Keynesian Vs Austrian: American History's Economic Schools

Austrian and Keynesian economics are two opposing schools of thought that are still thriving today. Austrian economics, founded in the mid-1800s, believes in the free market as the most efficient means of allocating resources. Keynesian economics, founded by John Maynard Keynes, believes that government intervention can stabilize the economy and maximize economic growth and employment. Austrian economists like Carl Menger, Ludwig von Mises, and Friedrich Hayek, emphasize logic and critical thinking, while Keynesian economists like John Maynard Keynes and Jake Hill advocate for government intervention to stabilize the economy. Austrian economics is generally critical of fiat currency, while Keynesian economics supports it. Austrian economics emphasizes free markets, private property, and minimal central bank intervention, while Keynesian economics emphasizes government intervention to stimulate the economy. Austrian economics theorizes that economic phenomena are caused by individual choices, while Keynesian economics focuses on aggregate demand as the driving force of the economy.

Austrian School: Free markets vs government intervention

Austrian School economics is a heterodox school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals along with their self-interest. Austrian-school theorists hold that economic theory should be exclusively derived from basic principles of human action.

The Austrian School believes that the free market is the most efficient means of allocating resources. Austrian economists make the libertarian argument that government intervention in the economy typically does more harm than good. They believe that government intervention in free markets makes negative business cycles more severe. Austrian economists also believe that companies should be allowed to fail during economic downturns to eliminate the least efficient businesses. This process also helps allocate more resources to the most efficient existing businesses, as well as to the creation of new businesses. Austrian economists believe in "sound money", convertible currency which is backed by gold or other hard assets.

The Austrian School uses logic and a priori thinking to discover economic laws of universal application, whereas other mainstream schools of economics make use of data and mathematical models. Austrian economists generally rely on logic and critical thinking more than complex statistical models and formulas. They believe maintaining free markets and protecting the money supply are keys to ensuring social progress and civil liberty.

The Austrian School theorizes that the subjective choices of individuals, including individual knowledge, time, expectation, and other subjective factors, cause all economic phenomena. Austrians seek to understand the economy by examining the social ramifications of individual choice, an approach called methodological individualism. It differs from other schools of economic thought, which have focused on aggregate variables, equilibrium analysis, and societal groups rather than individuals.

The Austrian School originated in 1871 in Vienna with the work of Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others. It was methodologically opposed to the Historical School, in a dispute known as the "methodology quarrel". The Austrian School owes its name to members of the German Historical School of Economics, who argued against the Austrians during the late 19th-century "methodology struggle".

Keynesian Economics: Aggregate demand

The British economist John Maynard Keynes is regarded as the founder of modern macroeconomics. His most famous work, 'The General Theory of Employment, Interest and Money', was published in 1936. However, his earlier work, 'A Treatise on Money' (1930), is often regarded as more important to economic thought. Keynes's theories revolutionised the way spending, output, and inflation were viewed.

Keynesian economics is a macroeconomic theory of total spending in the economy and its effects on output, employment, and inflation. The central belief of Keynesian economics is that government intervention can stabilise the economy. Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the Great Depression.

Keynesian economics is based on the assertion that aggregate demand, measured as the sum of spending by households, businesses, and the government, is the most important driving force in an economy. Keynes further asserted that free markets have no self-balancing mechanisms that lead to full employment.

Keynesian economics advocates using active government policy to manage aggregate demand to address or prevent economic recessions. According to Keynes, inadequate overall demand could lead to prolonged periods of high unemployment. An economy's output of goods and services is the sum of four components: consumption, investment, government purchases, and net exports. Any increase in demand must come from one of these four components.

During a recession, strong forces often dampen demand as spending goes down. For example, during economic downturns, uncertainty often erodes consumer confidence, causing them to reduce their spending, especially on discretionary purchases. This reduction in spending by consumers can result in less investment spending by businesses, as they respond to weakened demand for their products. This puts the task of increasing output on the shoulders of the government.

Keynesian economics supports a mixed economy guided mainly by the private sector but partly operated by the government. It recognises the role of government in sparking aggregate demand through federal spending and tax cuts, which leave more money in people's pockets, stimulating demand and investment.

Keynesian economics focuses on demand-side solutions to recessionary periods. The intervention of the government in economic processes is an important part of the Keynesian arsenal for battling unemployment, underemployment, and low economic demand. Keynesian theorists believe that, without intervention, this cycle is disrupted, and market growth becomes more unstable and prone to excessive fluctuation.

Was American History More Keynesian or Austrian School?

In the history of economic thought, a school of economic thought refers to a group of economic thinkers who share a mutual perspective on the way economies function. The Austrian School is a heterodox school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals along with their self-interest. Austrian-school theorists hold that economic theory should be exclusively derived from basic principles of human action.

The Austrian School originated in 1871 in Vienna with the work of Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others. The school takes its name from members of the German Historical School of Economics, who argued against the Austrians during the late 19th-century 'Methodenstreit' or 'methodology struggle'.

The Austrian School theorises that the subjective choices of individuals, including individual knowledge, time, expectation, and other subjective factors, cause all economic phenomena. Austrians seek to understand the economy by examining the social ramifications of individual choice, an approach called methodological individualism. It differs from other schools of economic thought, including Keynesian economics, which have focused on aggregate variables, equilibrium analysis, and societal groups rather than individuals.

While the Austrian School has had an influence on economic thought, Keynesian economics has dominated economic theory and policy after World War II until the 1970s, when Keynesian theory's popularity waned due to its inability to address stagflation.

Austrian Economics: Subjective value

Austrian economics is a heterodox school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals along with their self-interest. Austrian-school theorists hold that economic theory should be exclusively derived from basic principles of human action.

