Friday, December 9, 2011

Krugman, Hayek versus Keynes and the Austrians

A bitter debate has broken out in the blogosphere about Hayek and what his legacy and influence was in modern economics.

The opening shot is fired by David Warsh, and then followed by Paul Krugman in a post that I am quite sympathetic to, as it happens:
David Warsh, “Ruizismus among the Austrians,”, December 4, 2011.

Paul Krugman, “Things That Never Happened In The History Of Macroeconomics,” December 5.
Other relevant anti-Hayek views:
Robert Vienneau, “On Hayek’s Lack Of Impact On Macroeconomic,” Thoughts On Economics, December 9, 2011.
Pro-Hayek responses are here:
Steven Horwitz, “Rizzo on Hayek vs. Keynes,” Coordination Problem, December 7, 2011.

Alex Tabarrok, “Hayek and Modern Macroeconomics,” Marginal Revolution, December 6, 2011.

“Hey Paul Krugman, Leading Economists Have Been Talking About Hayek’s Macro Throughout the Boom & Bust,”, December 5th, 2011.

Mario Rizzo, “Yes, Paul: It is Hayek versus Keynes,” ThinkMarkets, December 7, 2011.
The comments on Rizzo’s post are well worth reading as well, and above all this comment by Roger Koppl.

I will have much more to say about this soon, but some quick points:
(1) It is astonishing how quickly Austrians move to defend Hayek’s business cycle theory, when that is probably an example of one of his worst failures. Why do they persist in defending a theory based so obviously on neoclassical equilibrium models, when the latter are supposedly contrary to Austrian theory?

(2) When Krugman says that “Hayek essentially made a fool of himself early in the Great Depression,” he is entirely correct. There are two reasons why. The first is that his business cycle theory - while it certainly got traction at the LSE - was greeted with derision by economists at Cambridge in the tradition of Marshall:
“Immediately before giving his early 1931 lectures at LSE, which were his introduction to the school, Hayek gave a one-lecture to the Keynes-dominated Marshall Society at Cambridge. Richard Kahn, one of Keynes’ followers and later his literary executor, described the scene. Hayek had “a large audience of students, and also of leading members of the faculty. (Keynes was in London.) The members of the audience—to a man—were completely bewildered. Usually a Marshall Society talk is followed by a lively and protracted barrage of discussions and questions. On this occasion there was complete silence. I felt I had to break the ice. So I got up and asked, ‘Is it your view that if I went out tomorrow and bought a new overcoat, that would increase unemployment?’ ‘Yes,’ said Hayek. ‘But,’ pointing to his triangles on the board, ‘it would take a very long mathematical argument to explain why’” (Ebenstein 2003: 53).
Secondly, Hayek retreated from the stupidity of his liquidationism that he had held in the early 1930s:
“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).
(3) The later Hayek is found endorsing monetary stabilisation and giving qualified support for fiscal policy, positions which are essentially Keynesian:
“Did Hayek Advocate Public Works in a Depression?,” September 25, 2011.
Funny how these, especially point (3), have gone down the memory hole.

There are many other things to be said, and I intend to update this post after some more reading.


Some additional literature worth reading that is mentioned in this comment by Roger Koppl on Rizzo’s ThinkMarkets post:

Butos, W. N. and R. Koppl, 1997. “The Varieties of Subjectivism: Keynes and Hayek on Expectations,” History of Political Economy 29.2: 327–359.

Koppl, R. and W. J. Luther, 2011. “Hayek, Keynes, and Modern Macroeconomics,” Review of Austrian Economics (July): 1-19.
This paper can also be downloaded through the Social Science Research Network (SSRN).

Prychitko, David L. 2010. “Competing Explanations of the Minsky Moment: The Financial Instability Hypothesis in Light of Austrian Theory,” Review of Austrian Economics 23: 199-221.


Ebenstein, A. O. 2003. Friedrich Hayek: A Biography, University of Chicago Press, Chicago, Ill. and London.

Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas, Routledge & Kegan Paul, London.


  1. While I do agree with your position Lord Keynes, is the Keynes versus Hayek debate really all that new? See this review by Dr. Brady that suggests one dimension of the Keynes vs. Hayek debate is foreshadowed by another debate dating from the Enlightenment.

    And here's another working paper by Dr. Brady that discusses two of the aforementioned Enlightenment economists.

  2. David Warsh perhaps did not need to comment on Hayek's personal life.

    However, his personal life is partially relevant to how he became marginalised. Yes, his views were considered outdated. But why did fellow sympathisers and pro-markets also reject him? Why did Lionel Robbins, Milton Friedman, and others refuse to speak to him or give him a position in their departments when he was hunting for a job?

    Obviously because they did not the appreciate the fact that he left his entire family - wife and grown children - to marry his childhood sweetheart, with nothing but a note.

    The result being that even a free marketer such as Friedman refused to give Hayek a position in University of Chicago. A reminder that no matter how hard people try to be otherwise, they can not ignore people's personal failings when evaluating their professional judgment.

  3. "Why did Lionel Robbins, Milton Friedman, and others refuse to speak to him or give him a position in their departments when he was hunting for a job?"

    I'm not so sure about Friedman's attitude to Hayek. See this comment by Bruce Caldwell:

    "It must also be noted that it is a rumor, not a fact, that Friedman played a role in Hayek not getting a job at Chicago.

