The Major Schools of Economics

[David in MN]

This is my basic description of the three major schools of economics. It's not thorough, it's not perfect. I'm not a trained economist. If I step on toes getting details and nuances wrong, correct me and add to the conversation.

I'll add that while I tend to skew heavily to the side of the Austrians, all three have valid uses and applications. Without further ado...

Keynesian Economics

Created by John Maynard Keynes, this school believes the economy is ruled by demand. If you remember your 9th grade supply and demand chart, that's it in a nutshell. Economic problems are caused by low demand so the key to generating wealth and full employment is having a robust demand for services and products. In a recession, the government should step in to provide the missing demand while the "animal spirits" that drove down the economy sort things out.

Keynesianism uses very large macro data to attempt to aggregate supply and demand to determine the business cycle and whether the government should be taxing or spending.

On the positive:
Keynes recognized that a community of wealthy people sitting in their houses isn't a healthy economy. In fact a billionaire alone on an island is quite poor. Keynes hit on the idea that money needs to move in an economy to generate wealth and happiness. He also offered an idea to smooth out the business cycle, something lacking before him.

On the negative:
Keynes said some things that have haunted him. In particular, blaming the "animal spirits" for recessions and responding to claims that his spending plans wouldn't work in the long run with "in the long run you're dead" implying that it didn't matter. He suffered as well in the 1970s when markets suffered stagflation (stagnant economy with inflation) which his models claimed couldn't happen. His approach is often criticized as being way too oversimplified.

The Chicago School (or Supply Side or Monetarism)

This is started in the latter half of the 20th century by a few economists but mainly Milton Friedman at the University of Chicago. Rather than Keynes Friedman advocated a slow steady increase in money supply. Rather than printing cash to deal with a recession, the central bank could predictably inflate at a known amount (often pegged to population growth) and thus avoid wild currency swings. This gets called "supply side" because monetarists will tell you that "inflation is everywhere and always a monetary phenomenon" (Friedman). By controlling the supply, the economy would (in their model) flatten out over time. Friedman believed this supply to have greater economic influence than demand.

The Chicago School also sought to differentiate itself as the math people. A monetarist will pride himself on ever complex models and subtleties they argue are lost in Keynesian aggregation. They look for much more nuance "at the margin" rather than as whole. The Chicago School also delved into market explanations for behavior under George Stigler. It has given the supply siders explanations for why government interference is itself a bad thing.

On the positive:
Controlling money supply has had some effect. It has allowed central banks to step back and let markets sort out problems rather than dumping money in as demand changes. It seems to have had a stabilizing effect on inflation. Stigler's influence with information as a currency and "regulatory capture" as a counter to government overseers also provided deep value. It also can't be overlooked that a Keynesian believes a war is good for an economy while a monetarist would "have to see the data".

On the negative:
Detractors of the Chicago School question the assumption that the market is always right. Austrian Economists would joke that a monetarist squeezed hard enough becomes a Keynesian as we saw in the TARP bailout. In short, the major complaint from the Keynes people are that monetarists don't do enough while the Austrians claim they do too much.

Austrian School
The Austrian School (so named as an insult to differentiate it with the prominent Prussian School) was popularized by Ludwig von Mises. We could go back to Menger and Say but for now, let's stick to Mises. Mises' core idea was that recessions are caused by low interest rates. People overcommit to projects and when interest goes up they are left with no customers. A student of Mises, Hayek, went further to explain that capitalism was knowledge as only a market sorts value. Another Austrian, Schumpeter, gets lumped in often as well with his concept of capitalism as creative destruction. Some Austrians (notably Rothbard) would practically do away with economic metrics and statistics and prefer logic based a priori storytelling (low interest caused the bust just as the free vodka caused the hangover).

On the positive:
Adherents to the Austrian School have an odd ability to predict the future. Ron Paul and Peter Schiff called the housing bubble (as one example). Austrians are very good at determining market forces rather than data. Hayek's insights on how markets "generate knowledge" were vital. The Austrians also predicted the fall of communism.

On the negative:
They've never been taken seriously. No politician wants to hear that he can't help the market. They also infight badly. Hayek remained a neo-classical while Rothbard embraced Mises. And their theories often lack any mathematical background. Terms like "high interest" are very subjective.

That's a very brief starting point where I ran roughshod over a lot of people smarter than me. I'll follow up with more (if I know it) and I fully expect to be corrected from time to time.

