Austrian School

Austrian School

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The Austrian School of economics is a heterodox
Heterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...

 school of economic thought. It advocates methodological individualism
Methodological individualism
Methodological individualism is the theory that social phenomena can only be accurately explained by showing how they result from the intentional states that motivate the individual actors. The idea has been used to criticize historicism, structural functionalism, and the roles of social class,...

 in interpreting economic developments (see praxeology
Praxeology
Praxeology is the study of human action. Praxeology rejects the empirical methods of the natural sciences for the study of human action, because the observation of how humans act in simple situations cannot predict how they will act in complex situations...

), the theory that money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...

 is non-neutral
Neutrality of money
Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption....

, the theory that the capital structure of economies consists of heterogeneous goods that have multispecific uses which must be aligned (see Austrian business cycle theory), and emphasizes the organizing power
Spontaneous order
Spontaneous order, also known as "self-organization", is the spontaneous emergence of order out of seeming chaos. It is a process found in physical, biological, and social networks, as well as economics, though the term "self-organization" is more often used for physical and biological processes,...

 of the price mechanism (see economic calculation debate). Austrian economists are generally advocates of laissez faire policies.

Whereas mainstream economists generally use mathematical models and statistical methods
Econometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...

 to model and test economic behavior, Austrian economists argue that mathematical models and statistics are an unreliable means of analyzing and testing economic theory. Instead, they advocate deriving economic theory logically from basic principles of human action, a study called praxeology. Additionally, whereas experimental research and natural experiment
Natural experiment
A natural experiment is an observational study in which the assignment of treatments to subjects has been haphazard: That is, the assignment of treatments has been made "by nature", but not by experimenters. Thus, a natural experiment is not a controlled experiment...

s are often used in mainstream economics, Austrian economists generally hold that testability in economics
Experimental techniques
Experimental research designs are used for the controlled testing of causal processes.The general procedure is one or more independent variables are manipulated to determine their effect on a dependent variable...

 and mathematical modeling of a market are virtually impossible. They claim that modeling a market relies on human actors who cannot be placed in a lab setting without altering their would-be actions. Supporters of using models of market behavior to analyze and test economic theory argue that economists have developed numerous experiments that elicit useful information about individual preferences.

Austrian contributions to mainstream economic thought include involvement in the development of marginalism
Marginalism
Marginalism refers to the use of marginal concepts in economic theory. Marginalism is associated with arguments concerning changes in the quantity used of a good or service, as opposed to some notion of the over-all significance of that class of good or service, or of some total quantity...

 and the subjective theory of value
Subjective theory of value
The subjective theory of value is an economic theory of value that identifies worth as being based on the wants and needs of the members of a society, as opposed to value being inherent to an object....

 on which it is based, as well as contributions to the economic calculation debate. From the middle of the 20th century onwards, the Austrian school has been considered outside the mainstream of economic thought. Its reputation rose in the mid-1970s, after Austrian economist Friedrich Hayek
Friedrich Hayek
Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...

 shared a Nobel Prize in Economics in 1974.

Mainstream economists are generally critical of methodologies used by modern Austrian economists. In particular, the Austrian method of deriving theories has been criticized by mainstream economists as being a priori or non-empirical
Empirical
The word empirical denotes information gained by means of observation or experimentation. Empirical data are data produced by an experiment or observation....

. Some scholars have argued that Austrian economists are often averse to the use of mathematics and statistics.

Etymology


The Austrian School derives its name from the identity of its founders and early supporters, who were citizens of the old Austrian Habsburg Empire, including Carl Menger
Carl Menger
Carl Menger was the founder of the Austrian School of economics, famous for contributing to the development of the theory of marginal utility, which contested the cost-of-production theories of value, developed by the classical economists such as Adam Smith and David Ricardo.- Biography :Menger...

, Eugen von Böhm-Bawerk
Eugen von Böhm-Bawerk
Eugen Ritter von Böhm-Bawerk was an Austrian economist who made important contributions to the development of the Austrian School of economics.-Biography:...

, Ludwig von Mises
Ludwig von Mises
Ludwig Heinrich Edler von Mises was an Austrian economist, philosopher, and classical liberal who had a significant influence on the modern Libertarian movement and the "Austrian School" of economic thought.-Biography:-Early life:...

, and Friedrich Hayek
Friedrich Hayek
Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...

. In 1883, Menger published Investigations into the Method of the Social Sciences with Special Reference to Economics, which attacked the methods of the Historical school. Gustav von Schmoller
Gustav von Schmoller
Gustav von Schmoller was the leader of the "younger" German historical school of economics.-Life:Schmoller was born in Heilbronn. His father was a Württemberg civil servant. Young Schmoller studied Staatswissenschaften at the University of Tübingen...

, a leader of the Historical school, responded with an unfavorable review, coining the term "Austrian school". Currently, adherents of the Austrian School can come from any part of the world, but they are often referred to simply as "Austrian economists" and their work as "Austrian economics".

Origins


Classical economics
Classical economics
Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill....

 focused on the labour theory of value, which holds that the value of a commodity is equal to the amount of labour required to produce it. French classical economists Jean-Baptiste Say
Jean-Baptiste Say
Jean-Baptiste Say was a French economist and businessman. He had classically liberal views and argued in favor of competition, free trade, and lifting restraints on business...

 and Frédéric Bastiat
Frédéric Bastiat
Claude Frédéric Bastiat was a French classical liberal theorist, political economist, and member of the French assembly. He was notable for developing the important economic concept of opportunity cost.-Biography:...

 considered that value was subjective. In the late 19th century, attention then focused on the concepts of “marginal” cost and value. The Austrian School was one of three founding currents of the marginalist revolution of the 1870s, with its major contribution being the introduction of the subjectivist approach in economics. Carl Menger's 1871 book, Principles of Economics
Principles of Economics
Principles of Economics is a book by economist Carl Menger which is credited with the founding of the Austrian School of economics...

,
was the catalyst for this development; while marginalism was generally influential, there was also a more specific school that grew up around Menger, which came to be known as the “Psychological School,” “Vienna School,” or “Austrian School.” Thorstein Veblen
Thorstein Veblen
Thorstein Bunde Veblen, born Torsten Bunde Veblen was an American economist and sociologist, and a leader of the so-called institutional economics movement...

 introduced the term neoclassical economics
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

 in his Preconceptions of Economic Science (1900) to distinguish marginalists in the objective cost tradition of Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

 from those in the subjective valuation tradition of the Austrian School.

