DEFINITION of Austrian School

The Austrian school is an economic school of thought that originated in Vienna during the late 19th century with the works of Carl Menger, an economist who lived from 1840-1921. The Austrian school is set apart by its belief that the workings of the broad economy are the sum of smaller individual decisions and actions; unlike the Chicago school and other theories that look to surmise the future from historical abstracts, often using broad statistical aggregates.

Also known as the "Vienna school" and the "psychological school."

BREAKING DOWN Austrian School

The Austrian school holds a special view of the modern business cycle; it contends that boom cycles are actually a misallocation of capital resources caused by interfering monetary policy. When central banks effectively expand the money supply by lowering interest rates, it creates a multiplying effect in the economy. This leads business owners to incorrectly assess the amount of available capital and the level of demand by consumers. Eventually, overinvestment by corporations leads to a "bust" cycle in which prior misallocations must be worked out.

Among the theoretical contributions of the early years of the Austrian school are the subjective theory of value, the idea that an object's value is not inherent and is instead worth more to different people based on how much they desire or need the object; marginalism in price theory; and the formulation of the economic calculation problem, each of which has become an accepted part of mainstream economics.

Critics of the Austrian School

Mainstream economists have been critical of the modern day Austrian school since the 1950s and consider its rejection of mathematical modeling, econometrics (applying statistical and mathematical theories in economics for the purpose of testing hypotheses and forecasting future trends), and macroeconomic analysis to be outside mainstream economic theory, or heterodox. Austrians are also critical of mainstream economics. Although the Austrian school has been considered heterodox since the late 1930s, it gained popularity in the 1970s after Friedrich Hayek, a famous Austrian economist who is known for his numerous contributions to economics and political philosophy, shared the 1974 Nobel Prize In Economics.