Austrian School

From Wikipedia, the free encyclopedia

The Austrian School is a school of economic thought that is based on the concept of
methodological individualism that social phenomena result from the motivations and actions of
individuals.[1][2][3][4] It originated in the late-19th and early-20th century Vienna with the work of
Carl Menger, Eugen Bhm von Bawerk, Friedrich von Wieser, and others.[5] It was
methodologically opposed to the Prussian Historical School (a dispute known as Methodenstreit).
Current-day economists working in this tradition are located in many different countries, but their
work is still referred to as Austrian economics.
Among the theoretical contributions of the early years of the Austrian School are the subjective
theory of value, marginalism in price theory, and the formulation of the economic calculation
problem, each of which has become an accepted part of mainstream economics.[6]
Many economists are critical of the current-day Austrian School and consider its rejection of
econometrics and aggregate macroeconomic analysis to be outside of mainstream economic theory,
or "heterodox."[7][8][9][10] Austrians are likewise critical of mainstream economics.[11] Although
the Austrian School has been considered heterodox since the late 1930s, it began to attract renewed
academic and public interest starting in the 1970s.[12]

Methodology
The Austrian School theorizes that the subjective choices of individuals including individual
knowledge, time, expectation, and other subjective factors, cause all economic phenomena.
Austrians seek to understand the economy by examining the social ramifications of individual
choice, an approach called methodological individualism. It differs from other schools of economic
thought, which have focused on aggregate variables, equilibrium analysis, and societal groups
rather than individuals.[13]

Ludwig von Mises

In the twentieth and twenty-first centuries, economists with a methodological lineage to the early
Austrian School developed many diverse approaches and theoretical orientations. For example, in

1949, Ludwig von Mises organized his version of the subjectivist approach, which he called
"praxeology", in a book published in English as Human Action.[14]:3 In it, Mises stated that
praxeology could be used to deduce a priori theoretical economic truths and that deductive
economic thought experiments could yield conclusions which follow irrefutably from the
underlying assumptions. He wrote that conclusions could not be inferred from empirical
observation or statistical analysis and argued against the use of probabilities in economic models.
[15]
Since Mises' time, some Austrian thinkers have accepted his praxeological approach, while others
have adopted alternative methodologies.[16] For example, Fritz Machlup, Friedrich Hayek, and
others, did not take Mises' strong a priori approach to economics.[17]:225235 Ludwig Lachmann,
a radical subjectivist, also largely rejected Mises' formulation of Praxeology in favor of the
verstehende Methode (interpretive method) articulated by Max Weber.[13][18]
In the 20th century, various Austrians incorporated models and mathematics into their analysis.
Austrian economist Steven Horwitz argued in 2000, that Austrian methodology is consistent with
macroeconomics and that Austrian macroeconomics can be expressed in terms of microeconomic
foundations.[19] Austrian economist Roger Garrison writes that Austrian macroeconomic theory
can be correctly expressed in terms of diagrammatic models.[20] In 1944, Austrian economist
Oskar Morgenstern presented a rigorous schematization of an ordinal utility function (the Von
NeumannMorgenstern utility theorem) in Theory of Games and Economic Behavior.[21]

Fundamental tenets
Fritz Machlup listed the typical views of Austrian economic thinking.[22]
(1) Methodological Individualism: In the explanation of economic phenomena we
have to go back to the actions (or inaction) of individuals; groups or "collectives"
cannot act except through the actions of individual members.
(2) Methodological Subjectivism: In the explanation of economic phenomena we
have to go back to judgments and choices made by individuals on the basis of
whatever knowledge they have or believe to have and whatever expectations they
entertain regarding external developments and especially the perceived
consequences of their own intended actions.
(3) Tastes and Preferences: Subjective valuations of goods and services determine
the demand for them so that their prices are influenced by (actual and potential)
consumers.
(4) Opportunity Costs: The costs with which producers and other economic actors
calculate reflect the alternative opportunities that must be foregone; as productive
services are employed for one purpose, all alternative uses have to be sacrificed.
(5) Marginalism: In all economic designs, the values, costs, revenues,
productivity, etc., are determined by the significance of the last unit added to or
subtracted from the total.
(6) Time Structure of Production and Consumption: Decisions to save reflect

