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Q&A: Keynes or Hayek - did the crisis prove either heavyweight right?

The debate over whether governments should spend us out of recession or let market forces deal with the mess is hotting up again. Which of the founding fathers of modern economics was right?

Q&A: Keynes or Hayek - did the crisis prove either heavyweight right?

The row about whether governments should spend us out of recession or let market forces deal with the mess is hotting up again. But who is right?

As the US prepares for congressional elections in November the row about whether President Obama’s response to the crisis was flawed is picking up pace with the opposition saying the government should change tack, stop throwing money at the problem and allow the market to take over the reins.

What are the two camps saying?

Obama has recently announced plans for another $180 billion in stimulus made up of $50 billion in fresh spending and $130 billion in tax breaks for small businesses.

The Republicans are calling for a halt to the stimulus saying that the money that the government has already spent is being wasted. With the jobless recovery they argue that stimulus cannot work and market forces need to be allowed to re-price the market.

At the core of the row is the fact that left wing politicians base their views on the work of John Maynard Keynes while the Republicans in the US believe Austrian economist Friedrich August Hayek had it right.

What did Keynes and Hayek recommend?

Keynes argued that the market cannot always be relied upon and governments need to step in with monetary and fiscal policies when growth falters.

His ideas were taken up by many governments around the world after the Second World War but were spurned in the 1970s as economists argued that the government was not able to smooth the economic cycle.  

One of Keynes' most visceral critics was Hayek who argued that Keynes wasn’t really an economist at all. He argued that the market needs to be free of government shackles to work effectively

The debate was dead in the water and Keynes seemingly confined to history until, faced with a growing certainty that the ramifications of the banking crisis were going to be far-reaching, politicians decided to step in.

Still not sure who said what? Watch Hayek and Keynes face off in 'Fear the Boom and Bust', a rap battle from Yes, really.

So were the bailouts based on Keynes?

For his supporters the unravelling of the world economy provided the much-needed real world test of his theories.

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28 comments so far. Why not have your say?


Sep 27, 2010 at 09:58

It would be funny if it wasn't so serious.

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Sep 27, 2010 at 10:06

The problem is both theories are largely unfalsifiable. If the American economy fails to recover then Keynesians will point to the fact that the Republicans blocked a larger stimulus, whereas Hayekians will say that the stimulus was too large and that caused the problem. Without access to an alternate path of history it is difficult to see who was right.

On the other hand: Ireland and Spain were two countries in broadly similar positions at the start of this recession (banks failing, housing bubble, high unemployment). Ireland made deep cuts and is now in a double-dip recession, while Spain managed to halve their deficit through a large stimulus that increased tax receipts (this is before they were forced to make cuts by outside forces). Does that mean Keynes was right and Hayek supporters are free market fantasists? It's not for me to say, but the answer is definitely yes.

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jeff lampert

Sep 27, 2010 at 10:20

Wrong Questuion:

The answer to the right question is:

Double-entry book keeping is open to abuse: it causes "leveraging and de-leveraging" by artificial figures, creating false and alleged profits, on which vast unearnt bonuses are paid!

Keynes realised this!

Hayek did not!

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Truth Searcher

Sep 27, 2010 at 10:36

I always thought part of Keynes theory was to save in the good times to pay for buying a way out of recession in the bad times. Well we all know how governments spend at every good or bad time to excess so it would never be provable one way or another, until it's actually tried. same goes for the Austrian theory, until it's tried no one will know.

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William Bishop

Sep 27, 2010 at 11:05

It is easy to say what Hayek would have recommended; letting nature take its course, and, if this led to a 1930s style depression, that would have been a necessary corrective to prior excess. No doubt Keynes would have been in favour of a bail out and some immediate government support in order to avert the above. It is by no means clear, however, what his attitude would have been to very large government deficits as a legacy of this process, once economies were, if rather tentatively, on the recovery path. Keynes' original criticisms of government policy were of attempts to continue pursuing a balanced budget when economies were in danger of collapse. His view of deficits of 10%+ of GDP when economies were no longer in such danger was never defined, but could well have been quite different from what the Krugman/Balls element seems to presume.

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Chris Powell

Sep 27, 2010 at 11:19

Truth is that it is all about the exchange rate.

