Speeches and Presentations

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I should like to take this opportunity to introduce you to Austrian Economics, a field which – at least outside philosophical and economic circles – is probably not very well known. The Austrian School of Economics was founded by Carl Menger with the opus “Principles of Economics”, which was published in 1871. Other prominent proponents of the Austrian School are, amongst others, Eugen von Böhm-Bawerk, Friedrich von Wieser, Ludwig von Mises, Joseph Schumpeter, Gottfried von Haberler and Fritz Machlup. One of the most prominent figures of Austrian Economics, Friedrich von Hayek, was awarded the Nobel Prize in 1974.¹)

The proponents of Austrian Economics formulated groundbreaking theories in various economic areas such as marginal utility theory, basic choice theory, credit, money and prices, as well as in socio-economic areas generally referred to as libertarianism in the sense of limited government and free markets.

Austrian Economics follows an evolutionary approach which puts human action at the center of economic phenomena and traces the unintended consequences of these actions. It is this inter-temporal, dynamic approach to socio-economic behavior that makes Austrian Economics distinctive and highly relevant up to this day.

Still, talking about Austrian Economics is a challenging task: The school developed over a time span of more than one century, thus covering wide-ranging economic aspects in a sometimes heterogeneous way. Moreover, Austrian views have often been out of sync with mainstream economics.

Yet, in my view, Austrian Economics today is more relevant than ever. Let me just focus on a few issues.

Allow me to start with one of the basic challenges all mature economies are facing today: How should they adapt to globalization? I think Schumpeter basically provided us with a valid concept, when he wrote in 1942, “The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns enterprises as U.S. Steel²) illustrate the same process of industrial mutation that continually³) revolutionizes the economic structure from within, continually destroying the old one, continually creating a new one.”⁴) This process of “creative destruction,” as Schumpeter coined it, goes hand in hand with continuous innovation and progress as it creates a competitive pressure that is an “ever-present threat” which “disciplines before it attacks,” thus keeping the economy healthy and dynamic.

Of course, it is understandable that the word “destruction” creates fears, even more so when it relates to jobs. However, many policy makers’ reaction to these fears, which is frequently of a protectionist nature, accompanied by rising government expenditures, debt and tax burdens, has very often made things worse than better. 

Today, most economists will agree that vigorous reforms must be placed at the top of the European agenda. We need reforms that make our economies more flexible and competitive, reforms that encourage and reward change and modernization and that address job fears by promoting education and lifelong learning. Such an approach would certainly make our economies more dynamic, innovative and healthy, just as Schumpeter argued.

Reforms should also aim at improving price and wage flexibility as well as factor mobility, which is especially important within a monetary union. There are two main reasons why Austrian economists have never tired of arguing in favor of flexible markets:

First, if prices – instead of quantities – are allowed to adjust and labor mobility increases, this will improve our economies’ resilience to shocks, smoothen output fluctuations and, most importantly, hold unemployment at bay.

Second, and this is one of the most important insights Hayek⁵) provided, flexible prices are important in order to disperse knowledge effectively. For Austrians, markets are not states of perfect knowledge. Rather, market prices are real-time “facts”, which provide economic agents with incentives to adjust their behavior accordingly, such as to benefit most from these prices. Their adjusted behavior will, in turn, impact on supply and demand as well as on market prices to the benefit of the overall economy. This process is very similar to the concept of the “invisible hand” introduced by Adam Smith⁶) in much more general terms.

Business cycles represent another area of interest to several Austrian economists. For instance, Joseph Schumpeter⁷) emphasized the role of innovation, such as railways and electricity at the time, and probably information and communication technologies today. Mises⁸) and Hayek⁹) stressed the role of credit, the “right” (“natural”) level of interest rates and the time dimension in the account of boom and bust.

In their “Austrian Business Cycle Theory,” which was developed in the 1930s, Mises and Hayek maintained that, as long as market interest rates are right, i.e. they reflect the natural rate of interest¹⁰), there can be no systematic business cycle. However, if authorities deliberately lower interest rates below the natural rate with the aim of expanding the economy, there will be an artificial boom, resources will be misallocated and the market goes wrong. In the usual course of such an artificial boom, Austrian economists expect that real interest rates will start to rise owing to overinvestment. This eventually turns the boom into a bust, thus leading to the necessary cleansing of misguided investments in the corporate sector as well as in the capital markets.

