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The Fight Continues: Keynes and Hayek on Prices

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F.A. Hayek and John Maynard Keynes are two of the most controversial economists in history. They are also the two that are most often mentioned in undergrad economics courses. But even though these two have managed to break through to the mainstream, many still do not fully understand the differences between the two economists’ beliefs. 

Previously, I  discussed how Hayek and Keynes differed in regards to their views on spending and planned economies. Hayek, whose views were closely aligned with the Chicago school of economics, believed that markets operate organically and, as such, should not be constrained to the confines of government orchestration. This led him to conclude that government intervention, including but not limited to the setting of prices, inhibits the free market from reaching its full potential.

Keynes, on the other hand, believed the exact opposite. For Keynes, the more government intervention the better. He believed that laissez-faire economics was dangerous for consumers and was destined to fail. This faith in government institutions would also transfer over to his views on price theory.

Keynes on Pricing

Like most things regarding the economy, Keynes was a huge advocate of government intervention. As George Selgin put it, Keynes’s believed that “government authorities should manage money so as to achieve a stable level of consumers’ prices.”

Expanding on this, Selgin says:

“But, although some of Keynes’s writings, and the General Theory especially, may have laid the groundwork for inflationary policies, Keynes himself regarded them as supporting a monetary policy that would stabilize consumers’ prices. The desirability of a stable consumers’ price index is a persistent theme of Keynes’s monetary writings, from the Economic Consequences of the Peace (1919) to How to Pay for the War (1940). In this respect at least Keynes saw eye-to-eye with several of his more important contemporaries, including Irving Fisher and such members of the “old” Chicago School as Loyd Mints and Henry Simons.”

Keynes believed that prices were closely tied to monetary policy. Selin says, “But, although some of Keynes’s writings, and the General Theory especially, may have laid the groundwork for inflationary policies, Keynes himself regarded them as supporting a monetary policy that would stabilize consumers’ prices.

Let the Market Do Its Thing

For anyone familiar with Hayek, it will not be surprising to learn that he believed that prices are an organic product of the market. Since Hayek believed that the market was capable of operating without constant government supervision, he thought it was unwise to give the government the power to determine prices.

Instead, he believed that prices were a response to market demand. If an item was proving itself to be of value to willing consumers, that demand would provide a basis for entrepreneurs to structure pricing. 

To explain this in more technical economic terms, Selgin explains that Hayek, “believed that the general level of output prices should be allowed to vary in response to changes in factor productivity, falling in response to both anticipated and unanticipated improvements in productivity, and rising in response to any productivity setback.”

Until demand dies down, and consumers are demonstrating their unwillingness to pay a certain price for an item or service, there was no reason to reduce prices. If, on the other hand, demand continues to climb, entrepreneurs and business owners may decide to raise the price of a good or service since it is proportional to the demand. Keynes would have never trusted the market enough to believe that prices could be set and stabilized through demand.

 

The Fight Continues: Keynes and Hayek on Spending

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John Maynard Keynes and F.A. Hayek were both influential men of their time. But, as discussed in the first two parts of this series, they both had very different views on how the economy should operate.

In the previous installment of this series, we discussed how both Hayek and Keynes differed on their views regarding planned economies and government intervention. As we have already seen in my liveblogging of Hayek’s The Road to Serfdom, Hayek was a staunch supporter of individualism and stood in opposition to planned economies because he felt they would result in less freedom for the individual.

For Keynes, government intervention was the only way to achieve desired ends for the national economy as a whole, even if this meant individual rights were squashed along the way. But the differences between the two economists do not end there.

One of the most contentious issues between Hayek and Keynes was the matter of spending as a means of instituting economic prosperity.

Spending Your Way to Prosperity  

Most rational human beings understand that if they are having financial problems, they cannot spend their way to prosperity. And while individuals seem to grasp this point quickly when their own personal money is at stake, many economists and state planners still have not learned this lesson. And unfortunately, Keynes is one of the main reasons this “spend your way to prosperity” myth still exists today.

