Indeed, Occupy Wall Street’s mantra — tax the rich — is simply the second point in the ten‐point action plan laid out in The Communist Manifesto: “A heavy progressive or graduated income tax.” In spite of their shared antipathy towards the establishment, it’s as if the descendants of America’s Founding Fathers were dueling it out with the offspring of Karl Marx and Friedrich Engels. Never mind.
Let us step back from the street protests and identify the primary culprit of the huge economic dislocations that began in the fourth quarter of 2007. The application of Austrian Business Cycle Theory allowed practitioners to anticipate the crash. As for the culprit, all indicators pointed to the Federal Reserve (Fed). The Austrians weren’t alone in anticipating the crash and fingering the Fed, however. The followers of Prof. Hyman Minsky foresaw a Minsky Moment well in advance of the Panic of 2008-09. Dr. Bob Barbera’s book The Cost of Capitalism: Understanding Market Mayhem and Stabilizing our Economic Future contains a clear Minsky‐like diagnosis. But perhaps the most amazing prediction was made by Prof. Fred Foldvary, a student of the 19th century American political economist and advocate of the “single tax” on land Henry George. In a 1997 article “The Business Cycle: A Georgist‐Austrian Synthesis,” Prof. Foldvary wrote, “The next major [real estate] bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war.” Prof. Foldvary’s analysis also anticipated the perpetrator of the downtown — the Fed.
That said, Austrian Business Cycle Theory is the most relevant because it hits the nail on the head when it comes to a critique of the specific thing that was (and is) driving the Fed’s monetary policy: inflation targeting. For the Fed, and for most other central banks, monetary policy boils down to hitting an inflation target, such as a two percent annual growth rate in the consumer price index. It’s as if nothing else matters. But, one of the main lessons delivered by the late Friedrich Hayek, one of the early pioneers in Austrian business cycle research, is that a reliance on one magic index, such as the consumer price index, to guide monetary policy is a recipe for disaster. Indeed, Nobelist Hayek stressed that changes in general price indexes don’t contain much useful information. He demonstrated that it is the divergent movements of different market prices during the business cycle that count.
The accompanying chart of relative prices illustrates this perspective. Former Fed Chairman Alan Greenspan and his successor Prof. Ben S. Bernanke — inflation targeters through and through — thought the economy was sailing smoothly on calm waters during the 2003-07 period. After all, the consumer price index (less food and energy) was growing at a very regular “targeted” pace of 2.1% per annum during that period. By contrast, the Austrians saw the huge relative price distortions in major commodity and asset groups. For example, share prices were accelerating at an 11% annual rate during the 2003-07 period; housing prices measured by the Case‐Shiller index were rising at an annual rate of 13% during the 2003–2006 (Q1) period; and commodity prices measured by the CRB index rose at a 13% annual rate during the 2003–2008 (Q2) period. For the Austrians, these surging prices and relative price distortions resulted from the Fed’s ultra‐lax monetary policy. They correctly anticipated that trouble was just around the corner.
Even after the Panic of 2008-09, the Fed (and other central banks) remains in denial, refusing to admit that monetary policy had anything to do with creating the bubbles that popped and the ensuing economic difficulties.
The Deputy Governor of Sweden’s Riksbank and a well‐known pioneer of inflation targeting Prof. Lars Svensson made clear what all the inflationtargeting central bankers have in mind: