Sunday, January 31, 2010

Austrian School of Economics, a Simple Description

We don't often hear about the Austrian School. More often, the voices of Keynesianism and Monetarism are heard. In today's world of the great recession, it is Keynesian theory that is in charge at the Fed, The Treasury and the President's Council of Economic Advisors. To observe Keynesian theory, we can look to current government policy. Monetarists are the people we hear being critical of Keynesian economic theory or existing policy. There are no voices for Austrian economic theory that are taken seriously. They are viewed as anti-establishment, independent, wrong and non-conforming. I would like to try to document some of what I have learned about the beliefs, and criticisms, of Austrian economics. Despite it’s avoidance of mainstream popularity, there is a well organized school of thought and a small number of practitioners who make a number of points that strike me as important. I see no benefit for allowing their ideas to be ostracized from my understanding of economics.

The fundamental theory of the Austrian school, also known as the Psychological School, is that Austrian economists view entrepreneurship as the driving force in economic development, see private property as essential to the efficient use of resources, and usually (if not always) see government interference in market processes as counter productive. They are laissez-faire advocates whenever possible. In practice, Austrians construct and test theories using deduction. They stress deduction because deduction, if performed correctly, leads to certain conclusions and inferences that must be true. Though Austrian economists do not discount induction, they hold that it does not assure certainty like deduction. [1] Mainstream economists hold that conclusions that can be reached by pure logical deduction are limited and weak. Compare the Austrian process with the more conventional mathematical and statistical methods, and a focus on induction and empirical observation to construct and test the theories of the other schools mentioned.

The Austrian School has consistently argued that a "traditionalist" approach to inflation yields the most accurate understanding of the causes (and the cure) for inflation. Austrian economists maintain that inflation is always and everywhere simply an increase in the money supply (i.e. units of currency or means of exchange), which in turn leads to a higher nominal price level for assets (such as housing) and other goods and services in demand, as the real value of each monetary unit is eroded, loses purchasing power and thus buys fewer goods and services. The Austrian School also maintains that the effects of increasing the money supply are magnified by credit expansion, as a result of the fractional-reserve banking system employed in most economic and financial systems in the world. Accordingly, many Austrian economists support the abolition of the central banks and the fractional-reserve banking system, and advocate instead a return to money based on the gold standard.

The main criticism of Austrian economic theory is that it can not be proved with mathematical formulas or models of empirical observations. Observation and deduction is not proveable.
1. Samuelson, Paul (1964). Economics (6th ed.). New York: McGraw-Hill. pp. 736.

Much of the content for this post was found in the description of Austrian School in