[surfivor]

 I tend to think economics is just political leanings disguised as a science .. I doubt any of the economics theories are totally accurate .. I also think alot of manipulation occurs and falls into the realm of conspiracy. Teaching people in school that it is an actual theory that works is also probably some kind of manipulation or brainwashing, although it does work to some extent probably but it seems to be very inexact.

At least some of the Austrian guys seem to acknowledge the Federal reserve is a private bank, but Austrian school seems to be the same as libertarian .. I guess Keynesian is liberal (democrat) and Chicago or (Reaganomics ?) must be republican ? So each political leaning gets a school ?

[Morning Sunshine]

oh thank you!.  I will need to read and reread this to fully understand it.

[Smurf Hunter]

I tend to think economics is just political leanings disguised as a science .. I doubt any of the economics theories are totally accurate

Same might be said for medicine or engineering as well.

What's the saying?  No plan survives contact with the enemy.

[surfivor]

Same might be said for medicine or engineering as well.

What's the saying?  No plan survives contact with the enemy.

 But I had to figure it out for myself no one taught me

[RitaRose1945]

Ron Paul and Peter Schiff called the housing bubble (as one example). Austrians are very good at determining market forces rather than data.

You know, I'm still stunned that there was even a question of this happening, but I hear people were surprised by it all the time.


It was obvious to me that the climb couldn't go on forever, and that would have been back in 2005.  We started laying people off in 2006 at the title company where I was working.  I survived for a year until I was laid off in 2007.

[surfivor]

Lots of people in the alternate media seemed to know the 2008 crash was going to happen.

They've never been taken seriously.

 alternative media, libertarians are considered part of fake news

[bigbear]

It's important to note the Keynes and Hayek debated the role of the gov't in economics during Great Depression and pre/post-WWII era.  Keynes advocated for more gov't intervention.  Hayek (intimately familiar the USSR) advocated against gov't intervention because of the economic mismatches it causes.  Keynes was able to win the ear of guys like FDR and Churchill to set the stage for the massive war build up and the post-war rebuild.  The New Deal and nationalization of UK industries are among the results.  War spending and rebuilding sent money through the economy.  Jobs, innovation, and stocks went well for decades.  The rest is history as far as Keynesian dominance in the political landscape is concerned.  Then the 1970's stagflation hit.  Friedman/Chicago School originally was more in line with the Hayek/Austrian line, but he defined inflation as a monetary issue.  Plus his theory on consumption was very influential on Reagan and "trickle-down economics".  Hayek was very influential on Thatcher as she privatized the industries that Churchill had previously nationalized. 

No economic discussion is complete without at least a cursory look at the "Parable of the Broken Window" and how various schools of thought interpret it.

https://en.wikipedia.org/wiki/Parable_of_the_broken_window

Keynesians would say that broken windows stimulate the demand for window makers.  Politically, they would be looking for strategic or important industries to protect/grow.  The New Deal, Churchill nationalized quite a few industries, Soviet Russia and trade agreements take pages from the Keynesian playbook.  I think at the end of the day, Trump will prove to be a Keynesian.

Chicago would have less to say specifically about the broken window itself, but about not having money sitting in the shop owners savings account.  If there's enough money floating around (i.e. supply), then the shop owner would value it less and would be more likely to replace the window (like Reagan, Greenspan, Bernanke). 

Austrians would say replacing a broken window prevents that money from being spent elsewhere.  Spending it to fix damages is not truly productive for the overall advancement/welfare of society.  There aren't many politically influential economists currently around because Austrian economics doesn't provide much of a political solution to a problem.  Which is part of the 'problem' of the Austrian school.  The wealth of a nation isn't mobilized in a certain way to get an immediate return on investment.  So in the short run, it's weaker at responding to a crisis and doesn't proactively seek strength as a whole. 

The BBC did a great video series on Keynes and Hayek a few years back called the "Masters of Money".  They included Marx in the series.
Pt. 1 (Keynes) https://www.youtube.com/watch?v=CkHooEp3vRE
Pt. 2 (Hayek) https://www.youtube.com/watch?v=EIYqTj402PE
Pt. 3 (Marx) https://www.youtube.com/watch?v=oaIpYo3Z5lc

[Smurf Hunter]

Austrians would say replacing a broken window prevents that money from being spent elsewhere.  Spending it to fix damages is not truly productive for the overall advancement/welfare of society.  There aren't many politically influential economists currently around because Austrian economics doesn't provide much of a political solution to a problem.  Which is part of the 'problem' of the Austrian school.  The wealth of a nation isn't mobilized in a certain way to get an immediate return on investment.  So in the short run, it's weaker at responding to a crisis and doesn't proactively seek strength as a whole. 

