Hayek and Keynes: What Have We Learned?
O'Driscoll, Gerald P., Journal of Private Enterprise
In 1932, there was an exchange of letters to the Times between a group of Cambridge and Oxford economists, including J. M. Keynes. A group of University of London economists, including F. A. Hayek, responded. It was a public manifestation of the Hayek/Keynes controversies that would roil the economics profession. The Hayek/Keynes debate both repeated 19th century controversies and anticipated differences of theory and policy that spilled into the 21st century. These included the role of saving, public spending, private investment, and budget deficits. The financial crisis and the emergence of large structural deficits make the debate relevant once again.
JEL Codes: B22, B25, B31, E21
Keywords: Keynes; Hayek; Deflation; Knowledge problem; Investment; Deficits; Say's Law
"The great debate is still Keynes versus Hayek. All else is footnote."
-Mario J. Rizzo, New York University
By 1932, the world was engulfed in depression, and the economics profession was enlivened by the debate between John Maynard Keynes and Friedrich A. Hayek on the causes and cures for that depression. The debate is conventionally dated to have begun with Hayek's two-part review of Keynes' Treatise on Money (Caldwell, 2004, p. 177). The debate was aimed at the profession and carried chiefly out in professional journals such as Economica and Economic Journal. As Caldwell (2004, p. 176) observes, "their exchange was one episode in the much larger story of the making of the Keynesian revolution [including] the battle between Cambridge and the LSE. . ." The aforementioned journals were the house publications of the two schools.
The debate was held outside the view of the general public. But in 1932, it broke out with letters to The Times (of London) in a manner making the essential arguments accessible, if not to the general public, at least to the readers of The Times. The policy recommendations are presented clearly by both sides. The letters are lengthy (almost mini op eds by today's standard), but the analysis is sketchy and limited by space considerations. There is little room for hedging, and conclusions are presented starkly. The reader gets the gestalt of the two sides, shorn of the complexities of their respective models. Brevity has benefits.
It is chiefly a battle of London versus Cambridge. The opening salvo was a letter dated October 17, 1932, and signed by six economists: D.H. MacGregor of Oxford and five Cambridge men: A.C. Pigou, Keynes, Walter Layton, Arthur Salter, and J. C. Stamp. The University of London response was printed two days later and signed by T.E. Gregory, F.A. von Hayek, Arnold Plant, and Lionel Robbins. The positions staked out, however, came to be most associated with Keynes and Hayek (the third and second signatories, respectively, on their sides). For shorthand, I will refer to "Keynes" and "Hayek." I do so both for ease of exposition (form), and because I believe the views in the two letters by and large represent the mature positions of Keynes and Hayek (substance). I take note where that may not be true.
II. Keynes Letter
Keynes opens with the observation that in time of war it is "a patriotic duty" of private citizens to curtail consumption to release resources to the government "for a vital national purpose." In other words, citizens must save more. The conditions of 1932 require quite the opposite. There is a "lack of confidence," and there is no guarantee that savings will be transformed into either public or private investment.
The private economy intensifies the effect of a lack of confidence, and discourages all forms of investment leading to consumption output. As a consequence, private economy cuts down national income by almost the amount of additional savings.
In a depression, the public interest requires that the public consume, not save. And citizens acting collectively should spend collectively even on projects such as a "swimming-bath, or a library, or a museum. …