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Keynes and Hayek: some commonalities and differences.

In this paper I will reflect on the relationship, both personal and intellectual, between John Maynard Keynes and Friedrich Hayek. The two are typically portrayed as intellectual rivals, and the differences between them juxtaposed in rather broad terms: Keynes as favoring government regulation of the economy, in particular control of the business cycle by deficit spending during a downturn; Hayek as favoring a free market economy with minimal intervention by the government. Now though there are certainly elements of truth in such broad portrayals, part of my goal in this paper is to establish that the actual history was (as is usually the case) more complicated, more nuanced, and as an historian I am obliged to add, more interesting.

So what about the actual Keynes-Hayek relationship? The first perhaps surprising fact to note is that when Hayek was a college student in Vienna after World War I, Keynes was one of his heroes, as he was to many central Europeans after the war. This was because of Keynes' condemnation of the harsh terms of the Versailles Peace Treaty in his Economic Consequences of the Peace (Keynes, [1919] 1971). Keynes' criticisms of the treaty had little effect, and Hayek was among those who witnessed firsthand the devastating hyperinflation that wiped out the savings of the middle classes in Austria and Germany in the early 1920s, which in many people's minds was instrumental in paving the way for the rise of fascism there. This gave Hayek a lifelong appreciation of the dangers of inflation.

About a decade later Hayek and Keynes crossed swords. In 1931 Hayek was invited to the London School of Economics to give four lectures on monetary theory. The lectures were published that year as a book with the title Prices and Production (Hayek, 1931). People who attended later told him that he was nearly incomprehensible when he was reading the lectures, but whenever he answered questions he was quite clear. Of course nothing impresses an academic audience like someone being incomprehensible, so the end result was that they offered him a job.

In the summer of that year, even before he even began teaching, he published a review of Keynes' new book, A Treatise on Money, a book that Keynes had been working on for years and which was supposed to establish his credentials as a major monetary theorist (Keynes, [1930] 1971). This initiated a fierce debate over their respective theories of the business cycle.

I say fierce because it really was unprecedented: one of Keynes' fellow Cambridge economists chastised Keynes in print afterward, likening his assault on Hayek to "body-line bowling"--this being a reference to the game of cricket, when the bowler aims for the batsman's body rather than for the wicket, a striking metaphor (see Pigou, 1935, pp.23-24).

The grounds for the debate were really quite simple--both men had in their respective theories of the cycle drawn upon a framework that had been developed by a Swedish economist named Knut Wicksell. Wicksell wrote in German. Hayek, of course, read German. Keynes, for his part, in a footnote in the Treatise made the fatally self-deprecating remark that "in German I can only clearly understand what I know already" (Keynes, [1930] 1971, Vol. 5, p.178). It was as if Keynes had painted a bull's-eye on the cover of his book. Hayek's critique was that Keynes had only borrowed a portion of Wicksell's framework, ignoring completely the capital theoretic foundations that Wicksell had developed in another book. In contrast, Hayek had incorporated Wicksell's capital theoretic insights into his own theory.

In its own quiet way, Hayek's review was a polite but really quite devastating attack: he basically said that Keynes had not done his homework. (Gunnar Myrdal, who would share the Nobel prize with Hayek some forty years later, was even less flattering, noting Keynes' book as an example of the British penchant for unnecessary originality.) If we recall that Keynes was a Cambridge don, the editor of The Economic Journal, and a major public figure in England, whereas Hayek, who at age 31 was 16 years Keynes' junior, was a young upstart from another country, and that this was all taking place as the "slump of 1930" was turning into the Great Depression, we can see that the stakes were pretty high.

Keynes was apoplectic about the review. His biographer noted that Keynes' copy of it was the most marked-up document in Keynes' collection of writings by others (Moggridge, in Keynes, 1973, p.243). As is usual in the academic world, he expressed his displeasure by writing a response to it that was published a few months later. What was unusual is that Keynes used the review not simply to defend his own theory but also to attack Hayek's book. And what an attack it was! I will quote from the most famous passage, which will give you some idea of the general tone:

The book as it stands, seems to me to 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 (Keynes [1931] 1973, p.252).

Body-line bowling indeed.

