Martin Wolf asks his readers their opinion of the Austrian school of economics (whose most famous adherent in this country is Ron Paul):
I think we can say that conventional neo-classical equilibrium economics did a poor job in predicting the crisis and in suggesting what should be done in response. We can also say that neo-Keynesians pointed out some important precursors of the crisis, in particular, the destabilising role of huge private sector financial deficits in countries with large external deficits, such as the US, and the Keynesian view certainly played a big part in the post-crisis response, as did that of Milton Friedman.
Yet some would argue that economists working in the Austrian tradition were more nearly right than anybody else. In particular, they have argued that: inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global “malinvestment” explains the subsequent financial crash. I have sympathy with this point of view. But Austrians also say - as their predecessors said in the 1930s - that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing. Mass bankruptcy is extremely costly. Moreover, it is impossible to separate what is healthy from what is unhealthy during a general economic collapse triggered by an implosion of the financial system.
This isn't an endorsement by any means -- but it's interesting to see the Austrians get some credit from one of the most famous economic journalists in the world. (Be sure to read the comments following Wolf's post for a fascinating discussion.)
More surprising, Paul Krugman himself doesn't dismiss the Austrians out of hand (he just does that to anyone who disagrees with him politically). But he does think they misunderstand unemployment:
The Austrian view is that unemployment in a slump results from the difficulty of “adaptation of the structure of production” — workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods.
But this immediately raises the question, why isn’t there similar unemployment during the boom, as workers are transferred into investment goods production?
I’ve asked this question repeatedly over the years, and all I get is one of two things: gobbledygook, or “but during the phase of rising investment, the economy is booming!”, which is of course circular. In practice, Austrians seem to be Keynesians during booms without knowing it; they realize that high demand produces a boom, but don’t realize that this contradicts their own theory of slumps.
My own (amateur) view, for what it's worth, is the Austrian theory of the business cycle makes a lot of intuitive sense, but that the school's contemporary political program is hopelessly utopian. Hayek's insights into political philosophy and epistemology will endure, whereas support for a return to the gold standard, among other things, will remain a marginal position.
And this is as good a time as any to urge you to check out Jeffrey Friedman's new Hayek Project. It's a great place to learn more about the man who Irving Kristol said possessed "as fine and as powerful a mind as to be found anywhere." (Though Kristol disagreed with Hayek on several points, including whether or not America ever was or ever will be on a "road to serfdom," and whether, as Kristol put it, men "can live in a free society if they have no reason to believe it is also a just society." Kristol's answer was no.)