What is Austrian Economics? Austrian Economics V/S Keynesian Economics

Every human has different needs, and human actions are always influenced by human needs. The basis of Austrian Economics is the study of human behaviour to determine changes in the market forces.
 

Austrian Economics is different from Keynesian and neoclassical economics, it takes into consideration “practical actions” rather than emphasizing on statistics and mathematical equations.

 

Let us understand the concept of Austrian Economics through this blog.

 

 

Austrian Economics

 

Carl Menger is considered to be the “father of Austrian economics”, he proposed the theory of Austrian Economics in the 19th century. Carl Menger said that the concept of product value is subjective, every individual has a different need and has different purchasing powers.

 

(Related Reading: What is Economics? Keynesian And Behavioural Economics)

 

According to him “product’s value was dependent upon its ability to satisfy human needs.” The introduction of “Austrian economics” also led to the origination of  “diminishing marginal utility” (i.e. decrease in the satisfaction of consumers from extra units of consumption). 

 

Alongwith Carl Menger Ludwig von Mises, Eugen von Böhm-Bawerk, and Friedrich Hayek are some popular Austrian economists that contributed to the “Austrian theory”. 

 

Austrian Economics, school of thought originated in Vienna, and hence it is also called “the vienna school of economics”. 

 

Austrians discarded the beliefs of neoclassical and Keynesian economists, they believed that markets should be free from “government interference”. Austrians further emphasized that markets are “self regulatory” and if an increase in money supply is not accompanied by a simultaneous increase in the production of goods it might lead to an increase in prices.

 

Austrians focus entirely on the “utility of a product”, as per them if a product has no utility, it will not be purchased by a consumer. It uses the “logic of priori thinking”. 

 

Austrians believed that government control in a market leads to distortion; it disrupts the existing production and supply cycle. According to the theory of Austrian economics, the market system is neither managed nor regulated by any individual player, when a proper demand and supply chain come together it creates an efficient system. 

 

(Must Check: Difference Between Economic Growth and Economic Development)

 

The main focus of Austrian economics is not on the aggregate economy, but rather on equitable distribution of resources. As you must have understood the basics of Austrian economics, let's move further with beliefs of Austrian economics.

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Carl Menger, the father of Austrian Economics

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Beliefs of Austrian Economics

 

 

1. Austrians believe recessions are caused by Credit Cycles

 

Credit Cycle refers to expansion and contraction in the cycle of credit. As per Austrian economics, the recession in the economy is caused by central banks. They believe that the central bank extends credit to companies at low interest rates, which ultimately leads to recession. 

 

2. Austrians believe in Philosophy of Free Market Capitalism 

 

As per Austrian economists free markets provide a better system, they further lay emphasis on a system where no government intervention disrupts the market force.

 

3. Austrians believe in maintaining a fixed gold standard for fiat money circulation

 

Gold standard is a system in which countries fix the value of their respective currencies, based on the value of gold. The countries that adopt a fixed gold standard set a “fix price” for their gold. “Fix gold” standard helps in determining the value of currency.

 

Austrians believe it is important to maintain a fixed gold standard as it places a regulation on the government, their fiat money circulation and printing. When the specific amount of gold will be set aside for money printing, the ever increasing rate of inflation will remain in control.

 

      4.  Austrians believe in their own fiscal policies and discards the Keynesian Fiscal Policy

 

Austrians believe any effort by the government to push the demand cycle leads to inefficiency and misutilization of resources. The government must not intervene in market at any cost; and should let the forces of demand and supply adjust on their own. 

 

Let us move further to understand the laws of Austrian economics.

 

 

Laws of Austrian Economics

 

(Please note Investopedia is used as a reference for this section)

 

• Determination of Price: The Austrian economists believe that prices are usually determined by different factors like an  individual’s action in the market, market sentiment, high/low demand of a specific good. According to Austrians, subjective factors influence the determination of prices. They further emphasized that “cost of production” is also determined by subjective factors.

 

(Must Check: A Guide to Price Ceiling and Price Floor)

 

• Determination of Interest Rates: As per Austrian economists the interest rates are determined by the people’s collective sentiment. If the majority of people are saving their money that means a higher interest rate is available to consumers. 

