The Battle Over the Economy: A Review of Popular Schools of Economic Thought (Part 1)
by Andrew West
(January 23, 2000)
The rate hike by the Federal Reserve has spurred a lot of discussion and a lot of disagreement about inflation and the economy. While differing opinions in economics have always been a reality, I thought it would be a good idea to clear the air a bit and go over the current opinions of the major schools of economic thought on these subjects.
What makes a review of the various schools of economic thought so frustrating? Because the school with the best track record of economic and market predictions, which we'll look at next week, typically gets the least amount of respect and attention.
Austrian School
Followers of the Austrian school are typically quite negative about current conditions. Most think we are in a huge credit expansion and money supply growth is temporarily "inflating" asset prices rather than consumer prices. They expect this situation will reverse; that stock prices will fall and consumer prices will rise, and also suggest that this reversal would have happened already if not for mass-euphoria (a bubble), and/or ever-increasing liquidity from the Fed.
Most Austrians believe that central banking and fiat money will inevitably lead to inflation and economic crisis. They also believe that a true gold standard is the only way to avoid inflation, which is considered to be any expansion of fiat (legal, paper) money. Though I agree with Austrian economics advocacy of free banking and the gold standard, the school's analysis of money supply is flawed.
Monetarist School
Monetarists believe that money supply should expand at a slow, constant rate. Deviations from this "proper" rate of money supply growth are said to cause booms and busts, and money growth above this rate is considered inflationary. Monetarists believe that a gold standard is inferior to a monetarist-managed central bank targeting money supply growth - which could keep prices and economic growth stable.
Keynesian School
The Keynesians appear to be pretty confused, because their framework doesn't describe the current situation well (as usual). Neo-Keynesians like Paul Krugman suggest that global and technological changes require that economic policy be determined on a contradictory and ad hoc basis by people who have super-human knowledge of economic affairs (like himself). Keynesians support the Philips Curve, which claims employment and inflation are positively correlated. Many believe that the Philips Curve suggests inflation is coming, and thus the economy should be managed to prevent this. Alan Greenspan, while using different terminology, seems to deploy this ad-hoc Keynesian framework, tempered with some "New-Era" (see below) views.
Keynesians demand central banking as a policy tool, by which a "right" amount of positive inflation can be generated to keep employment and economic growth high (e.g. Krugman believes that inflation and devaluation is sometimes necessary to spur growth). Keynesians also believe that inflation is a rising CPI.
New-Era School
"New-Era" economists have recently sprung up, mostly on Wall Street. Their unifying theme is that recent technological changes make old economic theories inapplicable. Some state that any bad policy decisions by governments will be "routed-around" by technology, making economies essentially bulletproof.
New-era types sometimes bolt new-era ideas onto the other schools of thought, adding that new technology just makes everything better. For example, some new-era/Keynesians agree that the Philips Curve exists, but that technology-driven productivity growth will allow the economy to bypass the curve's constraints by shifting the non-inflationary rate of employment upwards. Others say that technology has created a new era in which old economic rules don't apply. One writer at Forbes calls his economic framework "the infinite and the zero"- expect infinite future power at nearly zero cost from technology, transforming the economy to allow fast growth and low prices for everything.
New-era economists typically don't think much about central banks. Technology is considered to be in the economic drivers' seat, and technology will keep prices from rising. Like Keynesians, most think that inflation is a rising CPI.
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While some of these schools have some theories not totally without merit, there's another school, namely the Supply-side school, that I believe has got its finger closest to the pulse, and in my next article I'll tell you why.
Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.
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