Monday, February 8, 2010

John Maynard Keynes vs. Fredrick A. Hayek

Many people seem to have difficulty understanding the differences between economic theories. The two schools of economics I will discuss are the Austrian School of Economics versus the Keynesian philosophy and which one I believe is better.
I start off with a quote from John Maynard Keynes book The General Theory: “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 that believe themselves to be quite exempt from intellectual influence are usually are the slaves of some defunct economist.” I believe that Keynes wrote this because he himself knew that stimulating the economy and increasing aggregate demand through government spending in theory would work in the short term but would only make the free market function less effective in the long run.
Keynes believed that it was the job of economists to steer markets through monetary and fiscal policy. In a recession or depression the problem of “sticky wages” is solved by boosting aggregate demand. Aggregate demand is the total of consumption plus investment plus government spending. Keynes belief was that as the economy is vibrant and growing that wages will be bid upward until the economy slows. Once the economy slows, wages will become sticky and inelastic to demand. When this happens it’s the government job to stimulate spending which should further keep wages up and spur economic growth. The government can do this through public works, digging ditches, and war. All of these actions will have the same effect and boost aggregate demand. Keynes also discussed the paradox of thrift and believed that because in the long run we all die there’s no long run benefit of saving of saving a good chunk of your earned wages. Furthermore, if you have a bad interest rate monetary policy and there’s a liquidity trap then deficit spending might be the cure. A liquidity trap is money stuck in the bank that should be lent out to allow businesses the opportunity to grow but after a large credit expansion banks will hoard the cash to repair their balance sheets which were destroyed during the inevitable bust.
On the other side of the coin you have Fredrick A. Hayek of the Austrian School of Economics that believes in setting the market free. Austrian economists believe that Keynesians ignore human action and motivation. When credit is cheap and interest rates are artificially low, the money supply is being inflated at the Federal Reserve. The credit expansion is planting the seeds of the inevitable bust which is built in the system. This system of expanding the money supply allows politicians the cover for bailouts, payoffs, and buying votes through mechanizations and the lure of a free lunch. In the end all the taxpayer is left with is a ton of debt to payback. When living high on the cheap credit hog don’t look for a cure from the hair of the dog that bit you. You can’t cure a debt crisis with more debt just like you can’t cure an alcoholic with more alcohol. Real savings must come first if you want to invest the market coordinates time with interest. The mal investments that wreck the economy in the bust period is devalued capital that is fueled by low artificial interest rates and the expansion of credit. The money flowing from the Federal Reserve is confused with new loanable funds and is just inflation looking for a place to go. All that’s left after the boom is devalued capital which doesn’t make up the slack. Focusing on spending in the long run is a theory that’s dead and also immoral. FDR once said “In politics, nothing happens by accident. If it happens you can bet it was planned that way.” Stimulus via government spending makes things worse because of the perverse incentives. The end result of the credit crunch isn’t a liquidity trap but a broke banking system. In Hayek’s book The Fatal Conceit he is quoted writing “The curious task of Economics is to demonstrate to man how little they really know about what they imagine they can design”.
Problems are engineered to provoke fear and public outcry. The reaction of the public shock and outrage is channeled through the media’s control. Then the inevitable solution is willfully and unquestionably accepted by the public as correct and in their best interests. Keynes is quoted in his book The End of Laisez-Faire, The Economic Consequences of Peace; “For at least another hundred years we must pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still” In conclusion in Keynes book The General Theory he writes: “The theory of aggregate production, which is the point of the following book, nevertheless can be much easier adapted to conditions of totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies that I call my theory a general theory.”

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