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Comparing Keynesian and Austrian Economics

Keynesian vs. Austrian Economics-

Economics is the lifeblood of every nation. How money flows through from employers, to employees, to governments, and back again is the basic idea of economics. There are many different theories on how economics actually works however. Two prominent economic theories that are often hotly debated are Keynesian and Austrian economics.

The two schools of thought share drastically different views on economic functions and the role of the private and public sectors. Before attempting a comparison of the two methodologies, let’s take a closer look at the evolution and basic methods of the two economic schools of thought.

Many economic theorists trace the roots of Austrian economics back to the fifteenth century and the followers of St. Thomas Aquinas. As his followers sought an explanation for the full range of human action and social organization, they took notice of the existence of economic laws and the inevitable forces of cause and effect.

Austrian Economics

Austrian Economist Ludwig von Mises

Ludwig von Mises
Austrian Economist

The first true wave of Austrian economics as it is known today came from Vienna in the Austrian Empire during the mid-19th century. Several notable economists from the Austria-Hungary region of Europe were responsible for the development of what has become known as Austrian economics. Those individuals included Carl Menger, Eugen von Böhm-Bawerk, Ludwig von Mises, and Friedrich Hayek.

Social cooperation, however, can be based only on the foundation of private ownership of the means of production… The assertion that there is irrational action is always rooted in an evaluation of a scale of values different from our own. Whoever says that irrationality plays a role in human action is merely saying that his fellow men behave in a way that he does not consider correct.  —Ludwig von Mises

“Despots and democratic majorities are drunk with power. They must reluctantly admit that they are subject to the laws of nature. But they reject the very notion of economic law . . . economic history is a long record of government policies that failed because they were designed with a bold disregard for the laws of economics …

All those not familiar with economics (i.e., the immense majority) do not see any reason why they should not coerce other people by means of force to do what these people are not prepared to do of their own accord…

On the market it is not mankind, the state, or the corporative unit that acts, but individual men and groups of men, and that their valuations and their actions are decisive, not those of abstract collectives. .” —Ludwig von Mises, in Austrian Economics: An Anthology

Human beings are an integral piece of economic activity, Austrian economic followers don’t believe any scientific methods are applicable to economics because “humans are too complex for such a treatment because humans are not passive and non-adaptive subjects. There are no statistical characteristics to human behavior. It is purposeful rather than random, and changeable rather than constant.”

In short, Austrian economists believe that the private sector should be the sole driving force of an economy. The premise of Austrian economics is to allow the private sector to control the economy without outside factors influencing the marketplace. Austrians believe that recessions and depressions are normal and necessary functions of any economy that serve to purge the marketplace of unnecessary or weak enterprises that waste precious capital investment. These drops help pave the way for new businesses, new capital investment, and new jobs. They also believe that through monetary stimulation government intervention amplifies what would otherwise be a moderate recession making it more severe and possibly even converting them into depressions.

Keynesian Economics


John Maynard Keynes

Keynesian economics was developed in the early 20th century based upon the previous works of authors and theorists in the 19th and 20th century. John Maynard Keynes is the father of Keynesian economics and first presented his full theories in 1936 when he published “The General Theory of Employment, Interest, and Money.”

The basic theory to Keynesian economics revolves around a partnership between the private and public sector in growing, nurturing, and protecting a healthy economic situation. Keynesian economics believes that private sector decision-making occasionally results in inefficient practices that have a negative impact on a greater macroeconomic scale. The result is a need for the public sector to step in and correct the direction of the economy with monetary and fiscal policies.

In short, Keynesian economics views any recession or depression as unnecessary and believes in the need for the public sector to step in and prevent the loss of current businesses and jobs.

Real Life Economics

In relating these two competing theories to events in human history, we need look no further than the Great Depression for their differing viewpoints. Keynesian economics called for the public sector, the administration of Franklin D. Roosevelt in this case, to step in and adopt fiscal and monetary policies to try and stabilize the economy. This was done through stimulus funds, public works projects, and other general government deficit spending.

Austrian economics on the other hand would have had the government remain on the sidelines and wait for the market to correct itself and the economy to emerge from the downturn stronger, without the government running up a deficit to prop up the economy.

Keynsian’s believe that, government deficit spending and the commencement of World War II with its massive military spending, pulled the economy out of the depression and helped provide for a boom in the years following the war. Austrians believe that government policies prolonged the recession, and created a “double dip” and drove the economy into the depression in the first place. And that by the time the War came around, the excesses had finally been worked out of the economy and it was ready to recover and that all the War did was create shortages of materials and destroy productive capacity and thus the world was poorer as a result.

Keynesian economics enjoyed great popularity from the publishing of Keynes book in 1936 through the mid-1960s when the U.S. government pulled back and increased taxes. At that point Austrian economics began to take hold as the U.S. economy discovered that all the stimulus was doing was creating inflation and by the 1970′s both inflation and unemployment were rising (thus the advent of “Stagflation“). The Reagan administration was the first that followed a more Austrian approach and is credited with reducing inflation and cutting the Misery Index in half. (The Misery index is a combination of Unemployment and Inflation.)

The current global situation has restarted the debate over the merits of Keynesian and Austrian economics as governments across the globe battle to jump start stagnant economies. With Keynsians saying that the Trillion Dollar stimulus saved the Western World from economic ruin and Austrians saying that it did nothing but transfer private debt to the public sector. And it didn’t even erase the debt, but simply moved it from one balance sheet to another and so it is still a ticking time bomb. Bankruptcy although unpleasant eliminates debt from the books allowing for a fresh start.

The 2008 crisis was made much worse by:

  1. Government policies allowing the transfer of risk from private issuers to Public agencies through the resale of loans to Fannie Mae and Freddie Mac.
  2. Government policies encouraging loans (via lower lending requirements)  to individuals unable to repay them.
  3.  The problem was exacerbated by derivatives that converted these junk loans into high quality debt instruments by theoretical diversification although that diversification was among like quality borrowers subject to the same underlying factors. See The Big Short: Inside the Doomsday Machine

 See Also:

One of the major tenants of Keynesian economics is that during a recession as the private sector is shrinking the public sector should increase and provide jobs and run deficits. But the side of Keynesian economics that most politicians forget is that the public sector is supposed to shrink and budgets are supposed to be balanced and debts repaid during good economic times.

Ludwig von Mises Institute

Editor’s Footnote:

According to American Thinker :

Despite  clothing itself in the garb of egalitarianism and tolerance, the progressive  movement, which draws much of its influence from Keynes, has a nasty history of  fostering the perfect society through government dictum… extending the scope of societal  engineering to the sphere of human birth is the next logical  step.  In  addition to being both an anti-Semite and a pedophile, John Maynard Keynes, whose work popularized government-directed planning, was an  endorser of eugenics and the centralized control of the world’s  population. Keynes was the Director of the British Eugenics Society from 1937-1944.

In other words, Keynes believed in the power of government to control every aspect of life from finance to the number of children you were allowed to have. Taken to its logical conclusion we have the former Soviet Union and Communist China as failed examples of this type of experiment.

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