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In December 2008, Dr Anthony Evans and I wrote an article for the IEA asking, in these testing times for central banks, whether there is room for Austrian Ideas at the top table.

Historically there have been roughly three main ideas that explain macroeconomic fluctuations, and they can be demonstrated with a brief (and highly stylised) overview. The first to emerge stems from Vienna, with the works of Ludwig von Mises and Friedrich Hayek. This focuses on the communicative role played by interest rates, which signal to entrepreneurs the willingness of consumers to forgo current goods for the sake of greater future consumption. When central banks create monetary expansion this disrupts the signal and alters relative prices. Entrepreneurs invest due to low interest rates, but since this is not backed by greater savings the ‘boom’ is unsustainable. When inflationary pressures caused by the printing of money mean that interest rates rise, a recession is the inevitable consequence.

The second is associated with John Maynard Keynes and his followers in Cambridge, England (such as Joan Robinson) and Cambridge, Massachusetts (such as N. Gregory Mankiw and Paul Krugman). This approach shifts attention from demand or supply shocks to emphasise the frictions within a market economy that amplify relatively minor shocks into real (i.e. output and employment) effects. Issues such as price rigidity and capital market imperfections are market frictions that require aggregate demand management to overcome.

The third main idea is associated with the New Classical and real business cycle (RBC) theorists who view cyclical activity as being the outcome of random productivity shocks. Under certain assumptions supply-side shocks (such as energy prices, changes in productivity, regulations, civil unrest) alter the natural rate of output, and the economy efficiently responds.

For simplicity we label these three main frameworks as ‘Vienna’, ‘Cambridge’ and ‘Chicago’, and use doughnut charts to illustrate their similarities and differences:

We argue that

the neoclassical synthesis of classical (Chicago) and Keynesian (Cambridge) macroeconomics that underpins central bank philosophy is a necessary but not sufficient use of the ideas available. And as we shall see, current economic conditions are prompting a return to distinctly Austrian (Vienna) ideas across the mainstream media.

We conclude,

There seems to be an increasing acceptance amongst economic commentators that loose monetary policy has fuelled credit bubbles; a too-narrow focus on CPI has prevented central bankers from fully noticing; and the risk of a minor recession should outweigh the threat of future inflation. By providing the context for these ideas we hope this interest is extended to central bankers. In these testing times there should be an open mind for the most appropriate frameworks to influence monetary policy. There is a vacant seat at the top table, and it is time that it was filled.

We encourage you to read the whole article.

Stop all the clocks, cut off the telephone, and prevent the dog from barking with a juicy bone.

Because where there used to be just two standard economics primers that the aspiring Austrian student could get started with, there are now three.

We have already reviewed the first two primers, here at the Cobden Centre:

• Economics in One Lesson
• Economics for Real People

However, these may have just been superseded by a third: How an Economy Grows and Why It Crashes, by Peter D. Schiff and Andrew J. Schiff.

The Schiff brothers have created this new primer by basing it upon two cartoon-style books written in the 1980s by their father, Irwin A. Schiff, that have since gone on to become underground classics and which are also available on Scribd:

• The Kingdom of Moltz
• How an Economy Grows and Why It Doesn’t

These two books have been blended together into a cohesive unitary whole and brought right up to date, with much more text added than in the original books, to nail home all of the major lessons of Austrian economics.  (Or as we Austrian adherents sometimes like to call it, True economics.)

Quite simply, this new Schiffian book is a joy to read as it follows the story of three Robinson-Crusoe-Style men — Able, Baker, and Charlie — and maps out how they and their descendants travel in time from a lost island of rude existence — catching and eating one fish per day with their bare hands — to a land filled with government-subsidised universities offering voters fun degree courses in surfboarding.

