John Maynard Keynes John Maynard Keynes was born on 5 June 1883.

An Old Etonian, he excelled academically at Cambridge University - where he later taught. During World War I, Keynes joined the Treasury, and in the wake of the Versailles peace treaty, he criticised the exorbitant war reparations demanded from Germany, which he said would not only harm Germany's economy but that of other countries as Germany would not be able to afford to buy foreign exports. In 1944, he led the British delegation to the Bretton Woods conference in the United States. At the conference he played a significant role in the planning of the World Bank and the International Monetary Fund. Keynes advocated that governments could control the business cycle, and his theories proved very popular with western economies in the 1950s and 1960s. He died on 21 April 1946.

Friedrich August Hayek Friedrich August Hayek was born on 8 May 1899 in Austria-Hungary. The economist and philosopher, who taught at the LSE, is best known for his defence of free-market capitalism. Hayek served in World War I, and said the experience led him into his career in the hope that he could help society avoid the same mistakes that led to the war. The global Great Depression was the backdrop against which Hayek formulated many of his theories - especially those which were opposed to Keynes. After the British depression of the 1920s, Hayek promoted the idea that private investment, rather than government spending, would promote sustainable growth. In 1974 Hayek won the Nobel Prize for Economics for his pioneering work in the theory of money and economic fluctuations. Hayek lived in Austria, Great Britain, the United States and Germany, and became a British subject in 1938.

The severe global financial crisis that followed the 2008 financial crisis and the apparent inability of economic theory to explain ( let alone predict ) rekindled interest in the work of two great thinkers who influenced as few economic thought and government practice in the twentieth - century Austrian Friedrich Hayek and the British John Meynad Keynes . However today, the necessary reflection on the state of economic science should be based more on common assumptions that are shared by two lead men and less on existent differences among them. As the stock market crash of 1929 plunged the world into turmoil, two men emerged with competing claims on how to restore balance to economies gone awry. John Maynard Keynes, the mercurial Cambridge economist, believed that government had a duty to spend when others would not. He met his opposite in a little-known Austrian economics professor, Freidrich Hayek, who considered attempts to intervene both pointless and potentially dangerous. The battle lines thus drawn, Keynesian economics would dominate for decades and coincide with an era of unprecedented prosperity, but conservative economists and political leaders would eventually embrace and execute Hayek's contrary vision. The contemporary relevance of Keynes and Hayek, as present-day arguments over the virtues of the free market and government intervention rage with the same ferocity as they did in the 1930s. Undoubtedly the two thinkers divide large variations, but have been crass simplifications , misunderstandings and frequent (sometimes handy ) Fre interpretations , resulting in the current dominance of a Keynes caricature who wants to be identified with any kind of state regulation of economic activity and Hayek identified with a market fundamentalism . It is characteristic that Keynes to last text published after his death , highlights the (under conditions and time ) efficiency of " invisible hand (The Balance of Payments of the United States, Economic Journal, 1946) while respectively Hayek separated economic liberalism defended by the dogmatic application of laissez-faire ( the Road to slavery , 1944 ) . Root of the debate At its root the Keynes/Hayek clash concerned alternate theories about how business cycles work. The main difference between Keynes and Hayek theories are the situations that could lead into crisis and the way in which you encounter the crisis itself. Both theories of Keynes and Hayek consider as key element the indebtedness crisis. The conclusions, however, are different . For Hayek, the recovery has to do with the liquidation of surplus investment and the increase of savings.

For Keynes the recovery has to do with reducing the tendency for savings and the consumption growth in order to continue to exist having prospects in the business profitability. The Hayek demands more austerity, Keynes more spending. Differences For example, Keynes believed that intelligent, well-meaning planners manipulating economic aggregates such as demand and employment can bring about a happy end to business cycles. Hayek, by contrast, insisted that individual decisions and imbalances between specific prices and demand, or interest rates and specific plans for long-term productive projects, are where the economic action is. According to Hayek a monetary expansion decreases the nominal interest rate effect is lower than the real interest rate. Enterprises can in this case borrow more easily and turning them in producing consumer goods. The Keynes v. Hayek debate has been one of great controversy for many years. Keynes and Hayek were macroeconomics economists. Keyenes founded Keynesian Economics which is founded on a principle belief of demand-management. Demand-management is the principle that states that if planned correctly, the government and banks could get involved during an economic downturn, and restore full-employment. Keynes believed that the aggregate demand was the key measurement of economic activity throughout the nation. He argued that the banks and government could provide stimulus to the depression, which would create a demand for the resources of the nation so that full-employment could be reached. Hayek on the other hand, believed in liberalism. Liberalism is the principle belief that when there is an economic downturn, the government should stay out of the way. Hayekians believe that government stimulus packages would just make it more difficult for the private sectors to be able to efficiently self-repair its own problems. Hayek argued that the free market is far above the government when it comes to the allocation of goods and services. Hayek argued that the government should provide a few laws that the free market would have to obide that would allow the economy to work properly. Friedrich Hayek did not believe it was possible to spend your way out of an economic crash Hayek, et al. (Hayek for short), identified three areas of contention. First, they correctly identified Keynes's argument about the futility of savings as actually being an argument about what has classically been known as the dangers of hoarding, i.e., the potentially pernicious consequences of an economy-wide increase in the demand for money that is not met by a corresponding increase in the supply of money.

