For many people, economics is a topic best left to financial experts, university professors, and policymakers. One survey found that fewer than half of respondents understood what an increase in Gross Domestic Product means, while nearly two-thirds didn’t know that in times of inﬂation, money loses its value. This knowledge gap has a very real impact on people – it limits both their financial literacy and ability to make informed choices in the world.
Economics isn’t just about money: it’s about how we create, distribute, and consume wealth, and the steps we take to attain resources. Having a good grasp of economics improves how you evaluate critical issues – from buying a home and investing in the stock market to interpreting news headlines and caring for the environment.
The basic principles of economics affect everyone, and yet over time, many people have felt excluded from the discussion. To help open up the conversation and assist people in making better decisions, here’s a straightforward comparison of the two most important branches of economics:
The Austrian school was founded in 1871 by Carl Menger, a journalist, and an economist who wrote the book Principles of Economics. Menger’s work focuses on people, the incentives they face, their limited knowledge, and the environment within which they make their decisions. He emphasizes subjectivism, utility, and marginalism. Over the years, Austrian economics has provided valuable insights around money creation, supply and demand, inflation, and foreign exchange rates.
Austrian economists are heavily critical of government intervention. They assert that government attempts to stimulate higher demand from consumers only wastes resources and leads to more problems. They sustain that Central Banks create inflation by printing money and that fiat currencies allow governments to devalue exchange rates and dilute people’s savings. Instead, the Austrian school supports the Gold Standard, which only allows money to be created if it can be converted into gold – and so limits any increases in the money supply.
Austrian economists also argue that Central Banks keep interest rates low to facilitate excessive credit use, which ultimately leads to crashes like the 2008 financial collapse. One Austrian economist, Ludwig von Mises, used this theory to predict the Great Depression of 1929.
Another notable component of this school is that it relies less on statistics and empirical models, and favors a logical deduction of people’s behavior. For example, that prices are determined by an individual’s preference to buy or not buy a particular good. This type of thinking is distinct from other mainstream schools of economic thought, which rely more on data and mathematical models to prove theories.
Keynesian economics was developed by John Maynard Keynes, who lived through the Great Depression and felt that existing economic theory could not sufficiently explain the crisis. At its core, Keynesian economics asserts that aggregate demand (the total spending of households, businesses, and government) is the most important driving force in an economy and that short-term changes to boost aggregate demand can prevent or address recessions, as well as reduce unemployment.
Unlike Austrian economists, Keynesians believe that government intervention is a necessary part of economic cycles: when growth slows, central banks should print money and lower interest rates to jumpstart struggling economies.
More contemporary Keynesians also argue that in a globalized world, governments have to implement pricing and policy controls to predict and react to volatile market conditions, which is why they place a strong emphasis on modeling tools and data. Whereas Austrian economists rely on their ability to make correct assumptions about human nature, Keynesian economists rely on the validity and applicability of empirical evidence.
Natural economic cycles or a need to intervene?
The central difference between the two schools of thought is the role of governments in the economy. Keynesian economics argues that markets aren’t always efficient and that if spending stops, the state has to fill the gap. Reducing interest rates and printing money are all justified in the eyes of Keynesians.
On the other hand, Austrian economists state that the economy goes through natural processes, including financial crises, and that government action ultimately does more harm than good. It attributes drops in spending to deeper imbalances in the financial system that need to be corrected, not covered with reactionary fiscal policies.
At Coro, we’re with the Austrian school of thought. We believe that when the government interferes with the economy, everyday people suffer as a result. The ongoing COVID-19 crisis is a clear example: the Fed has printed the equivalent of $3 trillion to kickstart spending, which has also triggered price increases and creeping inflation rates – creating greater uncertainty for the people already hardest hit.
Too often, government intervention is rationalized by its short-term consequences, but we have to remember that financial stability is rooted in the long-term. Rather than keep masking holes in the economy, it’s the job of governments to fix them well, and for good.