Keynes theory only worked in the 30's for the UK and Japan because there currency collapsed. It did not for the US and they relied on World war 2, to start booming.

Japan has spent and spent over the last 20 years with a small amount of QE and are still not pulling out of a deflationary period. They have not had a weak currency.

The EURO is the problem in Ireland, Greece etc.

This is why the UK is such a basket case this time around. We have had a massive de-valuation but we have no business left to benefit. We are a public sector country. We are now open for business.

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Catherine Byrne

Sep 27, 2010 at 12:28

Only ONE can be trusted. Obvious which one... As an accountant, I was often asked "How much tax will I pay? The answer, of course, is "How much do you want to pay?" The "market" or rather the PLAYERS in it, have no wider responsibility than to THEMSELVES - and I think we all know how THAT works...

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Sep 27, 2010 at 12:37

There was a crucial difference in the 1930s - according to Keynes himself Britain receive annual interest payments on international investment amounting to £100mn - that is about £3bn in today's money Today Britain is paying out interest at around £40 bn a year and rising.

He also emphasised that when urging people to spend he emphasized that they should buy British-made goods.

WHat a hope today.

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William Phillips

Sep 27, 2010 at 13:22

Why choose either defunct western bourgeois liberal thinker?

Why not ask the Chinese how they manage 10% growth and a good deal of piratical capitalism under the aegis of strict dirigiste planning, with the occasional death sentence for exploiters, a rudimentary welfare state and absolutely no electoral democracy? Which oriental thinker inspires the Beijing leaders?

For about half a millennium the West dominated the world under a system of private ownership and gold-based money originating in mediaeval Italy, By now it has degenerated into parliamentary follies and stagnation in share prices, while politicians fiddle their exes, social mobility freezes, money is paper and banksters are bailed out by the toiling masses.

Maybe the next 500 years will belong to the rising Asian powers who will have quite other ways of doing things... and who will impose their moeurs on us as we once tried to foist ours on them.

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Sep 27, 2010 at 13:44

I have just looked up Keynes's letter to Hayek after reading his book The Road to Serfdom. I shall quote:

"We all have the greatest reason to be grateful to you for saying so well what needed to be said. It is a grand book.

You will not expect me to accept quite all the economic dicta in it , but morally and philosophically I find myself in agreement with virtually the whole of it; and not only in agreement with it, but in a deeply moved agreement.

28 June 1944.

You were saying?

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Catherine Byrne

Sep 27, 2010 at 14:30

The market players STILL can't be trusted, Bernard. I hope you never buy another tap washer from Wolseley from today. Why don't we all pretend we're Swiss-domiciled and no-one need pay tax. Ask Lord Ashcroft for tips.

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David Evershed

Sep 27, 2010 at 15:01

Is quantative easing Keynsian or Hayekian or something else?

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jeff lampert

Sep 27, 2010 at 15:33

William Phillips

Are you suggesting an alternative to "double entry bookeeping" and repeated leveraging and deleveraging?

In which case we are on nearly the same page!!

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an elder one

Sep 27, 2010 at 16:43

I used to think I was a bit thick in not being able to understand 'economics', but am now to some degree reassured by the appearence, that judging by the ongoing debates on its inherent mechanisms, no one else does either. Let us all hope that our government accidently gets it right.

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jeff lampert

Sep 27, 2010 at 17:04


Supply vs Demand = Price

followed by


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an elder one

Sep 27, 2010 at 17:08

For what its worth I suggest neither Keynes nor Hayek disagreed with the other, they were after all debating the same subject but with different emphases. From the little involvement I had years ago in decision making by the artificies of Kepner Treogo the ultimate solution will depend on the relative weightings of the various parameters in the mathematical model; which are usually entirely subjective, with all the vested interests that entertains.

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Sep 27, 2010 at 18:01

Old English adage, and no doubt every language has an adage of like effect, wisdom of millennia, cut you coat according to the cloth you have.

If in a deep hole, stop digging.

Keynes may have had the idea of govt spending, assuming the budget was in balance, but I doubt that he would have sanctioned devaluation (QE) when the budget spending was so out of kilter to income and already driving us into a deep hole.

That would mean digging even deeper, and then having the earth pile down on top of you because you were so deep you couldn't throw it clear of the whole.