"time preferences" regarding consumption in the immediate, distant, or indefinite

future, and investments are made in view of larger outputs expected to be obtained
if more time-taking production processes are undertaken.
Two important tenets held by the Misesian branch of Austrian economics may also be
added to the list:
(7) Consumer Sovereignty: The influence consumers have on the effective
demand for goods and services and, through the prices which result in free
competitive markets, on the production plans of producers and investors, is not
merely a hard fact but also an important objective, attainable only by complete
avoidance of governmental interference with the markets and of restrictions on the
freedom of sellers and buyers to follow their own judgment regarding quantities,
qualities, and prices of products and services.
(8) Political Individualism: Only when individuals are given full economic
freedom will it be possible to secure political and moral freedom. Restrictions on
economic freedom lead, sooner or later, to an extension of the coercive activities
of the state into the political domain, undermining and eventually destroying the
essential individual liberties which the capitalistic societies were able to attain in
the nineteenth century.

Contributions to economic thought

Opportunity cost

Friedrich von Wieser

The opportunity cost doctrine was first explicitly formulated by the Austrian economist Friedrich
von Wieser in the late 19th century.[23] Opportunity cost is the cost of any activity measured in
terms of the value of the next best alternative foregone (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.[24]
Opportunity cost is a key concept in mainstream economics, and has been described as expressing
"the basic relationship between scarcity and choice".[25] The notion of opportunity cost plays a
crucial part in ensuring that resources are used efficiently.[26]

Capital and interest

Eugen Bhm von Bawerk

The Austrian theory of capital and interest was first developed by Eugen Bhm von Bawerk. He
stated that interest rates and profits are determined by two factors, namely, supply and demand in
the market for final goods and time preference.[27][28]
Bhm-Bawerk's theory was a response to Marx's labor theory of value and capital. Bhm-Bawerk's
theory attacked the viability of the labor theory of value in the light of the transformation problem.
His conception of interest countered Marx's exploitation theory. Marx famously argued that
capitalists exploit workers by paying them less than the fruits of their labor sell for. Bohm-Bawerk
countered this assertion by invoking the concept of time preference to demonstrate that everyone
values present consumption more than future consumption, and therefore that a difference between
the (smaller) salary laborers are paid in the present and the (greater) price for which the goods they
produce are later sold need not be exploitative.[28]
Bhm-Bawerk's theory equates capital intensity with the degree of roundaboutness of production
processes. Bhm-Bawerk also argued that the law of marginal utility necessarily implies the
classical law of costs.[27] Some Austrian economists therefore entirely reject the notion that interest
rates are affected by liquidity preference.

Inflation
In Mises's definition, inflation is an increase in the supply of money:[29]
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.[30]
Hayek pointed out that inflationary stimulation exploits the lag between an increase in money
supply and the consequent increase in the prices of goods and services:
And since any inflation, however modest at first, can help employment only so long as
it accelerates, adopted as a means of reducing unemployment, it will do so for any
length of time only while it accelerates. "Mild" steady inflation cannot helpit can lead
only to outright inflation. That inflation at a constant rate soon ceases to have any
stimulating effect, and in the end merely leaves us with a backlog of delayed
adaptations, is the conclusive argument against the "mild" inflation represented as
beneficial even in standard economics textbooks.[31]

Economic calculation problem

Friedrich Hayek
The economic calculation problem refers to a criticism of socialism which was first stated by Max
Weber in 1920. Mises subsequently discussed Weber's idea with his student Friedrich Hayek, who
developed it in various works including The Road to Serfdom.[32][33] The problem concerns the
means by which resources are allocated and distributed in an economy.
Austrian theory emphasizes the organizing power of markets. Hayek stated that market prices
reflect information, the totality of which is not known to any single individual, which determines
the allocation of resources in an economy. Because socialist systems lack the individual incentives
and price discovery processes by which individuals act on their personal information, Hayek argued
that socialist economic planners lack all of the knowledge required to make optimal decisions.
Those who agree with this criticism view it as a refutation of socialism showing that socialism is
not a viable or sustainable form of economic organization. The debate rose to prominence 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.[34]
Mises argued in a 1920 essay "Economic Calculation in the Socialist Commonwealth" that the
pricing systems in socialist economies were necessarily deficient because if government owned the
means of production, 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.[34] This led
him to write "that rational economic activity is impossible in a socialist commonwealth."[35]

