Answer to Austrian Economists

I wrote a piece called "The Great Recession." It prompted a follower of the "Austrian Economists" (A Libertarian group) to ask whether the Federal Reserve was pumping too much money into the economy and whether that was causing recessions.
I said I'd look into it and finally went to my local library after a few unsuccessful internet searches and asked about Federal Reserve Board interest rates going as far back as possible (It was easy to find rates going back a few weeks or months, but the librarian had to search for a bit to find them going back further) and I then pulled up a list of recessions (That wasn't hard at all).

Recession of 1953

1951 1Q1951 2Q1951 3Q1951 4Q1952 1Q1952 2Q1952 3Q1952 4Q

Recession of 1957

1955 1Q1955 2Q1955 3Q1955 4Q1956 1Q1956 2Q1956 3Q1956 4Q

Recession of 1960

1958 1Q1958 2Q1958 3Q1958 4Q1959 1Q1959 2Q1959 3Q1959 4Q

Recession of 1980

1978 1Q1978 2Q1978 3Q1978 4Q1979 1Q1979 2Q1979 3Q1979 4Q

Recession of 1990

1988 1Q1988 2Q1988 3Q1988 4Q1989 1Q1989 2Q1989 3Q1989 4Q

Recession of 2001

1999 1Q1999 2Q1999 3Q1999 4Q2000 1Q2000 2Q2000 3Q2000 4Q

Recession of 2007

2005 1Q2005 2Q2005 3Q2005 4Q2006 1Q2006 2Q2006 3Q2006 4Q


Non-recession of 1970

1968 1Q1968 2Q1968 3Q1968 4Q1969 1Q1969 2Q1969 3Q1969 4Q

Non-recession of 1996

1994 1Q1994 2Q1994 3Q1994 4Q1995 1Q1995 2Q1995 3Q1995 4Q

Non-recession of 2006

2004 1Q2004 2Q2004 3Q2004 4Q2005 1Q2005 2Q2005 3Q2005 4Q

So what do we have?
1953, interest rates in the two years beforehand were completely flat.
1957, we see what looks like a classic rise with rates going from 1.50 to 3.00.
1960, rates wobbled from 2.94 to 1.75, but then rising from there to 4.00.
1980, 6.37 to 11.27 in a straight line upwards.
1990 saw a very gradual rise from 6.00 to 7.00.
2001 saw another gradual rise from 4.50 to 6.00.
2007 saw a rise from 3.25 to 6.25.
With the non-recessions, we see a rise from 4.50 to 6.00 in 1968-69 not leading to a recession.
1994 to 1995, a rise of 3.00 to 5.25 did not lead to a recession.
2004 to 2005, a rise of 2.00 to 4.75 did not lead to a recession.

So, the initial question I received after I wrote my piece on the economy was "Why didn't I account for the actions of the Fed?" What does the Fed do? Basically, it sets the interest rate. The reason why the economists I read did not account for the interest rate set by the Fed appears to be that there's really not much of a connection between what interest rate the Fed sets and how the economy reacts (Note that the list of recessions I linked to above lists a different reason for each recession). It appears there's usually a rise in the interest rate in the two years before a recession, but not always and sometimes it's a steep rise and sometimes it's a gradual one. 1950-1970, rises tended to be extremely gradual with not much change from quarter to quarter at all. That period saw three recessions.
The early 1980s saw extremely high interest rates, going up as high as 14.00, as Paul Volcker was using those rates to eliminate the inflation that had persisted so stubbornly up to that point.
So I find the explanation that the Fed plays an extremely decisive role in the ups and downs of the economy to be an unconvincing one. Obviously it plays a role, but there appear to be many other meaningful factors that also affect the economy.


Tim G. said...

Thanks for digging up these numbers! I'll definitely bookmark this and absorb it as I have the time (Finals week. Ugh.) I really appreciate the effort you've put into this.

I wanted to comment at PhillyIMC, but I had trouble seeing the CAPTCHA image....

Anyway, the Austrians celebrate their own "Austrian Theory of the Business Cycle". I don't claim to understand it in full, but its intuitively appealing on the surface:

Dan Mahoney:
Austrian Business Cycle Theory: A Brief ExplanationMurray Rothbard:
Why the Business Cycle HappensWikipedia:
Austrian Business Cycle TheoryToo much stuff to read in one sitting.

What I'd really like to see from them, though, is something like Wikipedia's list of recessions, with the "causes" column filled out by Austrian economists using actual, specific historical data like the figures you've pulled up. I don't know if they have a thing like this, though. I've never seen it, in any event. If they don't have one, I'd say it reflects unfavorably upon their theory.

The Austrian Theory of the Business Cycle has its critics, of course. Here's one from our buddy Paul Krugman, and another one by an assistant professor of economics at George Mason University. It begins about halfway down the page.

I would be remiss, of course, if I did not include the Austrian critique of Krugman's critique.

I haven't absorbed any of these links yet because I'm knee-deep in finals, but there they are. If I find a good Austrian list of causes of recessions, I'll pass it right along.

Tim G. said...

Here is a 40 minute speech (Yawn! I know....) from Thomas E. Woods, Jr. in which he describes the causes of the recessions from 1837 to 1920. His book "Meltdown" might have info on the more recent recessions from the Austrian perspective. If I get around to reading it, I'll let you know.

Rich Gardner said...

I'll stick these on PhillyIMC for you and pass on the comment about the CAPTCHA.
Yeah, I was puzzled as to why you weren't giving me links to charts and graphs and I was instead seeing lots of text.
Good luck on the finals! Been there done that, well worth having done it, but no desire to relive it.