Austrian, Chicago and Keynesian economics compared on one table

Every policy claim arrives carrying a suitcase. A senator says the stimulus "created jobs." A commentator says the Fed "caused the bubble." A think tank says a tax cut "pays for itself." Each sentence has a theory of how the economy works packed inside it, and the speaker almost never opens the suitcase.

This post opens it. Three schools of thought supply most of the assumptions behind the economic arguments Americans hear: the Austrian school, the Chicago school and the Keynesian school. If you know where they differ, you can spot the assumption behind a claim in about a sentence and a half, and you can decide whether you share it. I will lay them out on one table, walk through the rows, and then say what I think conservatives should take from each. I will state each school the way its own members would, because a comparison that caricatures one of them is a sales pitch.

The three schools in one paragraph each

Austrian. Rooted in Vienna in the 1870s with Carl Menger, and carried by Ludwig von Mises and Friedrich Hayek. It stresses subjective value, the knowledge carried by prices, and the idea that credit created by central banks distorts the structure of production and causes booms that must bust. For the full story, see The Austrian school in plain words, from Carl Menger to Friedrich Hayek.

Chicago. Associated with the University of Chicago's economics department in the middle and later twentieth century, with Milton Friedman, George Stigler and Gary Becker among its best-known figures. It applies price theory to nearly everything, trusts markets, is skeptical of discretionary government policy and emphasizes the role of the money supply, a position often called monetarism.

Keynesian. Named for John Maynard Keynes, whose General Theory of Employment, Interest and Money appeared in 1936. It holds that total spending in the economy, called aggregate demand, can fall short of what is needed for full employment, that markets may not correct this quickly on their own, and that government spending and central bank policy can fill the gap. Paul Samuelson's textbook, first published in 1948, carried a version of this view into American classrooms.

The table

A table is a compression, and every cell hides a debate. But it is a useful map. Let me take the rows in turn.

Row by row

What causes a recession

This is the dividing line. The Austrian says a recession is the correction of an earlier boom, and the cause of the boom is cheap credit. The Chicago economist says recessions are, in large part, monetary events: when the money supply shrinks or grows erratically, output suffers. The Keynesian says a recession is a shortfall of spending, and the shortfall can persist because prices and wages do not fall fast enough to restore balance.

You can feel the difference in how each would explain the same event. Take the housing collapse of the late 2000s. The Austrian points to years of low interest rates and government-promoted lending (see The 2008 housing crash began with Washington's push for easy mortgages). The Chicago economist stresses the failures of monetary policy in the crisis and the damage done when money and credit contracted. The Keynesian stresses the collapse in household and business spending after the housing bust and the need to fill the demand gap.

The role of money

All three accept that money matters, but they weigh it differently. Friedman and Schwartz's 1963 A Monetary History of the United States, 1867 to 1960 is the central Chicago text. Its most famous chapter argued that the Federal Reserve allowed the money supply to fall by nearly 30 percent between the fall of 1930 and the winter of 1933, turning a recession into the Great Depression. Friedman's later formulation, that inflation is always and everywhere a monetary phenomenon, remains the shorthand of the school. For the history of how the Fed's job was written, read The Fed's dual mandate and the 1977 law that gave it two masters, and for a look at the 1970s, The Great Inflation of the 1970s was a policy choice, not bad luck.

The Keynesian doubts that monetary policy can always do the job. Keynes himself used the idea that in a deep slump people may hoard cash and ignore low interest rates, which is sometimes called a liquidity trap. And the Austrian says the very act of managing the money supply is the root of the trouble.

Fiscal stimulus

Here the Keynesian stands apart. The core Keynesian claim is that a dollar of government spending can generate more than a dollar of output, because the recipient spends part of it, and the next recipient spends part of that. The ratio is called the multiplier. In a slump with idle workers and factories, the Keynesian says, the multiplier can be greater than one, and a government that borrows and spends can lift the economy.

The Chicago and Austrian responses differ in detail but agree that the claim is weak. The Chicago economist points to Friedman's permanent income hypothesis (1957): households base their spending on their long-run expected income, not on a one-time check, so a temporary stimulus does little. The Austrian says the stimulus only preserves the malinvestments the bust should clear. I test the Keynesian claim against the record in the 2009 stimulus promised unemployment under 8 percent, then came 10.

Regulation

Stigler, a Nobel laureate in 1982, published "The Theory of Economic Regulation" in 1971, arguing that regulation is often acquired by the industry it regulates and designed for its benefit. That is a Chicago-school insight with large implications for conservatives. It is close in spirit to Hayek's point about knowledge. And its practical meaning shows up in big companies love the regulations their small rivals cannot afford, where the incumbents turn the rulebook into a moat. Keynesians are more willing to defend regulation where markets fail, though many agree that capture is a real danger.

Method

Austrians trace economic laws from the logic of human action. Chicago economists try to test everything. Keynesians build models of the aggregate economy and revise them in light of experience. The disagreement is not merely academic. It determines what kind of evidence will change a person's mind.

One town, three diagnoses

Let me make the differences concrete with a labelled hypothetical. Picture a small town, Millbrook, where the biggest employer, a furniture factory, lays off a third of its workers after a year of cheap borrowing and a building boom that suddenly stalls. The town's diner, hardware store and car dealer all see sales drop.

