In Economics, a school of economic thought is a group of economic thinkers who share or shared a common perspective regarding the way economies work. Systematic economic theory has been developed mainly since the beginning of what is termed as the modern era which started with the rise of early classical economists belonging to the mercantilist and physiocrats schools. They were succeeded by the mainstream classical economists such as Adam Smith, David Ricardo, JS Mill, Alfred Marshall etc.
Like any other branch of knowledge, economics has been evolving over a period of time incorporating new thinking and benefitting from the progress made in other branches of studies. Because of the strong emotions involved as well as the changing nature of the views about the best ways to tackle the contemporary challenges facing a political economy, pendulum keeps on changing with a 50 years’ cycle.
Highly interventionist Mercantilists who took the state control for granted irrespective of its necessity or desirability on logical grounds, were followed by the minimalist Classical economists led by Adam Smith. While opposing the role of state intervention in market mechanism as a rule, he advocated it as an exception and that too in very strong manner. Their views about the role of state were challenged by Keynes and dominated the economic thinking in most of the post war years till contended by the supply side economists led by Friedman. Keynes again became in fashion after the 2007/8 financial crises and so on.
Reflecting the socio-political conditions of the late Middle Ages and early Renaissance period, these economists treated economic activity as subservient to dictates of the social classes. Thus they treated economic activity as a good which was to be taxed to raise revenues for the nobility and the Church. Consequently, they favoured the regulation of the economic exchanges by the feudal rights and privileges-right to collect toll by the feudal lords, or hold fairs. Similarly, they did not object to guild rights or the religious restrictions on lending. However, their main emphasis was to encourage trade throughout a particular area.
The Physiocrats were 18th century French economists who emphasized the importance of productive work, and particularly agriculture, to an economy’s wealth. Their early support of free trade and deregulation influenced Adam Smith and the classical economists.
Comprising Ludwig von Mises, Friedrich Hayek, Carl Menger, and Murray Rothbard, Austrian school of economics advocated the purposeful economic decisions of the individual. According to them, the free market can solve most of our problems and the more we reduce government or eliminate government, the better off we will all be. We can fix the economy by reducing government and central bank involvement in free market forces.
The Classical school, which lasted until 1870 is associated with the 18th Century Scottish economist Adam Smith, and those British economists that followed, such as Robert Malthus and David Ricardo.
The main idea of the Classical school was that markets work best when they are left alone because the price mechanism acts as a powerful ‘invisible hand’ to allocate resources to where they are best employed as value of every product or service was determined mainly by scarcity and costs of production. According to them there is nothing but the smallest role for government as the economy would always return to the full-employment level of real output through an automatic self-adjustment mechanism.
Emerging capitalists from the age of feudalism, these economists hated outside intervention in the markets (particularly governmental regulation) as a disruption to the natural order of markets. They believed that in a flexible wage-price environment supply created its own demand because of increased incomes generated during the process. As such, there was no fear of any over production.
If there is some unemployment, they contended, just increase the dose-produce more and make the wages flexible i.e. reduce them. Their exclusive emphasis on supply side of the economy later on became the main reason for their failure on conceptual and practical level to predict the Great Depression of the 1930s or offer any plausible explanation for its persistence for such a long time.
However, before condemning them in their failure to properly assess the situation we must keep in mind the peculiar economic conditions in which they were living prior to the Great Depression. It was a period of all over economic expansion due to rapid development of science and technology, increasing population and the availability of vast markets in the colonies. Naturally, they inferred wrong signals from the conditions obtaining on the ground and concluded that there was no fear of any overproduction-supply will create its own demand
Associated with the work of William Jevons, Leon Walrus and Carl Menger, the neo-classical school of economic thought perfected the economic ideas of Classical Economists and is considered to be the pioneers of the modern economic theory. Believing and practising scientific methodology, with plausible assumptions and hypothesis, these economists attempted to derive general rules or principles about the behaviour of firms and consumers. In fact, they were responsible for promoting the modern concept of economic rationality in the behaviour of an individual and a firm while taking decisions.
For example, they argue that the economic agents like a firm or a consumer acts rationally when looking to maximise utility or to maximise profits. This contrasting objectives of maximising utility and profits, they argued, forms the basis of demand and supply theory. Another important contribution of neo-classical economics was a focus on marginal values, such as marginal cost and marginal utility.