Business cycles
The Austrian theory of the business cycle ("ABCT") focuses on banks' issuance of credit as the
cause of economic fluctuations. Although later elaborated by Hayek and others, the theory was first
set forth by Mises, who believed that banks extend credit at artificially low interest rates, causing
businesses to invest in relatively roundabout production processes. Mises stated that this led to a
misallocation of resources which he called malinvestment.
According to the theory, malinvestment is induced by banks' excessive and unsustainable expansion
of credit to businesses.[36] Businesses borrow at unsustainably low interest rates and overinvest in
capital-intensive production processes, which in turn leads to a diversion of investment from
consumer goods industries to capital goods industries. Austrians contend that this shift is
unsustainable and must eventually be reversed, and that the re-adjustment process will be more

violent and disruptive the longer the putative malinvestment in capital goods industries continues.
According to the Austrian view, the proportion of income allocated to consumption rather than
saving is determined by the interest rate and people's time preference, which is the degree to which
they prefer present to future satisfactions. According to this view, the pure interest rate is
determined by the time preferences of the individuals in society. If the market rate of interest
offered by banks is set lower than this, business borrowing will be excessive and will be allocated to
malinvestment.[37]
Newly extended credit thus malinvested will circulate from the business borrowers to the factors of
production: landowners, capital goods producers, and capital goods workers. Austrians state that,
because individuals' time preferences have not changed, the market will tend to reestablish the old
proportions between current and future production. Depositors will tend to remove cash from the
banking system and spend it (not save it), banks will then ask their borrowers for repayment, and
the excessive capital goods will be liquidated at lower prices to retire the now-unprofitable loans.
[36]
Role of government disputed
According to Mises, central banks enable the commercial banks to fund loans at artificially low
interest rates, thereby inducing an unsustainable expansion of bank credit and impeding any
subsequent contraction.[36][38] [36][39] Friedrich Hayek disagreed. Prior to the 1970s, Hayek did
not favor laissez-faire in banking and said that a freely competitive banking industry tends to be
endogenously destabilizing and pro-cyclical, mimicking the effects which Rothbard attributed to
central bank policy. Hayek stated that the need for central banking control was inescapable.[40]

History

Jean-Baptiste Say

Etymology
The Austrian School owes its name to members of the German historical school of economics, who
argued against the Austrians during the late-19th century Methodenstreit ("methodology struggle"),
in which the Austrians defended the role of theory in economics as distinct from the study or
compilation of historical circumstance. 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, a leader of the Historical school, responded with an
unfavorable review, coining the term "Austrian School" in an attempt to characterize the school as
outcast and provincial.[41] The label endured and was adopted by the adherents themselves.[42]

First Wave

Carl Menger
The school originated in Vienna, in the Austrian Empire. Carl Menger's 1871 book, Principles of
Economics, is generally considered the founding of the Austrian School. The book was one of the
first modern treatises to advance the theory of marginal utility. 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.[43] While marginalism was generally
influential, there was also a more specific school that began to coalesce around Menger's work,
which came to be known as the Psychological School, Vienna School, or Austrian
School.[44]
Menger's contributions to economic theory were closely followed by those of Bhm-Bawerk and
Friedrich von Wieser. These three economists became what is known as the "first wave" of the
Austrian School. Bhm-Bawerk wrote extensive critiques of Karl Marx in the 1880s and 1890s, as
was part of the Austrians' participation in the late 19th-century Methodenstreit, during which they
attacked the Hegelian doctrines of the Historical School.

Early twentieth century in Vienna

Several important Austrian economists trained at the University of Vienna in the 1920s and later
participated in the private seminar of Mises. These included Gottfried Haberler,[45] Friedrich
Hayek, Fritz Machlup,[46] Karl Menger (son of Carl Menger),[47] Oskar Morgenstern,[48] Paul
Rosenstein-Rodan[49] Abraham Wald,[50] among others.