The school originated in Vienna
Vienna
Vienna is the capital and largest city of the Republic of Austria and one of the nine states of Austria. Vienna is Austria's primary city, with a population of about 1.723 million , and is by far the largest city in Austria, as well as its cultural, economic, and political centre...

, in the Austrian Empire
Austrian Empire
The Austrian Empire was a modern era successor empire, which was centered on what is today's Austria and which officially lasted from 1804 to 1867. It was followed by the Empire of Austria-Hungary, whose proclamation was a diplomatic move that elevated Hungary's status within the Austrian Empire...

. However, later adherents of the school such as Murray Rothbard
Murray Rothbard
Murray Newton Rothbard was an American author and economist of the Austrian School who helped define capitalist libertarianism and popularized a form of free-market anarchism he termed "anarcho-capitalism." Rothbard wrote over twenty books and is considered a centrally important figure in the...

 have derived the roots of the thought of the Austrian School from the Spanish Scholastics
School of Salamanca
The School of Salamanca is the renaissance of thought in diverse intellectual areas by Spanish and Portuguese theologians, rooted in the intellectual and pedagogical work of Francisco de Vitoria...

 teaching at the University of Salamanca
University of Salamanca
The University of Salamanca is a Spanish higher education institution, located in the town of Salamanca, west of Madrid. It was founded in 1134 and given the Royal charter of foundation by King Alfonso IX in 1218. It is the oldest founded university in Spain and the third oldest European...

 of the 15th century and the French Physiocrats
Physiocrats
Physiocracy is an economic theory developed by the Physiocrats, a group of economists who believed that the wealth of nations was derived solely from the value of "land agriculture" or "land development." Their theories originated in France and were most popular during the second half of the 18th...

 of the 18th century. The School owes its name to members of the German Historical School of economics
Historical school of economics
The Historical school of economics was an approach to academic economics and to public administration that emerged in 19th century in Germany, and held sway there until well into the 20th century....

, who argued against the Austrians during the Methodenstreit
Methodenstreit
Methodenstreit is a German term referring to an intellectual controversy or debate over epistemology, research methodology, or the way in which academic inquiry is framed or pursued...

("methodology struggle"), in which the Austrians defended the reliance that classical economists placed upon deductive logic. Their Prussian opponents derisively named them the "Austrian School" to emphasize a departure from mainstream German thought and to suggest a provincial, Aristotelian
Aristotelianism
Aristotelianism is a tradition of philosophy that takes its defining inspiration from the work of Aristotle. The works of Aristotle were initially defended by the members of the Peripatetic school, and, later on, by the Neoplatonists, who produced many commentaries on Aristotle's writings...

 approach.

First wave


Carl Menger was closely followed by Eugen von Böhm-Bawerk and Friedrich von Wieser
Friedrich von Wieser
Friedrich Freiherr von Wieser was an early member of the Austrian School of economics. Born in Vienna, the son of Privy Councillor Leopold von Wieser, a high official in the war ministry he first trained in sociology and law...

, in what is known as the "first wave" of the School. Austrian economists developed a sense of themselves as a school distinct from neoclassical economics during the economic calculation debate with socialist economists
Socialist economics
Socialist economics are the economic theories and practices of hypothetical and existing socialist economic systems.A socialist economy is based on public ownership or independent cooperative ownership of the means of production, wherein production is carried out to directly produce use-value,...

. Ludwig von Mises and his student Friedrich Hayek represented the Austrian position in contending that without monetary prices and private property, meaningful economic calculation is impossible. The Austrian economist Böhm-Bawerk wrote extensive critiques of Marx in the 1880s and 1890s, as was part of the Austrian economists' participation in the late 19th Century Methodenstreit, during which they attacked the Hegelian
Georg Wilhelm Friedrich Hegel
Georg Wilhelm Friedrich Hegel was a German philosopher, one of the creators of German Idealism. His historicist and idealist account of reality as a whole revolutionized European philosophy and was an important precursor to Continental philosophy and Marxism.Hegel developed a comprehensive...

 doctrines of the Historical School
Historical school of economics
The Historical school of economics was an approach to academic economics and to public administration that emerged in 19th century in Germany, and held sway there until well into the 20th century....

.

Austrian economics after 1920 can be broken into two general trends. One, exemplified by Friedrich Hayek, while distrusting many neoclassical concepts (like most of the corpus of Keynesian macroeconomics
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...

), generally accepts a large part of the neoclassical methodology; the other, exemplified by Ludwig von Mises, seeks a different formalism for economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

, considering the neoclassical methodology to be irredeemably flawed.

Post-WWII


By the mid-1930s, the mainstream had more or less absorbed what were seen as the important contributions of the Austrians. After World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...

, Austrian economics was ill-thought of by most economists because it rejected mathematical and statistical methods in the area of economics.

Its reputation rose somewhat in the late-20th century with the work of Israel Kirzner
Israel Kirzner
Israel Meir Kirzner is a leading economist in the Austrian School.-Early life:The son of a well-known rabbi and Talmudist, Kirzner was born in London, England and came to the United States via South Africa.-Education:After studying with the University of Cape Town, South Africa in 1947-48 and...

 and Ludwig Lachmann
Ludwig Lachmann
Ludwig Lachmann was a German economist who became a member of and important contributor to the Austrian School.-Education and career:...

, and renewed interest in Hayek after he won the Nobel Memorial Prize in Economic Sciences. Hayek's work was influential in the revival of laissez-faire thought in the 20th century. Following Hayek, one of Ludwig von Mises's students, Murray Rothbard, became prominent in both Austrian applied theory and libertarian philosophical thought.

Current influence


According to Austrian school economist Peter J. Boettke, the position of the Austrian School within the economics profession has changed several times from the center to the fringe of the mainstream. Currently, it remains a distinctly minority position.

The former U.S. Federal Reserve Chairman, Alan Greenspan
Alan Greenspan
Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...

