A primer on Austrian Economics

A superb interview of Peter Boettke, a leading scholar of Austrian economics. You finally get to know what the school is mainly about (in plain english).

First how did the name come about?

What is Austrian economics? How does it differ from standard economics?

Like a lot of things in economics, it’s the opponents that give the labels to people. The people who were practising economics at the University of Vienna thought they were just doing economics. It’s the critics who said, “Oh! That’s those Austrian economists.” It’s a label that gets to be associated with a set of propositions, both analytical – about the way you study economics, its methodology – and about the policy conclusions of economics. Representatives of that tradition came out of Vienna in the late 19th and early part of the 20th century. They then migrated to the London School of Economics, and to Switzerland, and eventually to the United States, where they held positions at places like Harvard, Princeton and Chicago. They coalesced around New York University, which became a hub of teaching Austrian economics.

What is the difference in Austrian vs other schools? Well others are just interested in the outcome. For Austrian, processes are as important:

Analytically, the biggest difference between the Austrians and their mainstream brethren is a focus on processes of adjustment and changing conditions, as opposed to static or equilibrium states of affairs. In a supply and demand curve, a standard economist would focus on the price and quantity vector that would clear the market. The Austrians want to talk about all the exchanges and activity that take place that results in that vector being discovered and the market being cleared.

Imagine if refrigeration wasn’t an option and you had some fish to sell. You start selling them at $10 a fish, and this many people buy the fish. After a while it slows down and you still have some fish remaining. As the day wears on you’re trying to get rid of the fish because they’re going to spoil. So you adjust your price down, you sell it at $8 a fish, or $6 a fish or $5 a fish. Eventually the market clears and all the fish find a buyer. In standard economics, we talk about the price and quantity vector that would clear that market, and the formal techniques of economics – a series of simultaneous equations – would get us to that vector. The Austrians don’t disagree with that price and quantity vector. But they want to talk about all the activity, a lot of which is what we call entrepreneurship – people adjusting the price, arbitrage opportunities and so on. Eventually you get to that vector, but your focus isn’t on the vector, it’s on all the stuff that goes on before it’s discovered.

He goes on to explain critical thoughts of Mises, Hayek etc. And also  some nice books which help explain the Austrian perspective..

Austrian school perspective on 2008 crisis:

Mises made at least three significant contributions to economics. The first contribution is in money and business cycle theory. What Mises tried to show is how money is central to all exchanges, because in a monetary economy, goods trade for money and money trades for goods. Goods don’t trade directly with other goods. Since money is one-half of all exchanges, if you screw around with money, you’re going to screw around with all the exchanges in the economy. He postulated that when the government distorts the monetary unit, through the manipulation of money and credit, it can generate boom-and-bust cycles. So rather than the business cycle being inherent to capitalism, it’s a consequence of distortions caused by the manipulation of money and credit.

Hasn’t what just happened with the housing boom and bust proved the Austrians right then?

There’s a Wall Street Journal profile on me, in that vein. People do argue this. This is why Paul Krugman gets so incensed. You know you’re doing something right when people get really mad. There are technical issues involved here that make this more nuanced. I have an e-book called The House that Uncle Sam Built which is a short little piece directed at the general public that tries to tell this story, how the Austrian story is consistent with what we’ve seen.

Hmmm..This explanation is what makes most Keynesian angry with  Austrian school. It does not really have a prescription to ease the depression kind of situation:

Whereas for Hayek recovery requires the liquidation of excessive investments and an increase in consumer saving, for Keynes it consists in reducing the propensity to save and increasing consumption in order to sustain companies’ profit expectations. Hayek demands more austerity, Keynes more spending.

We have here a clue as to why Hayek lost his great battle with Keynes in the 1930’s. It was not just that the policy of liquidating excesses was politically catastrophic: in Germany, it brought Hitler to power. As Keynes pointed out, if everyone – households, firms, and governments – all started trying to increase their saving simultaneously, there would be no way to stop the economy from running down until people became too poor to save.

It was this flaw in Hayek’s reasoning that caused most economists to desert the Hayekian camp and embrace Keynesian “stimulus” policies. As the economist Lionel Robbins recalled:  “Confronted with the freezing deflation of those days, the idea that the prime essential was the writing down of mistaken investments and…fostering the disposition to save was…as unsuitable as denying blankets and stimulus to a drunk who has fallen into an icy pond, on the ground that his original trouble was overheating.”

I think it is useful to pick each school’s key insights to build different perspectives. But we just end up taking strong stands only to see some schools working fine in some situation and disaster in the other…

In the end a superb mathematical perspective on Austrian Economics:

Most standard economics assumes that the relationships we are trying to understand can be captured by a continuous function that’s smooth and twice differentiable. What the Austrian analytics suggests is that life is not actually a continuous and smooth function that’s twice differentiable, but instead a lumpy function, a discrete function, in which there are all kinds of difficulties in the ability for us to model them the way our standard approach does. So, instead, what we engage in is discursive reasoning. You use the logic of economic action, the logic of choice, you worry about opportunity cost and presume individuals are doing the best that they can, given their situation. But notice, even in that phrase, you have to spend a lot of time specifying what that situation is. That situation is full of historical context and institutional details. A lot of your story is made up of the specification of the context in which economics decisions are made.

Simply amazing way to say how economics has become so mathematical over the years…

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One Response to “A primer on Austrian Economics”

  1. Pravin Says:

    thanks for covering this.physics envy doesnt begin to describe how current economics is not economics at all.it is econometric skullduggery with multipliers etc.
    there is some disingenous mention of lumpy functions.that is just pandering by Boettke. head over to mises.org to understand the epistemological need for economics to avoid maths.it is not because they are bad at math,but because it is a wrong tool in the wrong social science.
    praxeology is based on apriori truths and logical deductions(just like math).empirical method of economics is based on falsifiability which itself cant be falsified.so positivist economics is basically bogus at its epistemological root.

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