The Keynesian economist walks in and says: the layoffs have cut spending, the diner's lost customers will cut its staff, and the spiral will feed itself. The county should borrow and fund a road project, hiring the idle workers, so that their wages get spent at the diner and the spiral stops.

The Chicago economist asks a different question first: what happened to the money? If the regional banks stopped lending because the central bank tightened, the fix is to restore the flow of money, not to build a road. And if the road is paid for by taxes or borrowing that households expect to repay later, they will save more now, and the stimulus will largely wash out. Chicago also asks what rule would have prevented the swings in the first place.

The Austrian economist asks what the boom was built on. If the furniture factory expanded because credit was artificially cheap, then the layoffs are the town discovering that it built more capacity than people actually wanted. The honest answer is that the workers and capital must move to uses that are really in demand, and a road project that keeps them in place only delays the move.

Three diagnoses, three prescriptions, one town. Notice that each school sees something real. The loss of spending is real, the monetary question is real and the misallocation is real. The argument is over which one is the cause and which are the symptoms, and the evidence from the decades since the schools formed is mixed enough that an honest person should hold the conclusions with care. The names matter too: Becker, the Chicago economist who won the Nobel Prize in 1992, built his reputation by showing that choices about schooling, family and crime respond to incentives, which is the instinct a Millbrook family would use to decide whether to retrain or move.

Who each school suits

The Austrian suits the reader whose deepest concern is the integrity of money and the dangers of concentrated power over credit. If your central worry is the Federal Reserve and the debt, and you think the system rewards leverage and punishes saving, the Austrian framework explains why and offers a clear moral account of thrift.

The Chicago school suits the reader who wants evidence and rules. It is the school most comfortable with data and the most likely to give a policy prescription that can be tested, such as a steady money growth rate, school choice or a negative income tax. Many of the reforms conservatives point to with pride, from deregulation to the end of the draft, were argued by Chicago economists.

The Keynesian suits the reader who wants to understand the arguments the other side is making. Even if you reject the policy conclusions, you cannot understand why Washington reaches for a stimulus in a downturn without grasping the demand-shortfall story. And some of its insights, such as the paradox of thrift and the role of confidence, are real.

What conservatives should keep from each

I promised a verdict. Here it is, in numbered points.

1. From the Austrians, keep the knowledge problem and the warning about easy credit. Prices carry information that no planner can gather, and artificially cheap money has costs that surface later. Both points are worth holding even if you reject the full business-cycle theory. And keep the moral emphasis on saving and time preference.

1. From the Chicago school, keep the method and the rules. Test claims against evidence. Prefer predictable rules to the discretion of officials who cannot know enough. Friedman's distrust of discretionary power is a Founding instinct in economic dress: write the rule down and bind the officials by it. And keep Stigler's warning about capture.

1. From the Keynesians, keep the humility about aggregate demand and the reminder that confidence matters. A conservative should not pretend that nothing ever goes wrong with spending. But reject the leap from "demand can fall" to "therefore the government should borrow and spend," because the record of that leap is weak, as the 2009 case shows. And be wary of the political economy: a theory that justifies spending in bad times and says little about restraint in good times will be used for spending in all times. (For the budget-rule history, see From Gramm-Rudman to PAYGO, a timeline of fiscal rules that bent.)

1. From all three, keep the habit of asking what is unseen. Every policy has costs that arrive later or fall on someone not at the table.

A note on honesty

A reader might ask whether this is just picking the parts I like. Fair question. The answer is that economic schools are not creeds. They are bundles of claims, some well supported and some not, that grew up in response to particular problems. Mises and Hayek were answering socialism. Keynes was answering mass unemployment. Friedman was answering both inflation and the confidence of central planners. Each was right about something important, and none was right about everything. A reader who treats any of them as a faith will be misled by that school's weak points, and a reader who ignores all of them will be at the mercy of whoever speaks most confidently.

Conservatives have a particular reason to be careful. Our tradition values prudence, the recognition that human knowledge is limited and that institutions embody lessons we cannot fully articulate. That favors a pragmatic use of all three rather than allegiance to one. (And for a primer on how to spot unsound claims in a recession, read eleven questions about recessions and who decides when one has started.)

The case in brief

1. The Austrian, Chicago and Keynesian schools differ first on what causes recessions: a credit-fueled boom correcting itself, a monetary mistake, or a shortfall of spending.
2. They differ on money (Friedman and Schwartz's 1963 history is Chicago's central text), on fiscal stimulus (only the Keynesians expect a large multiplier) and on regulation (Stigler's capture theory is Chicago's contribution).
3. The Austrians suit readers focused on sound money and the limits of knowledge, the Chicago school readers who want evidence and rules, and the Keynesians readers who need to understand the case for stimulus.
4. Conservatives should keep the knowledge problem and the warning about cheap credit, the Chicago commitment to evidence and rules, and the Keynesian humility about demand without its habit of endless spending.

What you can do: the next time a politician or pundit makes an economic claim, ask which school's assumption it rests on, and look up the claim's source on the Congressional Budget Office site before you repeat it.