Economics, Monetary Policy, Pethokoukis, U.S. Economy

Why do Rand Paul and Obama distrust the free market so much?

Gage Skidmore (Flickr) (CC BY-SA 2.0)

Gage Skidmore (Flickr) (CC BY-SA 2.0)

Rand Paul and President Obama. One a libertarian, the other a left-liberal progressive. But they apparently have at least one thing in common: a belief that markets are fragile things. Both subscribe to the view that a speculative bubble caused the Great Recession. As Obama said in his recent Knox College speech, “But by the time I took office in 2009, the [housing] bubble had burst, costing millions of Americans their jobs, their homes, and their savings.” (Actually, it was passive Fed tightening in 2008, in a replay of the Fed’s Great Depression error, that turned a possible modest downturn into the Great Recession.)

That comment led economist Brad DeLong to call Obama a “neo-Austrian” or accidental Hayekian since Austrian economics — which can count Paul as a loyal devotee — contends the business cycle is driven by speculative excess leading to economic bubbles. Markets break down. Markets fail. Richmond Fed economist Robert Hetzel calls this the “market disorder” view of how economies work and the role government should play:

Adherents of the market-disorder view believe that sharp swings in expectations about the future from unfounded optimism to unfounded pessimism overwhelm the ability of offsetting changes in the real interest rate to stabilize economic activity. … The view that financial fragility produces real instability is associated with the belief that markets are inherently unstable. From this view, it follows that economic stability requires the regulation of markets through government intervention.

Where Friedrich Hayek and JM Keynes, Paul and Obama, disagree is what should happen when markets fail. Keynes-Obama argue for fiscal stimulus, Hayek-Paul for liquidation — “Let the banks fail!” — to purge the rot out of the system. As Milton Friedman said of the Austrian approach:

I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You’ve just got to let it cure itself. You can’t do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and in the United States, they did harm.

Milton Friedman (and Adam Smith) had a different view of markets from Keynes/Hayek/Obama/Paul, that they were sturdy and self-regulating if the price system was allowed to work. Again, Hetzel frames the two views:

Do fluctuations in the business cycle originate in instability in financial markets due to excessive risk taking? Alternatively, do they originate in instability in money creation due to the failure of central banks to allow the price system to work? … The monetary disorder view is that the price system works well to equilibriate the economy provided that money creation and destruction do not prevent interest rates from adjusting. There is no inevitable movement from boom to bust

Hetzel and today’s “market monetarists” want the Fed to follow a monetary rule that provides for a stable nominal anchor — like nominal GDP — and allows market forces to determine the real interest rate and other real variables amid a stable monetary backdrop. Indeed, economist Scott Sumner has proposed letting Fed policymakers determine a goal of monetary policy, such as stable growth in nominal GDP, and then having markets, via a futures market, “implement the policy by adjusting the monetary base until it’s at a level where the expected 12-month forward level of NGDP equals the policy goal.” Basically, market-driven central banking.

Instead, the Fed currently operates with discretion to deal with supposed market failures and, as Friedman wrote in Free to Choose, “continues to promote the myth that the private economy is unstable, while its behavior continues to document the reality the government is today is the major source of economic instability.” Paul sort of gets this, I guess, but instead of arguing for “ending the Fed” he should argue for “ending the Fed as we know it” and embrace a market-driven monetary policy as proposed by Sumner. And begin to trust markets.

25 thoughts on “Why do Rand Paul and Obama distrust the free market so much?

  1. Well, recent history has shown that the market is a fragile thing when it comes to Federal Reserve bungling. First, the “possible” modest downturn was caused by a Federal Reserve enabled housing bubble. Second, the downturn was exacerbated by the Federal Reserve mismanagement of nominal GDP. Rand Paul would say he distrusts the Federal Reserve not the market. Why do you not distrust the Federal Reserve, especially after two major screw ups?

    • Thank you. The malinvestment created by the central bank is totally unnecessary and the ensuing problems have created misguided distrust of free-markets. Statists usually trot out these arguments when the crisis occurs. Rand Paul and the Austrians are on sound footing here.

