Hayek vs Keynes debate rebroadcast

Back in the ’30s, at the time of the original Keynes-Hayek debate, Hayek had a solid methodological system that could explain the causes of the recession of the late ’20s and early ’30s, and it’s subsequent gyrations, up and down.

The root cause was excessive credit creation by the world’s main central banks, and their fractional reserve private sector mints, the banks. This bank credit was loaned out to businesses who bought extra kit to produce goods and services more efficiently. The boom in producer sectors bid up relative prices for their resources. Higher wages for labour meant more consumption, boosting consumer sectors. This in turn pushed up relative prices in those sectors. Competition for resources bid up prices until no one believed the prices were sustainable — pop goes the mega bubble, and boom turns to bust. This is called the Austrian Theory of the Business Cycle.

At the BBC LSE Hayek v Keynes debate, Lord Skidelsky told us that everyone knew it was excess credit that caused this boom, and that this was called the “Treasury View.”

This of course is not true; the noble Lord is misinformed. The Treasury View was advanced by members of the Chancellor’s department saying, in short, that for every increase in public expenditure advocated by Keynesian types to alleviate the Great Depression effects, there would be an equivalent reduction in private sector expenditure that would mean that the net effect in the economy is zero.

Whilst I hold that this is a valid view, it is not one that gives us the theoretical tools to understand why boom and bust happen in the first place. Mises and Hayek gave us these tools with the Austrian Theory of the Business Cycle.

Neither the Treasury View, as expounded by the likes of Ralph Hawtrey, nor the Keynesian view were based on a series of logical deductions from root causes. The best Keynes could offer as an explanation for boom and bust was “animal spirits”.  He is Theory Lite in this respect.

Unfazed by his shaky foundation, Keynes confidently prescribed how to correct an animal-spirit-induced bust.  We are told to spend when the private sector is not spending. Who does this? The government on our behalf.  The Treasury View makes clear that it’s futile to tax the private sector in order to spend, so we have the cries from modern day Keynesians to carry on borrowing and spending in order to force a correction . If you haven’t got the correction you desire, you have not borrowed enough! So say the likes of Krugman and Skidelsky, drunk on the intoxicating work of Keynes.

The faulty logic than runs underneath this way of thinking is called the “Circular Flow of Income.” This is now bread and butter in any economics text book. One person’s income, when spent on goods and services, becomes another person’s income. Cut one and you cut all. Therefore, a series of cuts or austerity measures is exactly what you should not be doing at a time of bust; you need to keep everyone’s income up.

Hayek held that relative prices and income where what mattered, not gross aggregates . If a man has an income of £100 and costs of £90, we can say he has a profit of £10. Then recession hits and he has an income of £85 and still costs of £90, so he is sunk by £5. Thus the aim of the man in question, with income of £85 is to get his costs down to under £75 and restore his profitability. As this is done, the foundations for recovery are laid. Even better, if he can get costs to £74, on lower income and a lower costs base, he is in fact more profitable than in the glorious boom times!

In the 5 mins each speaker had in this debate to present their case, some of this came across and some of it did not. Jamie Whyte and George Selgin did a fantastic job at putting forward the case for Hayek. Skidelsky sadly did not represent Keynes very truthfully, for the reasons I have outlined above. Selgin picked him up on various other errors and misrepresentations.

This debate is very relevant for today as no doubt we will be told the current market corrections are “Animal Spirits”, and that the answer is further government intervention.

The BBC tell us the debate had over 1 million listeners and was in their top 5 podcasts. In all my years studying at the LSE and as a donor to it, I have never seen three lecture theatres full of public and students alike. Not even for visiting Heads of State!

This is the debate of our times.

I am delighted to say that the program will be re-run, and they expect another 1.5 millions viewers.  Our friend at the Mises Institute, Stephan Kinsella, has blogged all the details here. If you want to educate yourself a little more on these matters, or even if you think you are very familiar with all of the issues, the debate is definitely worth a listen.  If you can’t wait for the next BBC broadcast, you can find it online as an MP3.