  4. Robert Vienneau has the last word in the debate (as usual!):

  5. Unlearningecon,

    A very nice link to Robert Vienneau.


  6. LK, what did you think of Michael Brady's review of Nicholas Wapshott's book?

  7. "LK, what did you think of Michael Brady's review of Nicholas Wapshott's book? "

    Very interesting.

    Some minor points:

    "Both Keynes and Smith are virtue ethicists while both Bentham and Hayek were utilitarians following Locke."

    I not so sure about Smith. There has been a longstanding problem about Smith's ethics - the so-called "Adam Smith problem": how the virtue ethics of the Theory of Moral Sentiments fits in with the Wealth of Nations. As I seem to remember, Smith also endorses some version of natural rights.

    Both Keynes and Smith base their policy on the virtue ethicist's pursuit of justice as the ultimate goal of ethics, which includes social, political, and economic justice.

    I do know that Keynes was influenced by Moore's Principia Ethica. Keynes said that he rejected the consequentialist portions of that treatise, though this statement is perhaps questionable when looking at Keynes' practical moral reasoning, e.g., R. B. Braithwaite, 2005 [1975], "Keynes as a Philosopher," in M. Keynes (ed.), Essays on John Maynard Keynes, Cambridge University Press, Cambridge, pp. 243-244.

    Also, it seems to me that virtue ethics is merely a subspecies of teleological/consequentialist ethics: virtue ethics and utilitarianism all come under the same general category.

  8. I do have to agree that there has been too much importance placed on Hayek and his impact on Macroeconomics. I think many of his ideas were good, especially on capital theory (in his 30s years), and that he did engage in some crucial debates with Keynes early on, but his contribution and significance towards modern economics is overblown. The two most famous "laissze faire" economists will always be Milton Friedman and Adam Smith.

    The problem with Hayek is that he deviated substantially from Mises in many ways. Not saying this itself is the "problem", but it becomes an issue because many people conflate Hayek's ideas with Mises. And then add Rothbard, who more visibly disagreed with Hayek on many issues. The discrepancy can be seen best by looking at the two most dominant strands of current Austrianism, i.e, the folks at the Mises Institute, who try to follow in the praxeological footsteps of Mises and Rothbard, and those of the George Mason/Coordination Problem/Free Banking etc folks, who base their Austrian ideas off of folks like Hayek, Lachman, Kirzner, add in some other thinkers from other schools, etc. Their differences can be enormous, especially in the realm of methodology, money, equilibrium constructs, and so on and so forth. The Austrian School of Economics, pre 2008, is so nitch and unheard of that most people assume that all of the ideas from their thinkers were similar. For many people, FA Hayek and Schumpeter (who wasn't really a full blown Austrian) are the most famous Austrians.

  9. "the folks at the Mises Institute, who try to follow in the praxeological footsteps of Mises and Rothbard,"

    The Mises Institute Austrians depart even from Mises, e.g., Mises accepted a consequentialist argument for the existence of a minimal state and even certian government interventions on consequentialist moral grounds:

    “Economics neither approves nor disapproves of government measures restricting production and output. It merely considers it its duty to clarify the consequences of such measures. The choice of policies to be adopted devolves upon the people. But in choosing they must not disregard the teachings of economics if they want to attain the ends sought. There are certainly cases in which people may consider definite restrictive measures as justified. Regulations concerning fire prevention are restrictive and raise the cost of production. But the curtailment of total output they bring about is the price to be paid for avoidance of greater disaster. The decision about each restrictive measure is to be made on the ground of a meticulous weighing of the costs to be incurred and the prize to be obtained. No reasonable man could possibly question this rule (Mises, L. 1998 [1949]. Human Action: A Treatise on Economics, Ludwig von Mises Institute, Auburn, Ala. p. 741).

    You don't see arguments like that on

  10. Thanks fr responding. To me at least, virtue ethics is not a sub-species of consequentialist ethics, it's a unique branch of moral philosophy different from the utilitarian variety or the deontological variety.

    Also, what did you make of Dr. Brady's comparison paper of Adam Smith, John Maynard Keynes, and Jeremy Bentham? I thought it was an excellent and insightful work!

  11. "The Mises Institute Austrians depart even from Mises, e.g., Mises accepted a consequentialist argument for the existence of a minimal state and even certian government interventions on consequentialist moral grounds:"

    Not everyone at is an anarchist, nor do all books printed/sold by Mises org espouse fullblown "Rothbardian" laissez faire/praxeology.

    Mises' utilitarianism/etc was criticized by Rothbard, and not everything Mises says is 'A-okay', just like not everything Rothbard says is 'A-okay'. I don't believe this particular quote is Mises' way of advocating fire regulations, but his main point is that economics is value free and economics can only teach the consequences of action, and not judge whether such action is "good" or "bad" or what "should be done" (Mises was not perfect on this, especially his utilitarianism, and Rothbard soundly criticized him on this point). When deciding between a a regulation, Mises says people must weigh between the benefits and the costs. Sometimes people may perceive the benefits to be greater than the costs, and go with a regulation (e.g. fire). But I think his point always was that government regulation can never improve prosperity.

    Just two pages earlier:

    "However, government does not have the power to encourage one branch of production except by curtailing other branches...What alone counts is the fact that people are forced to forego some satisfactions which they value more highly and are compensated only by satisfactions which they value less...While government has no power to make people more prosperous by interference with business, it certainly does have the power to make them less satisfied by restriction of production." (p.737)