Some 70 years ago, Haberler pointed out that the “price level can be a misleading guide and that its stability is no sufficient safeguard against crises and depression, because a credit expansion has a much deeper and more fundamental influence on the whole economy, especially on the structure of production, than that expressed in the mere change of the price level”¹¹). For Austrians, relative prices in product markets – and let me add, relative prices in asset markets – count as well. 

In many respects, the high-tech industry boom and bust that occurred around the turn of the millennium very well fit both Mises and Hayek’s Austrian Business Cycle Theory and Schumpeter’s theory. Even though it would be interesting to discuss this issue further, I would rather raise the following question: Does Austrian business cycle theory provide us with some insights at the current juncture of global economic developments?

In response to the global downturn of 2001, central banks around the world cut interest rates in order to cushion the fallout of the high-tech bust and heightened geopolitical insecurity. Whether interest rates have been below the natural rate since then is not clear, not least because we assume that the natural – or “equilibrium” – interest rate varies over time.

This notwithstanding, global key interest rates by many measures, such as real interest rates and Taylor rules, appear to have been rather low over the last couple of years. Economic activity on a global basis has responded heterogeneously to monetary policy and other measures, such as fiscal expansion, not least because some authorities implemented their policy measures more aggressively than others. However, investment in general appears to have been channeled less vigorously into capital goods than during former economic upturns. 

In the corporate sector, we are even witnessing the rather unusual situation that corporations appear to be saving more, which at this stage of the business cycle can hardly be explained by the ongoing process of balance sheet repair alone. Since corporate and household savings have to be channeled somewhere, this capital finds its way into financial instrumentson a global basis and into housing investment on a regional basis, as indicated by rising house prices and surprisingly low long-term interest rates. Official capital flows from oil-producing and Asian countries also contributed to low long-term interest rates, above all in the U.S.A.

Whether these global developments represent a savings glut, as Bernanke¹²) argues, or whether they are attributable to excess monetary liquidity remains an open, but crucial question. According to the Austrians, both an increase in private savings and a credit expansion aided by monetary authorities set into motion market processes whose initial allocation effects are similar, but whose ultimate consequences differ sharply. 

In short, a global savings glut, if it represents genuine savings and investments, vindicates a vigilant, but still rather composed attitude of central banks, whereas global excess liquidity entails much more problematic aspects. As Mises stated in 1936, “such an expansion of credit can only produce temporary results, as the initial recovery will be followed by a deeper decline which will manifest itself as a stagnation of commercial and industrial activity”¹³).

Yet again, whether we witness a global savings glut or global excess liquidity is not clear. I guess we are confronted with both issues at the same time, with some regions being rather affected by the first and others rather by the second issue.

In an environment characterized by such unprecedented challenges, the Eurosystem is well placed, as the ECB’s monetary policy strategy is based on a comprehensive analysis of both economic and monetary developments.

Our economies are heading into uncharted waters – in many respects. In such an environment, delivering reliable policy advice is of crucial importance. At the same time, the risks of getting it wrong are high. There is a lot of well-meant policy advice, and it is often of a rather interventionist and even protectionist nature. However, advice along these lines would require a very profound insight into the forces which shape our economies and an even better understanding of how the proposed measures would play out in our globalized world. But do economists really have this insight? I think that Hayek would dismiss this type of advice as “pretence of knowledge” which, if implemented, would eventually do more harm than good.

Nonetheless, policymakers have to take decisions all the time. Thus, providing no advice is no option. In formulating the advice I would give, let me come back to the findings of Schumpeter, Hayek and, actually, all the other Austrian economists: We have to make our economies more flexible!

In a flexible economy, people stand a better chance of making fuller use of their capabilities; they have fewer reasons to be afraid of losing their jobs, as new jobs could be found more easily; a flexible approach permits the economy to adjust more quickly and automatically; economic cycles are smoothened as adjustment mechanisms are allowed to kick in at an earlier stage, in a more effective and less disruptive manner. All this would create a situation in which policymakers’ event-driven action becomes less decisive, though not utterly redundant.

Let me conclude by quoting Hayek: “If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.”¹⁴)