Essential Hayek: Economic Booms and Busts

In this video, we explore Hayek's work on economic booms and busts, for which he was awarded a Nobel Prize in Economics in 1974. Hayek points out that a common mistaken conclusion about the larger economy is that economic downturns—recessions—are caused by too little overall demand. A follow-up mistaken conclusion is that the appropriate cure for recessions is a set of government policies that increase demand. This is part of a Fraser Institute project to present the ideas of F.A. Hayek. Presented by Donald J. Boudreaux.  Source: The Fraser Institute YouTube channel.


In this video, we explore Hayek's work on economic booms and busts, work for which he was awarded a Nobel Prize in Economics in 1974. One of Hayek's key observations was that when governments interfere in the economy it results in people acting in ways that are not sustainable. Which ultimately leads to booms and then inevitably, busts.

Let's simplify this idea with an example. This is Brian. Brian is a politicians who thinks he has a great idea for creating jobs and widespread prosperity. With the best of intentions, Brian convinces his government to support companies so that they can develop and build factories to sell chocolate-covered pickles. The Brian's plan is flawed. He assumes there will be great demand for chocolate covered pickles. Were there truly a great demand for chocolate covered pickles, the pickle industry would naturally respond and build factories of covered pickles with chocolate, all without the government's assistance.

So what happens when there is no real demand by customers for chocolate covered pickles? The resources provided by the government, whether in the form of direct support like subsidies or indirect support loan guarantees, distorts the economy by encouraging people to make bad decisions. In this, case to use resources to make chocolate covered pickles.

As the lack of demand for these pickles becomes apparent, businesses must adjust by retooling or even scuttling factories, adjusting their production lines, changing their distribution networks, et cetera. All of these things mean idle resources in the short term, as businesses adjust to the reality the market. The challenge is to ensure that producers have the knowledge and the incentives to produce goods and services that people want. Government interference, such as through subsidies were specially importantly by manipulating the money supply, obscures that knowledge by distorting prices. This interference by initially causing produces to tool up to produce things that consumers don't really want inevitably result in produces having to tool down and re just in order to better meet true consumer demeans.

The core insight from Hayek on economic booms and busts is that government interference, even when done with the best intentions, changes people's behavior by changing incentives and changing signals in the market. These changes resulting investments that are not sustainable and which ultimately lead to recessions or busts.

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