“Austerity” has become the watchword of the year. Governors, prime ministers, and presidents around the world are talking about cutting welfare benefits, curtailing public union power, and reducing deficits. We’ve over-promised at the public trough, and now we must pay the price. Whoever is elected president in November is going to face the need to retrench.

Yet only one school of economic thought, that of Friedrich Hayek and Ludwig von Mises, predicted and prescribed austerity before the Great Recession. More prominent branches of free-market economics, no less than spendthrift progressives, have been slow to realize that neither fiscal nor monetary stimulus can cure what ails the West. As the psalmist says, “The rejected stone has become the chief cornerstone.”

Nobody in power was talking austerity in 2008, when the financial crisis hit. Big government and its patron saint, John Maynard Keynes, were in the saddle, with Republicans and Democrats falling over each other to run up deficits and pass the Troubled Asset Relief Program. Keynes’s biographer, Robert Skidelsky, came out with a bestseller, The Return of the Master.

The monetarists, meanwhile, students of Milton Friedman and the Chicago school of economics, were extravagant in their own way. The Federal Reserve’s Ben Bernanke had told Friedman on his 90th birthday, in 2002, “You’re right, we did it”—causing the Great Depression by allowing the money supply to collapse—“We’re very sorry. But thanks to you, we won’t do it again.” Yet what was the monetarist response to the crisis?

Central bankers and professors of money and banking answered as one: Inject liquidity! Cut interest rates! Over the next two years, Bernanke instituted two rounds of “quantitative easing” (QE1 and QE2), a duplicitous name for printing money, and adopted a zero interest rate policy (ZIRP). He was convinced that Friedman would be smiling down from the Pearly Gates.

Maybe he’s right about that—or half-right. Last month on the London Underground I ran into Paul Krugman, last of the old “crude” Keynesian breed. He was in the city to promote his book, End This Depression Now! For the next half hour, we debated the causes and cures of the Great Recession. Krugman insisted that we need to double or triple the deficit—but only in the short run. “We must eventually adopt austerity.” He paraphrased St. Augustine: “Give me austerity, but not yet.”

I asked him if there was anyone equal to him in debate. He couldn’t think of anyone, so I suggested Milton Friedman—a safe bet because Friedman died in late 2006. Krugman nodded reverently, but insisted, “If Milton Friedman were alive today, he would be anathema to the Tea Party Republicans because he would have favored easy money to end this crisis.”

“But not TARP and the deficits,” I replied. Krugman sheepishly nodded. Friedman was convinced by the empirical data that fiscal activism—deficit spending—was unnecessary and even counterproductive. Monetary policy could do all the heavy lifting. British monetarist Tim Congdon confirms this. In his excellent and underappreciated work Money in the Free Economy, Congdon cites Friedman’s denigration of fiscal policy: “A deficit is not stimulating because it has to be financed, and the negative effects of financing it counterbalance the positive effects, if there are any, of spending.”

Massive government expenditures and deficits during World War II appeared to get us out of the Great Depression. But wait—Friedman was quick to point out that monetary policy was also activist: M2 grew at a 20 percent annualized clip from 1940-45. In another famous example, the Kennedy-Johnson tax cut of 1964 engineered by the Keynesians appeared to be stimulative. But wait—monetary policy was also expansionary during this time.

Congdon, following Friedman’s lead, looks at natural experiments where fiscal and monetary policy moved in opposite directions to see which one dominated. Monetary policy won out in almost every case. He observes that in 1981 the Thatcher government in Great Britain raised taxes by £4 billion in a recession, while adopting expansionary monetary policy. Three-hundred and sixty-four Keynesian economists signed a statement in The Times decrying the move and predicting economic collapse. Yet the economy roared. Why? Because monetary policy was liberal at the time, offsetting fiscal austerity. Congdon concludes: “Contrary to a large number of textbooks, the size of the government’s budget deficit is by itself not necessarily of any importance to aggregate demand.”

If he were alive, Friedman would not be surprised that trillion-dollar deficits have had little impact in stimulating the U.S. economy. What government gives, private business takes away. Despite record profits and historically low interest rates, corporations are holding back on spending and hiring because of the uncertainty caused by wasteful government spending.

The deficits have run their course without success, leaving us with mounds of debt and interest payments. Monetary easing, Friedman would agree, is the only game in town. But even easy money is not having the effect it once did. Mises said it best: “We have outlived the short run, and are now suffering from the long-run consequences of [Keynesian-monetarist] economics.”

The Great Recession is in its fourth year, and the legacy of big-government macroeconomics is long indeed—unsustainable and chronic deficit spending; permanent easy money; excessive dependence on the welfare state (with 46 million on food stamps); overregulation (including Sarbanes-Oxley and Dodd-Frank); an anti-saving, debt-ridden consumer society; deteriorating public infrastructure; economic stagnation; and a stop-start market on Wall Street. Political leaders around the world are looking for a new model with which to restore prosperity and economic stability.

What about the supply-siders? Tax cuts play a role in encouraging economic growth, but in an age of rising deficits legislators are reluctant to slash rates aggressively. Supply-siders blundered in the past decade by repeatedly contending that “deficits don’t matter” and assuming that we could grow our way out. Unfortunately, without constitutional restrictions on government spending, increased revenues from more efficient tax policies simply lead to more spending without solving the deficit problem.

There is only one school that consistently defends the classical model of fiscal and monetary responsibility as established by Adam Smith in The Wealth of Nations. And that is the school of austerity, led by the Austrian economists Ludwig von Mises and Friedrich Hayek—whom Krugman laughingly calls the “Austerians.” But nobody is laughing anymore.

