From anAustrian perspective, two drivers behind the financial crisis were the pressureon interest rates by monetary authorities and the use of mathematical equationsin attempt to lessen risks.Firstly, Austriansuse the Austrian Business Cycle Theory to provide an explanation for the financialcrisis (Maier & Koumparoulis, 2012). The theory entails that economicgrowth is sustainable if follows from greater investment funded by highersaving, but is unsustainable if follows from credit expansion, as was the caseprior to the financial crisis. This conclusioncan be explained as follows. In a freely functioning market economy, theinterest rate provides a signal that coordinates the plans of savers and investors.

The natural interest rate ensures that just enough is invested now to be ableto produce in future the consumption goods that consumers demand in the future.When monetary authorities engage in credit expansion, interest rates fall belowthe natural interest rates. Consequently, the information embedded in interestrates is misleading, and savers and investors are provided by inconsistent signals.It gives consumers the signal to consume more now and at the same time spursadditional investments. Investors build up additional capacity for providingadditional products in the future but the demand for these products will not bethere because consumers spend more now than in the future. This inconsistency impliesthat capital is malinvested throughout the economy. There will be temporaryhigher growth due to the boost of investment and consumption, but eventually,as the shortage of underlying demand for capital goods comes forward, capacity utilizationdecreases, and the boom that was launched by credit expansion ends in a bust,or to say, the financial crisis of 2008/9.Secondly, accordingto Austrians, one mistake was to view economics as a science on the order ofphysics, one that can be reduced to quantities, numbers, and mathematicalformulas (Veryser, 2013).

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The Austrian School distrusts mathematical modelingand understands economics as a science of individual human action. Austrians believe human actionsplayed a significant role in fueling the financial crisis. Bankers kept on borrowingmore mortgages with the view that in time, the value of real estate wouldincrease. They thought that with time they would gain high interest rates whileconsumers looked forward to higher returns. They were speculating huge profitsfrom the mortgage loans and did not consider the corresponding risks.

Thispushed the value of the mortgages beyond their real value. Bankers expected consumersto invest in the loans, but due to the rising prices of goods, people preferredto spend, leading to overconsumption. Thus, there was much speculation ratherthan relying on real economic calculations. From an Austrian perspective, the improperspeculations by humans contributed to the financial crisis.

If theentrepreneurs did proper economic calculations and had strong cost allocationsystems and, none of the consequences faced would have risen (Maier &Koumparoulis, 2012).Next considerthe monetary policies used in response to the financial crisis. These policieswere based on Keynesian models which prescribe expansionary policies to remedy theweak aggregate demand in times of economic stagnation (Tempelman, 2010). Centralbanks indeed responded to the financial crisis by lowering the short-termnominal interest rates to zero, as well as resorting to more unconventional policiesby targeting long-term interest rates via the purchase of government securitiesand by supporting needy sectors of the credit markets (Tempelman, 2010). These followedpolicies are at odds with recommendations made by Austrians. In the Austrianview, expansionary monetary policy is assumed to set up another unsustainableboom. For Austrians, the real solution is simple: allow the marketplace to workto realize a restructuring of the economy.

The resources that have beenmalinvested should be reallocated to other areas (Hoogduin, lecture December19, 2017). It is only after the economy experienced this that growth can startafresh based on an analysis of the future consumer behavior. Thus, creditexpansion doesn’t bring sustainable economic growth, but merely postpones it,as it delays structural adjustments such as business closures and othereliminations of unproductive uses of capital.

Refusing to allow markets torestructure only sets the stage for a bigger crisis.