Since the original broadcast, the debate has continued online.  On the 3rd of August, PrimeEconomics published a list of eight alleged fallacies in the Keynes/Hayek debate, drawing a number of responses, including some from George Selgin.  On the same day, Selgin posted his own account of the debate at FreeBanking.org.  More recently, on the 18th of August, Selgin took up Skidelsky’s suggestion that “no government has ever achieved a speedy recovery from a recession by clamping down on its spending or reducing its indebtedness”, citing the US recovery from a deep recession in 1920.  The following day, Skidelsky published his account of the Keynes-Hayek rematch at Project Syndicate, declaring

Except to Hayekian fanatics, it seems obvious that the coordinated global stimulus of 2009 stopped the slide into another Great Depression.

You can read Selgin’s response at FreeBanking.org.

Personally, I look forward to the day when Paul Krugman will come and stand on that same stage where Hayek delivered his famous Prices and Production lectures, and engage in serious debate with Austrian economists. How many lecture theatres would that fill? What global TV audience would it draw?

For those at the BBC and for those at the LSE, I think my next Distinguished Hayek Fellowship Teaching Programme event the LSE should be just this debate, and I would be happy to support and fund whatever I can. I repeat, this is the debate of our times.  Only someone of the stature of Krugman can represent Keynes, we need to move this debate up and along now.

Related articles
  • Hayek vs Keynes at the LSE – John Phelan, 27 July 2011


  • Paul Danon says:

    Government spending is actually private spending. The money spent has been appropriated from real people (or it will be later through debt-repayments). It’s all the same (private) money, except money that’s expropriated by government is spent in politicians’ interests rather than the people’s. Far from being mean and destructive, cuts in public spending, borrowing and taxation are like a lovely, gift-wrapped present from government to people, making the latter freer and richer. As with so much to do with government, though, the present is tainted – it’s really a gift back to us of what is actually ours.

  • What’s the relevance of the man with an income of £100 and costs of £90 who sees his income drop to £85 in a recession?

    Presumably the implication is that EVERYONE should cut costs in a recession. But that’s a physical and mathematical impossibility because each person’s expenditure is someone else’s income. An ATTEMPT by everyone to save money in a recession just leads to inadequate aggregate spending, which means excess unemployment: Keynes’s “paradox of thrift”, or “excess demand for money” to use a more recent and currently fashionable phrase.

    • Simon Bennett says:

      Hello Ralph

      Surely in a true recession/depression the money supply reduces, due to liquidation of unsustainable debts and malinvestments. This is deflation, which leads to the fall in prices of assets, goods, services, labour, etc. This fall in prices is the market naturally adjusting after the artificial credit expansion.

      The whole point of this natural process of market correction is not so much about the sustaining or destroying of demand, but about fundamental shifts in the structure of pricing and production. If people and businesses are engaged in fundamentally unproductive activities they need to become unemployed/go out of business so that these precious resources are then able to move to activities which are more productive and profitable.

      It seems to me that Keynesianism ignores this simple and self evident reality. Trying to keep prices high and wages from falling is simply standing in the way of the market healing itself, and is ultimately counter productive and hugely damaging.

      Deflation is a necessary consequence of inflation. To put it simply, the only way to prevent a bust is not to have a boom in the first place. Once the boom has happened the bust must happen. The longer it is put off the worse the final debacle will be.

      The example of the man with falling wages is really false, since it assumes that as his wages fall his costs remain the same. In a deflationary period both wages AND prices fall. Whether his costs and his wages go up or down relative to one another is completely dependent on the particular distortions that are present in the economy, which were created by the previous artificial credit expansion.

      One of the many errors of Keynesian theory is the assumption that saving is ultimately destructive. This is absurd, since the excess savings should naturally be channelled into investment in the means production, thereby making the economy ultimately more productive. These savings will only be stuffed under the mattress and hence not put to good use if interest rates are kept artificially low by central planners!

    • Rob Thorpe says:

      An ATTEMPT by everyone to save money in a recession just leads to inadequate aggregate spending, which means excess unemployment: Keynes’s “paradox of thrift”, or “excess demand for money” to use a more recent and currently fashionable phrase.