, speaking of the originators of the School, said in 2000, "the Austrian school have reached far into the future from when most of them practiced and have had a profound and, in my judgment, probably an irreversible effect on how most mainstream economists think in this country." Nobel Laureate James M. Buchanan
James M. Buchanan
James McGill Buchanan, Jr. is an American economist known for his work on public choice theory, for which he received the 1986 Nobel Memorial Prize in Economic Sciences. Buchanan's work initiated research on how politicians' self-interest and non-economic forces affect government economic policy...

 is sometimes considered to be a member of the Austrian School and he stated that, "I certainly have a great deal of affinity with Austrian economics and I have no objections to being called an Austrian. Hayek and Mises might consider me an Austrian but, surely some of the others would not." Republican
Republican Party (United States)
The Republican Party is one of the two major contemporary political parties in the United States, along with the Democratic Party. Founded by anti-slavery expansion activists in 1854, it is often called the GOP . The party's platform generally reflects American conservatism in the U.S...

 U.S. congressman Ron Paul
Ron Paul
Ronald Ernest "Ron" Paul is an American physician, author and United States Congressman who is seeking to be the Republican Party candidate in the 2012 presidential election. Paul represents Texas's 14th congressional district, which covers an area south and southwest of Houston that includes...

 is a firm believer in Austrian school economics and has authored six books on the subject. Paul's former economic adviser, Peter Schiff
Peter Schiff
Peter David Schiff is an American investment broker, author and financial commentator. Schiff is CEO and chief global strategist of Euro Pacific Capital Inc., a broker-dealer based in Westport, Connecticut and CEO of Euro Pacific Precious Metals, LLC, a gold and silver dealer based in New York...

, is an adherent of the Austrian school. Jim Rogers
Jim Rogers
James Beeland Rogers, Jr. is an American investor, author, and occasional financial commentator. He is currently based in Singapore. Rogers is the Chairman of Rogers Holdings and Beeland Interests, Inc...

, investor and financial commentator, also considers himself of the Austrian School of economics. Chinese economist Zhang Weiyin
Zhang Weiyin
Zhang Weiyin is a prominent Chinese economist and was head of the Guanghua School of Management at Beijing University. He is known for his advocacy of free markets and his ideas have been influenced by the Austrian School.-Biography:...

, who is known in China for his advocacy of free market reforms
Chinese economic reform
The Chinese economic reform refers to the program of economic reforms called "Socialism with Chinese characteristics" in the People's Republic of China that were started in December 1978 by reformists within the Communist Party of China led by Deng Xiaoping.China had one of the world's largest...

, supports some Austrian theories such as the Austrian theory of the business cycle. Currently, universities with a significant Austrian presence are George Mason University
George Mason University
George Mason University is a public university based in unincorporated Fairfax County, Virginia, United States, south of and adjacent to the city of Fairfax. Additional campuses are located nearby in Arlington County, Prince William County, and Loudoun County...

, Loyola University New Orleans
Loyola University New Orleans
Loyola University New Orleans is a private, co-educational and Jesuit university located in New Orleans, Louisiana, United States. Originally established as Loyola College in 1904, the institution was chartered as a university in 1912. It bears the name of the Jesuit patron, Saint Ignatius of Loyola...

, and Auburn University
Auburn University
Auburn University is a public university located in Auburn, Alabama, United States. With more than 25,000 students and 1,200 faculty members, it is one of the largest universities in the state. Auburn was chartered on February 7, 1856, as the East Alabama Male College, a private liberal arts...

 in the United States and Universidad Francisco Marroquín
Universidad Francisco Marroquín
Universidad Francisco Marroquín is a private, secular, university in Guatemala City, Guatemala. According to the school's website, "the mission of Universidad Francisco Marroquín is to teach and disseminate the ethical, legal and economic principles of a sociey of free and responsible persons."...

 in Guatemala. Austrian economic ideas are also promoted by bodies such as the Mises Institute and the Foundation for Economic Education
Foundation for Economic Education
The Foundation for Economic Education is one of the oldest free-market organizations established in the United States to study and advance the freedom philosophy. Murray Rothbard recognizes FEE for creating a "crucial open center" that he credits with launching the movement...

.

Two modern schools of thought are seen as being either Austrian economics, or as the direct philosophical heir of Austrian economics. These are the Free Banking
Free banking
Free banking refers to a monetary arrangement in which banks are subject to no special regulations beyond those applicable to most enterprises, and in which they also are free to issue their own paper currency...

 and anarcho-capitalist
Anarcho-capitalism
Anarcho-capitalism is a libertarian and individualist anarchist political philosophy that advocates the elimination of the state in favour of individual sovereignty in a free market...

 movements. Although they have competing views of monetary policy, they share a fundamental view of most economic philosophy. Free Banking advocates tend to see themselves as coming directly from Hayek's later progress, especially his work The Denationalization of Money
The Denationalization of Money
The Denationalization of Money is a paper written by Friedrich Hayek, and published in 1977, in which he advocated the establishment of a free market in money.-Message:...

, while the anarcho-capitalists tend to follow the views of Rothbard and Mises.

Methodology


Methodology is where Austrian economists differ most significantly from other schools of economic thought. Mainstream schools such as Keynesians
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...

 and Monetarists
Monetarism
Monetarism is a tendency in economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over...

 adopt empirical, mathematical, and statistical methods, and focus on induction
Inductive reasoning
Inductive reasoning, also known as induction or inductive logic, is a kind of reasoning that constructs or evaluates propositions that are abstractions of observations. It is commonly construed as a form of reasoning that makes generalizations based on individual instances...

 to construct and test theories. Austrian economists reject empirical statistical methods
Econometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...

, natural experiment
Natural experiment
A natural experiment is an observational study in which the assignment of treatments to subjects has been haphazard: That is, the assignment of treatments has been made "by nature", but not by experimenters. Thus, a natural experiment is not a controlled experiment...

s, and constructed experiments
Experimental economics
Experimental economics is the application of experimental methods to study economic questions. Data collected in experiments are used to estimate effect size, test the validity of economic theories, and illuminate market mechanisms. Economic experiments usually use cash to motivate subjects, in...

 as tools applicable to economics, saying that while it is appropriate in the natural sciences where factors can be isolated in laboratory conditions, the actions of humans are too complex for such a treatment because humans are not passive and non-adaptive subjects. As Austrian economist Jeffrey Herbener has noted "there are no statistical characteristics to human behavior. It is purposeful rather than random, and changeable rather than
constant". Austrian economists claim one should instead isolate the logical processes of human action. Mises called this discipline "praxeology." The Austrian praxeological method is based on the heavy use of logical deduction
Deductive reasoning
Deductive reasoning, also called deductive logic, is reasoning which constructs or evaluates deductive arguments. Deductive arguments are attempts to show that a conclusion necessarily follows from a set of premises or hypothesis...

 from what they assert to be undeniable, self-evident axioms or irrefutable facts about human existence.

