it did not consider credit expansion on an international scale by all the capitalist countries simultaneously. In the second half of the 19th century, this theory of the trade cycle fell into discredit, and the notion that the trade cycle had nothing to do with money and credit gained acceptance. The attempt of [[Knut Wicksell|Wicksell]] (1898) to rehabilitate the Currency School was short-lived.<ref name="Mises_business_cycle" />

== Questions Addressed ==

The Austrian business cycle theory attempts to answer the following questions about things which Austrian theorists, notably [[Murray Rothbard]], believe appear during the business cycle:<ref>[http://www.mises.org/rothbard/agd/chapter1.asp#boom_and_depression America's Great Depression], Murray Rothbard</ref>
* Why is there a sudden general cluster of business errors?
* Why do [[capital good]]s industries and asset market prices fluctuate more widely than do the [[consumer good]]s industries and consumer prices?
* Why is there a general increase in the quantity of money in the economy during every boom, and why is there generally, though not universally, a fall in the [[money supply]] during the depression (or a sharp contraction in the growth of [[credit (finance)|credit]] in a recession)?

== The Theory Explained ==
{{Wikipedia text}}
According to the theory, the boom-bust cycle of malinvestment is generated by excessive and unsustainable credit expansion to businesses and individual borrowers by the [[bank]]s.<ref name="econlib.org">[http://www.econlib.org/library/Mises/msT.html Theory of Money and Credit], Ludwig von Mises, Part III, Part IV</ref> This [[money creation|credit creation]] makes it appear as if the supply of "saved funds" ready for investment has increased, for the effect is the same: the supply of funds for investment purposes increases, and the [[interest rate]] is lowered.<ref>[[The Mystery of Banking]]. [[Murray Rothbard]]</ref> Borrowers, in short, are misled by the bank [[monetary inflation|inflation]] into believing that the supply of saved funds (the pool of "deferred" funds ready to be invested) is greater than it really is. When the pool of "saved funds" increases, entrepreneurs invest in "longer process of production," i.e., the capital structure is lengthened, especially in the "higher orders", most remote from the consumer. Borrowers take their newly acquired funds and bid up the prices of capital and other producers' goods, which, in the theory, stimulates a shift of investment from consumer goods to capital goods industries. Austrians further contend that such a shift is unsustainable and must reverse itself in due course. Proponents of the theory conclude that the longer the unsustainable shift in capital goods industries continues, the more violent and disruptive the necessary re-adjustment process.

The preference by entrepreneurs for longer term investments can be shown graphically by using any [[discounted cash flow]] model. Essentially lower [[interest rates]] increase the relative value of cash flows that come in the future. When modelling an investment opportunity, if [[interest rates]] are artificially low, entrepreneurs are led to believe the income they will receive in the future is sufficient to cover their near term investment costs. In simple terms, investments that would not make sense with a 10% cost of funds become feasible with a prevailing interest rate of 5% (and may become compelling for many entrepreneurs with a prevailing interest rate of 2%).<ref>[http://mises.org/story/2810 Manipulating the Interest Rate: a Recipe for Disaster], Thorsten Polleit, 13 December 2007.</ref>

The proportion of [[Consumption (economics)|consumption]] to saving or investment is determined by people's [[time preference]]s, which is the degree to which they prefer present to future satisfactions. In a stable money environment<ref>[http://mises.org/daily/1186 Sound Money and the Business Cyle], John Cochran, March 19, 2003</ref> the interest rate is the price signal reflecting the balance of consumption and saving. If the goods and services presently on offer encourage people to spend, interest rates will be higher, reflecting people's short-term time preferences. If the goods and services presently on offer do not encourage people to spend, interest rates will be lower, reflecting people's desire to save their money (and spend their money on goods and services in the future). Thus, interest rates in a stable money environment<ref>[http://mises.org/daily/1186 Sound Money and the Business Cyle], John Cochran, March 19, 2003</ref> are determined by the time preferences of depositors.<ref>[http://www.econlib.org/library/Mises/msT.html Theory of Money and Credit], Ludwig von Mises, Part II</ref>

