Financial Crises: Keynesian and Austrian School Perspectives

Keynesian economists and Austrian school economists offer fundamentally different approaches to responding to financial crises, rooted in contrasting views about the economy's functioning and the role of government.

1. Cause of Financial Crises

• Keynesian View:
  • Financial crises arise from a collapse in aggregate demand, exacerbated by irrational behavior, market failures, and external shocks.
  • Insufficient spending leads to unemployment, underutilized resources, and prolonged economic downturns.
• Austrian View:
  • Crises result from distortions in the economy caused by artificial credit expansion and low interest rates, typically driven by central bank policies.
  • These distortions create malinvestments—investments in unproductive or unsustainable sectors—leading to eventual market corrections.

2. Role of Government in the Economy

• Keynesian View:
  • Government has an active role in stabilizing the economy during crises by stimulating demand through fiscal and monetary policy.
  • Belief in counter-cyclical measures, such as increasing public spending or cutting taxes during a downturn.
• Austrian View:
  • Minimal government intervention is ideal. Crises are seen as necessary corrections to prior market distortions.
  • Government intervention (e.g., bailouts, stimulus spending) only prolongs the crisis by preventing the liquidation of bad investments and delaying recovery.

3. Policy Recommendations

• Keynesian Economists:
  • Fiscal Policy: Advocates for increased government spending, public works programmes, and tax cuts to boost aggregate demand. These can be financed by running a higher fiscal deficit.
  • Monetary Policy: Supports lowering interest rates and quantitative easing to increase liquidity and encourage borrowing.
  • Example: The New Deal during the Great Depression or the 2008 U.S. stimulus package under President Obama.
• Austrian Economists:
  • Non-Intervention: Advocates allowing the market to self-correct by liquidating unproductive assets and letting prices adjust naturally.
  • Focus on reducing government spending, cutting deficits, and avoiding inflationary policies like printing money.
  • Example: The Austrian view would criticize interventions like the 2008 bailouts of banks and auto manufacturers as exacerbating long-term problems.

4. View on Debt

• Keynesian View:
  • Public debt incurred during crises is acceptable if it stimulates economic growth and reduces unemployment.
  • Once the economy recovers, the government can reduce deficits.
• Austrian View:
  • Debt is harmful because it misallocates resources and creates a burden on future generations.
  • Encourages policies that prevent excessive borrowing and restore fiscal discipline.

5. Focus of Recovery

• Keynesian Economists:
  • Prioritize short-term recovery by addressing immediate unemployment and demand shortfalls.
  • View recessions as preventable and manageable with the right policy tools.
• Austrian Economists:
  • Focus on long-term structural health, even if it requires enduring short-term pain during the adjustment period.
  • View recessions as necessary to "cleanse" the economy of inefficiencies.

6. Criticism of Opposing Views

• Keynesian Critique of Austrians:
  • Non-intervention during crises leads to unnecessary suffering, higher unemployment, and slower recovery.
  • Austrians underestimate the severity of aggregate demand failures and over-rely on market self-correction.
• Austrian Critique of Keynesians:
  • Keynesian policies create moral hazard, encouraging reckless behavior by assuming government will always intervene.
  • Stimulus measures and easy credit only lead to new bubbles and future crises.

Topical Examples:

1. 2008 Global Financial Crisis:
   • Keynesian economists supported stimulus packages and bailouts to stabilize the economy.
   • Austrian economists argued that these measures propped up failing banks and companies, delaying the recovery and creating long-term imbalances.
2. COVID-19 Pandemic Response:
   • Keynesians advocated for massive fiscal stimulus, such as the U.S. CARES Act, to prevent economic collapse.
   • Austrians criticized the increased government debt and warned about inflation and market distortions as side effects.

Conclusion:

The Keynesian approach emphasizes active government intervention to mitigate short-term economic pain, while the Austrian approach advocates for market self-correction to ensure long-term stability and efficiency. Both perspectives offer valuable insights, but their applicability depends on the specific context and priorities of the crisis response.