Just as Ludwig von Mises and Murray Rothbard begin with Robinson Crusoe scenarios in Human Action and Man, Economy, and State, Able, Baker, and Charlie start out with nothing but their bare hands and then work their way up through capital savings and capital goods production (building nets to catch fish), all the way through to every aspect of modern government-dominated economics (with oriental agents eventually using cartloads of Fish Reserve Notes to buy up everything of any worth on the original island).

One of the best parts of travelling through this telescoped journey is working out who represents who in the cartoons.  Ben Barnacle and his ‘Strong Fish’ policy are easy enough to work out, but can you guess who Franky Deep and Cliff Cod are, with their ‘Official Fish’ policy conundrums?

It actually goes well for the island until Franky Deep ousts Grouper Cleveland.  But from then on it’s a downward fish school spiral until the islanders hit a remarkably similar economic reef to our own.  The Schiff brothers then take this situation on a few years to show where the island will end up if it keeps following the fantasy fish policies of Barry Ocuda.

As well as being a great quick read, virtually every economic and financial policy you can think of is explored and examined within the pages of this book, without there being a single “There She Blows!” moment where everything suddenly reverses meaning, as happens between Classical micro-economics and Keynesian macro-economics, when saving and production flip from being moral and sensible to becoming immoral and nonsensical.

Instead, this book is simply based upon the sound rigorous principles of Austrian economics, which work from back to front in all climates, on every island, for all time, and which make sense all the way through from micro to macro.

In simple fish-related terms, reading this book will give you a whale of a time.

If I am forced to find a flaw, I suspect that the book will date fairly rapidly and will need to be updated in five to ten years, unlike either Economics in One Lesson or Economics for Real People; however, I am confident that this necessary update in a few years time will not be beyond the wit of the Schiff brothers to carry out, as and when it is required.

In the meanwhile, that still gives us plenty of fish-time Fridays to read and enjoy the current version, a flavour of which can be seen in the following YouTube video:

• http://www.youtube.com/watch?v=78a84qbT5-w

Before purchasing the book, you may also want to read these two splendid reviews:

• The Best Introduction to Economics in Print (LewRockwell.com)
• Review: “How An Economy Grows & Why It Crashes” by Peter Schiff (BlackSheepReport.com)

A key question in the debate over fractional reserve banking is the extent to which people know that banks lend their deposits out to others. People must accept that if they all went to get back their deposits, the banks would not be able to pull in all the money they have lent on, and the system would collapse. The fact is that not all people want their money back at the same time, so the scheme works and allows interest to be paid. I have always held that people would be horrified if they knew what was actually done with their money. In the absence of any empirical data, the Cobden Centre commissioned a group of students at ESCP Europe working under our Founding Fellow, Dr Anthony Evans, with the market research company ICM, to survey the views of 2000 people. Anthony has written an informative and useful summary. The report considers the key questions of solvency and liquidity, and concludes that “by reasonable auditing standards, high street banks are insolvent”.

My take is that people are confused. 74% think they own their money, when of course they do not, the bank does. 15% want safe keeping and 67% want easy access. Easy access implies safe keeping to me as there is no access if you have a bank run. I do feel that clarity, more so than ever, is required to start the clearing up of this mismatch of understanding between what a bank actually does and what people think it does. This can only be resolved by a change in law as mentioned in this article. At the same time, our fractional reserve free banking colleagues may take comfort from our finding that 61% of those surveyed do not mind having their money lent out so long as the lending isn’t reckless. This strengthens the position of allowing FRFB between consenting adults. The debate will roll on. We hope this will add an empirical edge that will sharpen the focus of some of the best thinking Austrian economists.

I am minded to return at a later date and commission a further survey that helps spell out to the public the actual bank credit creation multiplier as this is not brought out by our questions, and see what the empirical data throws back at us. I suspect that hairs will stand up on the back of necks, with a general sense of horror, but these are my prejudged views and I would be interested to see the evidence.

In the meantime, I recommend this video of Anthony’s presentation of our findings to the Liberty 2009 Conference: