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HAYEK VS. KEYNES

A COMPARISON BETWEEN THE IDEAS OF KEYNES AND HAYEK

Macroeconomics Innovative Assignment (Semester II)

Harshita Keswani (1007) FY - B

A comparison between the ideas of Keynes and Hayek on the Boom and Recession of the economy

Some of the key points which highlight the difference between the ideas of the two economists are as follows:

1. Keynes wanted to steer the markets and wanted government intervention to frame policies and keep the economy in equilibrium. Whereas, Hayek wanted to set the markets free.

2. According to Hayek, the boom and bust cycle takes place because of low interest rates but Keynesian view said that it happened because of animal spirits. ‘Animal Spirits in Keynesian Economics is a term used for emotional and intuitive factors that drive business decisions whether to make investment gambles. In other words, it is also the reckless spending of money without any savings.’

3. Keynes believed that the reason for persistent unemployment prevailed due to sticky wages and in order to overcome this, the economy should boost aggregate demand. ‘Sticky wages is another term used for nominal wages.’ Also he believed that if the circular flow is getting low, the government should spend more to get it back to normal. Since Hayek didn’t believe in government intervention and wanted to set markets free, he had no such concepts.

4. Also, Keynes believed in ‘Paradox of Thrift. The paradox of thrift states that, ‘If everyone tries to save more money during times of recession then aggregate demand will fall and will in turn lower total savings in the population because of decrease in consumption and economic growth.’ So according to him, savings lead to destruction. On the other hand, Hayek believed that in order to invest and pay back debt, real savings were necessary. Keynes

spending point of view is also highlighted in point (3) where he says government should spend more.

5. Keynesian Economics supports the notion that monetary and fiscal policies are equally correct. ‘Monetary Policy is the process by which the monetary authority of the country controls the supply of money often targeting the rate of interest for purpose of promoting economic growth and stability’ and ‘Fiscal Policy is the use of government expenditure and revenues to influence the economy.’ Hayek believed that boom gets started with the expansion of credit in the economy. The rates in the markets are low as a result of which the demand for real loanable funds falls and inflation rises.

6. Keynes said that an economy is like a window. Once it is broken it can never take the same shape. In context of the economy, once it is in disequilibrium, it may come back to the equilibrium level but the conditions will never be the same. Hayek’s theory highlighted the fact that market coordinates time with interest.

7. As read in the earlier points, Keynes’ point of view was to spend more. He also said that if the central bank’s interest policy tanks, it would lead to liquidity trap. ‘Liquidity Trap’ is a term used in Keynesian Economics to refer to a situation where monetary policy is unable to stimulate an economy, either through lowering interest rates or increasing the money supply. Hayek contradicts this point by saying that the boom turns into bust as the interest rates rise leading to a rise in cost of production. He says that credit crunch isn’t a liquidity trap instead it’s a broke banking system. ‘Credit Crunch’ is a reduction in the general availability of loans and credit or a sudden tightening of the conditions required to obtain loan from the banks. It is also referred to as ‘Credit Crises’.

The above points depicted how the theories of Keynes and Hayek were different from each other. In the present scenario, economists have come up with new theories that support the ideas of Keynes as well as the classical economists.