"It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable." Second, the London professors disputed that it mattered not the form spending took, whether on consumption or investment. They saw a "revival of investment as peculiarly desirable," as do today's proponents of supply-side economics. They distinguish between hoarding of money and savings that flows into securities, and reaffirm the importance of the securities markets in transforming savings into investment. Their third and greatest disagreement with Keynes was over the benefits of government spending financed by deficits. They demurred. "The existence of public debt on a large scale imposes frictions and obstacles to readjustment very much greater than the frictions and obstacles imposed by the existence of private debt." This was not the time for "new municipal swimming baths, &c" (Keynes's example). In our contemporary context, no stimulus. Finally, and importantly, they offered a way forward. Governments world-wide, led by the U.S. with the destructive Smoot-Hawley Tariff of 1930, had turned to protectionism and restrictions on capital flows. Hayek argued it was time "to abolish those restrictions on trade and the free movement of capital." The contribution of Keynes In the difficult days of the thirties , when the crisis decimated while sowing the storms that followed over the next decade , an economist stood up , he lifted above his ideologies that had inherited from his teachers , and tried to explain something that was both surprised himself and his teachers : the fact that in spite of wage reduction , interest rates, government's spending , employment, investments , economic activity , deficits were not improving . The more the employees were willing to work for pennies, the more reluctant became for employers to hire them. The lower the interest rate, the more factory owners avoid to borrow and invest in new products and new machinery. The time passed, wages fell, the official rate collapsed, assets evaporate, but "markets" stubbornly refused to recover: the investments that would attract by the rapid decline in labor costs and the cost of borrowing simply never came. It was a real mystery. In the market when the seller sometime reduce its price, usually increases the demand. The same with cars, houses, planes: the reduction of the price attracts buyers . But why this was not the case in the Great Depression of the thirties? Why the dramatic drop in 'price' did not lead to increase in "quantity "demand ( ie jobs , employment ); Keynes This mystery was undertaken to understand , and then explain to us , the Keynes. How? With a simple assumption: that what applies to markets, market and car stereo does not apply to two ' wayward ' markets - the labor market and the money market. In all other markets when the price drops sales increase. In times of crisis, however, said Keynes, in these two markets when the economy entered the global recession, the decline in "price" does not increase sales.

In labor markets, and money, at periods throughout the economy decline, reducing the " price ", ie the wage and the interest rate may well lead to a reduction in ' sales' , ie employment and investment. Keynes introduced in economics the idea that ' individual or micro market products and services function differently than operate all the markets together. That the rules governing the individual (eg buying computers) do not apply to the " whole " (for the economy as a whole ) . Since then, the adoption of the General Theory ( 1936 ) , begins the separation between micro (the study of " individual ") and macro (the study of the economy as an " organic whole ", with emphasis on ' problematic' purchases of labor and money) . In other words, Keynes argued, with much persuasion, that in the economy there is a gap between ' small ' and ' large , between the rules governing a company or an industry and those governing a macro - economy .

