Keynesian Vs Austrian School of Economics

Introduction

The Keynesian School and Austrian School of economics have contradictory beliefs in relation to how the economy should be run. The Austrian school approaches the economy with a laissez-faire ideology, where the economy should be able to self-regulate to a point of equilibrium. In contrast to this, Keynesian argued that the government should intervene in the economy. The two men who epitomize this conflict of opposing philosophies are the founder of Keynesian economics John Maynard Keynes and the renowned Austrian economist, Friedrich Hayek. In the following essay, I will give my views on which economic philosophy I believe to be more appropriate when managing the economy in the long run.

Evaluating Philosophies

A country fiscal policy, the government uses to manipulate the tax rates and government expenditure. Government intervention in the economy using fiscal policy can aid the economy’s growth and stability. In early 1930 the economy was run based on Austrian economics. It was believed that “all government expenditure should be financed from taxation”. As unemployment increased during The Great Depression, so did government expenditure. Despite this, the government retained a balanced trade account by reducing other expenditures. The government’s refusal to run a trade deficit only further damaged the economy. Keynes believed that if the government increases expenditure, it will boost the economy and reduce unemployment. By spending money in the economy, the government creates jobs, which leads to more consumption by consumers. This consumption increases aggregate demand, which in turn increases income. This is known as the multiplier effect. Running a trade deficit as Keynes advises as opposed to save to stimulate investment as Austrian economics suggests can lead to substantial growth in the economy. Is this a sustainable philosophy for the economy in the long run? The United States of America has the largest and most powerful economy in the world. The US consistently runs a trade deficit, but its economy remains stable. The US economy’s global dominance strengthens Keynes’s theory that running a trade deficit through fiscal policy can be a viable method of growing and maintaining an economy in the long run.

One of Keynesian economics core beliefs is that markets cannot clear because wages and prices are sticky. Workers are not receptive to wage reductions, which do not allow the market to clear quickly. Austrian economics assumes that wages and prices will rise and fall and because of this, the market will clear. This appears unrealistic but when looking at the market in the long run all fixed costs such as wages are flexible and no longer sticky. In the long run, the ‘invisible hand’ will regulate these prices and wages to a new point of equilibrium, as they are not sticky in the long run. The time it takes the market to adjust could be quite substantial. It is arguably more beneficial to the economy to receive an injection from expansionary fiscal policy rather than wait for the invisible hand to regulate the market. A faster recovery could be more beneficial to the economy in the long run.

Keynesian's economics goal is to increase aggregate demand and in doing so economic growth will follow. There is a risk if aggregate demand is increasing too much that inflation will occur. Inflation can result in a reduction in investment in the economy. It also can lead to the economy exporting fewer goods as other economies would look for cheaper alternative markets. This has a negative impact on the economy’s trade balance, causing the economy’s GDP and GNP to become less desirable. Austrian economics theorizes that supply creates the demand in the economy. The Austrian economic philosophy is not at risk of inflation from demand, as it believes “the general level of prices in the economy depends on the supply of money”.

Conclusion

After considering both Keynesian and Austrian economic philosophies, I believe Keynesian is the most appropriate philosophy to manage the economy in the long run. Its use of fiscal policy enables it to accurately control growth with both expansionary and contradictory policies. Austrian's laissez-faire ideology leaves the economy to stagnate with prevents growth. Such a free market would be difficult to manage because of the lack of control you have over it. If inflation rates are properly managed, Keynesian is the more suited economic strategy to manage the economy in the long run.

References

• SLOMAN, J., GARRATT, D., & GUEST, J. (2018). Economics (pg496)
• SLOMAN, J., GARRATT, D., & GUEST, J. (2018). Economics (pg495)