The subjective theory of value (STV) is an economic theory that explains how the value of goods and services is set and how it can fluctuate over time. The value of a good is not determined by any inherent property of the good, nor by the cumulative value of its components or the labour needed to produce it. Instead, it is determined by the individuals or entities who are buying and/or selling that good.

The modern version of STV was created independently and nearly simultaneously by William Stanley Jevons, Léon Walras, and Carl Menger in the late 19th century. Menger, considered by many to be the founder of Austrian economics, wrote in his "Principles of Economics" that:

> Value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs...

Menger further explained that with an increase in the number of goods, their subjective value for an individual diminishes. This is the concept of diminishing marginal utility.

According to STV, the value of a good may increase substantially following its creation if it is perceived as being more important or desirable. There are many variables that can influence this process, including changes in the age of the good, personal affinity, cultural significance, scarcity, and situational circumstances.

An additional variable, as pointed out by Menger, is the estimation of a good's value due to uncertainty and lack of knowledge. People sometimes estimate the importance of various satisfactions in a manner contrary to their real importance.

Wealth, according to STV, refers to individuals' subjective valuation of their possessions. Voluntary trades may increase the total wealth in society because each participant in the transaction has gained more value than they originally had.

Proponents of STV also believe that in a free market, competition between individuals seeking to trade goods will result in a market equilibrium set of prices emerging.

Austrian Economics vs Keynesian Economics in American History

In the history of economic thought, economists are often classified into schools of thought, though this is less common in the modern era. Economic thought can be roughly divided into three phases: premodern, early modern, and modern. Mainstream economics, which encompasses a wide range of views, is distinguished from heterodox approaches and schools within economics.

Austrian economics is a heterodox school of economic thought, while Keynesian economics has developed from the work of John Maynard Keynes and focused on macroeconomics in the short run. Keynesian economics has two successor schools: post-Keynesian economics and new-Keynesian economics.

While I cannot determine whether American history was more influenced by Keynesian or Austrian economics, I can tell you that Keynesian economics has been highly influential in the United States. Keynesian views entered the mainstream as a result of the neoclassical synthesis developed by John Hicks, and Keynesian economics reduced the appeal of heterodox schools.

Keynesian Economics: Fiscal and monetary policy

Keynesian economics, named after British economist John Maynard Keynes, revolves around the central tenet that government intervention can stabilize the economy. Keynesian economics is a school of thought that emerged in response to the Great Depression of the 1930s, during which existing economic theory failed to explain the causes of the economic collapse or provide adequate solutions. Keynes challenged the then-prevailing idea that free markets would automatically provide full employment, arguing instead that aggregate demand—the sum of spending by households, businesses, and the government—is the most important driving force in an economy.

Keynesian economics generally advocates for a regulated market economy, predominantly driven by the private sector but with an active role for government intervention during recessions and depressions. This intervention can take the form of fiscal policy actions, such as deficit spending on labour-intensive infrastructure projects, and monetary policy actions, such as reducing interest rates to encourage investment. These policies aim to stimulate the economy, increase aggregate demand, and maintain stability.

Keynesian economists believe that a free market can lead to periods of inadequate demand, resulting in extended periods of high unemployment. They argue that during a recession, consumer confidence and discretionary spending plummet, causing a reduction in spending by consumers and subsequently less investment spending by businesses. This, according to Keynesian economics, necessitates government intervention to increase aggregate demand, stimulate the economy, and reduce unemployment.

Keynesian economics also emphasizes the role of monetary policy, particularly the influence of interest rates on investment. Lowering interest rates can make previously uneconomic investments profitable and encourage consumer spending on large purchases.

Overall, Keynesian economics: Fiscal and Monetary Policy focuses on the role of government intervention in stabilizing the economy through fiscal and monetary policy measures, with the aim of increasing aggregate demand, stimulating economic growth, and reducing unemployment.

Austrian Economics: Money supply

Austrian economics is a heterodox school of economic thought that advocates strict adherence to methodological individualism—the concept that social phenomena result primarily from the motivations and actions of individuals along with their self-interest. Austrian-school theorists hold that economic theory should be exclusively derived from basic principles of human action.

Money Supply

Austrian economics defines money as the medium of exchange, the asset for which all other goods and services are traded on the market. Money is not consumed or produced but is held for future exchange. Austrians emphasise that money is non-neutral, meaning that an increase in the money supply will not have a neutral effect on the economy.

The Austrian school holds that an increase in the money supply not supported by an increase in the production of goods and services leads to an increase in prices. However, prices of all goods do not increase simultaneously. Prices of some goods may increase faster than others, leading to a greater disparity in the relative prices of goods. Austrian economists argue that this increase in the money supply is caused by banks' issuance of credit, which leads to economic fluctuations and the business cycle.

The Austrian school's view on money supply differs from other schools of economic thought. For example, the classical school of economics holds that objective costs of production determine the price, while the neoclassical school holds that prices are determined by the equilibrium of demand and supply. In contrast, the Austrian school argues that costs of production are determined by subjective factors based on the value of alternative uses of scarce resources, and the equilibrium of demand and supply is determined by subjective individual preferences.

American History: Keynesian vs Austrian School

In American history, Keynesian economics has had a more significant influence than the Austrian school. Keynesian economics developed from the work of John Maynard Keynes and focused on macroeconomics in the short run, particularly the rigidities caused when prices are fixed. It advocates for government intervention during a recession to inject spending into the economy. On the other hand, the Austrian school, represented by economists such as Ludwig von Mises and Friedrich Hayek, emphasises the importance of laissez-faire and free markets, arguing that government intervention distorts interest rates and leads to misallocation of capital and economic recession.

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