Both men eventually left the battle to work on new books. Keynes finished first, publishing in 1936 The General Theory, probably the most important book in 20th century economics, if one measures importance by the impact that it had on the thinking of economists and practice of economic policy (Keynes, [1936] 1973). Hayek's book, The Pure Theory of Capital, published five years later, was dense to the point of being almost unreadable (Hayek, [1941] 2007). He was to make his mark with another book, published as the war was coming to an end, The Road to Serfdom (Hayek, [1944] 2007).

There is a final twist to the story. Once the war had begun, the Keynes-Hayek relationship improved dramatically. They were on the same side in their recommendations for financing the war, with Hayek writing a strongly favorable review of Keynes' 1940 pamphlet, "How to Pay for the War" (Hayek, [1940] 1997). When the Battle of Britain began, the London School of Economics was evacuated to Cambridge, and Keynes found Hayek rooms at Kings College there. Finally, and most remarkably, after Keynes read The Road to Serfdom, he sent Hayek a letter in which he said,

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 (Keynes, [1944], 1980, p.385).

Hayek, for his part, said in a later interview, when asked to name the two people with whom he would most like to have a dinner and conversation, it was Keynes and Joseph Schumpeter. So as I said, the actual relationship between these two men was more complicated and interesting than one might first suppose.

I will now shift gears and look briefly at what I see as the chief differences between Hayek and Keynes. One of these of course has to do with their analyses of the business cycle. I think that the best starting point is to say that both of them were fully cognizant of the fact that a market system is occasionally plagued by a business cycle. I say this for two reasons: First, it sometimes seems like people today are surprised that a cycle could ever happen. And second, Hayek is sometimes portrayed as someone who thought that markets always work just fine. This is a man whose first book was titled Monetary Theory and the Trade Cycle (Hayek, 1933). Suffice it to say that Hayek was no Dr. Pangloss when it came to the workings of a market economy.

It turns out that Hayek's theory about the causes of a typical cycle offers a pretty good description of at least part of what happened in the latest meltdown, especially in terms of the Fed's interest rate policy and its effects on the housing sector. In Hayek's theory, problems start when the market rate of interest is held too low for too long. This always politically popular policy leads to malinvestment--too many investment projects get started that cannot ultimately be sustained. When people realize what has happened, investment spending collapses, and a recession begins. Recessions are the painful but necessary adjustment that returns the system back to equilibrium.

Where Keynes and Hayek differed, of course was in their response to the crisis. For Hayek, because a recession was the system moving itself back to equilibrium, he felt that any attempt to further inject credit into the system would just prolong the period of malinvestment and ultimately set the stage for a bout of inflation later. Hayek's counsel to simply sit back and let the system adjust was as politically popular during the 1930s as it is today--it was a non-starter.

Hayek's fears about inflation did not materialize after the Great Depression ended. On the other hand, they did materialize during the stagflation of the 1970s that marked the end of the activist Keynesian policy in the United States. Which of these two episodes has more relevance for the downturn of 2008 is anyone's guess. The danger, as both Keynes and Hayek recognized, was that fiscal and monetary stimulus will go on for too long. In many people's minds, the question boils down to this: Will Washington have the requisite knowledge and political will to start reducing the stimulus at just the right time?

This scary question brings us to a second difference between Keynes and Hayek. It was captured beautifully by Keynes' biographer Sir Roy Harrod, who talked of "the presuppositions of 6 Harvey Road," (that was the Keynes' family address in Cambridge), the idea that

Reform, in the larger, as in the smaller, sphere, was to be achieved primarily and principally by the discussion of intelligent people. In all vital matters their views would prevail. Public opinion would be wisely guided (Harrod, 1951, pp.3, 4).

Keynes was supremely confident that he and a small group of Oxbridge-trained experts could effectively manage the economy. Indeed, he was constantly making policy pronouncements and often changing his mind, so much so that he was often criticized or caricatured in the press. After one notorious policy flip-flop, there was a cartoon of Keynes as "the boneless man," and there was even a riff on the old joke about economists: "Where five economists are gathered together there will be six conflicting opinions, and two of them will be held by Keynes" (Jones, 1954, p.19).

Hayek, for his part, often spoke about the limits of our knowledge and the hubris of reason: we just do not have enough knowledge to control something as complex as an economy. George Will recently quoted Hayek on this point: "The curious task of economists is to demonstrate to men how little they know about what they imagine they can design" (Will 2009).