      Just to clear it up for other debaters, I think what Ralph means here by “saving” is the act of saving, not a stock of savings. So, I save if I receive some income and put it in a bank account or buy bonds. In this case “income” means wages or profits, not returns from sales of assets, it means income in the GDP sense.

      In this sense Ralph is quite right. If more income is saved and there isn’t a corresponding rise in investment spending (or consumer spending) then GDP will fall. This is the Samuelson cross. Money is spent on existing assets bidding up their price rather than on components of output. The issue though is: what exactly does it mean?

      The problem here, as Toby points out, is the confusion of wealth with GDP. GDP measures output not wealth. The overall wealth of a society is the capability to produce output, not the output itself. The output itself is a crude proxy for it.

      The public may decide to save on net, if they do so then GDP will fall temporarily. However, that isn’t necessarily detrimental. It may be that the real value of the many various components of GDP output has fallen and the real value of the many various existing assets has risen. If that happens then asset prices and the interest rate will adjust, and the relative prices of outputs will adjust too in time. Then after that growth of GDP will resume.

      The “paradox of thrift” which you discuss here is quite different to the “excess demand for money”. The idea of an excess demand for money is much older.

      When the Keynesians talk about the paradox of thrift they are talking about what I’ve described above. They’re concerned mainly about a change in the relative values that are ascribed to outputs and existing assets. I see no way of resolving this difficulty, I don’t see how any government official can see that the savings “leakage from the output flow” is too large.

      The target of monetary disequilibrium theory and “quasi-monetarism” is on money holdings not savings. It makes no difference to a Keynesian if savings come in the form of money, a current account balance or as bonds. It makes all the difference to us though because the latter isn’t a form of money. The aim of monetary disequilibrium based policies is to prevent plans being made on false information. It’s specifically to prevent unexpected inflation and deflation from confusing planning. It doesn’t gaurantee anything about GDP, it leaves the relative prices of produced and non-produced goods to find their own equilibria.

  • Toby Baxendale says:

    Ralph, all people who are producing unproductively on the new demand reality need to cut costs back. The quicker they do this, the better . The more profitable companies and household balance sheets, the better and the quicker the recovery. This is a relative move, not a move in aggregate.

  • Samuel Eglington says:

    I caught a bit of channel 4 news the other night an American economist was giving the Keyenian view unopposed. His comment that if busineses and consumers aren’t spending government is the only spender left and has to keep the economy going is pure nonsense. I’m a small businessman the reason I’m not spending is because I don’t know what anything is worth or what it is likely to be worth in the future. Nor do I have any idea what my customers will be able never mind willing to pay for my products. It is only when government stops wasteing my future earning potential on preventing deflation and allows the market to adjust (something it seems likely to do regardless) that I can start spending my capital in a productive way.

    • Simon Bennett says:

      Morning Samuel

      Some good solid common sense! I like you am extremely irked by the media’s obsession with putting forward the Keynesian lies which are promoting “solutions” which prevent the economy from fixing itself, and greatly magnifying the already dire position that we find ourself in. A position which incidentally, in my view at least, was caused precisely by those self same Keynesian policies in the first place.

      Keynesianism is quackery of the highest order and its proponents, like the buffoon Paul Krugman, are dangerous if well intentioned fools. I think the award of a Nobel prize to Krugman speaks volumes about the decay which has spread to the very heart of the western establishment.

  • Whig says:

    The debate was thought-provoking and good publicity, but I don’t really feel it will change any one’s mind. Keynesianism (whether that’s Keynes himself or simply those who profess to support him) remains an unsound but convenient mask for those who support government intervention in economies, frequently from entirely ulterior motives. Contrastingly, the only logical motive a Hayekian can have is that he seeks greater wealth creation.
    The main point, one that George Selgin tried to get across – I’m not sure he was quite clear enough on it – is that expressed here. The Hayekian view explains the boom-bust cycle; the Keynesian position is a misguided attempt to clear up the mess caused by government intervention with further government intervention! It’s one thing to argue over the possible means to alleviate the bust, but surely the most important object should be to avoid the boom-bust cycle altogether. It’s clear that it’s here that Hayekian economics has something unique to offer whereas Keynesian interventionism has nothing.

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