Keynes vs Hayek: The clash that defined modern economics

The confrontation between John Maynard Keynes, and his Austrian born free market adversary and friend, Friedrich August von Hayek, is one of the most famous in the history of contemporary economic thought. The debate took place during the Great Depression of the 1930s about the causes and remedies of business cycle downturns in market economies. The origins of this debate can be traced back to the book Treatise on Money (1930) written by Keynes, a rather obscure book, that was superseded by his masterpiece The General Theory of Employment, Interest, and Money (1936). Treatise on Money was a difficult book to read, and this probably caused Hayek and Keynes to misunderstand each other. As Keynes and Hayek were building their economic models at the same time, their debate was very much dominated by terminological definitions. One of the main topics that Keynes and Hayek corresponded about was the definition of savings and investment, and Hayek wrote three extensive systematic reviews of Treatise of Money. In turn, Keynes wrote only one article in response accusing Hayek of misrepresentation. The debate on Treatise of Money was rather one sided, and in 1932 Keynes withdrew from the debate to reshape and improve his central argument, which was to become The General Theory. This work became probably one of the most influential economic treatises immortalizing Keynes as one of the greatest 20th century economists. His lasting legacy, that was to become known as Keynesianism, is an economic perspective that argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes. The theory, therefore, advocates active policy responses by the public sector, including monetary policy actions by the central bank, and fiscal policy interventions by the government, to stabilize economic output over a business cycle. Many Keynesian economists have not regarded Hayek as their mans equal. However, there is an increasing agreement today that Hayek, although controversial, was one of the most influential 20th century economists. He made fundamental contributions to economics in the theory of business cycles, capital theory, and monetary theory. He was also awarded the Nobel Prize for economics in 1974, jointly with Gunnar Myrdal, for their pioneering work in the theory of money and economic fluctuations. Most of Hayeks work in the 1930s and the 1940s focused on the Austrian theory of business cycles. He believed that the price system of a free market was an efficient mechanism to coordinate peoples actions, and that markets were a result of spontaneous order that had evolved slowly over a long period of time, as a result of economic exchanges between people. that the Austrian School economists were more theoretical and mechanistic in their approach to economics, Hayek believed that

markets were highly organic, and any interference with the spontaneous order of free markets would distort their efficient operation. In fact, it can be argued that Keynes economic theory was more mechanistic, as economies could be manipulated in a machine-like fashion to behave according to the wishes of economic planners. A true Renaissance man, Hayek also made intellectual contributions in political theory, psychology, and methodology. It is perhaps because of his work in political theory that some economists, especially those with a Keynesian orientation, have wrongly dismissed his core economic research as ideologically motivated. This is the trap that Wapshott seems to walk in, either intentionally, or because of Hayeks criticism of the Keynesian model, that had become de facto orthodoxy for the most part of the 20th century, extends many decades, and to some extent, has remained unnoticed, or ignored, by many economists and policy-makers. Nevertheless, the book provides a delightful insight into the personalities of Keynes and Hayek. Keynes is portrayed as a privileged and bright economist at the top of his game effortlessly moving between academia, political elites, and his bohemian Bloomsbury group of friends. Hayek, however, is painted as a stiff, humorless, theoretical, and linguistically challenged, central European scholar, brought to London School of Economics (LSE) by Lionel Robbins to provide an alternative to the theories of Keynes and his Cambridge circus of almost evangelical followers. (3) Robbins, and the dons of the LSE, considered Keynes view that when free markets were left to their own devices, this sometimes caused economic slumps, and that decisive government action was needed to pull the economy back to an equilibrium state of full employment, as heresy. In contrast to Keynes, the Austrian economists thought that free markets, driven by peoples choices tended to adjust to equilibrium if left alone, and free from government intervention. Concerned with the increasing intellectual and policy influence by the new generation of Keynesian economists at Cambridge, Hayek was appointed to LSE to counterbalance Keynesian interventionist doctrine. Much less is spent on understanding the economics upon which the big-picture conflict was based. Indeed, Wapshott overemphasizes Hayeks 1944 book The Road to Serfdom, on the dangers of socialism. This book was written after Hayek moved to Britain where he observed that many British socialists were advocating some of the same policies of government control that had been advocated in Germany in the 1920s. His basic argument was that government control of peoples economic lives was a form of totalitarianism: Economic control is not merely control of a sector of human life which can be separated from the rest. it is the control of the means for all our ends (1944). The book became a best seller in the USA and it established Hayek as a leading classical liberal, or libertarian, as he would be called today. However, the success of the book, which was serialized in Readers Digest, typecast Hayek as a free market ideologue, detracting attention away from his scientific contribution in economics.