He was also wary about the effects of government intervention on the ability of ordinary people to make decisions. As he wrote in The Road to Serfdom, "The more the state plans, the more difficult planning becomes for the individual" (Hayek, [1944] 2007, p.114). The government itself can be one of the forces that induces uncertainty, and there is plentiful evidence of that happening in recent months.

Taken by itself, Hayek's message about the limits of our knowledge suggests the importance of proceeding with caution. If one links it up with other arguments about the nature of the political process, for example, those that are associated with the public choice school of James Buchanan, one's confidence that the political process will yield the right policy is further chastened.

Hayek's message, in short, is a much more depressing one than is Keynes'. These are depressing times, with many people hurting. But tonight is supposed to be a celebration of the start of a new Center, of Keynes, and of the art of Bloomsbury. So I will end with one of my favorite Keynes' stories, one that is always popular with my students and which offers a bit of a diversion. It is reported on here by his biographer, Roy Harrod:

... in his last two or three years he was in the habit of saying on festive occasions that the only thing he seriously regretted about the way in which he had managed his life was that he had not drunk more champagne! (Harrod, 1951, p.18).


Harrod, Roy. 1951. The Life of John Maynard Keynes. New York: Norton.

Hayek, Friedrich A. 1931. Prices and Production. London: Routledge.

Hayek, Friedrich A. 1933. Monetary Theory and the Trade Cycle. London: Cape.

Hayek, Friedrich A. 1940. "Book Review: John Maynard Keynes, How To Pay for the War." Repr. in The Collected Works of F. A. Hayek. Vol. 10. Socialism and War: Essays, Documents, Reviews, ed. Bruce Caldwell, 167-72. Chicago: University of Chicago Press, 1997.

Hayek, Friedrich A. 1941. The Collected Works of F. A. Hayek. Vol. 12: The Pure Theory of Capital, ed. Lawrence H. White. Chicago: University of Chicago Press, 2007.

Hayek, Friedrich A. 1944. The Collected Works of F. A. Hayek. Vol. 2: The Road to Serfdom: Texts and Documents, ed. Bruce Caldwell. Chicago: University of Chicago Press, 2007.

Jones, Thomas. 1954. A Diary with Letters, 1931-50. London: Oxford University Press.

Keynes, John Maynard. 1919. The Economic Consequences of the Peace. Repr. as Vol. 2 of The Collected Writings of John Maynard Keynes. London:

Macmillan, 1971.

Keynes, John Maynard. 1930. A Treatise on Money. Repr. as Vols. 5 and 6 of The Collected Writings of John Maynard Keynes. London: Macmillan, 1971.

Keynes, John Maynard. 1931. "The Pure Theory of Money: A Reply to Dr. Hayek." Repr. in The Collected Writings of John Maynard Keynes. Vol. 13: The General Theory and After: Part I, Preparation, ed. Donald Moggridge, 243-56. London: Macmillan, 1973.

Keynes, John Maynard. 1936. The General Theory of Money, Interest, and Employment. Repr. as Vol. 7 of The Collected Writings of John Maynard Keynes. London: Macmillan, 1973.

Keynes, John Maynard. 1944. "Letter to F. A. Hayek, June 28." Repr. in The Collected Writings of John Maynard Keynes. Vol. 27: Activities, 1940-1946. Shaping the Post-War World: Employment and Commodities, ed. Donald Moggridge, 385-88. London: Macmillan, 1980.

Keynes, John Maynard. 1973. The Collected Writings of John Maynard Keynes. Vol. 13: The General Theory and After: Part I, Preparation, ed. Donald Moggridge. London: Macmillan.

Pigou, A. C. 1935. Economics in Practice. London: Macmillan.

Will, George. 2009. "How the GOP Should Measure the Stimulus." Washington Post, July 29.

Bruce Caldwell *

Duke University

* This paper is a slightly revised version of a talk that I gave on February 17, 2009, to commemorate the creation of the Center for the History of Political Economy at Duke University.
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Author:Caldwell, Bruce
Publication:Journal of Private Enterprise
Geographic Code:4EUUK
Date:Sep 22, 2011
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