 

• Impact of Inflation: According to Austrian economists, increase in money supply must be accompanied by an increase in the production of goods; if by any chance this doesn’t happen then the prices of goods will increase automatically. 

 

(Related Blog: What is Inflation? Demand-pull and Cost-push)

 

Though the impact of inflation will be different on every good, it will ultimately create disproportion in the market. For example post inflation a  loaf of bread might cost the same but the bottle of milk will become expensive. 

 

• The Cycle of Business: Business cycles describe the expansion and recession periods of the economy. As per Austrians the business cycle is a result of government’s intervention in controlling money. 

 

They believe that government’s attempt to control the interest rates lead to recession in the economy. Austrians further emphasize that the government's short term business adjustments lead to unemployment. 

 

• Creation of Markets: The Austrian School focuses on a simple philosophy of people's actions. Contrary to the beliefs of classical and neoclassical economists, Austrians believe that individuals create markets. It believes that when different individuals interact with each other they facilitate the process of exchange.

 

• Capital Goods: Austrian economists believe that every capital good is different. Capital goods like tool, machinery building have different uses and cannot be swapped. Austrians argue that creation of wrong capital goods lead to economic waste. 

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Laws of Austrian Economics

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Austrian Economics v/s Keynesian Economics

 

1. The main concept of Keynesian economics is government control. Keynes believes that the government should intervene in the economy to change the aggregate demand. Government should control the demand to tackle the supply chain. 

 

While Keynes believe that government control is integral for proper working of an economy the Austrians discard this concept they believe that the market must be entirely free from government control. As the market is controlled by “individual’s actions” hence there is no active role of government. 

 

2. Keynes believes that the government runs a specific system, whether production cycle or consumption cycle everything is determined by government. 

 

On the other hand Austrians believe that people’s actions stimulate the demand for a specific product. Increase in individual’s spending determines the sentiment of the entire market the change in consumer’s habits is caused by their own actions and not by government’s interference according to Austrians.

 

3. Keynes treat capital goods as “homogenous”; although various capital goods like tools, machinery, buildings have different uses. Keynes club them all together, according to them spending $10,000 on machinery is same as spending $10,000 on the purchase of a new building, on the other hand Austrians distinguishes different capital goods.

 

(Related Blog: Capital in Economics - Characteristics, Types and Functions)

 

Austrians believe that every capital good serves a different purpose and they cannot be treated the same. 

 

Watch this video to understand the differences between Austrian Economics and Keynesian Economics. 

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Criticism of Austrian Economics 

 

“There are two sides to every coin”; while Austrian Economics provide an appropriate model for the growth of modern economies there are still some discrepancies in the beliefs of Austrian Economists. Let's understand the criticism of this economic theory. 

 

Austrian Economists mould the concept of inflation to suit their needs

Austrian Economists target Interest Rates

Austrian Economics is a well researched political ideology; and not an economic belief

 Austrian Economics misunderstands the functioning of the central bank and targets the concept of business cycles

 

How Austrian Economics is Connected to Bitcoin?

 

Cryptocurrencies are the next big revolution in the market that seek to provide a “decentralized system” that is free from government control. Many times the popularity of bitcoin is linked to Austrian economics. 

 

Bitcoins and other cryptocurrencies like dogecoin, ethereum, litecoin are free from the interference of the government, it's “people’s currency” that works for them. Even new additions to the blockchain networks are controlled by people and not the government. 

 

(Related Blog: What is the Future of Cryptocurrency?)

 

Austrian Economics also follows the philosophy of “people’s action and no government intervention” therefore ever since the concept of bitcoin came to the centre stage everyone compared the age old concept of Austrian Economics to the modern and new age concept  “cryptocurrencies”.

 

Conclusion

 

“Government is the great fiction, through which everybody endeavours to live at the expense of everybody else”- Frederic Bastiat 

 

An economy is nothing without its people; the main purpose of an economy is to serve its individuals to the fullest; its only people’s collective actions that provide the basis to the successful working of any economic system.

 

An increase in people’s purchasing power will always be directly proportional to an increase in production; hence the demand and supply chain is regulated by the” people’s behaviour”