School of Politics and International relations QAU

Name M. Adeel

Reg. No 04202213020

Class Bs. Political science 6 th

Submitted to Ma’am Ayesha Malik

Module Title PS-305 Politics of Int’l Economic Relation

A Comparative Analysis of the Austrian and Keynesian Schools of Economic Thought:

Perspectives from Roncaglia's a Brief History of Economic Thought

Alessandro Roncaglia's A Brief History of Economic Thought (2017) provides a critical

framework for examining the evolution of economic ideas, emphasizing the contrasting
paradigms of the Austrian and Keynesian schools. These traditions emerged from distinct
historical contexts and intellectual foundations, offering radically different interpretations of
market behaviour, state intervention, and economic stability. This passage explores their
origins, methodological approaches, core theoretical frameworks, and policy implications
through Roncaglia's analytical lens.

1 Intellectual Genesis and Foundational Thinkers

Austrian School:

The Austrian School originated with Carl Menger's Principles of Economics (1871), which
Roncaglia situates within the marginalist revolution. Menger broke from classical Ricardian
economics by advancing a subjective theory of value, arguing that value derives from
individual preferences and marginal utility not labour inputs or objective cost structures.
Menger viewed economics as a science of human action, stressing causal-genetic
explanations over equilibrium models. His successors Eugen von Böhm-Bawerk and
Friedrich von Wieser developed theories of capital, interest, and opportunity cost, laying
groundwork for Austrian capital theory.

Keynesian School:

John Maynard Keynes's General Theory of Employment, Interest and Money (1936) emerged
as a direct response to the Great Depression's catastrophic unemployment. Roncaglia
highlights Keynes's rejection of classical economics' laissez-faire optimism, particularly
Jean-Baptiste Say's law (supply creates its own demand). Keynes argued that market
economies lack self-correcting mechanisms to ensure full employment, leading to persistent
underemployment equilibria. His analysis drew on earlier work on probability and
uncertainty, emphasizing psychological factors influencing investment and consumption.
Keynes's focus on aggregate demand (total spending) as the engine of output and
employment revolutionized macroeconomics.

Table: Foundational Contrasts

Aspect Austrian School Keynesian School

Founding Text Menger's Principles (1871) Keynes's General Theory (1936)

Critique of classical value Great Depression

Historical Context
theory unemployment
 Core Innovation Subjective marginal utility Aggregate demand management

View of Static underemployment

Process of discovery (dynamic)
Equilibrium possible

2 Methodological Divergences: Individualism vs. Holism

Austrian Methodology:

Austrians adhere to methodological individualism, insisting economic phenomena must be

explained through individual actions and intentions. Roncaglia notes that Friedrich Hayek
extended this by emphasizing the dispersed nature of knowledge in society. Hayek argued
markets function as discovery processes, where prices synthesize fragmented information,
enabling coordination without central planning. Austrians reject mathematical modelling and
econometrics as inadequate for capturing subjective human choices and the tacit knowledge
guiding decisions. For them, equilibrium is never static but a continuous entrepreneurial
process of error correction.

Keynesian Methodology:

Keynes shifted focus to macroeconomic aggregates (consumption, investment, government

spending). While not dismissing individual behaviour, he argued that aggregate outcomes
could not be deduced from micro foundations alone due to fundamental uncertainty.
Roncaglia stresses Keynes's break with neoclassical economics: markets fail to clear due to
sticky wages/prices and volatile expectations. Keynes used simplified models (e.g., the
multiplier) to illustrate how demand shortfalls propagate through the economy. Later
Keynesians formalized his insights mathematically, but Roncaglia cautions that these risks
ossifying his emphasis on uncertainty and liquidity preferences.

3 Value, Markets, and Coordination Mechanisms

Austrian Value Theory:

Austrians anchor value in subjective preferences and marginal utility. Menger critiqued
classical theories for ignoring how individuals value goods based on specific needs rather
than labor inputs. Roncaglia underscores Menger's concept of "complementarity" among
goods—value emerges from goods' ability to satisfy hierarchical human needs. Hayek
expanded this into a theory of the market as an information system: prices signal scarcity and
coordinate decentralized knowledge. Government intervention distorts these signals, causing
misallocation.