Wapshott provides a workmanlike description of Keynes theory, but his treatment of Hayeks economics and the critique of The General Theory, is woefully inadequate. The fundamental tenet of The General Theory is that there is a direct and positive relationship between employment and the aggregate expenditure in an economy. Therefore, according to Keynes, total demand determines the employment level in the economy, and the existence of unemployment indicates that aggregate demand is insufficient to employ all factors of production. Keynes considered that the capitalist system was volatile, and there were times when the level of demand would be insufficient to maintain full employment. Therefore, Keynes recommended that the public sector should address this by controlling the level of aggregate spending in the economy. His recommendations to reduce unemployment can be categorized as follows: Interest rates should be reduced as far as possible to encourage private investment; A progressive tax system should be used to divert income from the wealthy to the lower paid, as their propensity to consume is higher; (4) The government should actively participate in public investment activity to supplement private investment, should this prove insufficient to maintain a level of aggregate expenditure that corresponds with full employment. After the publication of The General Theory, Hayek did not critique Keynes work as was expected; this he regretted ever after (Hayek in Sanz-Bas, 2011). However, Hayeks critique of Keynes is incorporated into many of his works including Monetary Nationalism and International Stability (1937), Profit, Interest, and Investment (1939), The Pure Theory of Capital (1941), The Campaign Against Keynesian Inflation (1974), The Fatal Conceit (1988). (5) It is perhaps because of the extended period of Hayeks writing that Wapshott fails to provide a full account of Hayeks economic thinking in general, and the critique of Keynesian theory in particular. It is beyond the scope of this review to discuss Hayeks critique in detail. However, one of Hayeks main criticisms of The General Theory was about Keynes assumption that unemployment could be solved through increases in aggregate spending. Keynes linked aggregate spending with employment; if spending in the economy was increased sufficiently, this would result in workers getting their old jobs back, and the economic crisis would be averted. In contrast to Keynes, Hayek argued that the crisis was a direct result of the misallocation of resources during the previous economic booms. Hence, Keynes solution to reestablish the same distribution of resources would not provide a sustainable solution to unemployment. The only solution to systemic unemployment, according to Hayek, required a liquidation of wrong investments and reallocation of productive resources.

To quote Hayek: If the real cause of unemployment is that the distribution of labour does not correspond with the distribution of demand, the only way to create stable conditions of high employment which is not dependent on continued inflation (or physical controls) is to bring about a distribution of labour which matches the manner in which in which a stable money income will be spent (1950). What we can infer is that Keynes solution to economic crises was a short-term panacea, while Hayek advocated a market driven solution that would result in a more sustainable productive economic structure. Such a structure would be consistent with consumer preferences. Trade cycles, according to Hayek, were a result of the government interference with the spontaneous order of the markets. Hence, the only way to avoid booms and busts, trade cycles, is to prevent them form occurring in the first place. Wapshott concludes his book by crediting Keynes for saving capitalism a second time. He makes a reference to Keynesian doctrine for solving the Great Depression, and the applicability of the same dogmatic panacea for the Great Recession from the 2008 onwards. He conjures the ghost of the Keynesian high priest, John Kenneth Galbraith, who scolds conservatives in the English-speaking countries for embracing Hayekian economics: better to accept the unemployment, idled plants, and mass despair of the Great Depression, with all the resulting damage to the reputation of the capitalist system, than to retreat on true principle.. What Wapshott misses in his argument is Hayeks central proposition: booms and busts are a result of malinvestment created by the government interference in the operation of free market, a result of the very policies advocated by the dogmatic Keynesians of today. I find myself in an unpleasant situation. I had preached for forty years that the time to prevent the coming of a depression is during the boom. During the boom nobody listened to me. Now people again turn to me and ask how we can avoid the consequences of a policy about which I had constantly warned. I must witness the heads of governments of all Western industrial countries promising their people that they will stop the inflation and preserve full employment. But I know that they cannot do this. I even fear that attempts to postpone the inevitable crises by new inflationary path may temporarily succeed and make the eventual breakdown even worse (1979).

Footnotes: 1. Hayek, Economica, August 1931; Economica, February, 1932; Prices and Production, 1931 2. Keynes, Economica, November 1931. Keynes on Prices and Production: The book as it stands, seems to me be one of the most frightful muddles I have ever read, with scarcely a sound proposition in it. It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in bedlam. 3. A critical reader of the book cant help notice the leading language used by Wapshott from the start. Keynes is described to have a commonsense understanding, while Hayek is described as intellectual, rather than practical. Keynes is motivated by understanding real life dilemmas and improving the lives of others, whereas Hayek is boxed in as a theoretician. 4. Keynes assumed that as incomes rise, people tend to save more. Therefore, the societys propensity to consume reduces as more of the income is saved. As a result, the societys investment multiplier will be lower. According to Keynes, the market mechanism is incapable to connect savings with investment. Instead, investment is dependent on business expectations and the creditors liquidity preferences that determine interest rates. As a result, the capitalist system is prone to suffer from a systemic lack of demand and, as a consequence, a chronic level of unemployment. 5. For further discussion: Cochran, J. P. (2011) 21st century boom-bust and recession-recovery; Sanz Bas, D. (2011) Hayeks critique of Keynes; Caldwell, B. (1998) the reasons why Hayek did not critique The General Theory.

