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Competing Economic Theories: What’s the Difference?

February 1, 2011

Before diving into the nitty-gritty and telling you why Austrian economists think China’s devaluation of the yuan is no big deal and why Keynesian economists think we haven’t been spending enough money to pull ourselves out of recession, I think it’s best to have an introduction to the theories I will discuss in this blog.  This blog will analyze various current and historical events mainly through the lens of the two largest and competing economic theories: Keynesianism and the Chicago school.  From time to time honorable mentions will go to the Austrian school and Marxism.

Below, I am providing a brief synopsis of the two theories so the uninitiated might better be able to follow later posts in this blog.  (For those who are already well-versed in economics, I invite you to add to and/or criticize or debunk anything said on this blog.  This blog is not meant to be extensive, but I’d like it to be as accurate as possible.)

Keynesianism

Keynesian economics is named after John Maynard Keynes, who is greatly responsible for modern macroeconomic theory thanks to his book The General Theory of Employment, Interest and Money. Keynesianism supports a regulated economy and money supply.  The krux of the theory is that a lack of aggregate demand is what leads to unemployment and thus economic recessions.  To combat this, Keynes proposed increasing the money supply during recessions.  More money would increase demand and keep unemployment stable (or at least keeping it from becoming as bad as it would have otherwise).  Keynes did note some limitations on this being an effective method of controlling the economy.  As the popular Keynesian Nobel Laureate and New York Times columnist Paul Krugman pointed out in 2008:

The key to Keynes’s contribution was his realization that liquidity preference — the desire of individuals to hold liquid monetary assets — can lead to situations in which effective demand isn’t enough to employ all the economy’s resources.

However, Keynes was widely criticized in the 1970s during a period of stagflation (a period of both high inflation and unemployment), which he posited could not happen.

Chicago school of economics

That stagflation criticism of Keynes allowed a new school of economics to gain popularity in the 1980s (in conjunction with the rise of Reagan).  This school of thought took its name from the University of Chicago, as many of the economic theories falling under this umbrella were developed by certain faculty members of the university.  This school of thought is generally used synonymously with supply-side economics, which is a free-market economic theory.  This theory promotes removing barriers to stimulate economic activity, such as lowering tax rates, allowing businesses to spend more by way of more investment and employment.

Milton Friedman is perhaps the most widely known and influential economist of the Chicago school.  Unlike Keynesian policy, Friedman and other Chicago scholars argued for a neutral monetary policy to promote long term economic growth.  Prices, Friedman claimed are based on the money supply.

Adjacent theories

Austrian and Marxist economics are two theories that may be touched on in this blog but they are largely considered more fringe.  I mention them because they have had some resurgence in recent years due to the current global recession.  The Austrian school has seen a rise in popularity due to promotions of Friedrick Hayek’s The Road to Serfdom and Karl Marx’s  Das Kapital became a bestseller again in Germany just a few years ago.

There is a lot of overlap between the Austrian school and the Chicago school, as they both promote free market economics.  Where differences occur in specific instances, I will try to elaborate in the post for that topic.  Marxism is an exception all on its own as it has largely stopped being developed.  However, some people have continued to try to apply and develop the theory to some extent, which I will try to use where appropriate.

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