  2. Virtually nothing in this post makes sense. Just because Obama once said people lost jobs after the housing bubble doesn’t make him a “neo Austrian.” A Fed that prints money whenever the economy slows down is not “market driven.” Rand Paul and Barack Obama have diametrically opposed views of what caused the housing bubble (the former blames government, the latter greedy Wall St. bankers). Austrians don’t believe markets are “inherently unstable,” they believe markets produce non-market based outcomes when artificially manipulated.

    If you want to explain Austrian economics, why not go to original sources, instead of Austrian critics? That Hetzel explanation is about the furthest thing from the Austrian business cycle theory. Doing so would be doubly beneficial in that you may begin to understand some of the basic mistakes your readers are correcting you on day in and day out.

  3. This post is either staggeringly ignorant or staggeringly dishonest. The Austrians don’t believe that the free market is inherently unstable; they believe that government interventions in the market (in particular, efforts to hold interest rates below market levels) cause it to become unstable. The notion that an interventionist monetary policy, which relies on psychological manipulation of economic actors, trying to coerce them to spend or invest against their better judgment, demonstrates faith in free markets, is Orwellian and bizarre.

  4. Actually, neither Obama nor Paul is an economist. Obama mistrusts the market because he is at heart a Socialist – he believes that the government should control the redistribution of wealth from the rich to the needy. Paul mistrusts the market because he is a libertarian – he distrusts everything except himself. (He’s also a whacko, but that is a discussion for another time.)

    • Topcat, do you know of a Socialist that knows how to create the next store of wealth for redistribution? Stalin, Lenin, Mao didn’t.

  5. Obama is definitely NOT a left liberal progressive. He has expanded all of GWB’s surveillance state, abandoned the public option for health care, granted blanket immunity to the telcos, etc.

    • What you cite are merely accidental consequences of Obama’s delegation of responsibilities, because he personally refuses to be responsible, and is no evidence for his qualifications as a “left liberal progressive”. Obama’s hero (for results, not necessarily for methods) is Mao – how does one characterize that ideology? Maoist (with Fascist tendencies) will do.

  6. topcat52 – We libertarians put great faith in free markets. The emphasis, however, is on the word “free.” Government interventionism in private lending practices created nearly a trillion dollars of loans that would not have otherwise been made. That’s nothing like a free market.

    • JeromeD, you are correct, we don’t have a true “free” market. Politicians are great at scaring people with untruths about a real free economy. Frankly, the majority would be better off with a real working free economy.

      Most of the “wild” swings in the economy are, ironically (or maybe not), due to the distortions caused by government “economic” policies. Its more then just things like the FED, but housing policies, rent seeking by large companies, money to farmers etc.

  7. I have more or less developed the feeling that booms just sort of run out of emotional fuel in the players. That is aside from the rigged failures which the brightest economists and promoters in the world set up and trigger (the brightest, incidentally, do not work for the government)

  8. JP displays a fundamental (willful?) ignorance of the market mechanism, and the role of fiat currency in the boom-bust cycle. As one Austrian put it, “Counterfeit [fiat} money creates counterfeit businesses that can only be maintained by further debasing the currency.” Until of course, the wheels fall off and a correction is called for. JP wrongly conflates Paul and the Austrians with Barry O. Barry is all for intervention, Austrians argue against it. The quote selection from Friedman, who was wrong about a number of things, is instructive. He says markets will correct, and they do, but neither Uncle Milty nor JP acknowledge that almost everything that FDR did to intervene made the Depression longer and deeper, just as predicted by Austrian business cycle theory, but almost no one else.

    JP is apparently incapable of seeing that the FED is not a creature of the free market, and that there are logical consequences to their actions that are contrary to the stated purposes of the FED. Count JP among the interventionists who in order to protect his bankster friends, MUST destroy Rand Paul and Austrian business theory. Only the ignorant will fall for it. Unfortunately, even if not especially among academics who should know better, their numbers are legion…..