Later twentieth century

Israel Kirzner

By the mid-1930s, most economists had embraced what they considered the important contributions
of the early Austrians.[8] After World War II, Austrian economics was disregarded or derided by
most economists because it rejected mathematical and statistical methods in the study of economics.
[51] Fritz Machlup quoted Hayek's statement, "the greatest success of a school is that it stops
existing because its fundamental teachings have become parts of the general body of commonly
accepted thought." [52] Mises' student, Israel Kirzner recalled that in 1954, when Kirzner was
pursuing his PhD, there was no separate Austrian School as such. When Kirzner was deciding
which graduate school to attend, Mises had advised him to accept an offer of admission at Johns
Hopkins because it was a prestigious university and Fritz Machlup taught there.[53]
After 1940, Austrian economics can be divided into two schools of economic thought, and the
school "split" to some degree in the late 20th century. One camp of Austrians, exemplified by
Mises, regards neoclassical methodology to be irredeemably flawed; the other camp, exemplified by
Friedrich Hayek, accepts a large part of neoclassical methodology and is more accepting of
government intervention in the economy.[54][55]
Henry Hazlitt wrote economics columns and editorials for a number of publications and wrote many
books on the topic of Austrian economics from the 1930s to the 1980s. Hazlitt's thinking was
influenced by Mises.[56] His book Economics in One Lesson (1946) sold over a million copies, and
he is also known for The Failure of the "New Economics" (1959), a line-by-line critique of John
Maynard Keynes's General Theory.[57]
The reputation of the Austrian School rose in the late-20th century due in part to the work of Israel
Kirzner and Ludwig Lachmann at New York University, and to renewed public awareness of the
work of Hayek after he won the 1974 Nobel Memorial Prize in Economic Sciences.[58] Hayek's
work was influential in the revival of laissez-faire thought in the 20th century.[59][60]

Split among contemporary Austrians

According to economist Bryan Caplan, by the late twentieth century, a split had developed among
those who self-identify with the Austrian School. One group, building on the work of Hayek,
follows the broad framework of mainstream neoclassical economics, including its use of
mathematical models and general equilibrium, and brings a critical perspective to mainstream
methodology merely influenced by the Austrian notions such as the economic calculation problem
and the independent role of logical reasoning in developing economic theory.[61]

Murray Rothbard
A second group, following Mises and Rothbard, rejects the neoclassical theories of consumer and

welfare economics, dismisses empirical methods and mathematical and statistical models as
inapplicable to economic science, and asserts that economic theory went entirely astray in the
twentieth century; they offer the Misesian view as a radical alternative paradigm to mainstream
theory. Caplan wrote that if "Mises and Rothbard are right, then [mainstream] economics is wrong;
but if Hayek is right, then mainstream economics merely needs to adjust its focus."[61]
Economist Leland Yeager discussed the late twentieth century rift and referred to a discussion
written by Murray Rothbard, Hans-Hermann Hoppe, Joseph Salerno, and others in which they
attack and disparage Hayek. "To try to drive a wedge between Mises and Hayek on [the role of
knowledge in economic calculation], especially to the disparagement of Hayek, is unfair to these
two great men, unfaithful to the history of economic thought" and went on to call the rift subversive
to economic analysis and the historical understanding of the fall of Eastern European communism.
[62]
In a 1999 book published by the Ludwig von Mises Institute (Mises Institute),[63] Hans-Hermann
Hoppe asserted that Murray Rothbard was the leader of the "mainstream within Austrian
Economics" and contrasted Rothbard with Nobel Laureate Friedrich Hayek, whom he identified as
a British empiricist and an opponent of the thought of Mises and Rothbard. Hoppe acknowledged
that Hayek was the most prominent Austrian economist within academia, but stated that Hayek was
an opponent of the Austrian tradition which led from Carl Menger and Bhm-Bawerk through
Mises to Rothbard. Austrian economist Walter Block says that the "Austrian school" can be
distinguished from other schools of economic thought through two categories - economic theory
and political theory. According to Block, while Hayek can be considered an "Austrian economist",
his views on political theory clash with the libertarian political theory which Block sees as an
integral part of the Austrian school.[64]
Economists of the Hayekian view are affiliated with the Cato Institute, George Mason University
(GMU), and New York University, among other institutions. They include Peter Boettke, Roger
Garrison, Steven Horwitz, Peter Leeson and George Reisman. Economists of the Mises-Rothbard
view include Walter Block, Hans-Hermann Hoppe, Jess Huerta de Soto and Robert P. Murphy,
each of whom is associated with the Mises Institute[65] and some of them also with academic
institutions.[65] According to Murphy, a "truce between (for lack of better terms) the GMU Austrolibertarians and the Auburn Austro-libertarians" was signed around 2011.[66][67]