Suppose there were two boulevards lined with shops selling similar goods and services, but one of the streets had uneven sidewalks, broken shop windows and was generally run down and ugly.
If the shop owners on "broken window" street invested the repair money into R&D, they may have better products and/or more efficient operations.
HOWEVER, if consumers were aesthetically turned off by the scummy appearance of that street, and instead chose to shop on the clean and pretty street, it wouldn't matter in the end.

Life is filled with paradoxes where things are theoretically correct, but there's some intangible factor in practice.

[bigbear]

An Austrian would say the broken window in that instance has adds negative value to the business.  And thus, needs to be replaced.

[David in MN]

It's important to note the Keynes and Hayek debated the role of the gov't in economics during Great Depression and pre/post-WWII era.... 

I don't think you'll get any argument from me. It's important for anyone reading this to understand these are VERY simplified ideas that could (and have) filled volumes of books.

I like the argument between Keynes and Hayek but  I find them best represented in the youtube Keynes/Hayek rap videos than in most writing. Hayek was a very difficult writer to read both because of his technical lingo and because English was his second language. His best work (my opinion) is his wonderful Nobel Prize lecture which challenges the validity of economics as a subject in terms of its historical recommendations.

http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1974/hayek-lecture.html

[osubuckeye4]

I tend to think economics is just political leanings disguised as a science .. I doubt any of the economics theories are totally accurate .. I also think alot of manipulation occurs and falls into the realm of conspiracy. Teaching people in school that it is an actual theory that works is also probably some kind of manipulation or brainwashing, although it does work to some extent probably but it seems to be very inexact.

At least some of the Austrian guys seem to acknowledge the Federal reserve is a private bank, but Austrian school seems to be the same as libertarian .. I guess Keynesian is liberal (democrat) and Chicago or (Reaganomics ?) must be republican ? So each political leaning gets a school ?

I'm having a hard time trying to articulate my position on this, I'll give it a shot.

I have a background in economics, I minored in it in college and do keep up with it (though, it's more as a hobby than something I get paid to do). I really don't think economics in and of itself is a sham... I think that oftentimes, the data that economists are trying to evaluate is the sham.... and economists/economics get thrown under the bus.


As you get further and further into economics you start to attempt to factor in more and more unknown (and really, impossible to accurately know) variables. Corruption, market interference, government intervention, subsidies, consumer confidence, etc.

Those things are oftentimes unknowns. Look at consumer confidence... there's 7 billion people in the world and there are tons of global markets that are interconnected. Determining consumer confidence isn't a science, it's a guess.  You do the best you can, but it's impossible to accurately pin it down.



I suppose the way I look at economics is....

Real-world economics is kind of like trying to solve math equations with variables missing.

An (extremely dumbed down) example would be:

6  3 =

Is it 6-3 = 3?

Is it 6*3 = 18?

Is it 6/3 = 2?


You have all these schools that try to look at that initial incomplete equation and figure out the answer, when the answer could be multiple things, depending on which factors/variables you're looking at.

Some schools get it right more than others. Sometimes it's because the philosophy is more accurate, other times it's because they luck into it more often than others.


There's definitely a method behind it, which is why I really don't think that it's accurate to say that it's politics masquerading as science. But... anyone trying to say that they have THE method is delusional.

[RitaRose1945]

And the human factor always screws up predictions anyway.


What if Kathy is the #1 name for babies in 1960, then all of those babies named Kathy get divorced in 1990-2000.  Now you've got a glut of men who hate the name Kathy, and if you try to open up "Kathy's Diner," it's likely not going to do well.  All those exes of other people who are also named Kathy are going to avoid it like the plague.


In a nutshell, humans are weird and often confusing.

[Chemsoldier]

And the human factor always screws up predictions anyway.


What if Kathy is the #1 name for babies in 1960, then all of those babies named Kathy get divorced in 1990-2000.  Now you've got a glut of men who hate the name Kathy, and if you try to open up "Kathy's Diner," it's likely not going to do well.  All those exes of other people who are also named Kathy are going to avoid it like the plague.


In a nutshell, humans are weird and often confusing.

I would argue that humans screw up the concept of what predictions can be. 

Economic systems are inherently complex and attempts to divine fine details into the future are simply not possible.  Perhaps large picture predictions, "More chaotic over the next 5 years" are possible. 

