So, more than 80 years after Friedrich Hayek and John Maynard Keynes first crossed swords, who won the most famous duel in the history of economics?
Although Keynesianism has been declared dead a number of times since the mid-1970s, Milton Friedman’s acknowledgment in 1966 that “in one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian” is a more accurate, if teasingly ambiguous, assessment of the state of economics in the early 21st century.
One key difference between the two men, whether an economy is best understood from the top down or the bottom up, through macroeconomics or microeconomics, left Keynes in the ascendant. His big-picture approach is universally used today, as are such concepts as gross domestic product, key tools by which economists measure an economy.
Friedman, in his monetarist prescriptions, refined Keynes, but he didn’t replace him. Monetarism “has benefited much from Keynes’s work,” he wrote in 1970. “If Keynes were alive today, he would no doubt be at the forefront of the [monetarist] counter-revolution.” Keynes was looking for a cure for mass unemployment. His remedy was to increase total aggregate demand. He suggested a number of routes: through monetary means, by lowering interest rates and funneling new money into the economy; by tax breaks; and through public works.
Friedman convinced economists that when on an even keel, the economy would be served better by a gradual, moderate, predictable increase in the supply of money. It was Friedman, not Keynes, whom most economists and politicians from the mid- 1970s on adopted as their guide, after the application of all three of Keynes’s remedies simultaneously for three decades resulted in stagflation. From the moment in 1979 when Paul Volcker, then the Federal Reserve chairman, rebooted the economy by deliberately inducing a recession, Friedman’s principles were widely applied. Friedman adopted Keynes’s idea of running an economy through macroeconomics, and politicians have gone along with it, whatever Hayekian rhetoric they may sometimes employ.
Hayek took an absolutist position, that because no one could know what was in the minds of every member of society, and that the best indicator of their conflicting needs was market prices, all attempts to direct an economy were misplaced. Over time, his failure to attract support during the Keynesian hegemony appeared to drive him into arguing his case ad absurdum. Eventually Hayek wanted state power to withdraw to a minimal citadel, and he wished to see every last element of the economy, even the issuance of money, in private hands because he challenged the state’s monopoly of money-creating powers. This put him in direct opposition to Friedman, who, while wishing for the government to be minimized, believed that an economy should be managed to provide steady growth.
While Hayek may have risen in influence in the last 30 years, Keynes has never been far from economists’ thoughts. The federal government’s urgent response to the financial crisis of 2007-8, initiated by George W. Bush and continued by Barack Obama, was thoroughly Keynesian, with both administrations intervening in the marketplace to head off the economy’s collapse. America faced an existential threat, and as in the 1930s, a failure to act was considered so foolhardy it was barely contemplated.
At the height of the crisis, there were few in the short run who countered this resurgence of Keynesianism, even fewer who with a straight face promoted the Hayekian solution, to let the market find its own level. The view of Austrian-American political philosopher Joseph Schumpeter that the free market must from time to time endure a period of “creative destruction” wasn’t allowed to be put to the test. Having so markedly been proved wrong, the widely held assumption that the free market always righted itself over time wasn’t given a second chance. Few have tried to plot the dire consequences that would accompany the collapse of the economy: How many people made unemployed; how many deprived of their homes; how many declared bankrupt; and how many businesses shuttered.
Yet Bush and Obama received little credit for taking precipitate action to avoid an economic Armageddon. And Keynesianism proved to be no panacea. As the stimulus failed to quickly reduce the numbers of unemployed, and the tales of “wasted” money for contentious public programs began to spread, many Americans became alarmed at the extent of government borrowing. For some, such as Harvard economics professor Robert Barro, Keynes became a figure of derision, a pied piper who lured the children of future generations into a dark cave of intolerable indebtedness. Others accused Obama and his economic advisers of being closet socialists. Hayek’s Austrian School argument -- that public money put into investments would be wasted -- was dusted off.
Like Keynes and Hayek, John Kenneth Galbraith didn’t live to see the Great Recession, but he had an explanation for why conservatives couldn’t applaud Keynes’s efforts to save capitalism from itself.
“Keynes was exceedingly comfortable with the economic system he so brilliantly explored,” observed Galbraith. “So the broad thrust of his efforts, like that of Roosevelt, was conservative; it was to help ensure that the system would survive. But such conservatism in the English-speaking countries does not appeal to the truly committed conservative. . . . 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. . . . When capitalism finally succumbs, it will be to the thunderous cheers of those who are celebrating their final victory over people like Keynes.”