Distinguishing Austrians from Keynesians

Yesterday, I argued that Paul Krugman’s analysis of the Chinese economy is straightforward Old Keynesian business cycle theory. At the end, I offered a basic distinction between the Austrian and Keynesian theories,

  1. The Austrian solution to unprofitable investment is to increase the real productivity of capital (by increasing savings and lowering the price of producers’ goods);
  2. The Keynesian/Monetarist solution is to increase nominal revenues, by conducting fiscal and/or monetary stimulus.

Thinking about it last night, (1) isn’t always completely true. Many Austrians, namely those who advocate for free banking, argue that an elastic money supply can help attenuate cyclical fluctuations by helping to maintain monetary equilibrium. This is basically what counter-cyclical monetary policy seeks. An Austrian wouldn’t go so far as to support Paul Krugman’s extreme inflation targeting scheme, laid out in his 1998 piece on Japan. But, many Austrians have lent support for concepts like NGDP targeting as good second-best solutions, or even as the best solution within the present institutional framework (see, for example, George Selgin here). All these solutions aim to maintain demand: they target the revenue side of firms.

Even an increase in savings can affect the revenue side. To compliment the loanable funds theory of interest with an alternative, Hayek developed the Ricardo effect in the late 1930s. The Ricardo effect argues that an increase in saving, or a fall in present consumption, will increase real wages for the final stage of production — and will increase the ratio of wages to rents — and therefore drive these firms to increase their demand for labor-saving machinery. This is a revenue side phenomenon, but it targets specific industries. (A theory of intertemporal coordination would have to describe a movement of revenues between industries, because it’s a theory of the allocation of inputs amongst the various production possibilities.)

My distinction may still be useful to quickly demarcate differences, but the issue does still get more complicated.