I think we put a lot of resources (time, money, people) into predictions and modeling for some time.  They are likely useful to some entities, however I think the predictions are so vague and variable I think their value to individuals is much more limited and we should likely expend far more brain power as individuals to having a resilient personal financial position.  That consists of making and having money.  Reducing your need for monetary income. Creating a personal life where you are not as dependent on money for happiness.

[RitaRose1945]

I would argue that humans screw up the concept of what predictions can be. 

Economic systems are inherently complex and attempts to divine fine details into the future are simply not possible.  Perhaps large picture predictions, "More chaotic over the next 5 years" are possible. 

I think we put a lot of resources (time, money, people) into predictions and modeling for some time.  They are likely useful to some entities, however I think the predictions are so vague and variable I think their value to individuals is much more limited and we should likely expend far more brain power as individuals to having a resilient personal financial position.  That consists of making and having money.  Reducing your need for monetary income. Creating a personal life where you are not as dependent on money for happiness.

True.

[David in MN]

This is actually considered the greatest pitfall of the Austrian business cycle by Austrian economists. The claim is that low interest rates cause a recession but we just don't know when or how bad.

Also note that Keynes (in his rawest form) doesn't actually try to predict at all. He responds to reduced demand.

The monetarists also aren't so future looking in their core inflation controlled model.

I also should mention that these are all schools of macroeconomics as opposed to microeconomics or finance. It's inflation, GDP, and debt as opposed to costs and profits of producing a product or how to invest and save for retirement. There are lessons that cross over but I wouldn't rely on them solely as tools to tell me if I should open a factory or buy tech stocks.

[RitaRose1945]

Side note: when I took economics several years ago, we also had to put together a business plan for a group project. I detest group projects, and this just affirmed my hate for them.


We were each assigned a different area of the plan to focus on, opening a tanning salon, then met again to tie them all together.  One woman in the group was a bit of a ditz, so we gave her an easy part - just figure out what would be the return on our investment.  Guess what the sales would be (totally made up number) and what our costs would be (also totally made up number), and then find the difference between the two for the ROI (return on investment).


We all go through our parts, and we get to her.  She says we would have zero returns.


Zero?  No profit or loss - exactly zero returns?


Yes, she said.  Zero.  She explained that the tanning machines would all be new and therefore unlikely to break down, so we probably wouldn't have to return any of them.  Zero returns.


 

[osubuckeye4]

This is actually considered the greatest pitfall of the Austrian business cycle by Austrian economists. The claim is that low interest rates cause a recession but we just don't know when or how bad.

Also note that Keynes (in his rawest form) doesn't actually try to predict at all. He responds to reduced demand.

The monetarists also aren't so future looking in their core inflation controlled model.

I also should mention that these are all schools of macroeconomics as opposed to microeconomics or finance. It's inflation, GDP, and debt as opposed to costs and profits of producing a product or how to invest and save for retirement. There are lessons that cross over but I wouldn't rely on them solely as tools to tell me if I should open a factory or buy tech stocks.

To me, the biggest pitfall of macroeconomics are:

1) As you're gathering/reviewing all the data, it's constantly changing. (look at the U.S. Census... it happens once every 5 years. So much changes over the course of 3 months, let alone 5 years)

2) You're relying on reporting entities to report their numbers honestly and in a transparent manner... this isn't oftentimes the case. (look at Enron/Worldcom... look at the housing fiasco in '08 when reporting agencies were getting strong armed into giving favorable ratings for poo-poo CDO portfolios)

3) While the different schools do weigh "interferences" like corruption and government intervention... those numbers are very speculative in nature and near impossible to accurately pin down when you get to a macro level. You can draw the line on the chart... but it's really more of a guess than anything else.


That's not to say that economics are a waste of time. If they are presented with accurate indicators/numbers, economists are correct way more often then they are incorrect. It's unfortunately a very inexact "science" though, for the reasons listed above.

[David in MN]

To me, the biggest pitfall of macroeconomics are:

1) As you're gathering/reviewing all the data, it's constantly changing. (look at the U.S. Census... it happens once every 5 years. So much changes over the course of 3 months, let alone 5 years)

2) You're relying on reporting entities to report their numbers honestly and in a transparent manner... this isn't oftentimes the case. (look at Enron/Worldcom... look at the housing fiasco in '08 when reporting agencies were getting strong armed into giving favorable ratings for poo-poo CDO portfolios)

3) While the different schools do weigh "interferences" like corruption and government intervention... those numbers are very speculative in nature and near impossible to accurately pin down when you get to a macro level. You can draw the line on the chart... but it's really more of a guess than anything else.