In an environment where the money supply is continually expanding through the issuance of credit, interest rates no longer reflect people's time preferences, as interest rates are set by the [[central bank]].<ref>[http://mises.org/daily/1186 Sound Money and the Business Cyle], John Cochran, March 19, 2003</ref> Because the debasement of the [[means of exchange]] in a low interest rate environment is universal, many entrepreneurs can make the same mistake at the same time (i.e. many believe investment funds are really available for long term projects when in fact the pool of available funds has come from credit creation - not real savings out of the existing money supply). As they are all competing for the same pool of capital and market share, some entrepreneurs begin to borrow simply to avoid being "overrun" by other entrepreneurs who may take advantage of the lower interest rates to invest in more up-to-date capital infrastructure. Mises suggests that a tendency towards over-investment and speculative borrowing in this "artificial" low interest rate environment is therefore almost inevitable.<ref name="econlib.org"/>

This new money then percolates downward from the business borrowers to the factors of production: to the landowners and capital owners who sold assets to the newly indebted [[entrepreneurs]], and then to the other factors of production in wages, rent, and interest. Austrian economists conclude that, since time preferences have not changed, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. In other words, depositors will tend to spend money on consumption items, capital investors will find their projects are unsustainable, banks will then ask their borrowers for payment and interest rates and credit conditions will deteriorate.<ref name="econlib.org"/>

Austrian economists theorize that capital goods industries will find that their investments have been in error; that what they thought profitable really fails for lack of demand by their entrepreneurial customers. Higher orders of production will have turned out to be wasteful, and the malinvestment must be liquidated.<ref name="Human Action">[http://mises.org/pdf/humanaction/pdf/humanaction.pdf Human Action], Ludwig von Mises, p.572</ref> In other words, the particular ''types'' of investments made during the monetary boom were inappropriate and "wrong" from the perspective of the long-term financial sustainability of the market because the price signals stimulating the investment were distorted by [[fractional reserve banking]]'s recursive lending "ballooning" the pricing structure in various capital markets.

This concept is captured by the term "heterogeneity of capital", where Austrian economists emphasize that the mere macroeconomic "total" of investment does not adequately capture whether this investment is genuinely sustainable or productive, due to the inability of the raw numbers to reveal the particular investment activities being undertaken and the inherent inability of the numbers to reveal whether these particular investment activities were appropriate and economically sustainable given people's real preferences.

The boom then, is actually a period of wasteful [[malinvestment]], a "false boom" where the particular kinds of investments undertaken during the period of fiat money expansion are revealed to lead nowhere but to insolvency and unsustainability. It is the time when errors are made, when speculative borrowing has driven up prices for assets and capital to unsustainable levels, due to low interest rates "artificially" increasing the [[money supply]] and triggering an unsustainable injection of [[fiat money]] "funds" available for investment into the system, thereby tampering with the complex pricing mechanism of the [[free market]]. "Real" savings would have required higher [[interest rates]] to encourage depositors to save their money in term deposits to invest in longer term projects under a stable money supply. According to von Mises's work, the artificial stimulus caused by bank-created credit causes a generalized speculative investment bubble, not justified by the long-term structure of the market.<ref name="econlib.org"/>

[[Ludwig von Mises]] stated that the "[[financial crisis|crisis]]" (or "[[credit crunch]]") arrives when the consumers come to reestablish their desired allocation of saving and consumption at prevailing interest rates.<ref name="Human Action"/><ref name="mises.org"/> The "recession" or "depression" is actually the process by which the economy adjusts to the wastes and errors of the monetary boom, and reestablishes efficient service of sustainable consumer desires.<ref name="Human Action"/><ref name="mises.org"/>

Since it takes very little time for the new credit-sourced money to filter down from the initial borrowers to the recipients of the borrowed funds (the various factors of production), why don't all booms come quickly to an end? Continually expanding bank credit can keep the borrowers one step ahead of consumer retribution (with the help of successively lower interest rates from the [[central bank]]). In the theory, this postpones the "day of reckoning" and defers the collapse of unsustainably inflated asset prices.<ref name="Human Action"/><ref name="goldensextant.com">[http://www.goldensextant.com/SavingtheSystem.html Saving the System], Robert K. Landis, 21 August 2004</ref> It can also be temporarily put off by price deflation or exogenous events such as the "cheap" or free acquisition of marketable resources by market participants and the banks funding the borrowing (such as the acquisition of land from local governments, or in extreme cases, the acquisition of foreign land through the waging of war).<ref>[http://mises.org/story/3010 War and Inflation], Lew Rockwell</ref>