New classical school of economics emerged during the 1970s and tried to explain the global macro-economic problems and issues of the period through reinterpretation of concepts used by the Classical Economists. For example, Robert Lucas used the concepts of rational behaviour and rational expectations for the 1970s crises.
Keynesian economics gets its name, theories, and principles from British economist John Maynard Keynes (1883–1946), who not only introduced new concepts in Economic theory but also converted economics into a study of the flow of incomes and expenditures and opened up new vistas for economic analysis.
He rose to the prominence during the Great Depression of the 1930s, when the prevalent economic theory, now known as Classical Economics, failed to explain the causes of this global recession which saw falling prices and increasing unemployment with consequential widespread poverty.
John Maynard Keynes did not believe in the idea that free markets would automatically provide full employment—that is, that everyone who wanted a job would have one as long as workers were flexible in their wage demands. He asserted that aggregate demand is the most important driving force in an economy. During a recession, free markets have no self-balancing mechanisms that lead to full employment because wages are not flexible in real life.
Consequently, government intervention through increased spending is the main policy tool to achieve full employment and price stability. He therefore strongly advocated unbalanced government budgets during recessions.
He also advocated aggressive use of monetary policy to stimulate the economy—for example, by reducing interest rates to encourage investment. He however cautioned its ineffectiveness during a liquidity trap, when increases in the money stock fail to lower interest rates and, therefore, do not boost output and employment.
Paul Krugman is one of the most prominent economists of our age and a strong advocate of Keynesian Economics. He has recently given a very cogent recent explanation of Keynesian economics and its all-time relevance.
Associated with the name of Milton Friedman, Monetarism is a school of thought consisting of those economists who accepted the Keynesian economics in principle but criticised it for giving too much importance to fiscal policy to achieve the economic objectives. Instead, they emphasize the role of governments in controlling the amount of money in circulation.
According to them variations in the money supply have major influences on national output in the short run and on price levels over longer periods. As such, Monetarists assert, the objectives of monetary policy are best met by targeting the growth rate of the money supply rather than by engaging in discretionary monetary policy.
In their highly influential book, A Monetary History of the United States, 1867–1960, Friedman and Anna Schwartz argued that inflation was always and everywhere a monetary phenomenon and advocated a central bank policy which should aim at keeping the supply and demand for money at equilibrium, as measured by growth in productivity and demand.
Made famous by George Katona & Amos Tversky, Behaviopual School of economic thought is a novel addition to the list. Becoming popular at a rapid speed, it emphasises to understand the workings of the economy by understanding the way the human mind reacts and adapts to markets and the economy.
Interestingly, they don’t make specific policy recommendations, but generally believe that we can better understand the economy if we better understand human psychology as it pertains to money, markets and the economy. According to them, the economy is complex, dynamic and uncertain and is being navigated by imperfect participants. Because of this it could be appropriate for government intervention at times.
Consisting of Scott Sumner, David Beckworth and Nick Rowe, Market Monetarist are trying to revive the traditional monetarism associated with the name of Milton Friedman. Using his framework, they maintain that the Central Bank can steer the economy by targeting the Nominal GDP (NGDP Targeting).
NGDP targeting is a monetary policy whereby the tightening or loosening of the money supply is dictated by a target on the nominal gross domestic product. For example, if we incorporate three targets in our strategy i.e. GDP, inflation and unemployment, then “5-5-5” plan would expand the money supply towards a target of 5% GDP growth, to be halted if inflation rose above 5% or unemployment dropped below 5%.
Marxism originates from the late 19th century works of German philosophers Karl Marx and Friedrich Engels. According to Marxist perspective, class conflict within capitalism arises due to intensifying contradictions between the highly productive mechanized and socialized production performed by the proletariat, and the private ownership and appropriation of the surplus product (profit) by a small minority of the population who are private owners called the bourgeoisie. As the contradiction becomes apparent to the proletariat through the alienation of labour, social unrest between the two antagonistic classes will intensify, until it culminates in social revolution.
The eventual long-term outcome of this revolution would be the establishment of socialism – a socioeconomic system based on social ownership of the means of production, distribution based on one’s contribution, and production organized directly for use. As the productive forces and technology continued to advance, Marx hypothesized that socialism would eventually give way to a communist stage of social development, which would be a classless, stateless, humane society.
Marxism has since developed into different branches and schools of thought, and there is now no single definitive Marxist theory.