Keynes viewed spending as one of the primary driving forces of the economy. In fact for Keynes, when countries are experiencing economic recessions, government spending holds the answer to the problem. Keynes viewed the free market as a beast that needed taming, frequently referring to the “animal spirit” of the marketplace, so it is no wonder he did not trust in the market process.

Keynes believed that when the economy was doing well, which in his mind meant unemployment rates were low and and growth continued steadily, the state should rein in spending. But when the national economy was not doing so hot, he believed that both spending and deficits should be increased.

Keynes did not trust in the free markets ability to self-regulate and make the proper adjustments needed in order to correct itself in times of economic recessions or depressions. Instead, he believed that by increasing spending, the government could encourage job growth and give the economy the jolt it needed to get going again.

It is for this reason that today we see many members of Congress call for an increase in government programs even in the midst of economic uncertainty. Rather than trust the “do nothing” approach and let the business cycle run its course, these bureaucrats want a proactive approach that also aligns with their own agenda, which often consists of creating new agencies or programs that further increase our national deficit.

But while spending may seem like the simple solution to so many of these subscribers of the Keynesian school of economic thought, classical liberalism offers another side to this spending story.

Broken Window Fallacy

This idea that spending is prosperous for the national economy has been discussed at length by both Hayek and Bastiat. Bastiat’s “What Is Seen and What Is Not Seen” essay focuses on the absurdity of what has been dubbed the “broken window fallacy.”

If a store owner begins his day by discovering that his storefront window had been smashed by a hooligan with a rock overnight, few people would see this as an opportunity for economic growth. But to the Keynesian, since the business owner has to replace his window, he is stimulating the economy by having to purchase new glass and have it installed.

But as both Hayek and Bastiat have explained, this does not result in economic stimulation. Since the business-owner now has to pay for the glass twice, once during the initial installation and again to replace the broken glass, he has doubled his losses. If the store owner did not have to spend his precious resources on replacing the window, imagine where the money could have been spent.

It could have gone to another sector, who in turn, spends the profits on another sector, and so on and so forth. This is true economic stimulation.

Yet, the broken window fallacy remains among the most popular economic myths influencing governments today. It is for this reason that after a natural disaster you see Keynesian talking heads praising massive destruction for the economic stimulation that will result from having to rebuild.

This is the very same line of thinking that fueled Keynes and it is why he believed deficit spending would benefit the national economy. And temporarily, this might be true our own national deficit situation shows that this type of stimulation does not work. The glazier now tasked with having to repair the storefront window may see a temporary boom, but it does not account for what Bastiat called the “unseen.” In this scenario, this would be the sector that is missing our on the store owner’s business because the funds that might have otherwise been spent, are now being directed towards rebuilding what was already there.

While it is simple for most individuals to grasp this concept, it is one that Keynesian economists continue to cling to rather than yielding to the wisdom of classically liberal economists like Hayek and Bastiat.

The Fight Continues: Keynes and Hayek on Planned Economies

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As touched upon briefly in the first part of this series, 20th-century economists F.A. Hayek and John Maynard Keynes did not agree on much. And while a lot has happened since these two men were alive and actively writing and speaking about economic philosophy, the two men’s influence on the national economy can still be seen and felt today.

It cannot be denied that both men have been influential in the field of economics–whether for better or for worse depending on which philosophy you are more inclined to accept. But their disagreements with each other offer a fascinating comparison specifically between those who believe in government intervention in the economy, and those who do not.

Keynes and Intervention

In order for an economy to be planned, it must have some sort of central authority at its helm directing it in a given direction. And, as is always the case, this governing authority is placed in the hands of the state.

For John Maynard Keynes, the government’s involvement in the national economy was integral. Keynes is primarily responsible for the rise of macroeconomics, which treats the entire economy as one whole entity, rather than several individual moving parts. And of course, in order to control a creature as vast as the U.S. economy, you would have to control almost every aspect of it in order to reach your goals.

This type of central economic planning usually comes in the form of policies that restrict almost all aspects of a given sector. From setting prices and wages to controlling which companies are allocated scarce resources and even barring entrance into employment sectors, the Keynesian model seeks full and complete regulation from the state.

