Keynes VS Hayek

Keynes VS Hayek
Book Review
Ermal Leci

How people use their money tells if they are good money managers or not, and the same is considered about countries too. How citizens operate with their money will affect the macroeconomics of it, do they tend to save more, do they like to be big spenders, they prefer investing, are the key factors on what pace the countries economy will go through.
Regarding the issue of the economic growth there are two schools, Keynesian school that want to steer markets and the Hayek’s Austrian school that wants to keep the markets free. John Maynard Keynes was an English economist, part of the Bloomsbury group who represented the Kings College in London, while Friedrich August von Hayek was an Austrian economist who represented the Austrian School, even though the vast amount of work he had done while he was lecturer in London School of Economics. The two schools opposed each other, and even today there are two types of economists who stand by one of the schools. The book “Keynes Hayek: The Clash that Defined Modern Economics” by Nicholas Wapshott, gives a clear and detailed insight of the schools on economic growth and key determinants on it. Furthermore the book illustrates in details the clash between these two schools, which gives us the idea that sometimes the clash was becoming personal.
For the Keynesian school the main factor that indicates the economic growth is the demand, therefore they encourage the government intervention in order to generate the demand and be matched by supply with employment of resources. Keynes promotes stimuli from the government interventions in times when country is facing economic difficulties and citizens are afraid of spending their savings, instead they gather cash and cause unemployment of the resources. Once in a radio broadcast he urged the housewives who were listening to him to go out and spend, because with that action they will help decrease state unemployment, he added that “ Many millions of pounds’ worth of goods could be produced each day by the workers and the plants which stand idle”1. Keynes suggests capital investments by the government in order to create employment and create demand. Than he mentions the multiplier effect and the chain reactions, by illustrating that whenever governments spends money on a new capital investment, create supply of jobs, people get employed and thus they spend the money they earned by creating demand for goods, thus suppliers of those goods employ more in order to fulfill the demand and the flow goes on further with the chain effect. The multiplier effect will always be above 0, and usually be more than 1.5. Another topic that Keynes touched was interest rates, and his thought was that the government should lower interest rates toward the commercial banks in return that they will lower their interest rate for their customers. This action will take the money stuck inside banks vaults into the economy, and citizens will be more appealed to investments. Keynes was the one who always stayed loyal to the equation C (Consumption) + I (Investment) + G (Government Spending)= Y (GDP), and always raised his voice that the government should intervene when the economy is bust since the opportunity cost of waiting for the economy to sort itself is really big. Actually during the great depreciation his theory was right. Keynes was always called when the economy was facing problems in England and US, but he found it difficult to communicate with politicians and thus sometimes the governments didn’t followed his advises. One of the Keynes most wise and popular quotes was “The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”2
Austrian School on the other hand promote carefulness of investment during the boom of the economy, and suggest not intervening in the markets while the economy is struggling, because market always sort itself and only than offer the maximum employment. Even though Keynes inspired Hayek when he was a student, later Hayek opposed him strongly on government intervention and capital investments since that will not help employment and it will only create a temporary fix. Furthermore he opposed low interest rates since the country will be full of debts and the investments made would be hasted, the interest rates will increase, and in the near feature we will struggle with devaluation of the investments. Hayek argued that this entire temporary fix will postpone the real problem and the country will have to deal with it again.
Hayek known as liberal economists promotes the real savings and investments. He stated that the economic growth relies on investments structure, only with well thought investments the economy will growth. Creating false demand doesn’t mean that that is the real demand and the signals of the economy would be misleading. Regarding interest rates Hayek again opposed the Keynes by stating that there is no need to intervene since the market sort them according to the time. So the economy situation would be reflected on the interest rate at real time. As liberal economist Hayek stated, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”3
Each school has its own advantages and disadvantages, furthermore countries economies are driven in different ways. When we took about Keynesian school and government interventions we see that in developing countries government can give to the economy a great hand with decent capital investments, mostly when economy is in very bad shape an intervention will give a proper boost toward improving trends. The best quote by Keynes was “ In the long run we are all dead”4, thus the opportunity cost of not reacting maybe would be higher. On the other hand, not always governments invest on the proper capital, and some times unintentionally they start a new bubble that will burst and impact will worsen the economies. While sometimes in the big developed countries, a government investment can distort the market with devastating side effects, and the multiplier effect would produce negative impact.
While Austrian school of thought or known as liberal economist, they don’t want to depend on the success of the government intervention and thus they wait for the market to find its ways and sort itself. In the big markets, this will prove to be a long-term solution even though a bit painful. But the market would have an incentive for creativeness and innovativeness toward sorting itself. In contrary the opportunity cost of waiting for the market to sort itself can be higher than the yield from waiting. Thus in some economies government interventions are unavoidable and mandatory. Even big markets need boosts and cash injections in order to keep the status. If Hayek had been alive during the Great Recession he probably would have said, “I told you so”5 the same way he said when Soviet Union collapsed in 1991 and he predicted it. Was Great Recession created by constant intervention of the governments into the economies? Most likely, but hence there was a need for some Keynes school of thoughts to get out of it. The overvalued backed mortgaged securities were going bust and all the derivatives lost value. The markets were all going down and unemployment was increasing, people were afraid to spend and there was no cash. Thus there was a significant demand for money. Than the Great Recession hit the old continent, the Eurozone countries suffered from it. PIGS (Portugal, Italy, Greece and Spain) where the ones who needed recovery packets the most, since other countries moved out of it gradually. Once again the dilemma between the two schools of thoughts began. In my opinion a Keynesian school was much needed in two cases in order to avoid the market black period that no one could forecast the consequences. It is not arguable that whenever there are economical problems there are civil unrests; USA and Europe knew that their economy would have been devastated if not intervening. Barack Obama the US President in “February 2009 urged Congress to pass a $ 787 billion stimulus bill in tax breaks and spending on unemployment benefits and infrastructure”6, he explained the intervention by stating: “We acted because a failure to do so would have led to a catastrophe”7. Yet that money was not on the people’s hand and the money demand was high, the unemployment was not getting down, which pushed the US congress toward another Keynesian style stimulus of $858 billion on November 2010. While in Europe the Germany was the leader economy that pushed European Union to help the countries in recession with recovery packets, in order to keep their currency alive and get the Europe out of the recession.
Considering the liquidity preferences during the Great Recession, the US and Europe were not ready for the Hayek school yet; hence they hesitated to immediately embrace the Keynes school and analyzed for a while how the market was responding. Again time proved that when the economies are in the downfall a government intervention will help them to get on their feet, and again it was proved that magnitude of the success of the intervention is in positive correlation with quality of the investments done by the government. Even after seven years the economy has not fully recovered, while the growing trends are not satisfactory.