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Sep 18, 2011

Influential Financial Economist Turns to Austrianism


Thomas Mayer is the chief economist of Deutsche Bank Group and head of Deutsche Bank Research. He has an impressive background as a highly placed analyst in major private and public financial institutions. Which is to say, when he speaks, people are much more likely to pay attention and to give weight to what he says than they are when those of us on the lunatic fringe spout off.

So, it is an event of considerable note that Mayer has recently given a speech in which he roundly condemns the major macroeconomic theories embraced since the 1930s and the government policies that have flowed from them. He holds these theories and policies responsible for creating false understandings of how the economy works and of what governments can and should do in their efforts to manage the economy and, in particular, to stabilize its growth path.

Mayer urges a turn away from economists’ attempts to ape natural scientists and a renewed appreciation of the lessons of economic history. “A revival of Austrian economics,” he concludes, “could be a good start for such a research program.” I certainly applaud this advice. Unfortunately, Mayer’s understanding of Austrian economics in general—and its theory of macroeconomic booms and busts, in particular—is somewhat defective. Nevertheless, he gets part of it right, and he is undoubtedly moving in the right direction.

Here are the bullet points that introduce his article:

• Failure of the “liquidations” to overcome the Great Depression of the early 1930s prepared the ground for an era of interventionist economic policies. Modern macroeconomics and finance nourished the belief that we can successfully plan for the future. But the present crisis teaches us that we live in a world of Knightian uncertainty, where the “unknown unknowns” dominate and our plans for the future are regularly thwarted by unforeseen and unforeseeable events.

• In a world of Knightian uncertainty, financial firms and investors need larger buffers to cope with the unforeseen, i.e., more equity and less leverage.

• In a world where markets are not always liquid but can seize up in a collective fit of panic, financial firms and investors also need a greater reserve of liquidity.

• Regulation can help to achieve both objectives, but it needs to realize its limits. First and foremost, firms should have the incentives to follow sound business practices. The best incentive is to make failure possible. Hence, we need resolution regimes for financial firms.

• In a world where people have imperfect foresight and do not always behave rationally, and markets are not always efficient, we need to accept that economic policy cannot fine-tune the cycle.

• For us economists, the lesson from recent events should be to rely less on the development of theories by “deduction” (like in natural sciences) and to apply more “induction” (like in social and historical sciences). Failure to study history makes us repeat the mistakes of the past.

Despite my reservations in a few regards, I find Mayer’s views in this speech to be on target for the most part, and I highly recommend it. In several regards, his presentation complements a recent article of mine in which I criticize major elements of currently received wisdom in macroeconomics—what I call “vulgar Keynesianism.”

(I am grateful to Ángel Martín Oro for bringing Mayer’s speech to my attention; see his article [in Spanish] with José Abad at LibreMercado.)

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