Austrian economics – definition and meaning

Austrian Economics comes from the late 19th century Austrian School of Economics, which focuses on the concept of methodological individualism. Austrian Economics promotes liberalism and laissez-faire economics, i.e. let the market find its way with the minimum of government interference.

Austrian Economics evolved from the works of the Austrian School’s founder Carl Menger (1840-1921), Austrian economist Eugen Böhm Ritter von Bawerk (1851-1914), and Friedrich Freiherr von Wieser (1851-1926), who was also an Austrian economist, and others.

Menger follower, Friedrich Hayek (1899-1992), an economist and philosopher who was born in Austria-Hungary and became a British subject in 1938, believed strongly that the state should not intervene in the economy.

Carl Menger Austrian EconomicsCarl Menger, founder of the Austrian School. (Image: Wikimedia)

Austrian Economists were the first to predict the eventual collapse of the command-economy regimes i.e. the Soviet Union’s and its satellite countries’ communist system.

Markets work perfectly

According to Hayek, ‘markets work perfectly’ – market prices balance supply and demand. He believed that the perfect market was one with easy access to information, no obstacles to entry and with prices that were determined by all participants.

Another Menger follower was Ludwig Heinrich Edler von Mises (1881-1973), an economist, sociologist and classical liberal who was born in Austria-Hungary and emigrated to the United States because he feared a Nazi takeover in Switzerland. Mises’ thought has exerted considerable influence on the libertarian movement in America since the middle of the last century.

According to the Ludwig von Mises Institute, located in Auburn, Alabama:

“The (Austrian) school emphasizes the spontaneous organizing power of the price mechanism and holds that the complexity of subjective human choices makes mathematical modeling of the evolving market practically impossible and therefore its scholars eschew what they consider ‘naïve’ and pointless mathematical modeling of the economy, considering much of mainstream economics a form of economic charlatanism.”

Austrian Economics became very popular during and after the 2008 global financial crisis. The Austrian School had forecast more than 100 years ago that too much debt, resulting from low interest rates, would lead to investment bubbles that burst – thus causing boom-bust crises.

Economy driven by supply – not demand

It contrasts sharply with Keynesian Economics, which claims that economic performance is determined by aggregate demand. Followers of the Austrian School of thought insist that the business cycle is driven by the supply-side of the economy, and not demand.

Mr. Menger would have been horrified at the quantitative easing (injecting money into the economy) implemented by authorities in nearly all the advanced economies following the 2008 global financial crisis.

Supporters of Austrian Economics say that when interest rates are too low, over-investment will follow, which can result in over-production and then a crisis. During the crisis supply drops until it eventually equals overall demand – and a new cycle begins.

Hayek and Keynes
Hayek believed an economy is driven by supply, while Keynes insisted aggregate demand is the driver.

The main challenge is not inflation, says the Austrian School of thought, but too much investment when there is more money than there should be slushing around, or excessively-low interest rates that can bring about a crisis.

When there is too much money in the economy, demand rises faster than the increase in goods and services, which leads to inflation.

In order to prevent a crisis, the level of interest rates needs to be reached at ‘naturally’, say followers of Austrian economics.

Video – The Austrian School of Economics

Steven Horwitz, an American economist of the Austrian School, explains why he considers economics to be among the humanities. Rather than trying to develop elaborate mathematical models, he focuses on people’s choices and perceptions and how prices help everyone spontaneously coordinate with everyone else.