Modern Monetary Theory (MMT or Chartalism)
A branch of the Post-Keynesian school of economics, Modern Monetary Theorists believe that there is no economic problem that fiscal policy can’t solve. Capitalism is naturally flawed and can only operate at full capacity if the government is used to permanently fill any demand shortages that exist. Fiscal policy in the form of tax cuts and spending increases in addition to the implementation of a government. Some notable economists of this School are Warren Mosler, Randall Wray and William Mitchell.
New Classical Economics
Associated with the names of Edward Prescott, Robert Lucas, Thomas Sargent, Robert Barro and late John Muth, the New Classical School arose out of the failures of the Old Keynesian schools during the 1970’s when it could not explain the failure of the Phillips Curve and the widespread stagflation of the time. Generally associated with a laissez faire approach to policy, it is the modern adaptation of the classical school based on Walrasian assumptions and rational expectations.
According to them, economic agents like firms and the consumers are rational agents, always making optimal decisions. Firms are always maximizing profits, but the economy is often shocked by “real” effects like unanticipated policy changes, changes in technology or changes in raw materials. As such, the contend, macroeconomics requires new classical micro foundations to be properly utilized.
New Keynesian Economics
The New Keynesians are those economists who rose to defend the Keynesian Economics when it came under criticism by the New Classicals in the 1970s and 80’s. However, over a period of time, they have improved upon the original Keynesian Economics and has adopted a fair amount of post Keynesian economic thinking, using some neoclassical foundations as well as Monetarist perspectives.
In particular, the New Keynesians will generally deviate towards the use of Monetary Policy, but will at times also recommend fiscal policy to help stabilize the economy. Although they believe that the economic agents are rational, ye advise the policymakers to improve economic stability and help attain full employment through various stabilization policies designed to combat a variety of market failures.
Few prominent New Keynesian economists are Brad Delong, Joe Stiglitz, Greg Mankiw, David Romer & Olivier Blanchard. Paul Krugman is one of the most famous and a strong advocates of Keynesian Economics. He has recently given a very cogent explanation of Keynesian economics and its all-time relevance
“I would summarize the Keynesian view in terms of four points:
- Economies sometimes produce much less than they could, and employ many fewer workers than they should, because there just isn’t enough spending. Such episodes can happen for a variety of reasons; the question is how to respond.
- There are normally forces that tend to push the economy back toward full employment. But they work slowly; a hands-off policy toward depressed economies means accepting a long, unnecessary period of pain.
- It is often possible to drastically shorten this period of pain and greatly reduce the human and financial losses by “printing money”, using the central bank’s power of currency creation to push interest rates down.
- Sometimes, however, monetary policy loses its effectiveness, especially when rates are close to zero. In that case temporary deficit spending can provide a useful boost. And conversely, fiscal austerity in a depressed economy imposes large economic losses.
Post-Keynesian Economics is a branch of Keynesian economics whose adherents like Joan Robinson, Nicholas Kaldor, Paul Davidson, Tom Palley and Marc Lavoie are die hard modern Keynesians. They believe that Keynesian Economics is as relevant today as it was in his days and there is no need for its revision-a stance taken by New Keynesians. For every modern problem, they get back to what the “true Keynes” thought about the economy and how to improve it.
To them JM Keynes had it all right all along. Involuntary unemployment is the result of aggregate demand shortages resulting primarily from failures by firms to maximize investment. Capitalism exists on an inherently unstable foundation and will at times require some forms of government intervention to achieve prosperity.
Currently, the great majority of economists follow an approach referred to as Mainstream Economics or sometimes called Orthodox Economics. In the USA, the Mainstream Economists are divided into schools. The Saltwater School associated with Berkeley, Harvard, MIT, Pennsylvania, Princeton, and Yale Universities like to favour classical economics.
The Freshwater School (represented by the Chicago school of economics, Carnegie Mellon University, the University of Rochester and the University of Minnesota),on the other hand, are associated with the neoclassical synthesis.
Some influential approaches of the past, such as the Historical School of Economics and Institutional Economics, have become defunct or have declined in influence, and are now considered Heterodox approaches. Other longstanding Heterodox schools of economic thought include Austrian Economics and Marxian Economics. Some more recent developments in economic thought such as Feminist economics and Ecological economics adapt and critique mainstream approaches with an emphasis on particular issues rather than developing as independent schools.