Axel Leijonhufvud Says the Subprime Crisis of 2008 More Closely Fits the ABCT than the Keynesian Framework

Axel Leijonhufvud, an economist known internationally for his work on the literature of John Maynard Keynes and Keynesianism, has suggested that the subprime crisis of 2008 more closely fits the Austrian business cycle theory of Ludwig von Mises and Friedrich Hayek, than the Keynesian framework.

In this paper, we provide evidence for that claim. More specifically, we assert the following: 

1. that the subprime crisis, or the “housing-bubble” is not an isolated incident. Rather, it is one of a number of related events whose origins can be found in the monetary policy that the Fed has adopted at least since 1980;
2. that when we concentrate on the most recent cycle, (Krugman, 2002), we find that the Fed intentionally replaced the dot-com bubble with a housing bubble, expanding the money supply at a rate of 10 percent (measured by M2), and reducing real interest rates too low for too long; 
3.  that Greenspan-Bernanke, on behalf of the Fed, asserted, without foundation and contrary to the evidence, that the crisis was not rooted in the politics of the institution they lead, but was rather a global phenomenon, a “savings glut,” which reduced the long-term interest rate naturally; 
4.  that the popular explanation that blames the deregulation of markets as a cause of the crisis, is also unfounded. In fact, the banking system is one of the most regulated sectors in the U.S. economy. It was, in fact, the excessive regulation of the system, which channeled the easy money policy of the Fed into real estate, thus distorting the physical capital structure of the economy;
5.  that the boom we have seen in the housing sector started between 2001 and 2004, and could only have persisted as long as the Fed was able and willing to keep interest rates low, a policy which risks the precipitation of general price inflation. In the face of this threat, the Fed finally raised interest rates, bowing to market pressure as the demand for loanable funds increased. This produced the inevitable deflating of the bubble and the onset of crisis and recession, not only in the real-estate sector, but also in the banking-sector which supported it during the boom;  
6.  that the long-term adjustment process involving as it does adjusting fundamental macroeconomic variables to underlying economic realities has real and enduring consequences. These effects are not “neutral.” Real capital value has been destroyed in the process;
7. that while there is a consensus among economists about expanding the monetary-base as the best “emergency strategy” when facing a possible secondary contraction, Bernanke could have avoided micro-engineering and the favoritism and moral hazard that it implies, and opted for open market operations, rather than the selective rescue of some large companies (those that were “too big to fail”); 
8. that accompanying the Fed’s monetary policy, the U.S. Treasury followed an expansionary fiscal policy in an effort to boost employment and thus mitigate recessionary expectations. But the fiscal deficits that the federal government and state-governments has and are accumulating have not delivered the promised employment increases. The fiscal crisis they have produced portend painful, but inevitable, adjustments—expansionary fiscal policies cannot continue and will have to be reversed. We conclude that it should be no surprise if the U.S. economy should fall into a new cycle in the coming years, even though economics does not provides the tools to predict the precise timing of it.

—Adrian Ravier and Peter Lewin, “The Subprime Crisis,” Quarterly Journal of Austrian Economics 15, no. 1 (Spring 2012): 46-47.