A couple weeks back I skipped over the big story of the newly released minutes of Federal Reserve Open Market Committee (FOMC) meetings from back in 2006, which showed a complete lack of interest in and complacency about early warnings that the housing bubble might burst with disastrous consequences. Today Robert Samuelson brings the story back up again in his Newsweek/WaPo column. And though Samuelson doesn’t say so, his account reads like yet another vindication of Hayek’s critique of the Keynesian “boom-and-bust” cycle and his corollary idea of inherent limitations of the attempted centralization of economic knowledge and decision-making:
There was no sense of a gathering crisis. All true, but it begs the central question: why? The FOMC members weren’t stupid, lazy or uninformed. They could draw on a massive staff of economists for analysis. And yet, they were clueless. . .
Such a crisis was not within the personal experience of members of the FOMC — or anyone. Nor was it part of mainstream economic thinking. Because it hadn’t happened in decades, it was assumed that it couldn’t happen. There had been previous real estate busts. From 1964 to 1966, new housing starts fell 24 percent; from 1972 to 1975, 51 percent; from 1979 to 1982, 39 percent; from 1988 to 1991, 32 percent. Declining home construction had fed economic slowdowns or recessions. So the natural question seemed: Would this happen now? The answer seemed “no.” The overall economy was strong. This is the most obvious reason for an oblivious FOMC.
But it is not the main reason, which remains widely unrecognized. Since the 1960s, the thrust of economic policy-making has been to smooth business cycles. Democracies crave prolonged prosperity, and economists have posed as technocrats with the tools to cure the boom-and-bust cycles of pre-World War II capitalism. It turns out that they exaggerated what they knew and could do.
There’s a paradox to economic policy. The more it succeeds at prolonging short-term prosperity, the more it inspires long-run destabilizing behavior by businesses, banks, consumers, investors and government. If they think basic stability is assured, they will assume greater risks — loosen credit standards, borrow more, engage in more speculation, relax wage and price behavior — that ultimately make the economy less stable. Long booms threaten deep busts. . .
The Fed slept mainly because it overlooked the possibility of boom-bust. It didn’t recognize that its success at sustaining prosperity — for which Greenspan was lionized — might sow the seeds of a larger failure.
So does this mean that Ron Paul is right, and that we should abolish the Fed, and perhaps return to the gold standard? Once again I was compelled to dust off my main text for last fall, The Constitution of Liberty, to see what Hayek might have to say. Here’s a few relevant excerpts from chapter 21, “The Monetary Framework”:
Governments have assumed a much more active part in controlling money, and this has been as much as cause as a consequence of instability. It is only natural, therefore, that some people feel it would be better if governments were deprived of their control over monetary policy. Why, it is sometimes asked, should we not rely on the spontaneous forces of the market to supply whatever is needed for a satisfactory medium of exchange as we do in most other respects?
It is important to be clear at the outset that this is not only politically impracticable today but would probably be undesirable if it were possible.
In other words, it doesn’t sound like Hayek would be a Paul voter, at least on this point. However, he’d certainly agree with Paul on the need for serious cuts in government spending:
A monetary policy independent of financial policy is possible so long as government expenditure constitutes a fairly small part of all payments and so long as the government debt (and particularly its short-term debt) constitutes only a small part of all credit instruments. Today this condition no longer exists.
That last sentence (published, recall, in 1961) is what you’d call today “an understatement.”
About the gold standard, Hayek offers little support (in this respect aligning himself with Milton Friedman, who also was a gold skeptic):
It is only natural that some people should regard a return to that tried system as the only real solution. And an even larger number would probably agree today that the defects of the gold standard have been greatly exaggerated and this it is doubtful whether its abandonment was a gain. This does not mean, however, that its restoration is at present a practical proposition.
It must be remembered, in the first place, that no single country could effectively restore it by independent action. Its operation rested on its being an international standard, and if, for example, the United States today returned to gold, it would chiefly mean that the United States would determine the value of the dollar. . .
I may be mistaken in my belief that the mystique of gold has disappeared for good, but, until I see more evidence to the contrary, I do not believe that an attempt to restore the gold standard can be more than temporarily successful.