Influence
Many theories developed by "first wave" Austrian economists have long been absorbed into
mainstream economics.[68] These include Carl Menger's theories on marginal utility, Friedrich von
Wieser's theories on opportunity cost, and Eugen Bhm von Bawerk's theories on time preference,
as well as Menger and Bhm-Bawerk's criticisms of Marxian economics.
Former U.S. Federal Reserve Chairman Alan Greenspan said that the founders of the Austrian
School "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."[69] In 1987, Nobel Laureate James M. Buchanan told an interviewer, "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."[70] Chinese economist Zhang Weiying, supports some Austrian
theories such as the Austrian theory of the business cycle.[71]
Currently, universities with a significant Austrian presence are George Mason University, New York
University, Loyola University New Orleans, and Auburn University in the United States, King Juan
Carlos University in Spain and Universidad Francisco Marroqun in Guatemala. Austrian economic
ideas are also promoted by privately funded organizations such as the Mises Institute,[72] and the
Cato Institute.

Criticisms
General criticisms
Mainstream economists have argued that Austrians are often averse to the use of mathematics and
statistics in economics.[73]
Economist Bryan Caplan argues that many Austrians have not understood valid contributions of
modern mainstream economics, causing them to overstate their differences with it. For example,
Murray Rothbard stated that he objected to the use of cardinal utility in microeconomic theory.
Caplan says that Rothbard did not understand the position he was attacking, because
microeconomic theorists go to great pains to show that their results are derived for any monotonic
transformation of an ordinal utility function, and do not entail cardinal utility.[61][74]
Economist Paul Krugman has stated that because Austrians do not use "explicit models" they are
unaware of holes in their own thinking.[75]
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.[76]
Economist Tyler Cowen has written that Kirzner's theory of entrepreneurship can ultimately be
reduced to a neoclassical search model and is thus not in the radical subjectivist tradition of
Austrian praxeology. Cowen states that Kirzner's entrepreneurs can be modeled in mainstream
terms of search.[77]
Economist Jeffrey Sachs argues 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."[78] Austrian economist Sudha Shenoy responded by arguing that
countries with large public sectors have grown more slowly.[79]
Economist Bryan Caplan has noted that Mises has been criticized for overstating the strength of his
case in describing socialism as impossible rather than as something that would need to establish
non-market institutions to deal with the inefficiency.[54][80]

Methodology
Critics generally argue that Austrian economics lacks scientific rigor and rejects scientific methods

and the use of empirical data in modelling economic behavior.[54][81][82] Some economists
describe Austrian methodology as being a priori or non-empirical.[54][73][83][84]
Economist Mark Blaug 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.[85]
Economist Thomas Mayer has stated that Austrians advocate a rejection of the scientific method
which involves the development of empirically falsifiable theories.[82][84] Furthermore, many
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.[86][87]
Although economist Leland Yeager is sympathetic to Austrian economics, he rejects many favorite
views of the Misesian group of Austrians, in particular, "the specifics of their business-cycle theory,
ultra-subjectivism in value theory and particularly in interest-rate theory, their insistence on
unidirectional causality rather than general interdependence, and their fondness for methodological
brooding, pointless profundities, and verbal gymnastics."[88]
Economist Paul A. Samuelson wrote in 1964, most economists believe, that economic conclusions
reached by pure logical deduction are limited and weak.[89] According to Samuelson and
economist Bryan Caplan, Mises' deductive methodology also embraced by Murray Rothbard and to
a lesser extent by Mises' student, Israel Kirzner was not sufficient in and of itself.[83] Bryan Caplan
wrote that the Austrian challenge to the realism of neoclassical assumptions helped work towards
making those assumptions more plausible.[61]

