I argue that the economics of Hayek and Keynes diverges most significantly not with respect to policy but in their understanding of the role of capital in a market economy, and how capital relates to issues of savings and investment. Specifically, Hayek's Austrian conception of capital provides a different, and very disaggregated, vision of the market process that can help identify the flaws in Keynesian theory and policy. Hayek's view of capital forces the economist to consider the microeconomic foundations of macro economic phenomena in a way that validates Hayek's complaint that Keynes's aggregates conceal the fundamental mechanisms of change.
JEL Codes: B22, B31, E12
Keywords: Keynes; Capital theory; Business cycles; Macroeconomics; Hayek
The Great Recession of recent years has rekindled an economic debate that first erupted around 80 years ago between future Nobel Laureate Friedrich Hayek and Lord John Maynard Keynes, perhaps the most important economist of the 20 century. From thousands of pages of text in academic journals, popular magazines, and online, to a rap video that has been seen by more than 2 million viewers, this round of the Hayek-Keynes debate is, quite plausibly, even largerscale and more intense than the original. Much of the current conversation has focused on the ways in which the two thinkers' visions of the economy were so different and thereby led to very different policy conclusions. The general idea is that Hayek had much more confidence in the self-correcting powers of markets while Keynes was more focused on the ways in which those processes could break down. In turn, the Hayekian perspective on recessions has seen the boom that precedes the bust as being the period that deserves the most attention, as it is there that government manipulation of the monetary system leads to intertemporal dis coordination and the mistaken investments that are eventually revealed as the boom turns to bust. Keynesians, by contrast, have devoted their energy to the bust phase of the cycle, perhaps unsurprisingly as Keynes's magnum opus was written and published during the very depths of the Great Depression.
Although these differences are certainly real and meaningful, they only scratch the surface of what I will argue is the most fundamental difference between Hayek and Keynes. To understand why they disagreed on the degree to which markets were self-correcting and therefore the degree to which governments were needed and able to improve on the outcomes markets produced, we need to get behind the broad visions of self-adjustment and the role of government to their actual economics. Here too, much has been written about the very different approaches to what is now known as macroeconomics that can be found in each thinker's work. However, the differences are unlikely to be found at the level of, say, the Austrian business cycle theory as such versus the Keynesian income-expenditure model as such. Those "macro" models rest on very different visions of the underlying microeconomic processes. Each thinker's view of the stability of the macroeconomy is really a reflection of how each understood the coordination processes of the micro economy. More specifically, I will argue that it is how each thinker understood, or failed to understand, the role of capital in the market economy that is at the core of their contrasting visions of the economy as a whole. These contrasting conceptions of capital are crucial for their understanding of the broader issue of whether the market is capable of generating intertemporal coordination or whether it is prone to systematic failures. Keynesianism has long believed the latter, and I will argue that Keynes's flawed view of capital can help to explain why, as well as why his view of intertemporal coordination is mistaken. Finally, I will look at how these views of capital contribute to how Hayek and Keynes saw the …