The "false" monetary boom ends when bank credit expansion finally stops - when no further investments can be found which provide adequate returns for speculative borrowers at prevailing interest rates. It is asserted that the longer the "false" monetary boom goes on, the bigger and more speculative the borrowing, the more wasteful the errors committed and the longer and more severe will be the necessary bankruptcies, foreclosures and depression readjustment.<ref name="Human Action"/>. There is also a notion of capital consumption contributing negatively to the readjustment period, which has been discussed in works such as ''[[Human Action]]''.<ref name="Human Action">[http://mises.org/pdf/humanaction/pdf/humanaction.pdf Human Action], Ludwig von Mises, Chp. 18</ref>

[[Ludwig von Mises]] and [[Friedrich Hayek]] warned of a major economic crisis before the [[Great Depression]]. Hayek made his prediction of a coming business crisis in February 1929. He warned that a financial crisis was an unavoidable consequence of reckless monetary expansion.

===The role of central banks===

All Austrian theorists consider the unsustainable expansion of bank credit through [[fractional reserve banking]] as the driving feature of most business cycles. However, Murray Rothbard paid particular attention to the role of central banks in creating an environment of loose credit prior to the onset of the [[Great Depression]], and the subsequent ineffectiveness of central bank policies, which simply delayed necessary price adjustments and prolonged market dysfunction.<ref>''[[America's Great Depression]]'', [[Murray Rothbard]]</ref> Rothbard begins with the assertion that in a market with no centralized monetary authority, there would be no simultaneous cluster of malinvestments or entrepreneurial errors, since astute [[entrepreneur]]s would not all make errors at the same time and would quickly take advantage of any temporary, isolated mispricing. In addition, in an [[openness|open]], non-centralized (uninsured) capital market, astute bankers would shy away from speculative lending and uninsured depositors would carefully monitor the balance sheets of risky financial institutions, tempering any speculative excesses that arose sporadically in the finance markets. The cycle of ''generalized'' malinvestment is therefore caused solely by ''centralized'' monetary intervention in the money markets by the [[central bank]].

Rothbard asserts that this over-encouragement to borrow and lend is initiated by the mispricing of credit via the [[central bank]]'s ''centralized'' control over interest rates and its need to protect banks from periodic [[bank run]]s (which Austrian economists believe then causes interest rates to be set too low for too long when compared to the rates that would prevail in a genuine non-[[central bank]] dominated [[free market]]).<ref name="econlib.org"/><ref name="mises.org">[http://mises.org/story/2810 Manipulating the Interest Rate: a Recipe for Disaster], Thorsten Polleit, 13 December 2007</ref>

==Other theories==
Since the cycles appeared on the scene at about the same time as modern industry, [[Karl Marx|Marx]] concluded that business cycles were an inherent feature of the capitalist market economy. Many current schools of economic thought, regardless of other differences and the different causes that they attribute to the cycle, agree on this vital point: That the business cycle originates somewhere deep within the free-market economy, and it can be only solved by some form of massive government intervention.<ref name="Rothbard_business_cycle" />

===Innovations===
It is sometimes held, that '''[[Innovation|innovations]]''' cause the ups and downs of the business cycle. The most prominent defender of that view was probably [[Joseph Schumpeter]]. He stated that booms are due to technological or other innovations whose implementations at first seem to promise high profits. After a while, more and more entrepreneurs copy the strategy of the pioneer firms until competitive behavior forces profits to go down again and a depression begins, in which the market is cleaned of unprofitable firms. This is a brief description of the well-known process of "[[creative destruction]]" — a term made famous by Schumpeter himself. The new state of equilibrium is only maintained until a new innovation creates the foundation for another boom.

