The Ludwig von Mises Institute

Advancing the scholarship of liberty in the tradition of the Austrian School for 30 years

Business Cycles
Mises Daily: Sunday, September 06, 1998 by Jeff Scott Milton Friedman, interviewed in Barron's (August 24, 1998), was asked: Q: You were acquainted with the Austrian economist Friedrich Hayek and also are familiar with the work of Ludwig von Mises and his American disciple, Murray Rothbard. When you were talking about bad investments, you were alluding to Austrian business-cycle theory. There is a certain concept that has pretty much gone into our parlance and understanding, which fits in with what you said about what happened in Asia. There can be times and conditions in which the stage can be set for malinvestment that leads to recession. Friedman Responds: A: That is a very general statement that has very little content. I think the Austrian businesscycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You've just got to let it cure itself. You can't do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and the United States, they did harm. He continues on to say "I don't think there are business cycles." **** First, this response from Jeff Scott Wells Fargo, San Francisco Dear Editor: Milton Friedman, in his interview with Gene Epstein (August 24, 1998) presents a caricature of the Austrian theory (and policy) of the business cycle, namely that Austrians are pleased to let the bottom fall out of the market when constructive corrective action is a plausible course.

In contrast to the Monetarist School, the Austrian School understands that economic upturns can be extended by the manipulation of credit and confidence. Central banks and Treasury departments create misleading signposts in the economy that channel capital into otherwise untenable investments. Sharp downturns are a natural response to such systemwide malinvestments. Policymakers and central bankers best deal with recessions of this type--the bust of a phony investment boom--by letting prices go where they must. And if those levels are lower and lower than anybody in business and government can imagine, so be it. Why should the appropriate economic policy be stalled by the pretense of imagination, or even worse, by a new inflationist policy? Austrians emphasize the importance of allowing price discovery to fulfill its function and work toward restoring confidence. Ultimately, there are no artificial means of restoring confidence; they are all nativist boosterism in one form or another. The lessons of current day Japan, suffering gross maladaptation, make this point rather clear. The unwillingness of their policymakers to allow prices to take their course has prolonged the misery for everyone. Sincerely, Jeff Scott