Who is the anointed economist of austerity? The leading theoretician appears to be Friedrich Hayek. Who would have thought that the austere Hayek would make a comeback after the financial crisis of 2008? He is the only Austrian to have won the Nobel Prize in economics, but until now his reputation has languished in the shade of Milton Friedman’s sun.

Perhaps the best example of Hayek’s resurrection is a bestselling book by British economist Nicholas Wapshott, Keynes-Hayek: The Clash That Defined Modern Economics. Even a popular rap song, “Fear the Boom and Bust,” has come out of the debate between Keynes and Hayek. (Google “Keynes Hayek” and it’s the first result to pop up.) The rap song is the brainchild of musician John Papola and George Mason University economics professor Russ Roberts. It’s a favorite way on campuses to explain the ideological divide in macroeconomics.

Why isn’t Milton Friedman the nemesis of Keynesian economics? Because during a crisis, he is not a classical economist. While he opposed fiscal stimulus, he advocated easy money to keep the economy from collapsing. Hayek and his mentor Mises are the real enemies of big government. Hard-core Austrians are true believers in the classical model of fiscal and monetary restraint, even during a Great Recession.

The first debate between Keynes and Hayek took place in the 1930s and is recounted in Wapshott’s book and in chapter 12 of my own Making of Modern Economics. Hayek, then teaching at the London School of Economics, opposed Keynes’s prescription of deficit spending and easy money to get out of the Great Depression. Hayek defended the classical “Treasury” view that governments, like the private sector, should cut costs and prudently live within their means even during downturns. He excoriated easy money as well, which he said would only make matters worse. If the central bank had any legitimate role, it was as a lender of last resort—but along the lines described by Walter Bagehot, who advocated in Lombard Street (1873) that the central bank lend money to troubled banks at higher, not lower, interest rates.

The Great Depression was so deep and long that eventually Keynes won the debate, at least in the minds of policy-makers. Hayek fell into obscurity and turned to political writing, producing his bestselling Road to Serfdom (1944) and The Constitution of Liberty (1960). After Hayek shared the 1974 Nobel Prize in economics with socialist Gunnar Myrdal amid the inflationary stagnation of that decade, interest in his economic thinking rose, but he still played a smaller role on stage than Milton Friedman—who won the Nobel in 1976—and the supply-siders.

Hayek, building on the original work of Ludwig von Mises, developed a macro model of the economy and the Austrian theory of the business cycle. Austrian macroeconomics is a sophisticated improvement in the classical model, while Keynesian macroeconomics seeks to demolish the House that Adam Smith built.

Hayek and the Austrians contend that easy-money policies—expanding the fiat money supply and artificially lowering interest rates below the natural rate—lead to structural imbalances in the economy that are not sustainable. Austrians predict that the Fed’s policies of QE and ZIRP will inevitably lead to further asset bubbles in the stock market, manufacturing, exports, and real estate, depending on who gets the money first. As Mises taught, “Money is never neutral.”

The Austrians conclude that the boom-bust cycle is not a natural phenomenon under free-enterprise capitalism but is caused by government intervention in the monetary sphere. A legitimate international gold standard and “freely competitive banking” would minimize the risks of a boom-bust cycle. (Incidentally, the Austrians are the only school of economics today that defends the classical model of the gold standard.)

Until the 2008 crisis, the Keynesians and monetarists were unconcerned about asset bubbles. A bear market in housing prices or high-tech stocks would, they thought, only have a marginal impact on the global economy and could easily be countered by deft monetary stimulus. The market recovered from the 1988-90 real estate bust and from the 2001-2002 dot-com stock-market collapse without a global meltdown, for example.

The real-estate/mortgage bust of 2008 changed all that, and suddenly the focus shifted to the only school that argued all along that “asset bubbles” had macroeconomic effects: the Austrians. Since then, the Austrians and their primary advocate, Friedrich Hayek, have been in the limelight, popularized by financial gurus like Peter Schiff and political figures like Ron Paul. Management theorist Peter Drucker once predicted that the “next economics” would have to come from the “supply side, productive sector,” by which he meant the Austrians. He had in mind Joseph Schumpeter of “creative destruction” fame, but Hayek will do.

In May, I visited Poland for the first time to give a series of lectures on Austrian economics. Most of my books have been translated into Polish, thanks to energetic publisher Jan Fijor. My lectures were packed with business leaders, academics, and students who had an insatiable interest in Austrian economics and finance.

Eastern Europe, in particular, is taking a Viennese waltz down the economy. Leaders there are focused on adopting sound monetary and fiscal policies along the classical/Austrian lines. The supply-side flat tax movement is also popular.

Right now Estonia is in the limelight because it’s the fastest-growing economy in the region, expanding at a 7.6 percent rate. It is the only eurozone country with a budget surplus. National debt is just 6 percent of GDP. How did they bounce back from the devastating 2008-09 crisis?

“I can answer in [three] words,” states Peeter Koppel, investment strategist at the SEB Bank: “Austerity, austerity, austerity.” Estonia went through three years of belt-tightening. Public sector wages were cut, the pension age was raised, benefits were reduced. “It was very difficult, but we managed it,” explains Juhan Parts, Estonia’s minister of economy and communication. This “little country that could” is now leading the way to recovery and prosperity. The Austrian way.

Books by and about Friedrich Hayek and those related to the topic of this article are available in The Imaginative Conservative Bookstore. Reprinted with the gracious permission of The American Conservative.