Predictors of the economic crisis and their solutions

The 2008 crash and onward has been the result of the end of a business cycle. There are multiple business cycle theories, but only two predicted the crash: the Austrian business cycle theory and the Post-Keynesian “debt deflation” theory. Even then, those theories are basically two sides of the same coin, both focusing on credit cycles.

Best explained by wikipedia:
“The first difference between these may be stated as debt-deflation being a demand-side theory, which emphasizes the period after the peak – the end of a credit bubble and contraction of debt causing a fall in aggregate demand – while the Austrian theory is a supply-side theory, which emphasizes the period before the peak – the growth of debt during the growth phase causing malinvestment. The theories may thus be seen as complementary, addressing different aspects of the issue.”

So, in 2008 what happened was the culmination of malinvestment and excess debt(loans) in the housing sector.

Solutions:

Austrians-Let interest rates rise and allow the debt to liquidate naturally. Bankruptcy hurts but it will cure the market.

Debt-deflationists-The government writes a check to every citizen and they pay off their debt. To prevent inflation, they restrict lending.

The Austrian solution is the right one, and the recession of 1921 is a great example of how it works, after WW1 inflation money contracted, but without government interference the problems were mostly resolved within a year. While the debt-deflation solution would get rid of the debt much faster, there are two many other problems that would result from it and continue to hamper the economy in the long term. Not to mention the moral hazard problem.

My long term solution: End the Federal Reserve, the central bank, because it exacerbates credit cycles. Replace it with free banking. I am not an advocate of outlawing fractional reserve banking(it is NOT fraud, as some<not all>Austrians claim), and thus credit cycles on a much, much smaller scale would still happen as banks expand and contract the money supply. As for money, go back onto the classical gold standard(NOT the gold-exchange standard) for the U.S. dollar, and allow competing or parallel currencies for competition.

The Deleveraging Trap « azizonomics