Scott Martinez Abreu

5/23/2015

ID#: 71094

MEM 6710-OL

Economic Business Cycles

According to Keynesians Theory, the business cycle is a natural product of the free market
which occurs because human psychology causes participants to make irrational decisions. These
decisions lead to a misallocation of resources in an economy and the creation of asset bubbles. So
when the economy experiences a downturn, governments must step in to provide liquidity to the
market in order to 'stimulate' the economy out of recession. Unfortunately, Keynesians does not
realize that goods and services, which are a large source of economic growth, do not automatically
come into existence when the money supply increases. Money has no inherent value; it is simply
a means of determining the allocation of resources within an economy. During downturns in the
business cycle, a period of deleveraging must take place in the market place. Asset prices must fall
and the money supply should consequently sink as assets were irrationally overpriced. Keynesian
economists dont understand this concept.
The Federal Reserve (Fed) failed to predict the Global Financial Crisis while the Austrian
School of Economics did. According to Timothy Geithner, former US Secretary to the Treasury,
We think the fundamentals of the expansion going forward still look good. Many professor and
investment managers warned about such a crisis years in advance while using Australian Business
Economics. A large part of the crisis was caused by debt financed consumption. According to
the former US Republican Presidential Candidate, Ron Paul, Austrian Business Economics
supporter, The special privileges granted to Fannie and Freddie have distorted the housing market
by allowing them to attract capital they could not attract under pure market conditions. Like all
artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices
fall, homeowners will experience difficulty as their equity is wiped out.
Many believe that the Global Financial Crisis was a result of policies such as the
Community Reinvestment Act of 1977. The government guaranteed mortgages through Fannie
Mae and Freddie Mac, and interest rates that were fixed far below the market rate. The low interest
rate policy of the Fed under Alan Greenspan enabled borrowers to access cheap money with which

they were able to speculate on sub-prime mortgages. Interest rates were lowered to 1% in 2003.
According to Schiff, markets are governed by two opposing forces: fear and greed. However, a
combination of bad government regulations and monetary policy dramatically shrunk the amount
of fear in the market, enabling speculators to make risky loans they would not have made under
normal market conditions. The Troubled Asset Relief Program and loose monetary policy created
a dangerous moral hazard that reduced fear of making losses. Using this economic standard, gains
are privatized while losses are socialized. In a free market economy, both gains and losses would
be privatized.
According to Keynesians Theory, all recessions are bad and must be suppressed by
government actions. This protects established businesses and jobs. The methods are elaborate
and costly, but a benefit to the public overall. Meanwhile, the Australian Economic Theory states
that when markets stray too far from reality they must be purged by adversity. This clears
unneeded or failing enterprises so capital is not allocated wastefully, and new businesses can
emerge. Periodic small recessions are the price of a healthy economy.
Among the consequences of Keynes economic theories, whether intended or unintended,
is the fact that Western economies are characterized by large, central governments, central banks
and massive debts. According to Dr. Andrew Gelman, Professor of Statistics and Political
Science at Columbia University, the law of unintended consequences is what happens when a
simple system tries to regulate a complex system. The political system is simple. It operates with
limited information (rational ignorance), short time horizons, low feedback, and poor and
misaligned incentives. Society, in contrast, is a complex, evolving, high-feedback, incentivedriven system. When a simple system tries to regulate a complex system you often get unintended
consequences. Government policies based on Keynesian theories and the institution of central
banking form a nexus of central economic planning. Control of the central planning process is a
winner-take-all proposition for businesses. In the U.S., the result is an alliance of the U.S. federal
government, the Federal Reserve along with the largest U.S. banks and the largest U.S.
corporations. The logical chain beginning with Keynes fundamental idea that government,
supported by a central bank, should play a large and active role in the economy sets the stage for
a centrally planned economy and ultimately produces a corporate state.

References
Austrian vs. Keynesian Business Cycle Theory; http://www.la.org.au/mkong/blog/austrian-vskeynesian-business-cycle-theory
Keynesian vs. Austrian economics made simple Good analogy; http://www.peakprosperity.com/forum/keynesian-vs-austrian-economics-made-simple-good-analogy/40845
Business Cycles Explained: Keynesian Theory by Learn Liberty; http://www.youtube.com/watch?v=g_647R_vUVc