That's not to say that economics are a waste of time. If you have accurate indicators/numbers, economics are correct way more often then they are incorrect. It's unfortunately a very inexact "science" though, for the reasons listed above.

4) Technology advancement. we've gone from scythes to GPS harvesters.

But I totally agree. I think the common man would be disheartened to know how the numbers are fiddled with. Yesterday's steak is today's ground beef and all. And I agree with your very valid point that two people might give different weight to different variables.

It's the imprecise nature of the science that I enjoy. And it's why I think all the schools and models have value. I liken them to realms in physics (my main discipline as an engineer). I can use Newtonian, quantum, or relativistic models and selecting the right model is as important as having the right data.

Thanks for adding more nuance, this is exactly what I was hoping to get going.

[osubuckeye4]

4) Technology advancement. we've gone from scythes to GPS harvesters.

But I totally agree. I think the common man would be disheartened to know how the numbers are fiddled with. Yesterday's steak is today's ground beef and all. And I agree with your very valid point that two people might give different weight to different variables.

It's the imprecise nature of the science that I enjoy. And it's why I think all the schools and models have value. I liken them to realms in physics (my main discipline as an engineer). I can use Newtonian, quantum, or relativistic models and selecting the right model is as important as having the right data.

Thanks for adding more nuance, this is exactly what I was hoping to get going.

Agreed 100%

I think that there's less "fiddling" than pessimistic people think... and there's way more "issues of perspective" than optimistic people think.


By issue of perspective... I mean the problem you run into when you ask 3 different people to describe the same event, but each were standing in a different vantage point when they witnessed the event.

Take an alleged crime.

The person looking down at the event from a 15th story window is oftentimes going to have a very different version than the person who is standing at ground level right next to the alleged criminal, and that version is oftentimes going to be different than the responding police officer who was two blocks away when the call was received

Put them each on the witness stand and they will all do their best to explain what they saw (they aren't "making it up", as they were each there), but, their vantage points/perspective lead to each having a different interpretation of the same event.

As a juror, it's oftentimes very difficult to figure it out... even when you have valid information (honest witnesses) on the stand telling you what they legitimately saw.



Economics indicators are essentially witnesses to the alleged crime... the main schools of economic thought are jurors. It's a difficult job trying to piece it together and figure it out when everyone is playing by the rules, then you throw in the occasional dishonest witness (corruption/cooked books/etc.) and it gets really convoluted.

It's not futile to attempt to issue the verdict, as you are basing that verdict off of logic and reason... but, it's also nowhere near an exact science.

[Carl]

Karma DAVE

[Morning Sunshine]

darn it all, I was hoping, when I asked Dave for this thread, for a nice simple "---is this and ----is thus" so I could be informed.  I guess it is like anything else: I need to put some time and energy into it.   

[osubuckeye4]

darn it all, I was hoping, when I asked Dave for this thread, for a nice simple "---is this and ----is thus" so I could be informed.  I guess it is like anything else: I need to put some time and energy into it.   

I should apologize, I have a tendency of overcomplicating things.


David did a good job of laying it all out in the beginning. I'm going take the weekend to recharge and when I come back I'll be more constructive in building on the core concepts he laid out... as opposed to jumping around and trying to show everyone where all the holes in economic theory are 

Have a great weekend everyone!

[David in MN]

darn it all, I was hoping, when I asked Dave for this thread, for a nice simple "---is this and ----is thus" so I could be informed.  I guess it is like anything else: I need to put some time and energy into it. 

Don't be intimidated. It's like anything. At first it's murky but becomes clear-ish.  If I were to recommend a very good starting point it's Hazlitt's Economics in One Lesson. It's kind of a Hayek Austrian base but easy to read and a great introduction.

I should apologize, I have a tendency of overcomplicating things.


David did a good job of laying it all out in the beginning. I'm going take the weekend to recharge and when I come back I'll be more constructive in building on the core concepts he laid out... as opposed to jumping around and trying to show everyone where all the holes in economic theory are 

Have a great weekend everyone!

First, you have not over-complicated an immensely complex issue. Second, thank you for praising me on distilling roughly 30 books into 20 sentences. I went over it in my head for days. Distilling Nobel Prize winners into a single idea is both necessary and wrong. My only hope is that with great help (such as yours) I can show that the onion has layers.