Inflation is a hot button issue for economists, and it continues to be a topic of much debate. A few schools of thought have cropped up surrounding the issue of inflation and how it impacts the fabric of society as a whole. The Austrian school of economics and its thought leaders are some of the most well-versed in how inflation impacts our day-to-day lives.
If you have been wondering how experts view inflation, here’s what you need to know about how the Austrian school of economics defines inflation.
What is the Austrian School of Economics?
For many investors and economists, the Austrian school of economics paves the way for how they think about their finances. Carl Menger, the author of Principles of Economics which was written back in 1871, is often credited as the father of this school of thought. The theories he proposed have been around for more than a century and are still just as valid today.
Part of his philosophy (and the philosophy of those who came after him) is that the intrinsic market value of goods and services is subjective. You may be willing to pay top dollar for something, but your neighbor likely does not place the same value on it.
Others have built on this theory of diminishing marginal utility such as Ludwig von Mises, Eugen von Bohm-Bawerk, and Friedrich Hayek. It may have started in Austria, but the popularity of the insights have had a global reach.
Some of their important thought processes include:
- Price Determination: Rather than prices that are influenced by supply and demand, Austrian economists believe that prices are subjective based on what someone is willing to pay.
- Capital Goods: Capital goods are also viewed as different, meaning that not all substitutions are going to yield the same results.
- Interest Rates: In the more classic view of how money functions, interest rates vary based on supply and demand of capital. On the other hand, Austrian economists believe that interest rates are subjective based on whether people want to spend money now or in the future.
Of course, one of the biggest areas where they stand out from other schools of thought in the world of economics is their views on inflation. Let’s take a closer look at how the Austrian school of economics differs from the Keynesian definition.
How the Austrian School of Economics Defines Inflation
Inflation is a complex subject that has been discussed at length by economists for decades. The Austrian school of economics has a unique take on how inflation works and what the general population can expect from this phenomenon.
First and foremost, it is important to define how inflation works according to the Austrian school. They believe that money supply without an increase in goods and services will cause prices to go up. But there is a difference between rising prices due to supply and demand and the falling value of a currency due to inflation, which is really a devaluation of the currency simply because more units of the currency are in circulation.
This means that some people will find new wealth but at the expense of others.
Ludwig von Mises writes that trying to control inflation is a challenge because there is not clear language surrounding it, only the word inflation to describe rising prices: “They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar.”
Consider how the government influences the economy by inserting more money into circulation. The items they purchase – whether they are food goods or something else entirely – will rise in price before anything else. This leaves many people spending more on some items without always earning more to keep up with inflationary costs.
Most of the confusion surrounding conversations about inflation is simply how it is being defined. True inflation is caused by an increase in the currency in circulation, period.
The Difference Between Keynesian Economics and Austrian Economics
Keynesians believe that they can control inflation by minimizing demand. When the economy is in poor shape (during a bust cycle, like a recession), inflation tends to be relatively low. When output is high and the gross domestic product is growing, the economy is at greater risk for inflation.
In other words, they hold the belief that prices often increase all the way around rather than piecemeal as Austrian economists believe.
Many Keynesian economists believe that the government should be involved to promote more employment and price stability – though the Austrians often believe the opposite. When the government becomes too involved in the purchase of items and prices in the economy, it often means that prices will increase and inflation will trail shortly after.
Do You Need Help Planning?
If you need help planning for the inevitable effects of inflation on your portfolio, you need the help of experienced professionals who are well-versed in the Austrian school of economics. Our services at Magellan Planning Group can help you with everything from comprehensive estate planning to financial and tax planning.
Reach out to us today to learn more about how we can help you plan ahead and mitigate the effects of inflation on your personal finances and investments.