With the 2007–2008 Crisis, the Instabilities Arising from Maturity Mismatches Appeared in New and Hidden Forms Such as Mortgage-Backed Securities

Austrian economics provides fundamental but too often ignored insights into the challenges of monetary and macroeconomic policymaking. The Austrian theory of the business cycle offers a persuasive account of the genesis of the 2007–2008 crisis: it was made possible by the reliance of central banks worldwide on the reduction of short-term rates of interest to promote private sector spending. This encouraged an unsustainable expansion of money and credit. The only substantive difference from previous financial crises, something that allowed the preceding credit boom to proceed for so far and so long, was that instabilities arising from maturity mismatches appeared in new and therefore hidden variants, through money market funding of mortgage-backed securities and other structured credit assets. Austrian economics also provides a valuable explanation of previous episodes of global economic instability, for example the breakdown in the early 1970s of the post-war Bretton-Woods fixed exchange rate system based on a gold exchange standard as a consequence of insufficient discipline on US monetary creation.

Austrian economics is also the only free-market orientated school of thought drawing full attention to the deficiencies of the global policy response since 2007–2008. Central banks and governments around the world have mitigated the impact of the crisis on output and employment, providing more than $10 trillion dollars of financial support to prevent bank failures, cutting short-term interest rates for all the major currencies close to zero and engaging in a sustained and aggressive fiscal expansion that has more than doubled the ratio of public sector debt to GDP.

These measures may have been effective short-term palliatives, but they have done little to deal with underlying causes. While substantial increases in regulatory capital requirements and a wide range of other regulations have reduced tax-payer exposure to banking risks, investors have been left in little doubt that they will be protected once again should the entire financial system once again be threatened. The resumption of growth in the advanced economies is based as before on credit creation and maturity mismatch. The mispricing of assets and misallocations of capital evident before the crisis have continued, in many cases becoming even more marked. Economic expansion has been much stronger than was generally expected in the 18 months following the collapse of Lehman brothers, but this recovery has not been strong enough to allow a winding down of fiscal expansion. A policy of temporary ‘pump priming’ has turned into a policy of permanent and unsustainable fiscal deficits.

—Alistair Milne, “Cryptocurrencies from an Austrian Perspective,” in Banking and Monetary Policy from the Perspective of Austrian Economics, ed. Annette Godart-van der Kroon and Patrik Vonlanthen (Cham, CH: Springer International Publishing, 2018), 223-224.

The Classical Concepts of a “Wage Fund” and of a “Subsistence Fund” (the Sum Total of All Funds Saved from Consumption and Available for Investment) Fell into Oblivion

Hahn (1920) and Keynes (1936) pushed Macleod’s approach to its logical conclusion. It was not savings that led to (credit-financed) investment but (credit-financed) investment that led to savings. Thus they had finally arrived at the exact antithesis of classical economics. If investments could easily be made without saving, then it would be superfluous to explore profound theories on the real economic importance of foregoing consumption. The classical concepts of a “wage fund” and of a “subsistence fund” (the sum total of all funds saved from consumption and available for investment) thus fell into oblivion. After the World War II, they were mentioned in textbooks only as a curious idea of the nineteenth century (see Braun 2012, 2014). Previously, cutting consumption was considered an indispensable prerequisite for the production of goods. Now it appeared to be superfluous, at best. More realistically, it appeared as a potential disruptive factor. After all, at least some part of income that was not spent on consumers’ goods would not be spent at all, but hoarded, with corresponding losses for “aggregate demand” and thus for production.

--Jörg Guido Hülsmann, “Mises' Monetary Theory,” in Banking and Monetary Policy from the Perspective of Austrian Economics, ed. Annette Godart-van der Kroon and Patrik Vonlanthen (Cham, CH: Springer International Publishing, 2018), 34-35.

The Financial Crisis Evolved into a European Sovereign Debt Crisis in Euro Area Periphery Countries

The financial crisis evolved into a European sovereign debt crisis as investors started to doubt the sustainability of government debt in euro area periphery countries. Capital left Greece, Ireland, Portugal, and later Spain and Italy. The capital flight from South to North sharply increased government bond yields in the euro area crisis economies. Discrimination between bonds did not only depend on debt-to-GDP ratios. Instead, investors revised expectations about future developments, tax revenues, or the sustainability of current account balances, pushing up government borrowing costs.

--Andreas Hoffmann and Nicolas Cachanosky, "Unintended Consequences of ECB Policies in Europe," in Banking and Monetary Policy from the Perspective of Austrian Economics, ed. Annette Godart-van der Kroon and Patrik Vonlanthen (Cham, CH: Springer International Publishing, 2018), 114.