Business cycle theory

Some research regarding Austrian business cycle theory finds that it is inconsistent with empirical
evidence. Economists such as Gordon Tullock,[90] Bryan Caplan,[54] Milton Friedman,[91][92]
and Paul Krugman[93] have said that they regard the theory as incorrect. Austrian economist
Ludwig Lachmann noted that the Austrian theory was rejected during the 1930s:
The promise of an Austrian theory of the trade cycle, which might also serve to explain
the severity of the Great Depression, a feature of the early 1930s that provided the
background for Hayeks successful appearance on the London scene, soon proved
deceptive. Three giants Keynes, Knight and Sraffa turned against the hapless
Austrians who, in the middle of that black decade, thus had to do battle on three fronts.
Naturally it proved a task beyond their strength.[94]
Theoretical objections
Some economists argue that Austrian business cycle theory requires bankers and investors to exhibit
a kind of irrationality, because the Austrian theory posits that investors will be fooled repeatedly (by
temporarily low interest rates) into making unprofitable investment decisions.[54][90][95] Bryan
Caplan writes: "Why does Rothbard think businessmen are so incompetent at forecasting
government policy? He credits them with entrepreneurial foresight about all market-generated
conditions, but curiously finds them unable to forecast government policy, or even to avoid falling
prey to simple accounting illusions generated by inflation and deflation... Particularly in

interventionist economies, it would seem that natural selection would weed out businesspeople with
such a gigantic blind spot."[96]
Economist Paul Krugman has argued that the theory 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.[93]
In response, historian David Gordon argues that Krugman's analysis misrepresents Austrian theory.
Gordon states, "unemployment, as Austrians see matters, stems mainly from rigid wage rates. If
workers accept a fall in wages, liquidation of the boom is compatible with full employment."[97]
Austrian economist Roger Garrison states that a false boom caused by artificially low interest rates
would cause a boom in consumption goods as well as investment goods (with a decrease in "middle
goods"), thus explaining the jump in unemployment at the end of a boom.[98] Garrison has also
stated that capital allocated to investment goods cannot always be redeployed to create consumption
goods.[99]
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.[100]
Milton Friedman objected to the policy implications of the theory, stating the following in a 1998
interview:
I think the Austrian business-cycle theory has done the world a great deal of harm. If
you go back to the 1930s, which is a key point, here you had the Austrians sitting in
London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out
of the world. Youve just got to let it cure itself. You cant do anything about it. You will
only make it worse. You have Rothbard saying it was a great mistake not to let the
whole banking system collapse. I think by encouraging that kind of do-nothing policy
both in Britain and in the United States, they did harm.[101]
Empirical objections
Jeffery Hummel has argued that the Austrian explanation of the business cycle fails on empirical
grounds. In particular, he notes that investment spending remained positive in all recessions where
there are data, except for the Great Depression. He argues that this casts doubt on the notion that
recessions are caused by a reallocation of resources from industrial production to consumption,
since he argues that the Austrian business cycle theory implies that net investment should be below
zero during recessions.[100] In response, Austrian economist Walter Block argues that the
misallocation during booms does not preclude the possibility of demand increasing overall.[102]
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."[91] He analyzed the issue using newer data in 1993, and again reached the same conclusion.
[92] Referring to Friedman's discussion of the business cycle, Austrian economist Roger Garrison
argued that Friedman's empirical findings are broadly consistent with both Monetarist and Austrian
views", and goes on to argue that although Friedman's model "describes the economy's performance
at the highest level of aggregation; Austrian theory offers an insightful account of the market
process that might underlie those aggregates."[103]

Principal works

Principles of Economics (1871) by Carl Menger[2]

Capital and Interest (1884, 1889, 1921) by Eugen Bhm von Bawerk[2]
The Theory of Money and Credit (1912) by Ludwig von Mises[2]
Human Action (1949) by Ludwig von Mises[2]
Individualism and Economic Order (1949) by Friedrich A. Hayek[2]
Man, Economy, and State (1962) by Murray N. Rothbard[2]

