Of Mises and Min(Sky): Libertarian and Liberal Responses to Financial Crises Past and Present

Abstract

This article compares two approaches to understanding and preventing financial crises, Austrian and Keynesian business cycle theory. The two are traditionally, and rightly, seen as having diametrically opposed prescriptions, with the Austrian approach opposing governmental intervention and blaming central bank policy for most crises, while the Keynesian approach advocates active governmental intervention to both prevent crises and to end them when they do occur. The article argues that both approaches nonetheless have much in common. Each emphasizes the importance of radical uncertainty in financial markets and analyzes business cycles as tied to credit cycles that turn on shifting investor expectations. The approaches differ, though, in their relative distrust of the ability of markets and governments to handle uncertainty.

The article suggests that both logical inquiry and historical experience have moderated the views of some adherents of each approach, and it suggests a middle way that it calls “cowardly interventions.” The Austrian theory of business cycle requires assumptions about investor expectations that seriously question how stable unregulated financial markets can be. The Keynesian theory in turn has trouble defending the ability of governments to effectively intervene in the ways it ideally prescribes. In other words, we should seriously distrust both markets and governments. Given this ecumenical distrust, the article finishes by exploring what a middle way looks like in monetary, fiscal, and financial regulatory policy. Monetary policy should balance the threats of inflation and unemployment and may need to pay more attention to financial bubbles than it has in the past. Fiscal policy should include relatively robust automatic stabilizers, but would reserve discretionary stimulus for extreme downturns at most. In regulation, the Dodd-Frank Act looks like a flawed but mostly positive exercise in cowardly interventions.

Keywords: Dodd-Frank Act, Hayek, Oakeshott, Keynes, financial regulation, financial crisis, shadow banking, Mises, Minsky, Austrian business cycle theory

JEL Classification: D80, E32, E58, G21, G30, K20, L51