According to Austrian economists, deduction is preferred to induction in interpreting economic developments, since if performed correctly, it leads to certain conclusions and inferences that must be true if the underlying assumptions are accurate. Austrian economists hold that induction does not assure certainty like deduction, as real world economic data are inherently ambiguous and subject to a multitude of influences which cannot be separated or quantified, one cause or correlation from another. Austrian economists therefore claim that mainstream economics has no way of verifying cause and effect in real world economic events, since economic data can be correlated to multiple potential chains of causation. Mainstream economists counter that conclusions that can be reached by pure logical deduction are limited and weak. Economists Bryan Caplan
Bryan Caplan
Bryan Caplan is an American economist, a Professor of Economics at George Mason University, Research Fellow at the Mercatus Center, adjunct scholar of the Cato Institute, and blogger for Econlog. He is best known for his work in public choice theory and for his libertarian ideology.-Personal...

 and Paul A. Samuelson have noted that such rejections of empirical evidence in economics has led to the Austrian School being dismissed within mainstream economics.

Differences with neoclassical economics


The Austrian school and neoclassical economics are similar in many respects. According to Austrian economists, the main area of contention between neoclassical economics and the Austrian school is on their view of the market system as a process, not only to be studied using equilibrium models, but to be viewed as an incessant process that only tends toward a constantly changing equilibrium. A second area of contention between neoclassical theory and the Austrian school is over the possibility of consumers being indifferent
Indifference curve
In microeconomic theory, an indifference curve is a graph showing different bundles of goods between which a consumer is indifferent. That is, at each point on the curve, the consumer has no preference for one bundle over another. One can equivalently refer to each point on the indifference curve...

 between choices neoclassical theory says it is possible, whereas Mises rejected it as being “impossible to observe in practice.” Additionally, Mises and his students argued, building on Czech economist František Čuhel, that utility functions are ordinal, and not cardinal
Cardinal number
In mathematics, cardinal numbers, or cardinals for short, are a generalization of the natural numbers used to measure the cardinality of sets. The cardinality of a finite set is a natural number – the number of elements in the set. The transfinite cardinal numbers describe the sizes of infinite...

; that is, the Austrians contend that one can only rank preferences and cannot measure their intensity. The Austrian School rejects any neoclassical results that are based on cardinal utility
Cardinal utility
In economics, cardinal utility refers to a property of mathematical indices that preserve preference orderings uniquely up to positive linear transformations...

 and criticizes mainstream economics for supposedly accepting cardinality, despite the fact that neoclassical economists have shown that their work holds for ordinal preferences
Ordinal utility
Ordinal utility theory states that while the utility of a particular good or service cannot be measured using a numerical scale bearing economic meaning in and of itself, pairs of alternative bundles of goods can be ordered such that one is considered by an individual to be worse than, equal to,...

.

There are a host of questions about uncertainty and the utility of "conventional" financial models raised by Mises and other Austrians, who argue for a fundamentally different means of risk assessment
Risk assessment
Risk assessment is a step in a risk management procedure. Risk assessment is the determination of quantitative or qualitative value of risk related to a concrete situation and a recognized threat...

 in economics compared to that used by mainstream economics. Mises and others argued that numerically accurate "probabilities" could never be assigned to "singular" cases. The utility and accuracy of financial modeling is an on-going source of debate, even within the Austrian School. These questions are directly linked to the dynamic market process approach to economic theory, where it is argued by Mises and others that the unique confluence of events in each moment of time in real markets makes the assignment of "objective" probabilities unrealistic, as these events are intrinsically unique and not capable of numerical probabilistic modeling. Mises and others argued that the application of probabilistic uncertainty would require the ability to exactly replicate objectively similar events to obtain an accurate understanding of the range of probabilistic outcomes of any event, and this is not possible in real markets, where past market events intimately affect the present and the future.

According to Austrian economist Joseph Salerno
Joseph Salerno
Joseph T. Salerno is an Austrian School economist in the United States. A professor at Pace University, Salerno is an active scholar in the areas of banking and monetary theory, comparative economics, and the history of economic thought.-Early life:...

, what most distinctly sets the Austrian school apart from neoclassical economics is the Austrian Business Cycle Theory:

Business cycles


The Austrian theory of the business cycle varies significantly from mainstream theories. Economists such as Gordon Tullock
Gordon Tullock
Gordon Tullock is an economist and retired Professor of Law and Economics at the George Mason University School of Law. He is best known for his work on public choice theory, the application of economic thinking to political issues...

, Bryan Caplan
Bryan Caplan
Bryan Caplan is an American economist, a Professor of Economics at George Mason University, Research Fellow at the Mercatus Center, adjunct scholar of the Cato Institute, and blogger for Econlog. He is best known for his work in public choice theory and for his libertarian ideology.-Personal...

, and Nobel laureates Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...

 and Paul Krugman
Paul Krugman
Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...

 have said that they regard the theory as incorrect.

In contrast to most mainstream theories on business cycles, Austrian economists focus on the credit cycle as the primary cause of most business cycles. Austrian economists assert that inherently damaging and ineffective central bank policies are the predominant cause of most business cycles, as they tend to set artificial interest rates too low for too long, resulting in excessive credit creation, speculative "bubbles
Economic bubble
An economic bubble is "trade in high volumes at prices that are considerably at variance with intrinsic values"...

" and artificially low savings.

According to the Austrian business cycle theory, the business cycle unfolds in the following way: Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation
Money creation
In economics, money creation is the process by which the money supply of a country or a monetary region is increased due to some reason. There are two principal stages of money creation. First, the central bank introduces new money into the economy by purchasing financial assets or lending money...

 process in a fractional reserve banking system. This in turn leads to an unsustainable "credit-fuelled boom" during which the "artificially stimulated" borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

 resources to be misallocated into areas which would not attract investment if the money supply remained stable. Austrian economists argue that a correction or "credit crunch
Credit crunch
A credit crunch is a reduction in the general availability of loans or a sudden tightening of the conditions required to obtain a loan from the banks. A credit crunch generally involves a reduction in the availability of credit independent of a rise in official interest rates...

" – commonly called a recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...

 or bust – occurs when credit creation cannot be sustained. They claim that the money supply suddenly and sharply contracts when markets finally clear, causing resources to be reallocated back toward more efficient uses.

Friedrich Hayek was one of the few economists who gave warning of a major economic crisis before the great crash
Wall Street Crash of 1929
The Wall Street Crash of 1929 , also known as the Great Crash, and the Stock Market Crash of 1929, was the most devastating stock market crash in the history of the United States, taking into consideration the full extent and duration of its fallout...

 of 1929. In February 1929, Hayek warned that a coming financial crisis was an unavoidable consequence of reckless monetary expansion. Economist Steve H. Hanke identifies the 2007-2010 Global Financial Crises
Late-2000s financial crisis
The late-2000s financial crisis is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s...

 as the direct outcome of the Federal Reserve Bank's interest rate policies as is predicted by the Austrian business cycle theory. Some analysts such as Jerry Tempelman have also argued that the predictive and explanatory power of ABCT in relation to the Global Financial Crisis has reaffirmed its status and perhaps cast into question the utility of mainstream theories and critiques.

Capital


Austrian economist Eugen von Böhm-Bawerk
Eugen von Böhm-Bawerk
Eugen Ritter von Böhm-Bawerk was an Austrian economist who made important contributions to the development of the Austrian School of economics.-Biography:...

 created a theory of capital as a response to Marx
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...

's theories on capital. Böhm-Bawerk's theory centered on the untenability of the labor theory of value in the light of the transformation problem
Transformation problem
In 20th century discussions of Karl Marx's economics the transformation problem is the problem of finding a general rule to transform the "values" of commodities into the "competitive prices" of the marketplace...

. He also argued that capitalists do not exploit workers; they accommodate workers by providing them with income well in advance of the revenue from the output they helped to produce. Böhm-Bawerk's theory equates capital intensity
Capital intensity
Capital intensity is the term in economics for the amount of fixed or real capital present in relation to other factors of production, especially labor...

 with the degree of roundaboutness
Roundaboutness
Roundaboutness, or roundabout methods of production, is the process whereby capital goods are produced first and then, with the help of the capital goods, the desired consumer goods are produced....

 of production processes. Böhm-Bawerk also argued that the law of marginal utility
Marginal utility
In economics, the marginal utility of a good or service is the utility gained from an increase in the consumption of that good or service...

 necessarily implies the classical law of costs.

Economic calculation problem



The economic calculation problem is a criticism of socialist economics
Socialist economics
Socialist economics are the economic theories and practices of hypothetical and existing socialist economic systems.A socialist economy is based on public ownership or independent cooperative ownership of the means of production, wherein production is carried out to directly produce use-value,...

. It was first proposed by Max Weber
Max Weber
Karl Emil Maximilian "Max" Weber was a German sociologist and political economist who profoundly influenced social theory, social research, and the discipline of sociology itself...

 in 1920. This led to Ludwig von Mises discussing Weber's idea with his student Friedrich Hayek, who expanded upon it to such an extent that it became a key reason cited for the awarding of his Nobel prize. The problem referred to is that of how to distribute resources rationally in an economy. The capitalist solution is the price mechanism; Mises and Hayek argued that this is the only viable solution, as the price mechanism co-ordinates supply and investment decisions most efficiently. Without the information efficiently and effectively provided by market prices, socialism lacks a method to efficiently allocate resources over an extended period of time in any market where the price mechanism is effective (an example where the price mechanism may not work is in the relatively confined area of public and common goods
Common good (economics)
Common goods are defined in economics as goods which are rivalrous and non-excludable. Thus, they constitute one of the four main types of the most common typology of goods based on the criteria:...

). Those who agree with this criticism argue it is a refutation of socialism and that it shows that a socialist planned economy
Planned economy
A planned economy is an economic system in which decisions regarding production and investment are embodied in a plan formulated by a central authority, usually by a government agency...

 could never work in the long term for the vast bulk of the economy and has very limited potential application. The debate raged in the 1920s and 1930s, and that specific period of the debate has come to be known by historians of economic thought as The Socialist Calculation Debate.

Ludwig von Mises argued in a famous 1920 article "Economic Calculation in the Socialist Commonwealth
Economic Calculation in the Socialist Commonwealth
"Economic Calculation In The Socialist Commonwealth" is an article by Austrian School economist and libertarian thinker Ludwig von Mises. Its critique against economic calculation in a planned economy triggered the decades-long economic calculation debate....

" that the pricing systems in socialist economies were necessarily deficient because if government owned the means of production
Means of production
Means of production refers to physical, non-human inputs used in production—the factories, machines, and tools used to produce wealth — along with both infrastructural capital and natural capital. This includes the classical factors of production minus financial capital and minus human capital...

, then no prices could be obtained for capital goods as they were merely internal transfers of goods in a socialist system and not "objects of exchange," unlike final goods. Therefore, they were unpriced and hence the system would be necessarily inefficient since the central planners would not know how to allocate the available resources efficiently. This led him to declare "…that rational economic activity is impossible in a socialist commonwealth." Mises's declaration has been criticized as overstating the strength of his case, in describing socialism as impossible, rather than having to contend with a source of inefficiency.

A recent paper on the computational complexity
Computational Complexity
Computational Complexity may refer to:*Computational complexity theory*Computational Complexity...

 of economic equilibrium notes that if finding a true economic equilibrium is not just hard but impossible for a central planner, then the impossibility applies equally well to a market system, since a system of dispersed calculators (i.e. a market) has no advantage over one large central calculator in overcoming complexity. While a true equilibrium may be impossible under both free markets and central planning, Austrians maintain that free markets are generally more efficient than central planning, since it is highly unlikely that a few economic planners would have a computational advantage over a distributed network of free market information.

Inflation


Ludwig von Mises asserted that inflation only results when the supply of money outpaces demand for money:
In theoretical investigation there is only one meaning that can rationally be attached to the expression Inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange-value of money must occur.


While supporters of Free Banking maintain the above definition, Murray Rothbard argued that inflation is by definition always and everywhere simply an increase in the money supply (i.e. units of currency or means of exchange), which in turn leads to a nominal price level that is higher than it would have been without the inflation, for assets (such as housing) and other goods and services in demand, as the real value of each monetary unit is eroded, loses purchasing power and thus buys fewer goods and services.

Given that all major economies currently have a central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...

 supporting the private banking system, money can be supplied into these economies by way of bank-created credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...

 (or debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

). Austrian economists therefore regard the state-sponsored central bank as the main cause of inflation, because they regard the bank as the institution charged with the creation of new money. When newly created currency reserves
Bank reserves
Bank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in the bank's vault . The central banks of some nations set minimum reserve requirements...

 are injected into the fractional-reserve banking
Fractional-reserve banking
Fractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves...

 system, private financial institutions generally choose to further expand the level of bank credit, which multiplies the inflationary effect many times over.

The Austrian School also views the "contemporary" definition of inflation as inherently misleading in that it draws attention only to the effect of inflation (rising prices) and does not address the "true" phenomenon of inflation, which they believe simply involves an increase in the money supply (or the debasement of the means of exchange). They argue that this semantic difference is important in defining inflation and finding a cure for inflation. Austrian economists maintain the most effective cure is the strict maintenance of a stable money supply. Ludwig von Mises, the seminal scholar of the Austrian School, asserts that:


Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. . . . As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.


Following their definition, Austrian economists measure the inflation by calculating the growth of what they call 'the true money supply', i.e. how many new units of money that are available for immediate use in exchange, that have been created over time.

This interpretation of inflation implies that, within a centralized banking system, inflation is usually the result of action taken by the central government or its central bank, which permits or allows an increase in the money supply. Mises includes bank credit as a significant contributor to inflation; the value of bank credit generated by private financial institutions and held within checking accounts greatly exceeds the value of physical paper bills and metallic coins issued by the Federal government (see Figure 1). In addition to state-induced monetary expansion via printing of paper money, Austrian economists also maintain that the effects of increasing the money supply are exacerbated by the credit expansion performed by private financial institutions practising fractional-reserve banking system, legally permitted in most economic and financial systems in the world.

Austrian economists claim that the state uses monetary inflation
Monetary inflation
Monetary inflation is a sustained increase in the money supply of a country. It usually results in price inflation, which is a rise in the general level of prices of goods and services . Originally the term "inflation" was used to refer only to monetary inflation, whereas in present usage it...

 as one of the three means by which it can fund its activities, the other two being taxing and borrowing. Therefore, Austrian economists often seek to identify reasons why the state resorts to allowing the creation new money (whether fiat paper
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...

 or electronic money) and what the new money is used for. Various forms of spending are often cited as reasons for resorting to inflation and borrowing, as this can be a short term way of acquiring marketable resources and is often favored by desperate, indebted governments. In other cases, the central bank may try avoid or defer the widespread bankruptcies and insolvencies which cause economic recessions by artificially trying to "stimulate" the economy through money supply growth and further borrowing via artificially low interest rates.

Accordingly, many Austrian economists support the abolition of the central banks and the fractional-reserve banking system, advocating either a gold standard
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...

 or that the market should choose what is used as money.

At the beginning of his career Alan Greenspan, former chairman of the Federal Reserve, was also a strong advocate of the gold standard as a protector of economic liberty:

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.


Advocates argued that the gold standard would constrain unsustainable and volatile fractional-reserve banking practices, ensuring that money supply growth ("inflation") would never spiral out of control. Ludwig von Mises asserted that civil liberties would be better protected:


It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings.

Opportunity cost



The opportunity cost doctrine was first explicitly formulated by the Austrian economist Friedrich von Wieser
Friedrich von Wieser
Friedrich Freiherr von Wieser was an early member of the Austrian School of economics. Born in Vienna, the son of Privy Councillor Leopold von Wieser, a high official in the war ministry he first trained in sociology and law...

 in the late 19th century. In its original and purist sense, opportunity cost doctrine argues that the only cost
Cost
In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...

 relevant to the price
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...

 of a product is the opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

 involved in choosing it over other competing, and mutually exclusive, options, and its technical coefficients of production.

Praxeology


Praxeology is the study of human action. Praxeology rejects the empirical methods of the natural sciences, because the observation of how humans act in simple situations cannot predict how they will act in complex situations. Ludwig von Mises developed his own system of praxeology which is adhered to by many Austrian economists. Mises' praxeology is a fundamental rejection of mathematical methods in economics, seeing the function of economics as investigating the essences rather than the specific quantities of economic phenomena. This was seen as an evolutionary, or "genetic-causal", approach against the alleged "unreality" and internal stresses inherent in the "static" approach of equilibrium and perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...

, which are the foundations of mainstream Neoclassical economics. This methodology is also driven by the belief that econometrics is inherently misleading in that it creates a fallacious "precision" in economics where there is none. Mises wrote of his economic methodology that "its statements and propositions are not derived from experience... They are not subject to verification or falsification on the ground of experience and facts."

General criticisms


Economist Bryan Caplan
Bryan Caplan
Bryan Caplan is an American economist, a Professor of Economics at George Mason University, Research Fellow at the Mercatus Center, adjunct scholar of the Cato Institute, and blogger for Econlog. He is best known for his work in public choice theory and for his libertarian ideology.-Personal...

 argues that Austrian economists have often misunderstood modern economics, causing them to overstate their differences with it. For example, many Austrian economists object to the use of cardinal utility
Cardinal utility
In economics, cardinal utility refers to a property of mathematical indices that preserve preference orderings uniquely up to positive linear transformations...

 in microeconomic theory; however, microeconomic theorists go to great pains to show that their results hold for all strictly monotonic transformations of utility, and so are true for purely ordinal preferences
Ordinal utility
Ordinal utility theory states that while the utility of a particular good or service cannot be measured using a numerical scale bearing economic meaning in and of itself, pairs of alternative bundles of goods can be ordered such that one is considered by an individual to be worse than, equal to,...

. The result is that conclusions about utility preferences hold no matter what values are assigned to them.

Economist Benjamin Klein has criticized the economic methodological work of Austrian economist Israel M. Kirzner. While praising Kirzner for highlighting shortcomings in traditional methodology, Klein argued that Kirzner did not provide a viable alternative for economic methodology.

Methodology


Critics argue that Austrian economics generally lacks scientific rigor, rejects the scientific method, and rejects the use of empirical data. Thomas Mayer
Thomas Mayer
Thomas Mayer is emeritus professor of economics at the University of California, Davis. He previously taught at West Virginia University, Notre Dame University, Michigan State University, and the University of California, Berkeley. He is known for his work in monetary policy and economic...

 has argued that Austrian economists have advocated a rejection of scientific methods which involve directly using empirical data in the development of (falsifiable) theories; application of empirical data is fundamental to the scientific method. Austrians argue that empirical data in and of itself cannot explain anything, which in turn implies that empirical data cannot falsify a theory.

Austrian economists reject empirical statistical methods
Econometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...

, natural experiment
Natural experiment
A natural experiment is an observational study in which the assignment of treatments to subjects has been haphazard: That is, the assignment of treatments has been made "by nature", but not by experimenters. Thus, a natural experiment is not a controlled experiment...

s and constructed experiments
Experimental economics
Experimental economics is the application of experimental methods to study economic questions. Data collected in experiments are used to estimate effect size, test the validity of economic theories, and illuminate market mechanisms. Economic experiments usually use cash to motivate subjects, in...

 as tools applicable to economics, saying that while it is appropriate in the natural sciences where factors can be isolated in laboratory conditions, the actions of humans are too complex for such a treatment because humans are not passive and non-adaptive subjects. As Austrian economist Jeffrey Herbener has noted "there are no statistical characteristics to human behavior. It is purposeful rather than random, and changeable rather than constant". Austrian economists claim one should instead isolate the logical processes of human action. Mises called this discipline "praxeology." The Austrian praxeological method is based on the heavy use of logical deduction
Deductive reasoning
Deductive reasoning, also called deductive logic, is reasoning which constructs or evaluates deductive arguments. Deductive arguments are attempts to show that a conclusion necessarily follows from a set of premises or hypothesis...

 from what they assert to be undeniable, self-evident axioms or irrefutable facts about human existence.

Austrian theories are not presented in mathematical form; proponents rely mainly on verbal arguments based on what are claimed to be self-evident axioms. Murray Rothbard has argued that the scientific method of the natural sciences is not applicable to the social sciences, and has rejected any attempt at using mathematics in the study of economics, calling it a form of "scientism
Scientism
Scientism refers to a belief in the universal applicability of the systematic methods and approach of science, especially the view that empirical science constitutes the most authoritative worldview or most valuable part of human learning to the exclusion of other viewpoints...

". Rothbard has argued that the use of the wrong methodology is what is truly unscientific. Mainstream economists believe that this makes Austrian theories too imprecisely defined to explain or predict real world events. Paul Krugman has stated that because Austrians do not use "explicit models" they are unaware of holes in their own thinking.

Mark Blaug
Mark Blaug
Mark Blaug , was a British economist , who has covered a broad range of topics over his long career. In 1955 he received his PhD from Columbia University in New York under the supervision of George Stigler...

 has criticized over-reliance on methodological individualism, arguing it would rule out all macroeconomic propositions that cannot be reduced to microeconomic ones, and hence reject almost the whole of received macroeconomics. Paul Krugman has stated that because Austrians do not use "explicit models" they are often unaware of holes in their own thinking.

Business cycle theory


According to most mainstream economists, the Austrian business cycle theory is incorrect.

Most mainstream economists argue that the Austrian business cycle theory requires bankers and investors to exhibit a kind of irrationality, because their theory requires bankers to be regularly fooled into making unprofitable investments by temporarily low interest rates. In response, Austrian economists Anthony Carilli and Gregory Dempster have argued that a banker or firm loses market share if it does not borrow or loan at a magnitude consistent with current interest rates, regardless of whether rates are below their natural levels. Thus businesses are forced to operate as though rates were set appropriately, because the consequence of a single entity deviating would be a loss of business.

Paul Krugman dubs the theory the "hangover theory", and has written that it cannot explain changes in unemployment over the business cycle. Austrian business cycle theory postulates that business cycles are caused by the misallocation of resources from consumption to investment during 'booms', and out of investment during 'busts'. Krugman argues that because total spending is equal to total income in an economy, the theory implies that the reallocation of resources during 'busts' would increase employment in consumption industries, whereas in reality, spending declines in all sectors of an economy during recessions. He also argues that according to the theory the initial 'booms' would also cause resource reallocation, which implies an increase in unemployment during booms as well. Krugman also argues that Austrian economists often explain the boom in terms of changes in demand, but then fail to accept the implications of that position during the bust.

Austrian economist David Gordon
David Gordon (philosopher)
David Gordon is a libertarian philosopher and intellectual historian influenced by Rothbardian views of economics. He is a senior fellow at the Ludwig von Mises Institute and editor of "The Mises Review."...

 has argued that prices on consumption goods may go up as a result of the investment bust, which could mean that the amount spent on consumption could increase even though the quantity of goods consumed has not.

Economist Jeffery Hummel is critical of Hayek's explanation of labor asymmetry in booms and busts. He argues that Hayek makes peculiar assumptions about demand curves for labor in his explanation of how a decrease in investment spending creates unemployment. He also argues that the labor asymmetry can be explained in terms of a change in real wages, but this explanation fails to explain the business cycle in terms of resource allocation. In response, Austrian economist Walter Block argues that the misallocation during booms is only relative, and that there is an absolute increase in demand. In addition, Hummel argues that the Austrian explanation of the business cycle fails on empirical grounds. In particular, he points out that investment spending remained positive in all recessions where there are data, except for the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

. He argues that this casts doubt on the notion that recessions are caused by a reallocation of resources from industrial production to consumption, since the Austrian business cycle theory implies that net investment should be below zero during recessions.

According to most economic historians, economies have experienced less severe boom-bust cycles after World War II, because governments have addressed the problem of economic recessions. This has especially been true after central banks were granted independence in the 1980s, and started using monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

 to stabilize the business cycle, an event known as The Great Moderation
The Great Moderation
In economics, the Great Moderation refers to a reduction in the volatility of business cycle fluctuations starting in the mid-1980s, believed to have been caused by institutional and structural changes in developed nations in the later part of the twentieth century...

. Critics have also argued that, as the Austrian business cycle theory points to the actions of fractional-reserve banks and central banks to explain the business cycles, it fails to explain the severity of business cycles before the establishment of the Federal Reserve in 1913. Supporters of the Austrian business cycle theory respond that the theory applies to the expansion of the money supply, not necessarily an expansion done by a central bank. Historian Thomas Woods
Thomas Woods
Thomas E. "Tom" Woods, Jr. is an American historian, economist, political analyst, and New York Times-bestselling author. He has written extensively on the subjects of American history, contemporary politics, and economic theory...

 argues that the crashes were caused by various privately-owned banks with state charters that issued paper money, supposedly convertible to gold, in amounts greatly exceeding their gold reserves.