The industrial revolution, the appearance of railway tracks, or the rise of cheap automobiles can be interpreted as examples. Furthermore, the [[dotcom bubble]] at the end of the last decade could have been due to innovations like the internet. Even the current crisis can be regarded as the result of financial innovations.<ref name="Kahler_Innovations">Malte Tobias Kahler. [http://mises.org/daily/3998 "Do Innovations Cause Business Cycles?"], Mises Daily, January 07, 2010, referenced 2010-01-07.</ref>

However, it is not technological innovation that generates the boom, but the general boom that makes it possible for more and more firms to implement their innovative ideas. In every moment there exist many ideas for possible innovations and improvements. The latest innovation has not yet been implemented in every business. If there are always many ideas whose only problem is to get enough funds, then it is not technology, but [[Saving|savings]] that limit development. To implement them, the companies need capital. Society has to save first and then grant credit.

There is, of course, nothing wrong with using credit for an innovative project. The problem only appears when these credits are created out of thin air, thus inducing [[malinvestment]]s. In an environment of monetary expansion, many innovative projects can be started that are in fact not sustainable. The clusters of innovative activities that seem to be the cause of inevitable depressions are in fact a symptom of the distortion of the market process that is introduced by fractional-reserve banks.

From a policy point of view, using political means to push forward new innovations (like "renewable energy sources") will not suffice to get the economy out of the slump. Moreover, it can be highly dangerous for the aid for such innovations to be flanked by expansive monetary policy.<ref name="Kahler_Innovations" />A recent study suggests that this was the case in Spain where a "green" bubble went boom and bust<ref name="Mariana_Renewable_Spain">Instituto Juan de Mariana. [http://www.juandemariana.org/pdf/090327-employment-public-aid-renewable.pdf "Study of the Effects of Public Aid to Renewable Energy Sources"] (pdf), pp. 19–20. March 2009, referenced 2010-01-08.</ref> — with all its destructive side effects, including unemployment.<ref name="Schwartz_Unemployment">Nelson D. Schwartz. [http://www.nytimes.com/2010/01/01/business/global/01jobless.html "In Spain, a Soaring Jobless Rate for Young Workers"], published December 31, 2009, referenced 2010-01-08.</ref>

===Mania theories===
An alternative class of explanations for booms and busts, might be categorized as mania theories. In a mania, investors become entranced by some particular investment—[[Tulip mania|tulip bulbs]], [[Mississippi Bubble|French colonial trading ventures]], Florida real estate, the "nifty fifty" stocks, or [[Dot-com bubble|Internet companies]]—and begin a self-perpetuating process of bidding more for the asset, seeing its price rise, bidding even more for it, and so on. Like a manic-depressive who can only maintain his manic phase for so long before crashing, eventually investors begin to have doubts about the focus of their mania, at which point the bubble bursts.

There is nothing in most mania theories that contradicts an Austrian account of boom and bust. The two theories look at the same phenomenon from the vantage point of two different disciplines: social psychology and economics. They may, in fact, prove to be complementary. The Austrian theory offers a coherent explanation of the onset of the mania—a credit expansion—and the onset of the depression—the cessation of the expansion. After all, the mere fact that people are excited about French-Colonial North America or the Internet cannot create a speculative bubble by itself. The funds to speculate with must come from somewhere, and the Austrian theory identifies where. On the other hand, mania theories might help to explain the reason that booms often seem to be channeled into certain faddish investments.<ref name="Callahan_Dot">Gene Callahan and Roger W. Garrison. [http://mises.org/journals/qjae/pdf/qjae6_2_3.pdf "Does Austrian Business Cycle Theory Help Explain the Dot-Com Boom and Bust?"], ''The Quarterly Journal of Austrian Economics'', Vol. 6, No. 2 (Summer 2003). Referenced 2010-01-10.</ref>

==Criticisms==
These are some of the more frequent or known criticisms of the theory.

===Central banking===
Some critics point out, that the theory blames the [[business cycle]] on central banks, but the cycle has been well known throughout 19th century, well before [[central bank]]ing in the modern sense and the 20th century growth of the state. One particular example are the United States and its wide range of monetary and banking systems.<ref name="Quiggin_Austrian">John Quiggin. [http://johnquiggin.com/index.php/archives/2009/05/03/austrian-business-cycle-theory/ "Austrian Business Cycle Theory"], posted on May 3rd, 2009, referenced 2009-11-11.</ref>

Many casual expositions of '''ABCT''' say things like, "The business cycle is not a feature of the free market, but instead is caused by the manipulations of the central bank." But it is far more accurate to say that ABCT blames the boom-bust cycle on [[fractional reserve banking]]. Specifically, when banks are allowed to issue paper money (or increase customers' electronic bank deposits) without an actual act of saving by somebody in the economy, then the resulting drop in interest rates is artificial. The false interest rate sets in motion an unsustainable boom period, which leads people to erroneously consume [[capital]] and which creates the inevitable bust.

