Keynesian vs. Classical & Austrian Economics

Keynesian vs. Classical & Austrian Economics

If you were to ask a room full of people whether they understood the general concepts of economics, most of them would answer in the affirmative. It’s just supply and demand, right? Let’s take it a step further. If you were to ask a random selection of people if they knew what  John Maynard Keynes, Milton Friedman, and Ludwig von Mises had in common, it’s likely that most of them would have no idea who any of those men were. And yet, those men were instrumental in shaping macroeconomics and the way in which decisions are made that largely determine the world order.

An Introduction to Macroeconomics

These men are all gone, but their work lives on. During their hay day, each of them was considered an expert in the field of macro-economics. Yet, they disagreed vehemently about the economy. Economic philosophies that advocate for government intervention, such as Keynesian Economics and Modern Monetary Theory are vastly different from more classical, laissez-faire systems of economics, such as those philosophies that originated in the Chicago and Austrian schools. The same holds true today; economists disagree more often than not.

Video: Keynesian vs. Classical & Austrian Economics: Intro to Macroeconomics

The Repo Market

If you’ve been following the news, then you may have heard that the Fed dumped four hundred billion dollars of our money into the repo market. This is where banks, hedge funds and various institutions lend each other money overnight, generally in the form of short-term government securities like U.S. Treasury bills, traded for cash, with the understanding that each transaction will be reversed, with a gain of 2 to 3 percent. When rates go up, the Fed takes our money and puts it into the repo market, in the form of government securities, in order to drive those rates back down. I say “our money” because every move that the Fed makes will affect the value of the dollars that people hold.

Depending on the news sources that you follow, this cash infusion into the repo market is either the beginning of a recession or is just the Fed doing its job. I’m not going to tell you which perspective is the right one but my goal today is to inspire you to learn more about macro-economics.

Keynesian Economics

A good way to start your journey into macroeconomics is by learning about Keynesian Economics. This was founded by John Maynard Keynes, and it is the accepted norm today. Most Democrats and Republicans claim to follow the principles of Keynesian Economics. Keynesian Economics is based on the idea that the economy goes through boom and bust cycles. Boom cycles are when we have economic prosperity; employment is high, businesses are making money, and people are spending money because sentiment is high. Bust cycles are when we have high unemployment, recession or worse. 

John Maynard Keynes

The goal in Keynesian Economics is for the government to soften the blow when we get into a bust cycle, so we don’t end up in deep recession or worse. To facilitate this process of government intervention in the market, we start by first regulating businesses, to stimulate employment and growth. Then, when we move into a bust-cycle, the government takes your tax dollars, and pumps them into the economy to stimulate growth. The goal is to incentivize businesses to hire more people and to instill confidence in consumers so that they, in turn, spend more money to drive the market. If it works, we move out of a bust cycle, avoid a deep recession and prosperity returns.

This process creates a lot of debt, so Keynesian economists say that we need to pay back this debt whenever we are prosperous. We’re supposed to do this by raising taxes and cutting spending during boom-cycles. But here’s the problem; we never pay down our debt. The reason for this is because politicians are driven by re-election, for themselves and for their party to maintain power. It’s unlikely that many people are going to vote for somebody who raises their taxes and cuts the programs that they want. So, Republicans and Democrats both increase spending on entitlement programs and the military, and neither side pays back the mountain of debt that they create. George Bush raised our debt six trillion dollars. Barack Obama raised our debt nine trillion dollars. Donald Trump raised our debt four trillion dollars in the last three years. How do we fix this?

The Chicago School of Economics

Let me introduce you to the Chicago School of Economics founded by Milton Friedman. He had the opposite view of Keynes about government intervention in the economy. He wanted to get the government out of the market. With his more classical view of economics, he said that we needed to let the market work. Rather than spending so much money, Friedman advocated for less spending and lower taxes. He wanted people to have the economic freedom to spend the fruits of their labor however they so choose, in a free and open market. Milton Friedman also said let’s stop striving for unattainable goals; in his view, the idea that we can achieve full employment was nonsense. There is a natural rate of unemployment that exists, as determined by the supply-side of an economy, and in his view, monetary policy as determined by a more Keynesian view of economics would have no positive effect on this outcome.

Milton Friedman

Historically, Milton Friedman was correct. Though unemployment did (arguably) reach 1% briefly during World War 2, it has never dropped much below 4% since 1948, and has instead fluctuated between four and ten percent, regardless of monetary policy. But, there’s more to this. Whenever unemployment has dropped below 4% in the United States, the economy quickly moved into a period of recession, suggesting that government intervention intended to drive down unemployment would eventually have the opposite effect; by all measures, good intentions have produced disastrous results. Of note, the U.S. unemployment rate as of September 2019 is at  3.5%.

Unemployment rates under 4% since 1948 led to recession

The Austrian School of Economics

Despite the fact that more classical economists from the Chicago School, like Milton Friedman, and Keynesian economists arrive at vastly different conclusions about the economy, they are both orthodox systems of economics. Both systems base their logic on empirical data and math. By contrast, the Austrian School of Economics it is a heterodox school of economics, completely different from these orthodox systems.

Ludwig von Mises

Founded by Ludwig von Mises, the Austrian School of Economics is based on an entirely different set of principles. Rather than relying on empirical data, Mises said that human beings are unpredictable. He held the praxeological belief that human beings are driven by purpose, using a variety of means to achieve their desired ends. Because of this viewpoint, Mises preferred logic and philosophy over the orthodox methods for making economic decisions. Here’s what’s interesting; even though Austrian Economics is heterodox, it arrives at most of the same conclusions at which the Chicago School of Economics arrives: we need to get the government out of the market.

Get Educated in Macroeconomics

In this article, I’m not going to tell you which school of economics is the right one. That’s for you to decide, but I would encourage you to learn more about macroeconomics. Read a book about Keynesian economics, such as The General Theory of Employment, Interest, and Money and ask yourself if it is being applied today as intended. Read a book by Milton Friedman from the Chicago School of Economics, such as Capitalism and Freedom, and ask yourself if there are aspects of this system that can be applied to the economy today, to get better results while simultaneously increasing every individual’s economic freedom. And, read a book about Austrian Economics, like Human Action by Ludwig von Mises and ask yourself if philosophy can be used to drive economic decisions. 

Regardless of the school of economics that you believe to be the most correct, by educating yourself you will achieve two things. You will be able to make more informed decisions at the voting booth, and you will be able to have more meaningful conversations with people with whom you disagree.

VIDEO: Keynesian vs. Classical & Austrian Economics: Intro to Macroeconomics

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Dennis Consorte

Dennis Consorte

Dennis has been published on Think Liberty and various other websites. He's a digital marketing professional with 20 years' experience in SEO, SEM, affiliate marketing, email marketing, and anything that drives traffic or increases audience engagement, mostly for ecommerce websites. He also codes and writes.