This is a temporary solution because later prices will rocket (they already have nearly doubled for basics, and imported) even further as we so dilute the currency that Mugabe will seem quite prudent (his cash is in dollars, not Zimbabwe currency) and his wife gets her money from her stolen farms and factories in dollars, probably outside the country in breach of regulations.

Better we cut now and excise the ulcer, rather than bathe it in warm water soothing the now pain so that it gets worse, as many are advocating (Balls for one and that is balls), because the pain will be longer lasting and more severe and the cuts ever deeper and worse whilst we wait and anyway, whenever we do it, the unions will strike and the damage done will be even greater.

If we wait the borrowings will be greater because we have to borrow more to pay the extra ( on redundant civil servants/quangos, done by Brown to hide and massage the unemployment figures, wages, and build up pension liabilities as well as have to service ever greater borrowings. The point of hyper inflation is rapidly being approached at which point we go into Zimbabwe hyper/super inflation, a fact which has escaped Bliar/Brown/Balls and Cable so far.

The Americans will soon discover their folly of following the socialist ideal. I.E. if this were food, they will soon be subsisting on gruel.

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Chris Kenney

Sep 27, 2010 at 19:48

How you spend your way out of a crisis when we have no money and the crisis was caused by debt?

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an elder one

Sep 27, 2010 at 20:10

Chris, you print some more until it is worth so little that the debt has virtually disappeared.

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an elder one

Sep 27, 2010 at 20:11

Shades of Weimar

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an elder one

Sep 27, 2010 at 20:12

and everyones wealth besides

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Terry Nicholas

Sep 27, 2010 at 20:15

It's not one or the other, it's a bit of both. After allowing market forces to take care of the excesses of the 1920's the US government increased spending and started an 80 year boom. This time, after Gordon Brown decides to try it backwards, it could be an 80 year bust.

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Catherine Byrne

Sep 27, 2010 at 20:48

Am I seeing he same old, same old bigoted Daily Mail cliches from some of the same names here? Listen, most people did well over the last dozen or so years. Most of the ones who are complaining (apart, of course from simple hatred of anything vaguely "Socialist") have themselves to blame - going wild with cheap money. Then blaming Brown, as if HE caused the worldwide financial chaos.

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an elder one

Sep 27, 2010 at 21:19

No one is blaming Brown for the worldwide chaos; that was due to greedy short termists playing with too many financial experiments; arguably to enable political aspirations - for the finance boys a useful encouragement - in some cases (home ownership for the many); Brown just made it worse here than elsewhere by flogging the family silver (sorry gold) and spending money that was not his and could not pay back as it turned out; not unlike a Ponzi when everything seems fine, until eventually the music stops.

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an elder one

Sep 27, 2010 at 21:39

Furthermore, most if not all did quite well over those dozen or so years, some exceedingly so as we have seen, but unfortunately for many ordinary people the reckoning approaches every day closer. Let us all see when it does arrive whether those dozen or so years with Mr Brown's pilotage were worth it.

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jeff lampert

Sep 27, 2010 at 22:15

Oh elder one, what part of Capitalism, as operated by Vince Cable's targets is NOT a "Ponzi" scheme?

Our pensions?

Public company shares we are encouraged to invest in?

Noty to metions CD and other financial instruments of mass destruction!

Eventually Madoff will be recognised as the Keynes of our time!!!

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Victor Meldrew

Sep 28, 2010 at 01:46

There are other theories, I rather like Hyman Minsky's financial instability hypothesis. He described the effects of hedge borrowers, speculative borrowers and Ponzi borrowers, back in the 60's and 70's.

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Rose G

Sep 28, 2010 at 08:30

I would not look to China for solutions - given the lack of human rights, the numbers of companies found to have sold products contaminated (including milk products for their babies), & causing death. After the many earthquakes revealed how shoddy workmanship has been in their building projects, how shabbily its people were treated when they were removed to make way for the Olympics, I would not hold China up as an economy or as a society in which ethical issues play any part.

It is amazing that in Britain today, our manufacturing base has been eroded as a result of the constant underselling of the price of our goods as a result of cheap & shoddy products from the asian continent - our workers are losing their jobs, & here we are wanting more cheap & shoddy goods to enter our markets!

If it is all about profits, I shudder to think how a Chinese style government would go down in the UK?

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