In 1969, Milton Friedman, after examining the history of business cycles in the U.S., concluded that "The Hayek-Mises explanation of the business cycle is contradicted by the evidence. It is, I believe, false." He analyzed the issue using newer data in 1993, and again reached the same conclusions. In 2001, Austrian economist James P. Keeler stated that the hypotheses of the theory are consistent with empirical evidence.

Laissez faire


Jeffrey Sachs
Jeffrey Sachs
Jeffrey David Sachs is an American economist and Director of The Earth Institute at Columbia University. One of the youngest economics professors in the history of Harvard University, Sachs became known for his role as an adviser to Eastern European and developing country governments in the...

 observes that among developed countries, those with high rates of taxation and high social welfare spending perform better on most measures of economic performance compared to countries with low rates of taxation and low social outlays. He concludes that Friedrich Hayek was wrong to argue that high levels of government spending harms an economy, and "a generous social-welfare state is not a road to serfdom but rather to fairness, economic equality and international competitiveness." Austrian economist Sudha Shenoy
Sudha Shenoy
Dr. Sudha Shenoy, Ph.D , was an Austrian school economist and economic historian. From 1986 to 2004, she worked as a lecturer in economics at the University of Newcastle in Australia...

 countered by claiming that countries with large public sectors have grown more slowly.

Seminal works

  • Principles of Economics
    Principles of Economics
    Principles of Economics is a book by economist Carl Menger which is credited with the founding of the Austrian School of economics...

    (1871) by Carl Menger
    Carl Menger
    Carl Menger was the founder of the Austrian School of economics, famous for contributing to the development of the theory of marginal utility, which contested the cost-of-production theories of value, developed by the classical economists such as Adam Smith and David Ricardo.- Biography :Menger...

  • Capital and Interest
    Capital and Interest
    Capital and Interest is a three-volume work on finance published by Austrian economist Eugen von Böhm-Bawerk.The first two volumes were published in the 1880s when he was teaching at the University of Innsbruck....

    (1884–1921) by Eugen von Böhm-Bawerk
    Eugen von Böhm-Bawerk
    Eugen Ritter von Böhm-Bawerk was an Austrian economist who made important contributions to the development of the Austrian School of economics.-Biography:...

  • Human Action
    Human Action
    Human Action: A Treatise on Economics is the magnum opus of the Austrian economist Ludwig von Mises. It presents a case for laissez-faire capitalism based on Mises' praxeology, or rational investigation of human decision-making. It rejects positivism within economics...

    (1940–1949) by Ludwig von Mises
    Ludwig von Mises
    Ludwig Heinrich Edler von Mises was an Austrian economist, philosopher, and classical liberal who had a significant influence on the modern Libertarian movement and the "Austrian School" of economic thought.-Biography:-Early life:...

  • Individualism and Economic Order
    Individualism and Economic Order
    Individualism and Economic Order is a book written by Friedrich Hayek . It is a collection of essays originally published between the 1930s and 40s, discussing topics ranging from moral philosophy to the methods of the social sciences and economic theory to contrast free markets with planned...

    (1948) by Friedrich Hayek
    Friedrich Hayek
    Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...

  • Man, Economy, and State
    Man, Economy, and State
    Man, Economy, and State: A Treatise on Economic Principles, first published in 1962, is a book on economics by Murray Rothbard, and is one of the most important books in the Austrian School of economics...

    (1962) by Murray N. Rothbard
    Murray Rothbard
    Murray Newton Rothbard was an American author and economist of the Austrian School who helped define capitalist libertarianism and popularized a form of free-market anarchism he termed "anarcho-capitalism." Rothbard wrote over twenty books and is considered a centrally important figure in the...

  • Competition and Entrepreneurship (1973) by Israel M. Kirzner
    Israel Kirzner
    Israel Meir Kirzner is a leading economist in the Austrian School.-Early life:The son of a well-known rabbi and Talmudist, Kirzner was born in London, England and came to the United States via South Africa.-Education:After studying with the University of Cape Town, South Africa in 1947-48 and...


Methodological works

  • Investigations into the Method of the Social Sciences with Special Reference to Economics (1883) by Carl Menger
  • Epistemological Problems of Economics (1933) by Ludwig von Mises
  • Ultimate Foundations of Economic Science (1962) by Ludwig von Mises
  • Studies in Philosophy, Politics and Economics (1967) by Friedrich Hayek
  • New Studies in Philosophy, Politics, Economics and the History of Ideas (1978) by Friedrich Hayek

Reference works

  • Economics in One Lesson
    Economics in One Lesson
    Economics in One Lesson is an introduction to free market economics written by Henry Hazlitt and published in 1946, based on Frédéric Bastiat's essay .The "One Lesson" is stated in Part One of the book:...

    (1946) by Henry Hazlitt
    Henry Hazlitt
    Henry Stuart Hazlitt was an American economist, philosopher, literary critic and journalist for such publications as The Wall Street Journal, The Nation, The American Mercury, Newsweek, and The New York Times...

  • Capitalism (1996) by George Reisman
    George Reisman
    George Gerald Reisman is Professor Emeritus of Economics at Pepperdine University and author of Capitalism: A Treatise on Economics . He is also the author of an earlier book, The Government Against the Economy , which was praised by F.A...


See also



External links


  • Austrian Economics Concise encyclopedia of economics
    Concise Encyclopedia of Economics
    The Concise Encyclopedia of Economics is a widely-used encyclopedia of economics. It is used by students and teachers from high school to college to graduate school, and is one of the most popular worldwide resources for researching and understanding topics in economics.Articles are written by...

    on Econlib
  • The Austrian School from the History of Economic Thought website.
  • Austrian School at Mises Wiki
  • Introduction to Austrian Economics, an online lecture series from the Foundation for Economic Education
    Foundation for Economic Education
    The Foundation for Economic Education is one of the oldest free-market organizations established in the United States to study and advance the freedom philosophy. Murray Rothbard recognizes FEE for creating a "crucial open center" that he credits with launching the movement...

  • A Primer on Austrian Economics by Jonathan M. Finegold Catalan, June 2010