Government intervention is still very much involved here. Were it not for legal privileges granted to banks, the practice of fractional-reserve banking would be "regulated" by market competition. Even if banks were legally allowed to extend more loans than they had cash (or gold) in the vaults, they would be very cautious with their overissue so long as a [[bank run]] would spell ruin. Yet time and again, even before the establishment of central banks, governments would allow the banks to "suspend specie payment" during panics. This practice of absolving privileged bankers of their legal obligations was simply institutionalized (in the United States) with the creation of the Federal Reserve. It is no coincidence that the worst boom-bust in US history occurred sixteen years after the formation of the modern American central bank.
<ref name="Murphy_Quiggin">Robert P. Murphy. [http://mises.org/story/3466 "Correcting Quiggin on Austrian Business-Cycle Theory"], Mises Daily: Monday, May 25, 2009, referenced 2009-11-11.</ref>

{{See also|History of money and banking in the US}}

===Rational Expectations===
"If investors correctly anticipate that a decline in interest rates will be temporary, they won't evaluate long-term investments on the basis of current rates. So, the Austrian story requires either a failure of rational expectations, or a capital market failure that means that individuals rationally choose to make "bad" investments on the assumption that someone else will bear the cost. And if either of these conditions apply, there's no reason to think that market outcomes will be optimal in general."<ref name="Quiggin_Austrian" />

First off, free individuals often make mistakes — even systematic mistakes. But even perfectly rational entrepreneurs who know a boom is underway cannot prevent their more reckless competitors from taking cheap (or now free) government loans and bidding away scarce resources. Workers don't care whether their paychecks come from genuine saving or from the printing press, and every few years there is always a fresh crop of naïve employers willing to borrow money and start new projects.

Second, Austrians emphasize that interest rates ''communicate information'' to entrepreneurs. In some critiques it seems that "everybody knows" that the true interest rate ought to be 5 percent, and so the central bank's efforts to push it down to 3 percent should be easily corrected. Yet nobody knows what the truly free-market [[interest rate]] is. That's why market prices are important in the first place, and why government distortions of these prices lead to real imbalances in the economy.<ref name="Murphy_Quiggin" />

Entrepreneurs don't need to speculate about a change in consumers’ "rate of [[time preference]]", or about the "supply of capital goods". An individual entrepreneur is concerned only with a very small set of market prices, namely, the prices of the inputs she will need for her projects, and the prices for which these products will sell. That’s the whole point of relying on the market rates of interest and other prices — it eliminates the need for individuals to speculate about aggregates that are far too complex for any single mind to comprehend.

Also, some expositions of ABCT assume an initial free market state, and then analyze the impact of a one-shot [[intervention]]. But in reality the government of each major country intervene permanently in the credit market by the creation of a central bank (or a centralized system of banks). Actors in these economies have no idea what the free market rate of interest would be in the absence of such interference; even if the rates were raised, the new rate could still be below the "natural rate".<ref name="Murphy_rational">Robert P. Murphy. [http://consultingbyrpm.com/files/2009.05.14%20ABCTRatExp%20Excerpt.pdf "The Rational Expectations Objection to Austrian Business Cycle Theory: Prisoner’s Dilemma or Noisy Signal?"] (pdf), last updated May 25, 2005, referenced 2009-11-12.</ref>

===Investment vs. Consumption===
If booms are driven by mistaken beliefs that investments have become more profitable, and labor and other resources are channeled into projects not compatible with the overall level of real savings, then consumption should go down, say some critics. But booms are characterized by high, not low, consumption. If the government can't make the economy more productive by pushing down interest rates, how could businesses possibly produce more investment and consumption goods during the boom?<ref name="Quiggin_Austrian" /><ref name="Cowen_ABCT">Tyler Cowen. [http://www.marginalrevolution.com/marginalrevolution/2008/10/paul-krugman-on.html "Paul Krugman on Austrian trade cycle theory"], posted on October 14, 2008, referenced 2009-11-14.</ref>

