Thursday, November 17, 2011

Less Keynesian, More Austrian

In the same week that J. Brad DeLong irresponsibly accuses Ludwig von Mises of a "monetary mental disorder," Amity Shlaes does just the opposite. In a column in the San Francisco Chronicle, Amity Shlaes gives her suggestions for how introductory macroeconomics can be improved at Harvard. She is writing in response to the "dozens of students Harvard University undergrads who walked out of the school's famous introductory economics course this month." Part of the students' complaint is that in the current class there is a lack of diversity of economic opinion and that conventional economic opinion helped contribute to the economic mess of 2008-11.

Shlaes acknowledges that the students had a right to be dissatisfied with economists and their models that together failed to predict the financial meltdown and Great Recession and still cannot explain why it happened. She rightly recommends including more Austrian economics in formal macroeconomics courses. After citing Joseph Schumpeter's observations about the cyclical nature of the economy and the importance of entrepreneurship, she gets to the heart of the matter.
Schumpeter's fellow Austrian Ludwig von Mises noted that credit expansions and booms lead to misallocations of cash. The Austrian School of economics, of which Mises is the modern father, called such misallocations "malinvestment and overconsumption." Malinvestment, in turn, ensures that the boom is doomed. No better example has existed than the money that poured into obscure mortgage securities in 2006 and 2007. But there was no Schumpeter and no famous Austrian School philosopher at Harvard at the time.
Shlaes also notes the crony capitalist aspect of the economic crisis in the form of Fannie Mae among others.That leads her to commend insights from public choice economics as well. She concludes by recommending, "Add in more Schumpeter, Austrian economics and public-choice theory in Ec 10, and at Harvard generally, and you'll be offering next year's freshmen diversity worthy of America's leading university."

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