Last Updated 07 Nov 2022

The Keynes VS Hayek

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Two economists, John Maynard Keynes and Friedrich A. Hayek, differed in economic thought that they formed two contrasting conservatories of economic thought. Hayek came from a school of laissez faire economics. This was known as the Austrian School. Keynes encouraged a government-centric approach that was named after him. John M. Keynes became discouraged at the outcome of British economic policy, particularly the serious policies imposed after World War I on the defeated Germany to pay. He predicted the Germans would one day, pay the allied nations back for the punitive, serious economic measures imposed on Germany. He was right because the harmful economic condition in Germany after WWI helped create a climate that allowed for the rise of Adolf Hitler.

The damaging payments hurt the German economy and the world economy by forcing Germany to make payments they could not make. As the Great Depression spread around the world, this only worsened. It also gave room to Keynes’ ideas for government spending. One of Keynes’ main points was the idea of the multiplier effect. This was the theory that a dollar spent by government would be multiplied by wages earned by employees employed through government projects which would produce more economic activity and boost Gross Domestic Product. Keynes’ idea caught on with the advent of World War II and the transition to a wartime economy.

In today’s political environment, traditionalists in America have mocked at Keynes’ theory while liberals have embraced him. Some, argue that Keynesian economics is essential to reserve capitalism. According to the New Yorker: “Astute conservatives have sometimes acknowledged that, fundamentally, Keynes was one of them; He came not to bury free enterprise but to save it from itself. “It is certain that the world will not much longer tolerate the unemployment which . . . is associated and in my view inevitably associated with present-day capitalistic individualism.” (Edmuson)

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The massive debt overshadowing many governments now, and the overwhelming deficits that they are running annually, has led to a revival of one of the most important counterpoints to Keynes economical philosophy F.A. Hayek argued that the economy cannot be controlled by political outcomes. He believed that it was not possible to know all the variables that go into an economic calculation making government interference ineffective at best and possibly even counterproductive. He believed that economic decisions could not be planned for in advance by the government. In Hayek’s words, doing so would betray a fatal vanity on the part of government bureaucrats which would only harm the economy more.

A respectable economic model is essential for the development of an organization, a firm, a company, and most importantly, a country. It is important to follow the right theories and make correct decisions at crucial times. In the last century, two highly talented economists proposed their own theories to be followed in the need of the hour. During the Great Depression, while the world was in dire need of pulling itself together, British economist John Maynard Keynes introduced the view that during the short term, the total expenditure influences the economic output, and total spending need not necessarily be a contributing factor to how productive the economy is. While Friedrich August Hayek, an Austrian (later British) economist, emphasized on the importance of free-market capitalism and believed in long-term planning.

Keynesian theory explained. As mentioned earlier, this theory focuses on the short-term goals. It states that the total spending of the economy, technically known as aggregate demand, is influenced by a number of factors, while the monetary output is influenced by aggregate demand. Some of the factors that influence the total expenditure include both fiscal and monetary policies. According to Keynes, these changes affect the output and employment, more than the prices. He firmly believed that we must live in the short run, because fluctuations in any component of the total expenditure (due to rigid prices), be it resource consumption or any investment, will cause the output to change.

This theory opposes its counterpart by stating that long-term investments must be considered and worked upon. Hayek said that the market evolves slowly as a result of human actions, and one of the reasons it fails to coordinate people's plans is the increase in the money supply. This results in cheap credit, distorted price signals, and artificial interest rates, which would result in excess investments in long-term projects. Ideally, he believed in long-term investments, but his central theme was the concept of equilibrium, i.e., coordination of all economic decisions.

Hayek’s economically central theme sees a connection among capital, monetary cycles and business cycles. He states that excess investment for the long term results in an economic bust which is a healthy way of readjustment. The best way to avoid these busts is to deal with their causes beforehand however according to Hayek’s theory. Keynesians economic stand point in reference to central theme states that prices show a slow response to demand and supply; this indirectly affects the labor forces.

When discussing attitudes, Hayek believes people are more rational whereas Keynes believes differently. Keynes thinks to fulfill current demands and meet requirements, people have more of an “animal-spirit.” Keynes focuses on pulling the economy out of the bust as soon as possible. Hayek has a long term focus; rather than moving expeditiously, this theory concentrates on avoiding boom-bust cycles. Keynes theory says that the market economy can be steered by the government; a regular circular flow of income exists due to predictable market forces. Hayek thinks it requires that the economy consists of free market forces although they are not very predictable.

The economic regulation does not have a good, positive economic regulation according to Hayek’s theory whereas the Keynes theory states its economic regulation is positive. In the Keynes theory bail outs are discussed in a way that the fact that it solves immediate problems first results in good bailouts. Hayek states it does not have good bailouts despite the following effective long term investments.

Keynes economic theory is pro-government. It believes that the government is knowledgeable and capable enough to improve the free market. It acts in the best interest of the people. Hayek beliefs are since it leads to mal-investment, this theory follows an anti-government policy; the people act in their own interests. Hayek’s theory has more respect for entrepreneurship and economic stability. Keynesian theory has more respect for job protection and human suffering.

The economy will settle down at the optimal level without any problem or hindrance according to Hayek. According to Keynes the economy settles down at the sub-optimal level, however it does so without any help. Savings should be hoarded for the future because it follows the classical view of Hayek’s theory. On the other hand, Keynes thinks that it firmly advocates that savings should be spent now. Since Hayek focuses on entrepreneurship, this theory believes that businesses do not run well or are not capable of running well must be liquidated as soon as possible. Keynes supports employment. Therefore, it believes in keeping bad businesses alive in order to protect job. This is especially during a recession. Many economists have now started to accept some corollaries of both theories from the two powerful economists. The biggest question is which theory is right? Which theory is wrong? Which theory must be followed to ensure the maximum benefit for the firm? Which theory suits best for the people? Overall which theory is best for the country?

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