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Hayek v Keynes Debate

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Fight of the Century

The Triumphant Return of Hayek

Newsweek writes:

Last year the consensus opinion was that we are all Keynesians now. Virtually everyone in the commentariat believed that John Maynard Keynes’s solution for the Great Depression—heavy government spending to resuscitate the economy—was also the answer to today’s global downturn...From Europe to the United States, as voters started to reward candidates focused on fiscal discipline and less government intervention, Keynesianism quickly fell out of favor.

One key exception was U.S. Federal Reserve chairman Ben Bernanke. Dissatisfied with the gradual recovery and a high unemployment rate, he let it be known that he thought more stimulus was in order, and realizing that was not in the congressional cards, he decided to take monetary activism to a new level by offering an open-ended commitment to pump as much money into the system as required to meet the Fed’s dual mandate of maximum employment and price stability. This is the first time a Fed chairman has explicitly stated that monetary policy can turbocharge an economic recovery. Bernanke says he is doing everything Milton Friedman would have had the Fed do. Friedman, the father of monetarism, argued that the Great Depression was largely the result of a major contraction in money supply, and that such a severe economic outcome could have been avoided had the Fed held the money supply stable.

The public doesn’t buy it. There’s a growing backlash against the Fed’s monetary activism, for two reasons. It is increasingly clear that the Fed can print all the money it wants to but has no control over where it ends up. Ever since the Fed stepped up talk of quantitative easing this summer, the prospect of easy money has driven up prices of commodities and emerging-market stocks, and Wall Street is abuzz with talk of the “next bubble.” Second, monetary activism suffers from the same fundamental flaw as Keynesianism, in that it protects inefficient players instead of injecting renewed vigor into the economy...

In a sign of the times, some of the most popular videos on YouTube this year are satires on economic policy; the latest lampoons the Fed amid a growing feeling that policymakers are committing what economist Friedrich Hayek called the “fatal conceit” in micromanaging the economic cycle. Hayek hated policy intervention of any kind.

read the article

Hayek v. Keynes volume 2

Spreading Hayek, Spurning Keynes

Peter J. Boettke, shuffling around in a maroon velour track suit or faux-leather rubber shoes he calls "dress Crocs," hardly seems like the type to lead a revolution.

But the 50-year-old professor of economics at George Mason University in Virginia is emerging as the intellectual standard-bearer for the Austrian school of economics that opposes government intervention in markets and decries federal spending to prop up demand during times of crisis. Mr. Boettke, whose latest research explores people's ability to self-regulate, also is minting a new generation of disciples who are spreading the Austrian approach throughout academia, where it had long been left for dead.

To these free-market economists, government intrusion ultimately sows the seeds of the next crisis. It hampers what one famous Austrian, Joseph Schumpeter, called the process of "creative destruction."

Governments that spend money they don't have to cushion downturns, they say, lead nations down the path of large debts and runaway inflation...

"What I'm really worried about is an endless cycle of deficits, debt, and debasement of currency," Mr. Boettke says. "What we've done is engage in a set of policies that's turned a market correction into an economy-wide crisis."...

And the tenures of Paul Volcker and Alan Greenspan at the Federal Reserve seemed to quell doubts about the central bank's ability to manage the U.S. economy.

But all along, the Austrians weren't so sure. Economics, they feared, was increasingly narrow and technical but not necessarily wise. They also remained skeptical of the Fed's approach to targeting stability in consumer prices.

That shouldn't be the Fed's goal, says Mr. Boettke, who a friend lured back to George Mason a year after he was denied tenure. The Fed, he says, should be to make money "as neutral as possible, like the rule of law, which never favors one party over the other."...

It wasn't a lack of government oversight that led to the crisis, as some economists argue, but too much of it, Mr. Boettke says. Specifically, low interest rates and policies that subsidized homeownership "gave people the crazy juice," he says.

read the WSJ article

Debate: More Stimulus?

Eighteen months after President Barack Obama administered a massive dose of spending increases and tax cuts to a weak economy, a brawl has broken out among economists and politicians about whether fiscal-stimulus medicine is curing the illness or making it worse...

One side says Mr. Obama's $862 billion fiscal stimulus prevented an even graver recession. Cutting the deficit right now, this side insists, would send the economy into a tailspin. The other side questions the benefits of the stimulus and argues addressing long-term deficits now is crucial to avoid higher interest rates and even bigger economic problems down the road.

And then there is a camp in the middle—defending last year's stimulus, but urging a deficit-cutting plan now...

"Too many are searching for answers in the discredited economic playbook of borrow-and-spend Keynesian policies," Rep. Paul Ryan, a Wisconsin Republican who is pushing a long-run deficit cutting plan, said this month. "I reject the false premise that only forceful and sustained government intervention in the economy can secure this country's renewed prosperity."...

Richard Trumka, president of the AFL-CIO union alliance, says if the government starts cutting deficits now, "We'll slip back into recession and possibly depression."...

But today, neither side can say with certainty whether the latest stimulus worked, because nobody knows what would have happened in its absence.

Fed Chairman Ben Bernanke backed fiscal stimulus in early 2009. Now he says the economy still needs fiscal stimulus, but says it must be accompanied with a credible plan to reduce future deficits. Like the Obama administration, he doesn't think that plan should be implemented until the economy is on more solid footing...

The case that government deficit spending can be vital at times of recessions dates to John Maynard Keynes, the British economist whose teachings dominated economics for decades after the Great Depression. "Pyramid-building, earthquakes, even wars may serve to increase wealth," Mr. Keynes said in his 1936 classic, "The General Theory of Employment, Interest and Money."

A counter-revolution led by Milton Friedman, of the University of Chicago, de-emphasized the role of government and gave rise to Ronald Reagan and Britain's Margaret Thatcher. Keynes lost favor during the stagflation of the late 1970s and early 1980s. The Fed and its manipulation of interest rates came to be seen as the best way for governments to manage the short-term ups and downs of the economy...

The Obama administration is stocked with heirs of Mr. Keynes, including academics Christina Romer and Mr. Summers. Ms. Romer famously projected in January 2009 that without government support, the unemployment rate would reach 9%, but with support the government could keep it under 8%. It's 9.5% today...

Underlying the debate is a long-running argument about how much of a lift the government gets from spending more or taxing less. Keynesians argue that when the economy is distressed, a dollar spent by the government multiplies in value. It gives a worker income the private sector has failed to produce, which he spends, creating demand for goods and services.

Ms. Romer argued last year that this "multiplier" for government meant every dollar spent created about $1.50 worth of demand...

Robert Barro, a Harvard economist, found even smaller multipliers: A government dollar spent creates about 80 cents worth of growth, or possibly less, he says. Government spending, he says, crowds out private sector spending that would otherwise be taking place...

Carmen Reinhart, a University of Maryland economist who has studied the fiscal aftermath of financial crises, says more stimulus could be counterproductive because it could lead the public to expect even higher taxes in the future...

"We are not in an easy position," she says. "Credibility is going to be difficult to achieve."

read the entire WSJ article

My thoughts: Central planning does not work. It does not matter if the method of central planning is fiscal policy or monetary policy. Politicians do not understand how economies work.
A recession is better understood as a "market correction". When a cluster of errors occurs from artificially low interest rates, this generates an unsustainable boom. Once the boom occurs the bust is inevitable. The Fed created the boom. Ben Bernanke will eventually be known as the worst Fed chairman ever. The Creature from Jekyll Island hopefully will die a quicker death due to the incompetence of Bernanke.

Keynesian economics never truly died, it was merely displaced by the monetarist economics of Milton Friedman and the Chicago School. Mainstream economic thought came to believe that monetary policy was most effective and that Keynesian solutions should be reserved for when monetray policy could not produce the desired effects.

Both Keynesians and monetarists do not truly understand how economies work. For the Keynesians, you can't spend yourself into prosperity. Pyramid-building, earthquakes, and wars are the solution to economic problems. Pyramid-building (also known as public works) is an unnecessary function of government that only serves to put the nation into deeper debt. Earthquakes and wars kill people and destroy capital, which is the opposite of what is needed for economic growth. For the monetarist, attempting to paper over a bubble that was originally created by easy money policy is insane. You don't solve problems by doing the same thing that caused the problem to begin with.

Hayek v. Keynes Again

Gerald P. O'Driscoll Jr. writes:

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?

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Russ Roberts on F.A. Hayek

Why Friedrich Hayek Is Making a Comeback

With the failure of Keynesian stimulus, the late Austrian economist's ideas on state power and crony capitalism are getting a new hearing.

He was born in the 19th century, wrote his most influential book more than 65 years ago, and he's not quite as well known or beloved as the sexy Mexican actress who shares his last name. Yet somehow, Friedrich Hayek is on the rise.

When Glenn Beck recently explored Hayek's classic, "The Road to Serfdom," on his TV show, the book went to No. 1 on Amazon and remains in the top 10. Hayek's persona co-starred with his old sparring partner John Maynard Keynes in a rap video "Fear the Boom and Bust" that has been viewed over 1.4 million times on YouTube and subtitled in 10 languages.

Why the sudden interest in the ideas of a Vienna-born, Nobel Prize-winning economist largely forgotten by mainstream economists?

Hayek is not the only dead economist to have garnered new attention. Most of the living ones lost credibility when the Great Recession ended the much-hyped Great Moderation. And fears of another Great Depression caused a natural look to the past. When Federal Reserve Chairman Ben Bernanke zealously expanded the Fed's balance sheet, he was surely remembering Milton Friedman's indictment of the Fed's inaction in the 1930s. On the fiscal side, Keynes was also suddenly in vogue again. The stimulus package was passed with much talk of Keynesian multipliers and boosting aggregate demand.

But now that the stimulus has barely dented the unemployment rate, and with government spending and deficits soaring, it's natural to turn to Hayek. He championed four important ideas worth thinking about in these troubled times.

First, he and fellow Austrian School economists such as Ludwig Von Mises argued that the economy is more complicated than the simple Keynesian story. Boosting aggregate demand by keeping school teachers employed will do little to help the construction workers and manufacturing workers who have borne the brunt of the current downturn. If those school teachers aren't buying more houses, construction workers are still going to take a while to find work. Keynesians like to claim that even digging holes and filling them is better than doing nothing because it gets money into the economy. But the main effect can be to raise the wages of ditch-diggers with limited effects outside that sector.

Second, Hayek highlighted the Fed's role in the business cycle. Former Fed Chairman Alan Greenspan's artificially low rates of 2002-2004 played a crucial role in inflating the housing bubble and distorting other investment decisions. Current monetary policy postpones the adjustments needed to heal the housing market.

Third, as Hayek contended in "The Road to Serfdom," political freedom and economic freedom are inextricably intertwined. In a centrally planned economy, the state inevitably infringes on what we do, what we enjoy, and where we live. When the state has the final say on the economy, the political opposition needs the permission of the state to act, speak and write. Economic control becomes political control.

Even when the state tries to steer only part of the economy in the name of the "public good," the power of the state corrupts those who wield that power. Hayek pointed out that powerful bureaucracies don't attract angels—they attract people who enjoy running the lives of others. They tend to take care of their friends before taking care of others. And they find increasing that power attractive. Crony capitalism shouldn't be confused with the real thing.

The fourth timely idea of Hayek's is that order can emerge not just from the top down but from the bottom up. The American people are suffering from top-down fatigue. President Obama has expanded federal control of health care. He'd like to do the same with the energy market. Through Fannie and Freddie, the government is running the mortgage market. It now also owns shares in flagship American companies. The president flouts the rule of law by extracting promises from BP rather than letting the courts do their job. By increasing the size of government, he has left fewer resources for the rest of us to direct through our own decisions.

Hayek understood that the opposite of top-down collectivism was not selfishness and egotism. A free modern society is all about cooperation. We join with others to produce the goods and services we enjoy, all without top-down direction. The same is true in every sphere of activity that makes life meaningful—when we sing and when we dance, when we play and when we pray. Leaving us free to join with others as we see fit—in our work and in our play—is the road to true and lasting prosperity. Hayek gave us that map.

Despite the caricatures of his critics, Hayek never said that totalitarianism was the inevitable result of expanding government's role in the economy. He simply warned us of the possibility and the costs of heading in that direction. We should heed his warning. I don't know if we're on the road to serfdom, but wherever we're headed, Hayek would certainly counsel us to turn around.

from the WSJ

Karen DeCoster responds:

My only complaint about the article is that Roberts refuses to acknowledge that, yes, centralizing power within the federal government does lead to totalitarianism. Roberts also states, “I don’t know if we’re on the road to serfdom…”, and my response is that we are already well down that road, and it’s ludicrous to say otherwise.

Glenn Beck Show on F. A. Hayek

Part I



6/8/10 episode

watch the entire episode

Bruce Caldwell on Hayek and the Economic Meltdown

Bruce Caldwell:

the Austrian /public choice one-two punch: we usually do not have the necessary knowledge to intervene effectively, and the political process is such that, even if we did, we still likely would get bad policy, and this together with an ever growing government sector.

read the paper

Annotated "Fear the Boom and Bust"

See and read it here.

Keynes v Hayek

Keynes v. Hayek: A Rap

F.A. Hayek Quote

"(t)he curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

Hayek v Keynes

"In the long run, we are all dead," John Maynard Keynes once quipped. An influential British economist, Keynes used the line to dodge the problematic long-term implications of his policy proposals. His analysis of the Great Depression redefined economics in the 1930s and asserted that increased government spending during a downturn could revive the economy.

President Barack Obama and congressional Democrats (very few of whom likely have read Keynes's 1936 book "The General Theory of Employment, Interest and Money") have dug up the dead economist's convenient justification for deficit spending in defense of their bloated stimulus legislation. But none ask the most important question: Was Keynes right?...

A father of public choice economics, Nobel laureate James Buchanan, argues that the great flaw in Keynesianism is that it ignores the obvious, self-interested incentives of government actors implementing fiscal policy and creates intellectual cover for what would otherwise be viewed as self-serving and irresponsible behavior by politicians. It is also very difficult to turn off the spigot in better economic times, and Keynes blithely ignored the long-term effects of financing an expanded deficit.

It's clear why Keynes's popularity endures in Congress. Intellectual cover for a spending spree will always be appreciated there. But it's harder to see any justification for the perverse form of fiscal child abuse that heaps massive debts on future generations...

In reality, no one spends someone else's money better than they spend their own. The charade of the current stimulus package, chockablock with earmarks to favored pet constituencies and virtually devoid of national policy considerations, is the logical consequence of Keynesianism in action. It is about politics and power, not sound economics, and I believe that the American people will reject it.

read the WSJ essay

My thoughts: Hayek will continue to win the intellectual battle and lose the political battle until the American people once again value freedom more than the security.

Bailout marks Karl Marx's comeback

If he were to rise from the dead today, Marx might be delighted to discover that most economists and financial commentators, including many who claim to favour the free market, agree with him.

Indeed, analysts at the Heritage and Cato Institute, and commentators in The Wall Street Journal and on this very page, have made declarations in favour of the massive “injection of liquidities” engineered by central banks in recent months, the government takeover of giant financial institutions, as well as the still stalled US$700-billion bailout package. Some of the same voices were calling for similar interventions following the burst of the dot-com bubble in 2001...

At first glance, anyone who understands economics can see that there is something wrong with this picture. The taxes that will need to be levied to finance this package may keep some firms alive, but they will siphon off capital, kill jobs and make businesses less productive elsewhere. Increasing the money supply is no different. It is an invisible tax that redistributes resources to debtors and those who made unwise investments...

But there is another approach that doesn’t compromise with free-market principles and coherently explains why we constantly get into these bubble situations followed by a crash. It is centered on Marx’s Proposal Number Five: government control of capital.

For decades, Austrian School economists have warned against the dire consequences of having a central banking system based on fiat money, money that is not grounded on any commodity like gold and can easily be manipulated. In addition to its obvious disadvantages (price inflation, debasement of the currency, etc.), easy credit and artificially low interest rates send wrong signals to investors and exacerbate business cycles...

As prices get distorted, malinvestments, or investments that should not have been made under normal market conditions, accumulate. Despite this, financial institutions have an incentive to join this frenzy of irresponsible lending, or else they will lose market shares to competitors. With “liquidities” in overabundance, more and more risky decisions are made to increase yields and leveraging reaches dangerous levels.

During that manic phase, everybody seems to believe that the boom will go on. Only the Austrians warn that it cannot last forever, as Friedrich Hayek and Ludwig von Mises did before the 1929 crash, and as their followers have done for the past several years...

As Friedrich Hayek wrote in 1932, “Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion. ... To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about ...”

The confusion of Chicago school economics on monetary issues is so profound as to lead its adherents today to support the largest government grab of private capital in world history. By adding their voices to those on the left, these confused free-marketeers are not helping to “save capitalism”, but contributing to its destruction.

read the entire essay

My thoughts: One of the best essays on the current crisis I have seen.

Here is the suggested Austrian solution:

Austrian Bailout Package--Part A
1. Suspend Basil II regulations (to at least 4/2/09)
2. Cancel FDIC insurance on all demand deposits after 1/1/09.
3. Increase FDIC premiums on short term time deposits of less than one year.
4. Make interest earned (starting 1/1/09) on bank time deposits and non-governmental, non-agency, and non-authority bonds tax free (not demand deposits and MMMF).
5. Convert Fannie Mae and Freddie Mac's status from conservatorship into receivership.
6. Convert AIG's status from government owned to receivership.
7. Cancel the Primary Dealer Credit Facility (PDCF) and the Term Securities Lending Facility (TSLF) at the end of the announced program (January 30, 2009).
8. Announce that the Federal Funds rate will be allowed to "float" at market rates starting January 30, 2009.
9. Announce that the Federal budget will be prorated beginning with the fiscal year starting 10/1/08 including all defense spending and transfer payments.
10. Restore constitutional monetary status to gold and silver to act as an alternative medium of exchange (no capital gains taxes).