I’m not sure most Austrian economists would not agree with that there will be pain during the liquidation phase of the business cycle. But I think this “pain theory” that is identified with Austrians and embraced by some is distorting.
One would not, for example, say that a heart surgeon attempting to save a man’s life by heart surgery is in favor of pain as the way to save the man, even though pain is most assuredly a byproduct of a major heart operation.
There would never be a critique of a heart surgeon, “Oh, he causes pain.” We all know such an operation is performed only to prevent further pain, and possibly death, down the road. In the same way, an Austrian economist who calls for a laissez faire attitude during the down phase of the business cycle is doing so only because he knows that the down the road alternative is worse. A resumption of money printing may prop up the earlier central bank manipulated capital structure, short-term, but it will only mean a greater liquidation down the road or hyper-inflation.
Thus, an Austrian calling for liquidation of malinvestments is more like a surgeon calling for a malignant tumor to be cut out. In either case, do you really want the alternative, for them to grow?
Austrian economists aren’t into pain anymore than heart surgeons and cancer surgeons. Austrian economists look at the business cycle and are really saying, “Look you better stop this now because it will only get worse.” That’s not a pain theory. It’s a theory to limit pain.
Malinvestments don’t go away. Isn’t the current housing mess evidence enough of that, despite all the “stabilizing” efforts? Thus, Eichengreen’s charge, that Austrian policy prescription would be ”inflicting intense pain,” must be examined relative to the options, which are, again, greater liquidation pain down the road, or hyper-inflation, both of which will cause greater damage to even more “innocent bystanders.”
The business cycle can reach deep into the economy. The only options to “fighting” and propping up malinvestments during the down phase of the business cycle will result in creating greater problems down the road. The call of Austrian economists for immediate liquidation of malinvestmnets is not because they are into pain, but because they understand that if liquidations don’t take place now pain will be much more severe down the road. In this sense, Austrians offer the most sound treatment to limit pain [during a recession].