Great Debates in Economics: Keynes versus Hayek
Keynes states “Public works, digging ditches, war has the same effect. Even a broken window helps the glass man have some wealth. The multiplier driving higher the economy’s health.” The Keynesian viewpoint argues that capitalism-based, market economies are inherently unstable. Private investment in particular is fickle and prone to extreme fluctuations driven by changes in business optimism, or what Keynes referred to as “animal spirits.” Moreover, the booms and busts will tend to feed on themselves, and therefore a market economy will swing back and forth between a boom that will lead to inflation and a bust that will generate high rates of unemployment. But there is good news in the Keynesian theory. Government can use fiscal and monetary policy to control aggregate demand and thereby promote economic stability. During a recession, government spending should be increased to offset the weak private investment, taxes should be reduced to stimulate consumption, budget deficits should be used to finance these activities, and finally monetary policy should keep interest rates low. Keynes is arguing that it does not matter much how the government spends stimulus funds. According to the Keynesian view, the key consideration is to spend the funds so they will generate income for those undertaking the project, and as those funds are spent, a multiple expansion in income and aggregate demand will result.
Keynes and Hayek had different ideas of savings in the economy. Keynes says “so forget about saving, get it straight out of your head. Like I said, in the long run—we’re all dead. Savings is destruction, that’s the paradox of thrift. Don’t keep money in your pocket, or that growth will never lift.” This meaning that he does not believe that saving is the way to lift an economy. Hayek says “real savings come first if you want to invest. The market coordinates time with...