The debates raging over what policies will pull the U.S. economy out of its Great Recession replicate one that occurred during the Great Depression. Thanks to the efforts of Richard Ebeling, a professor of economics at Northwood University, we have compelling and concise documentary evidence. He has unearthed letters to the Times of London from the two sides that mirror today's debates.
On Oct. 17, 1932, the Times published a lengthy letter from John Maynard Keynes and five other academic economists. Keynes, et al. (Keynes for short), made the case for spending — of any kind, private or public, whether on consumption or investment.
"Private economy" was the culprit that impeded a return to prosperity. If a person decides to save, there is no assurance that the funds "will find their way into investment in new capital construction by public or private concerns." They cite a "lack of confidence" as the reason that savings is not intermediated into investment. Accordingly, "the public interest in present conditions does not point towards private economy; to spend less money than we should like to do is not patriotic." They conclude by endorsing public spending to offset unwise private thrift.
Two days later, on Oct. 19, 1932, four professors at the University of London responded to the Keynes letter, and one of the signers was Friedrich A. Hayek who more than 50 years later would win the Nobel Prize in Economics.
Hayek, et al. (Hayek for short), identified three areas of contention. First, they correctly identified Keynes's argument about the futility of savings as actually being an argument about what has classically been known as the dangers of hoarding, i.e., the potentially pernicious consequences of an economy-wide increase in the demand for money that is not met by a corresponding increase in the supply of money. "It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable."
Second, the London professors disputed that it mattered not the form spending took, whether on consumption or investment. They saw a "revival of investment as peculiarly desirable," as do today's proponents of supply-side economics. They distinguish between hoarding of money and savings that flows into securities, and reaffirm the importance of the securities markets in transforming savings into investment.
Their third and greatest disagreement with Keynes was over the benefits of government spending financed by deficits. They demurred. "The existence of public debt on a large scale imposes frictions and obstacles to readjustment very much greater than the frictions and obstacles imposed by the existence of private debt." This was not the time for "new municipal swimming baths, &c" (Keynes's example). In our contemporary context, no stimulus...
Was Keynes correct that savings become idle money and depress economic activity? Or was the Hayek view, first articulated by Adam Smith in the Wealth of Nations in 1776, correct? (Smith: "What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too.")
Is all spending equally productive, or should government policies aim to simulate private investment? If the latter, then Mr. Obama is following in FDR's footsteps and impeding recovery. He does so by demonizing business and creating regime uncertainty through new regulations and costly programs. In this he follows neither Hayek nor Keynes, since creating a lack of confidence is considered destructive by both.
Finally, is creating new public debt in a weakened economy the path to recovery? Or is "economy" (austerity in today's debate) and thrift the path to prosperity now, as it has usually been considered before?
Wednesday, July 7, 2010
Hayek v. Keynes Again
Gerald P. O'Driscoll Jr. writes: