Keynes vs. Hayek: Government Intervention and Economic Crises
Keynes vs. Hayek: The Economic Debate
John Maynard Keynes (1883–1946): The Interventionist
Keynes, a British economist, is considered a foundational figure in modern macroeconomics. He advocated for interventionist government policy, utilizing fiscal and monetary measures to mitigate the adverse effects of recessions and depressions.
The Rise and Resurgence of Keynesian Thought
- Western economies widely adopted Keynes’s ideas during and after World War II, especially throughout the 1950s and 1960s.
- In the 1970s, economists like Milton Friedman challenged his thinking.
- The global financial crisis of 2007 led to a resurgence in Keynesian thought, providing a basis for the policies implemented by leaders such as Obama and Brown.
Key Keynesian Concepts
In post-World War I Britain, facing high unemployment, Keynes advocated for price stability and favored government spending on public works as a direct response to joblessness.
During the Great Depression, through works like A Treatise on Money and The Means to Prosperity, Keynes argued strongly for counter-cyclical public spending. These ideas were subsequently adopted in Germany, Sweden, and the US.
In 1936, Keynes published The General Theory of Employment, Interest and Money. This work fundamentally challenged the neoclassical orthodoxy, which held that markets, free from government influence, would naturally establish a full employment equilibrium.
- Core Argument: The General Theory argued that demand, not supply, governs the overall level of economic activity.
- Aggregate Demand: Demand is defined as the sum of Consumption + Investment.
- Policy Support: Keynesians often support the ideas of the Phillips Curve, which predicted an inverse relationship between unemployment and inflation.
The response to the 2007–2008 global financial crisis saw a return to robust government intervention, including bank rescues and massive fiscal stimuli.
Friedrich Hayek (1899–1992): The Free Market Advocate
Hayek, an Austrian School economist, was heavily influenced by Darwin’s concept of evolution, believing the market should decide economic outcomes. He argued that the boom and bust cycle is primarily caused by government interference in the free market.
Hayek’s Critique of Intervention
Hayek specifically criticized central banks for cutting interest rates to stimulate weak economies, arguing that these rates should not be manipulated. Economist Peter Schiff, following this line of thought, argues that had interest rates been higher before the 2007 crisis, the resulting economic damage would have been less severe.
- Microeconomic View: Hayek viewed the economy as consisting of a myriad of small, complex transactions.
- Complexity Argument: The economy is too complex for central planners to understand, meaning interference by government is doomed to fail.
- Bankruptcy: Bankruptcy is not a problem; it is a solution. It cleanses the free market of inefficient firms that should not survive.
Controlling inflation was vital to Hayek, a legacy of his experiences with hyperinflation post-World War I. He strongly opposed continuing government deficits financed by borrowing (debt), providing a key argument supporting austerity measures.
The Financial Crisis: Who Was Right?
The Keynesian Perspective (Pro-Stimulus)
From a Keynesian viewpoint, the crisis was caused by free market policies and light-touch regulation. Unregulated capitalism caused the global meltdown. The only solution is government stimulus, as there is no other immediate source of consumption or investment.
Keynesian solutions require governments to:
- Invest to rescue failing banks and companies.
- Guarantee the debts of troubled banks.
- Launch debt-financed spending packages as a stimulus.
- Print money if necessary.
The Hayekian Perspective (Pro-Austerity)
From a Hayekian viewpoint, the crisis was caused by intervention. For example, the US Government, post-9/11, set interest rates too low (around 1%) for too long, which led directly to the borrowing and spending bubble. A truly free market would have set rates much higher.
Hayekians argue that austerity is the necessary path, using the analogy: “Medicine—it tastes bad, but the patient recovers quicker.”