The answer is in the Austrian approach to [[capital]] theory. The low interest rates of the boom period mislead entrepreneurs into borrowing too much, but they also mislead consumers into borrowing too much and saving too little. This is physically possible because resources that otherwise would have gone into replenishing the capital structure are instead devoted to new projects or additional consumption goods. This "eating of the seed corn" can take a while to manifest in a complex, modern economy.<ref name="Murphy_Quiggin" />

====Unemployment in the boom====
In a similar vein, it is pointed out that there is generally no period of high [[unemployment]] when resources are transferred out of consumption-producing sectors into investment goods-producing sectors. There is no necessity that the transfer of resources out of investment goods-producing sectors be accompanied by high unemployment.<ref name="DeLong_ABCT">Brad DeLong. [http://delong.typepad.com/sdj/2010/04/what-is-austrian-economics.html "What Is Austrian Economics?"], April 2010, referenced 2010-04-27.</ref>

Suppose we start in an original equilibrium position, where unemployment is at the "natural" rate, reflecting the normal turnover of workers as some businesses fail, etc. Then a $100 billion in crisp new bills is printed, and handed out to bankers. The banks lend the new money to employers, who enter the labor market with the fresh wads of cash in their pockets. Armed with the money that was just created out of thin air, the employers bid up wage rates. Seeing the higher pay, many workers quit their current jobs and take new positions in the expanding sectors. Also, some previously unemployed workers end their job search and take positions with the employers who got their hands on the new $100 billion. There is no reason for unemployment to go up in the scenario just described.

But when the the influx of new money is cut off, the underlying economic fundamentals will reassert themselves. The workers who had been drawn into the expanding sectors by new money weren't ''supposed'' to move to those sectors. The employers in the boom sectors will lose their advantage over their competitors in other sectors. Without being propped up artificially by cheap money, the bloated boom sectors will realize their unprofitability. They will cut back on operations and lay off workers.

And why don't the laid-off workers move seamlessly back into the original niches from which they came? Why does a massive reservoir of unemployed workers build up after the bust, when no such reservoir built up during the boom? The answer is pretty simple: Workers are more eager to quit and take a better job than to be laid off and take a worse job. During the boom, workers are drawn into the expanding sectors by the promise of higher wages. They aren't forced into the expanding sectors by getting let go from their original position; instead they voluntarily leave. No less important is the '''capital consumption''' during the boom period. Society "eats the seed corn" through [[malinvestment]].<ref name="Murphy_explain">Robert P. Murphy. [http://mises.org/daily/3387 "Austrians Can Explain the Boom and the Bust"], Mises Daily, March 2009, referenced 2010-04-27.</ref>

===There was no inflation as measured by the CPI===
Some critics point out, that if prices did not rise (the CPI did not rise excessively) there was really no inflation. There was no wave of rising consumer price inflation in the 2000s.<ref name="DeLong_ABCT" />

However, as the [[CPI]] is an arbitrary index of prices, it does not necessarily capture the "true" inflation picture.<ref>[http://dailyreckoning.com/why-you-shouldnt-trust-the-core-cpi-numbers/ You shouldn't trust the CPI numbers]</ref> For example, in the 2000s, there was an unprecedented spike in house price inflation fuelled by credit growth. This is a form of inflation, but was not fully picked up in the inflation figures, which focus more on consumer goods.

Expansionary monetary policy makes prices higher than they otherwise would have been. For example, the extraordinary interventions in late 2008 — in which the M1 measure of the monetary stock rose 12 percent over a three-month period — went hand-in-hand with falling prices. Prices should have fallen in response to the bursting bubble. Prices would have fallen more, were it not for a floor under them with an aggressive influx of new money. At the same time, house prices rose at unusual rates during the boom years.<ref name="Murphy_Fed">Robert P. Murphy. [http://mises.org/daily/3252 "Evidence that the Fed Caused the Housing Boom"], Mises Daily, December 2008, referenced 2010-04-27.</ref><ref name="Murphy_explain" />

Murray Rothbard stressed that the stock-market [[Late 1920s bubble|bubble of the late 1920s]] — fueled by the Fed's policies — did not coincide with rampant consumer-price inflation.<ref name="Murphy_Chicago">Robert P. Murphy. [http://mises.org/daily/4875 "The Fed: The Chicago School's Achilles Heel"], see also [http://research.stlouisfed.org/fred2/graph/fredgraph.png?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23B3CDE7&graph_bgcolor=%23FFFFFF&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=CPIAUCNS&transformation=l graphic]. ''Mises Daily'', December 13, 2010. Referenced 2010-12-14.</ref>

==References==
{{Reflist}}

==See also==
*[[Ponzi scheme]]

==External links==
* [[Wikipedia:Austrian business cycle theory|Austrian Business Cycle Theory]] on Wikipedia
* [http://mises.org/daily/672 Austrian Business Cycle Theory: A Brief Explanation] by Dan Mahoney, May 2001
* [http://mises.org/daily/2673 Why Don't Entrepreneurs Outsmart the Business Cycle?] by Brian J. Stanley, August 2007
* [http://mises.org/daily/4730 Are the Austrians Too Harsh?] by John P. Cochran, October 2010
* [http://mises.org/daily/4682 Putting Austrian Business-Cycle Theory to the Test] by Robert P. Murphy, October 2010
*[http://www.anarcocapitalista.com/JHSLSE10.htm Financial Crisis and Economic Recession] by Professor Huerta de Soto
[[Category:Austrian School of Economics]]
[[Category:Economic concepts]]

Jesús Huerta de Soto

2011-02-05T19:24:32Z

213.97.135.200: /* External links */

[[File:HuertadeSoto.jpg|thumb|right]]
'''Jesús Huerta de Soto Ballester''' (born December 23, 1956, in [[Madrid]]) is a leading [[Austrian School]] economist and Professor of [[Political Economy]] at [[Rey Juan Carlos University]] of Madrid, [[Spain]]. He received doctoral degrees in Law (1984) and Economic and Business Sciences (1992), both from [[Complutense University of Madrid]], and an MBA from [[Stanford University]]. He has been a Professor of Political Economy at Complutense University of Madrid's Law School since 1979. In 1983, Huerta de Soto received the extraordinary Rey Juan Carlos Award in Economics, in 2005 the [[Centre for the New Europe|CNE]]'s [[Adam Smith Award]] for lifetime achievement<ref>http://www.cne.org/pub_pdf/2005_02_18_capball_PR.htm</ref> and in 2009 he was awarded a [http://www.newmedia.ufm.edu/gsm/index.php?title=Doctorado_Honor%C3%ADfico_durante_el_Acto_de_Graduaci%C3%B3n_(mayo_2009) honorary degree] from [[Universidad Francisco Marroquin]].

Huerta de Soto is also an adjunct scholar of the Ludwig von Mises Institute, a member of Mont Pelerin Society's Board of Directors, member of the Quarterly Journal of Austrian Economics' editorial board and director of the publication "Procesos de mercado: Revista Europea de Economía Política".

==Books==
* ''Planes de pensiones privados'' ("Private Pension Benefits")
* ''Lecturas de economía política'' ("Readings in Political Economy"), Huerta de Soto, ed.
* ''Socialismo, cálculo económico y función empresarial'' ("Socialism, Economic Calculation, and Entrepreneurship")
* ''Estudios de economía política'' ("Studies in Political Economy")
* ''Dinero, Crédito Bancario y Ciclos Económicos'' (Madrid: Unión Editorial, first Spanish edition 1998).
* [http://www.mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx ''Money, Bank Credit, and Economic Cycles''], translated by Melinda A. Stroup (Auburn, Alabama: [[Ludwig von Mises Institute]], first English edition 2006), xxix+876 pages, ISBN 0-945466-39-4. Also available as a [[PDF]] [http://www.mises.org/books/desoto.pdf file.]
* ''La escuela austríaca: mercado y creatividad empresarial'' ("The Austrian School: Market Process and Entrepreneurial Creativity")
* ''Nuevos estudios de economía política'' ("New Studies in Political Economy")
* ''The theory of dynamic efficiency''

==See also==
*[[Fractional-reserve banking]]
*[[Full-reserve banking]]