  9. The author seems to miss the point of what makes a free market “fragile”. It is the mandated monopoly control over legal tender money. That is precisely what the Federal Reserve and its banks have — a monopoly over all credit/money. The effect is that one can no longer separate a “broken” banking industry from a “broken” economy. And most economists (including both Keynes and Friedman) have long seemed incapable of even comprehending the difference between a banking system and a money system. Hayek only recognized the solution late in life — when he wrote Denationalization of Money.

    The analogy is the air hose in a scuba system. Dive deep underwater (where that air hose has a monopoly over your air), cut the hose — and you will die. Stand on the deck of a boat (where that air hose does not have an air monopoly), cut the hose — and you will not notice a thing.

    I find it quite stunning that neither the author – nor any of the commenters (many of whom seem to be Austrian-school) – seem to even mention this monopoly as THE source of the problem.

    Failure of banks has little impact on the broader economy (except via their customers) if there is a LEGAL alternative to bank-based money. A Fed that debases “bank currency” in order to prop up banks (or fulfill some unfulfillable macro mandate) has little impact on the broader economy if there is a LEGAL alternative to Fed-based money.

    In all cases, it is the monopoly over money that causes the “free market fragility” – not widespread bank insolvency or Fed credit decisions.

  10. Most career politicians are afraid of the free market no matter their “politics”, for this one major point.

    They would have far less “power” and “influence” over the American people.

    When there is a free economy it would only have the minimum needed amount of government regulation. Combine that with an economy that is largely doing well (which it would do if allowed to do so), because third parties wouldn’t be putting their undesired fingers into it messing it up.

    What results is: politicians are largely irrelevant to anything and anybody. Few people are then dependent on government services, and there wouldn’t be very many government regulators to be the bosses of. So they would have little to no influence on anything. Nobody would need a favor, there would be no post politics “employment”, and no paper to shuffle around.

    98% of today’s economic problems are problems caused by government policy.

  11. Apparently keeping back, allowing the banks to fail and deleveraging to occur (i.e., doing nothing), is now a form of government intervention.

    If this is what passes for an intelligent piece on economics at AEI, maybe I should send in my resume. I could use a little think-tank cash.

  12. Once again, for yet the nth time, Hayek was NOT a “liquidationist.” Read him. His prescription was not that far from modern market monetarism: stabilize MV, meaning make sure there was adequate money supply when the demand for money rose. Modern Austrians, like myself, make this argument as well.

  13. This column is fundamentally flawed from the outset. “…Austrian economics…contends the business cycle is driven by speculative excess leading to economic bubbles.”

    No, the Austrian school professes that bubbles are driven by the monetary policy manipulations of central bankers that create perverse incentives and cause mal-investments among investors. By accidently or intentionally missing this critical point, Pethokoukis gives us nothing but a straw man throughout the remainder of his piece.

    A correction from Pethokoukis or his editor is warranted.

  14. Austrians don’t think the market is a fragile thing; they believe that Fed interventions into the markets cause distortions. So ultimately, it’s not the market that’s to blame, it’s the FED. I think you’re awfully confused. It’s you who believes in “market disorder” since you think we need a central bank to police the money supply and manage interest rates. How can anyone take this article seriously after the first section is wildly inaccurate?

  15. As others have explained (Kubik, etc), the author completely misstates the Austrian view, among other things. The government’s intrusion in the market, via the Fed, legislation and other actions, causes distortions in the market. The only question is whether the author asserts these falsehoods for political gain or out of ignorance. Either way, I’m genuinely surprised to see this at a blog for an organization that’s supposed to be dedicated to free market principles.

  16. Good Grid.

    How can an author get so much wrong in a single article? I am astounded.

    I work in the computing industry. If I could make a living spouting the kind of BS about computers and software that Pethokoukis spouts about economics and monetary policy, I could be a rich man without bothering to do much work.

    Hmmm… now that I think about it, maybe that’s the point.

    But seriously. He actually thinks Austrians base their economics on “fragile markets”??? Where did this guy go to school?

  17. If you see someone with a bruise on their forehead, they are probably an Austrian economist…. who kept smacking their palms against their head while screaming ‘WHAT?’ while trying to read this. Tom Woods’ response is excellent.

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