See also

List of Austrian School economists

List of Austrian intellectual traditions
Perspectives on capitalism
Quarterly Journal of Austrian Economics
New Institutional Economics

References and notes

1. Carl Menger, Principles of Economics, online at
https://www.mises.org/etexts/menger/principles.asp
2. Boettke, Peter J. (2008). "Austrian School of Economics". In David R. Henderson (ed.).
Concise Encyclopedia of Economics (2nd ed.). Library of Economics and Liberty.
ISBN 978-0865976658. OCLC 237794267.
3. Methodological Individualism at the Stanford Encyclopedia of Philosophy
4. Ludwig von Mises. Human Action, p. 11, "r. Purposeful Action and Animal Reaction".
Referenced 2011-11-23.
5. Joseph A. Schumpeter, History of economic analysis, Oxford University Press 1996, ISBN
978-0195105599.
6. Birner, Jack; van Zijp, Rudy (1994). Hayek, Co-ordination and Evolution: His Legacy in
Philosophy, Politics, Economics and the History of Ideas. London, New York: Routledge.
p. 94. ISBN 978-0-415-09397-2.
7. Boettke, Peter. "Is Austrian Economics Heterodox Economics?". The Austrian Economists.
Archived from the original on 28 March 2009. Retrieved 2009-02-13.
8. Boettke, Peter J.; Peter T. Leeson (2003). "28A: The Austrian School of Economics 19502000". In Warren Samuels; Jeff E. Biddle; John B. Davis. A Companion to the History of

Economic Thought. Blackwell Publishing. pp. 446452. ISBN 978-0-631-22573-7.

9. "Heterodox economics: Marginal revolutionaries". The Economist. December 31, 2011.
Retrieved February 22, 2012.
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Austrians from getting more publications in mainstream journals is that their papers rarely
use mathematics or econometrics, research tools that Austrians reject on principle. ...Mises
and Rothbard however err when they say that economic history can only illustrate economic
theory. In particular, empirical evidence is often necessary to determine whether a
theoretical factor is quantitatively significant. ...Austrians reject econometrics on principle
because economic theory is true a priori, so statistics or historical study cannot 'test'
theory....
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B. Economics of Mobilization. Sulphur Springs, West Virginia: The Commercial and
Financial Chronicle. 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.
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42.von Mises, Ludwig (1984) [1969]. The Historical Setting of the Austrian School of
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von Mises Institute. Retrieved 27 July 2011. despite the particular policy views of its
founders ..., Austrianism was perceived as the economics of the free market
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Theory. Edward Elgar Publishing. p. 66. ISBN 978-1-84064-606-1.
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accepted the use of cardinal utility, when only the use of ordinal utility is defensible. As
Rothbard insists, "Value scales of each individual are purely ordinal, and there is no way
whatever of measuring the distance between the rankings; indeed, any concept of such
distance is a fallacious one." ...As plausible as Rothbard sounds on this issue, he simply
does not understand the position he is attacking. The utility function approach is based as
squarely on ordinal utility as Rothbard's is. The modern neoclassical theorists such as
Arrow and Debreau who developed the utility function approach went out of their way to
avoid the use of cardinal utility. ...To sum up, Rothbard falsely accused neoclassical utility
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Further reading
Agafonow, Alejandro (2012). "The Austrian Dehomogenization Debate, or the Possibility of
a Hayekian Planner". Review of Political Economy. 24 (2).
Harald Hagemann, Tamotsu Nishizawa, and Yukihiro Ikeda, eds. Austrian Economics in
Transition: From Carl Menger to Friedrich Hayek (Palgrave Macmillan; 2010) 339 pages
Holcombe, Randall (1999). The Great Austrian Economists. Auburn, Alabama: Ludwig von
Mises Institute. p. 273. ISBN 0945466048.
Stephen Littlechild, ed. (1990). Austrian economics, 3 v. Edward Elgar. Description and
scroll to chapter preview links for v. 1.
Schulak, Eugen-Maria; Unterkfler, Herbert (2011), The Austrian School of Economics: A
History of Its Ideas, Ambassadors, and Institutions, Auburn, Alabama: Ludwig von Mises
Institute, p. 262, ISBN 9781610161343