References: Caldwell, B. (1998) Why didnt Hayek review Keyness General Theory, History of Political Economy, 30:4. Cochran, J. P. (2011) Hayek and the 21st century boom-bust and recession-recovery, The Quarterly Journal of Austrian Economics, Vol. 14: 3. Hayek, F. A. (1944) The road to serfdom, Routledge, New York (2007) ______. (1950) Full employment, planning, and inflation. In Studies in Philosophy, Politics, and Economics, University of Chicago Press, Chicago. ______. (1979) Unemployment and monetary policy: government as generator of the business cycle, Cato Institute, San Francisco. Sanz-Bas, D. (2011) Hayeks critique of the general theory: a new view of the debate between Hayek and Keynes, The Quarterly Journal of Austrian Economics, Vol. 14: 3.

Keynes v Hayek: Two economic giants go head to head John Maynard Keynes and Friedrich August Hayek were two prominent economists of the Great Depression era with sharply contrasting views. The arguments they had in the 1930s have been revived in the wake of the latest global financial crisis.

When discussing Hayek it is important to correct a misconception: Hayek's is not a "do nothing" theory. It does not deny that we should maintain spending when boom turns to bust. But it goes further. Unlike Keynes, Hayek believed that genuine recovery from a post-boom crash called not just for adequate spending, but for a return to sustainable production - production purged of boom-era distortions caused by easy money. Hayek was dismissed as someone who wanted to "liquidate labour, liquidate stocks, liquidate the farmers," and so on. But an unsustainable boom is one after which some things really do need liquidating. The straightforward recipe for the revival of healthy investment following the 2008 crisis was to liquidate. Liquidate Bear Stearns! Liquidate Fannie Mae and Freddie Mac! Liquidate, in short, the whole sub-prime bubble-blowing apparatus that was nurtured by easy monetary policy. That would have meant letting insolvent banks that lent or invested unwisely go bust. But instead our governments chose to keep bad banks going and that is why quantitative easing has proven a failure. Quantitative easing failed because almost all the new money the government created has gone to shore up the balance sheets of irresponsible bankers. Now those banks sit on piles of idle cash while other businesses starve or cannot get started for want of credit. The economy is like a drunk throwing up the morning after the night before. It is disgorging itself - or trying to disgorge itself - of bad investments it was tempted to undertake largely because of easy money. Giving it still more money will not prevent the inevitable suffering. It might mask or delay it somewhat, but only at the cost of more suffering later. This is not the sort of advice that governments welcome. They want a painless, easy cure like the one Keynesians offer. But, as Hayekians warned again and again, there is no painless recovery from an unsustainable boom. The only way to have no pain is to avoid the boom itself.

Keynes's theory was forged in the Great Depression of 1929-1932 - the biggest economic collapse of modern times. As their economies contracted, governments responded to their mounting budget deficits by raising taxes and cutting spending. The Great Depression bottomed out at the end of 1932, with British unemployment having reached 20%, American unemployment even higher. Keynes wrote the General Theory in 1936 to explain why the recovery was so feeble. His revolutionary proposition was that following a big shock - usually a collapse in investment - there were no automatic recovery forces in a market economy. The economy would go on shrinking until it reached some sort of stability at a low level. Keynes called this position "under-employment equilibrium". The reason was that the level of activity - output and employment - depended on the level of aggregate demand or spending power. If spending power shrank, output would shrink. In this situation it was the government's job to increase its own spending to offset the decline in public spending - that is by running a deficit to whatever extent necessary. To cut government spending was completely the wrong policy in a slump. When an economy is booming, a hair shirt at the Treasury is the right policy, when it is stagnating it is the wrong policy. Keynes's message was: you cannot cut your way out of a slump; you have to grow your way out. Eighty years on we have still not fully learnt the lesson. Three years after the collapse of 2008, our economy is flat: there are no signs of growth, nor can the Osborne policy of a thousand cuts produce any. It was Friedrich Hayek, who represented the orthodox theories which Keynes attacked. According to Hayek the main cause of slumps was excessive credit creation by the banks leading to overspending. The boom was the illusion; the slump the reality. The situation following an injection of money by the banking system would be similar to that of a people on an isolated island, if, after having partially constructed an enormous machine they found they had exhausted all their savings before the new machine could turn out its products. They would then have no choice but to abandon, temporarily, the work on the new process and to devote all their labour to producing their daily bread without any capital. That is, go back to growing their own food - much as the Russians did when their economy collapsed in the early 1990s. Keynes was scathing in his comment on Hayek's book, Prices and Production, which he called "one of the most frightful muddles I have ever read". "It is an extraordinary example of how, starting with a mistake, a remorseless logician can end in Bedlam."