Keynesian Output-Employment Nexus:

Keynesians sidestep microeconomic value theory, focusing on effective demand as the

determinant of output and employment. Roncaglia notes Keynes's rejection of the classical
dichotomy (real vs. nominal variables): falling wages during recessions reduce demand
further, exacerbating unemployment. Prices/wages are "sticky" downward due to contracts
and uncertainty, preventing markets from self-correcting. Consequently, markets left alone
are inherently unstable and require stabilization.

4 Capital, Interest, and Business Cycles

Austrian Capital and Cycles:

Böhm-Bawerk's theory frames capital as a time structure of production: longer production

processes yield greater output but require savings to "wait" for returns. Interest arises from
time preference. Hayek integrated this with Knut Wicksell's "natural interest rate" concept to
develop the Austrian Business Cycle Theory (ABCT): artificially low central bank interest
rates spur unsustainable, capital-intensive investments. The eventual bust corrects these
distortions, making recessions necessary.

Keynesian Investment and Liquidity:

Keynes replaced time preference with liquidity preference theory: interest rates reflect the
cost of parting with liquid money, not rewards for saving. Investment hinges on unpredictable
expectations of future profitability, not just interest rates. Roncaglia highlights Keynes's
insight that during crises, liquidity preference becomes infinite (a "liquidity trap"), rendering
monetary policy ineffective. Hence, fiscal stimulus becomes essential to boost demand.

Table: Business Cycle Contrasts

Element Austrian View Keynesian View

Artificial credit expansion

Cycle Cause Demand collapses, animal spirits
(ABCT)
 Interest Rate Distorted away from natural rate Fails to stimulate in liquidity trap

Fiscal stimulus to fill demand

Crisis Solution Allow correction (no intervention)
gap

Government
Source of distortion Stabilizer against volatility
Role

5 The State's Role: Spontaneous Order vs. Managed Capitalism

Austrian Minimalism:

Austrians advocate laissez-faire, viewing state intervention as epistemically arrogant and

coercive. Hayek warned that Keynesian demand management leads down a "road to serfdom"
by expanding bureaucratic control. Roncaglia notes that Austrians support a rule-based
framework (e.g., gold standard, property rights) to enable spontaneous order but reject
discretionary policies .

Keynesian Interventionism:

Keynes saw state intervention as essential to safeguard capitalism from its instability.
Roncaglia stresses Keynes's view that unemployment threatens social cohesion and
individual freedom. The state must manage aggregate demand via countercyclical spending
(deficits in recessions, surpluses in booms). This underpinned the post-WWII Bretton Woods
system and welfare states, prioritizing full employment and social stability .

6 Roncaglia's Synthesis and Enduring Relevance

Roncaglia critiques both schools:

• Austrians underestimate coordination failures and the social costs of recessions.

Their rejection of empirical models risks dogmatism .
• Keynesians sometimes reduce uncertainty to calculable risk in mathematical models,
diluting Keynes's emphasis on fundamental uncertainty .

Historically, Keynesianism dominated post-1945 policy but faced crisis in the 1970s
stagflation, enabling an Austrian-influenced neoliberal turn . The 2008 financial crisis
sparked a Keynesian resurgence, as stimulus packages echoed The General Theory.
Meanwhile, Austrian critiques of central banking gained traction post-2008, highlighting the
schools' cyclical influence. Roncaglia concludes that both traditions illuminate facets of
capitalism: Austrians on market processes and information, Keynesians on demand dynamics
and stabilization .

Conclusion

The Austrian and Keynesian schools represent profound methodological and ideological rifts
in economics. Through Roncaglia's historical analysis, Menger's subjectivism and Hayek's
epistemic humility contrast sharply with Keynes's aggregate demand management and
acceptance of state intervention. While Austrians see markets as resilient information
processors, Keynesians view them as prone to collapse without stabilization. Their enduring
dialogue—reflected in debates from the Great Depression to the Great Recession—
underscores the adaptive complexity of economic thought in confronting crises. Roncaglia
reminds us that neither school offers universal truths, but together they enrich our
understanding of economies as dynamic, socially embedded systems.

BIBLIOGRAPHY:

Roncaglia, A. (2017) A brief history of economic thought. Cambridge: Cambridge University

Press.