And while it may be difficult for many to understand why so many Americans eagerly subscribed to Keynesian economics even though totalitarianism had just destroyed Europe, it is important to understand one of Keynes’ main focuses: full employment.

For military members returning home from war, transitioning back into the workforce was of the utmost importance. And while “full employment” was easy to obtain while many of your countrymen are drafted and forced into war, finding places for all these men in the post-war economy was not so simple. It is for this reason that so many fell victim to the belief that the government should be in control of the economy and especially the workforce.

But viewing the economy as something that can be tamed and mastered does not take into account all the individual factors that make the marketplace so great in the first place.

Hayek and Planned Economies

Hayek believed that planned economies are the greatest enemy of free market competition. After all, when the government is responsible for controlling what the market can and cannot do, the market ceases to be “free” at all. And since free markets were comprised of individual efforts, inhibiting market innovation is a direct threat to the individual. And above all, Hayek’s economic philosophies are centered around the importance of individualism.

One of the biggest problems with Keynesian macroeconomics is its utter and complete lack of recognition of the importance of the individual. In fact, since the individual usually serves as an obstacle for governments seeking complete control over the economy, the individual is the only real threat to planned economies.

For Keynes to achieve his economic goals, including full employment, the government would have to commandeer the entire economy, trampling on individuals along the way. While some may not see this as being as terrifying as it truly is, Hayek reminds us in The Road to Serfdom that without economic freedom there can be no freedom at all. And in Keynes’s ideal world, the government would be running the entire show, leaving very little room for individual dissent.

As Hayek so passionately expresses throughout his classic Road to Serfdom, this failure to understand the individual’s role in the economy is one of the major shortcomings of Keynesian economics. As soon as economists stop viewing the economy in terms of individual entities and instead view it only as a collective unit, innovation is stifled and the individual suffers.

When the government controls wages, for example, the individual loses out on the opportunity to negotiate the terms of payment based on his or her own set of skills. Instead, these types of policies treat all members of the workforce the same.

Additionally, when the government determines which companies are worthy of certain resources, it demeans the innovation process by not allowing individuals to experiment with burgeoning ideas that may come with a risk.

Overall these differences between the two men come down to the individual versus the collective, and for Hayek, the individual should always be protected and placed above the desire for a planned economy riddled with government oversight.

The Fight Continues: The Differences between Keynes and Hayek

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John Maynard Keynes and F.A. Hayek are two of the most controversial economic figures of the 20th century. Both made huge contributions to the field of economics and both stand in direct opposition to each other, which is one reason why they have presented such a fascinating juxtaposition over the last century.

For Keynes, the government’s involvement was integral to the field of macroeconomics, which treated the entire economy as one whole entity, rather than several individual moving parts. As has been discussed in The Road to Serfdom, this failure to understand the individual’s role in the economy is one of Hayek’s main concerns.

For Keynes to achieve his economic goals, which included such things as the idea of “full employment,” the government would have to commandeer the entire economy in order to direct it towards a given end. While some may not see this as being as terrifying as it truly is, Hayek reminds us of in Road to Serfdom that without economic freedom, there can be no freedom. And in Keynes’s ideal world, the government would be running the entire show. But the differences between the two men exceed far beyond this fact alone.

Over the course of a few essays, I will be diving into the differences between these two economists and why they both matter in our modern day. But before diving into the differences there are two videos that may help lay a foundation for understanding these two fascinating men.

In 2011, two parody rap videos were released in which two actors depicted the two economists debating their different stances on the economy. While economics is not usually the “hippest” topic to rap about, the videos made their way around the internet and suddenly everyone was talking about Hayek, Keynes, and Austrian economics.

The videos were released at the height of the Ron Paul movement when F.A. Hayek and his issues with Keynesian economics were suddenly being discussed as if it were celebrity gossip. And while the videos laid a strong foundation for the discrepancies between the two men, it is important to elaborate on a few of those differences, as I will be doing over the next few weeks.



 

 

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