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Talking points for the Keynes-Hayek Debate

Here is the prepared version of my opening statement for the Keynes-Hayek debate sponsored by Reuters that was held in New York City tonight. Due to time constraints, I skipped over some bullet points.

The video recording is now available: here.

• Friedrich Hayek developed a business cycle theory that explains how overly cheap credit from the central bank gives rise to an investment boom. In the boom, because interest rates are unsustainably low, investment is badly misallocated
o The boom is bound to go bust.
o Hayek’s theory doesn’t explain every recession in history, but it certainly does fit our recent housing boom and bust.
• The fit between Hayek’s theory and recent events is why we see the revival of interest in Hayek
o It’s why there’s a Hayek-Keynes rap video (“Fear the Boom and Bust”) with 3 million views.
o It’s why Nick Wapshott made Hayek the co-star of his book
o It’s why we are here discussing Hayek as the alternative to Keynes in anti-recession policy.
• By the way, for an account of the broader intellectual context of the Keynes-Hayek dispute, let me modestly recommend my forthcoming book, The Clash of Economic Ideas: Policy Debates and Experiments of the Last Hundred Years
o Available April 2012 from Cambridge University Press.

• In stark contrast to Hayek, the Keynesian theory of depressions offers no theory of the boom-bust cycle.
o Keynesian models completely abstract from the structure of production in the economy.
o The Capital stock is just one big uniformly productive lump
 Investment just makes the lump bigger, so there is no such thing as over-investment or wrongly directed investment
 it doesn’t matter where investment goes
 Employment is just employment.
o Keynesian models consequently fail to see how labor and capital are misallocated in a credit boom
o Or why economic recovery and sustainable growth are not just about aggregate demand.

• After the dot-com bubble burst in 2001, the Fed ramped up aggregate demand with rapid monetary expansion and ultralow interest rates, as Keynesians recommended.
o The Fed almost seemed to be trying to create a housing bubble to replace the Nasdaq bubble
o That experiment didn’t work out so well, did it?
o We have permanently reduced our real standard of living for wasting so much capital overinvesting in housing during the boom.

• So, What would Hayek have us do? Two things:
o Create a consistent monetary environment for saving and investment, without interest-rate distortions
o let necessary economic recalculation and adjustment take place.
• Critics have tried to tar Hayek as someone indifferent to the deflationary collapse of spending in the early 1930s, as though he counseled doing nothing to stop it.
o It's a bum rap.
o If they would actually read Hayek’s 1931 book Prices and Production, or his 1937 book Monetary Nationalism and International Stability, they would learn that he actually counseled central banks to prevent a collapse in spending.
o Hayek understood that a spending collapse has dire real consequences due to price stickiness.
o He did not subscribe to the Panglossian model of frictionless markets that some critics find a convenient straw man.
• Hayek explicitly called for constancy of what he called “the total money stream,” i.e. stabilization of nominal GDP.
o He was a forerunner of NGDP targeting
o To keep “the total money stream” constant means expanding the quantity of high-powered money to offset any forces shrinking the broader stock of money, or any increase in hoarding
o We can fault Hayek personally for failing to stay on this message consistently in the early 1930s.
 He himself later pleaded mea culpa on that.
o But his explicit monetary policy norm – to maintain nominal spending, is clear, and sensible, and not “do nothing”
 It would have prevented the deflationary spiral of the early 1930s, if the Fed had listened
 It would be an improvement today over the Fed’s unanchored policy

• Hayek’s perspective has further implications for re-starting sustainable economic growth after the bust:
o Don’t undertake public works whose costs exceed benefits—they are a waste
o Let market forces correct the real capital misallocations created by easy money during the boom
o Let artificially high asset prices fall relative to consumer prices
 Preferably not by inflating consumer prices.
o Let unemployed talent and idle machines move as rapidly as possible into appropriate and sustainable new employments.
 This means avoiding bailouts and subsidies and other forms of cronyism that misdirect investment
• If our goal is sustainable real growth, then we need to recognize that, contrary to Keynes, we cannot restore prosperity by building pyramids.