Now that you crossed the Rubicon, here's a little homework assignment for you:
1. In three paragraphs, defend Laissez-faire economics, viz. the Austrian school, against Keynesian economic theory.
No time limit.
Had some time before my weekend begins. You didn't say I had to answer all three at the same time, Prof! This is all based on just using Google and the like. I actually know Keynes and the basics from history classes. Hope I did well! I'll answer the other two by Monday. The first two paragraphs describes Austrian School and Keyensian school. Then I answer the question.
The Austrian School of Economics says that our society is a collection of individuals that make choices for themselves, according to The Concise Encyclopedia of Economics. Austrian School economists also believe that private ownership provides incentives to divide resources, which are inherently limited. Another explanation of the Austrian School, this one on Investopedia.com, says people create markets naturally. It gives an example that people, even those without experience in markets, left on a deserted island would eventually create a market mechanism. The Austrian School has been described as an early form of libertarianism, a philosophy that emphasizes limited government intervention into the lives of its citizens. The Austrian School also says prices act as a signal in the economic, natural interest rates and prices determine the amount of savings and production in an economy, and that savings and production drive economic growth and determine the strength of an economy. In short, the Austrian School says markets are essentially “hands off†and self-regulating, and government and other interventions into the market causes distortions like recessions and other economic hardships.
The Business Dictionary describes Keynesian economics as stating that economies are driven by the demand created by households, businesses and the government as opposed to that of the free market (as measured by Gross Domestic Product). Thus, one way to alter the downturn of the economy is to increase spending, particularly via the government. The most famous example of government intervention in the economy to spur economic success was via the New Deal, which saw a massive expansion of federal government programs intended to spur economic growth. Government intervention further came after our most recent recession, where President Obama introduced a stimulus package that saw government fund several projects intended to increase employment and spending.
Austrian economics has proven to be superior than Keynesian economics in several ways.
One way comes in the belief of what causes a recession. The Austrian School says recessions are part of a business cycle. The first step in the business cycle sees too much money enter an economy, either by the Federal Reserve keeping interest rates too low or banks lending too much money. An example of this comes from our most recent recession. Federal Reserve, known as the “bank of banks,†sets a “federal funds rate†used as a benchmark to set interest rates for banks to lend to businesses and individuals. Many critics have said this rate was set too low in the years before The Great Recession started in 2008, which inevitably distorted the market, leading to a recession. The movie “The Big Short†shows this. Large banks extended mortgages to many individuals not equipped to pay off their debts. Further problems were caused by government-required and sponsored policies that extended mortgages and other loans to entities unable to pay back their debts. This caused a nationwide rise in housing prices that inevitably caused a “bubble†that burst. Because of this bubble and the amount of outstanding loans, large banks required a taxpayer bailout in order not to collapse entirely. The easy access to money banks had (via a cheap interest rate) caused them to take too many risks, all because of a distorted market based off of intervention from both the Federal Reserve and government housing policies. This model has proven, at least in our most current economic collapse, true. Keynesian models suggest that recessions happen when savings outpace investment, which can lead to a glut of supply, which in turn reduces investment. However, Keynesian thinkers also subscribe a theory of “animal spirits†to a recessionary cause. In essence, this model says negative confidence can prevent investment and economic growth. This “animal spirits†theory is a vague response not based on any actual factual basis. When do people start believing the economy is bad? They essentially believe the economy is bad when jobs are lost – as in, the economy has already turned bad. It’s a weak theory, at best.
Another way the Austrian School of Economics shows superiority over Keynes’ model comes in ways to fix the economy. As shown above, the primary reason why The Great Recession occurred in 2008 was because of excessive lending and risk-taking largely influenced by low interest rates put in place by the Federal Reserve. The Keynesian cure to this model is to reduce interest rates to essentially zero, and to also place money into the economy via a policy known as “quantative easing.†This policy saw the Federal Reserve buy products from banks in order to place more money into the economy and to further depress interest rates. One cartoon equates the difference between the Austrian School and Keynesian models to forest fighting – the Austrian School lets the fire burn out naturally so the forest can return to grow again while Keynesian thinkers attempt to put the fire out before the forest is destroyed. However, an updated version of the cartoon shows Kenynesians fighting the fire by pouring gasoline on the blaze. That is an adequate description – lowering interest rates to solve a problem caused by lower interest rates makes no sense.
A final way the Austrian School shows superiority over Keynesian models is just based on fairness. The Austrian School is based upon individual choices – individuals decide what is best for them, and resources are allocated in response. Keynesian models rely on a government response. This may open a large can of worms due to government interference. The government essentially interferes in the economy via stimulus packages. What can stop the federal government from deciding an economic problem is best fixed by allocating resources of its own choosing? For instance, say the president believes too few people have refrigerators. Why do too few people have refrigerators? This is likely because there is not a demand for refrigerators, or the people without refrigerators are not likely to afford the product. Can the federal government on its whim just force a company to make a refrigerator to sell cheaper than what it does normally? Can the federal government use its justifications for intervening in an economic crisis to take a refrigerator from a family that may have two to give to someone that has zero? Why would people who could by a second refrigerator make such a purchase? Why would someone without the means to do so look to improve their financial condition as they can expect a refrigerator to just be handed to them? Using Keynes to “repair†a broken economy may open up the doors for the government to take too much control over private property and personal lives at a later date in time.