==References==
<references/>

==External links==
*[http://www.jesushuertadesoto.com/madre2.htm Huerta de Soto's website]
*[http://www.mises.org/books/desoto.pdf Money, Bank Credit, and Economic Cycles (pdf)]
*[http://www.mises.org/journals/aen/aen17_2_1.asp An Interview with Jesús Huerta de Soto] in [[The Austrian Economics Newsletter]]. (Summer 1997; Volume 17, Number 2.)
*[http://www.anarcocapitalista.com/JHSLSE10.htm Financial Crisis and Economic Recession]
*[http://www.anarcocapitalista.com/JHSLeccionesindice.htm Lecciones de Economía en la Universidad Rey Juan Carlos de Madrid]

{{DEFAULTSORT:Huerta de Soto, Jesus}}
[[Category:Anarcho-capitalists]]
[[Category:Economists]]

Jesús Huerta de Soto

2011-02-05T19:21:23Z

213.97.135.200: /* External links */

[[File:HuertadeSoto.jpg|thumb|right]]
'''Jesús Huerta de Soto Ballester''' (born December 23, 1956, in [[Madrid]]) is a leading [[Austrian School]] economist and Professor of [[Political Economy]] at [[Rey Juan Carlos University]] of Madrid, [[Spain]]. He received doctoral degrees in Law (1984) and Economic and Business Sciences (1992), both from [[Complutense University of Madrid]], and an MBA from [[Stanford University]]. He has been a Professor of Political Economy at Complutense University of Madrid's Law School since 1979. In 1983, Huerta de Soto received the extraordinary Rey Juan Carlos Award in Economics, in 2005 the [[Centre for the New Europe|CNE]]'s [[Adam Smith Award]] for lifetime achievement<ref>http://www.cne.org/pub_pdf/2005_02_18_capball_PR.htm</ref> and in 2009 he was awarded a [http://www.newmedia.ufm.edu/gsm/index.php?title=Doctorado_Honor%C3%ADfico_durante_el_Acto_de_Graduaci%C3%B3n_(mayo_2009) honorary degree] from [[Universidad Francisco Marroquin]].

Huerta de Soto is also an adjunct scholar of the Ludwig von Mises Institute, a member of Mont Pelerin Society's Board of Directors, member of the Quarterly Journal of Austrian Economics' editorial board and director of the publication "Procesos de mercado: Revista Europea de Economía Política".

==Books==
* ''Planes de pensiones privados'' ("Private Pension Benefits")
* ''Lecturas de economía política'' ("Readings in Political Economy"), Huerta de Soto, ed.
* ''Socialismo, cálculo económico y función empresarial'' ("Socialism, Economic Calculation, and Entrepreneurship")
* ''Estudios de economía política'' ("Studies in Political Economy")
* ''Dinero, Crédito Bancario y Ciclos Económicos'' (Madrid: Unión Editorial, first Spanish edition 1998).
* [http://www.mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx ''Money, Bank Credit, and Economic Cycles''], translated by Melinda A. Stroup (Auburn, Alabama: [[Ludwig von Mises Institute]], first English edition 2006), xxix+876 pages, ISBN 0-945466-39-4. Also available as a [[PDF]] [http://www.mises.org/books/desoto.pdf file.]
* ''La escuela austríaca: mercado y creatividad empresarial'' ("The Austrian School: Market Process and Entrepreneurial Creativity")
* ''Nuevos estudios de economía política'' ("New Studies in Political Economy")
* ''The theory of dynamic efficiency''

==See also==
*[[Fractional-reserve banking]]
*[[Full-reserve banking]]

==References==
<references/>

==External links==
*[http://www.jesushuertadesoto.com/madre2.htm Huerta de Soto's website]
*[http://www.mises.org/books/desoto.pdf Money, Bank Credit, and Economic Cycles (pdf)]
*[http://www.mises.org/journals/aen/aen17_2_1.asp An Interview with Jesús Huerta de Soto] in [[The Austrian Economics Newsletter]]. (Summer 1997; Volume 17, Number 2.)
*[http://www.anarcocapitalista.com/JHSLSE10.htm Financial Crisis and Economic Recession]

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[[Category:Anarcho-capitalists]]
[[Category:Economists]]