On Labor Day, I finally got around to watching the Keynes v. Hayek debate at the London School of Economics on August 3 between Robert Skidelsky and Duncan Weldon on behalf of Keynes and George Selgin and Jamie Whyte on behalf of Hayek. Inspired by the Hayek-Keynes rap videos, the debate, it seems to me, did not rise very far above the intellectual level of the rap videos, with both sides preferring to caricature the other side rather than engage in a debate on the merits. The format of the debate, emphasizing short declaratory statements and sound bites, invites such tactics.
Thus, Robert Skidelsky began the proceedings by lambasting Hayek for being a liquidationist in the manner of Andrew Mellon (as rather invidiously described by his boss, Herbert Hoover, in the latter’s quest in his memoirs for self-exculpation), even though Skidelsky surely is aware that Hayek later disavowed his early policy recommendations in favor of allowing deflation to continue with no countermeasures. Skidelsky credited FDR’s adoption of moderate Keynesian fiscal stimulus as the key to a gradual recovery from the Great Depression until massive spending on World War II brought about the Depression to a decisive conclusion.
Jamie Whyte responded with a notably extreme attack on Keynesian policies, denying that Keynesian policies, or apparently any policy other than pure laissez-faire, could lead to a “sustainable” recovery rather than just sow the seeds of the next downturn, embracing, in other words, the very caricature that Skidelsky had just unfairly used in his portrayal of Hayek as an out-of-touch ideologue. George Selgin was therefore left with the awkward task of defending Hayek against both Skidelsky and his own colleague.
Selgin contended that it was only in the 1929-31 period that Hayek argued for deflation as a way out of depression, but later came to recognize that a contraction of total spending, associated with an increasing demand by the public to hold cash, ought, in principle, to be offset by a corresponding increase in the money supply to stabilize the aggregate flow of expenditure. Larry White has documented the shift in Hayek’s views in a recent paper, but the argument is a tad disingenuous, because, despite having conceded this point in principle in some papers in the early to mid-1930s, Hayek remained skeptical that it could be implemented in practice, as Selgin has shown himself to be here. It was not until years later that Hayek expressed regret for his earlier stance and took an outspoken and unequivocal stand against deflation and a contraction in aggregate expenditure.
I happen to think that one can learn a lot form both Hayek and Keynes. Both were profound thinkers who had deep insights into economics and the workings of market economies. Emotionally, I have always been drawn more to Hayek, whom I knew personally and under whom I studied when he visited UCLA in my junior year, than to Keynes. But Hayek’s best work verged on the philosophical, and his philosophical and scholarly bent did not suit him for providing practical advice on policy. Hayek, himself, admitted to having been dazzled by Keynes’s intellect, but Keynes could be too clever by a half, and was inclined to be nasty and unprincipled when engaged in scholarly or policy disputes, the list of his victims including not only Hayek, but A. C. Pigou and D. H. Robertson, among others.
So if we are looking for a guide from the past to help us understand the nature of our present difficulties, someone who had a grasp of what went wrong in the Great Depression, why it happened and why it took so long to recover from, our go-to guy should not be Keynes or Hayek, but the eminent British economist, to whose memory this blog is dedicated, Ralph Hawtrey. (For further elaboration see my paper “Where Keynes Went Wrong.”) It was Hawtrey who, before anyone else, except possibly Gustav Cassel, recognized the deflationary danger inherent in restoring a gold standard after it had been disrupted and largely abandoned during World War I. It was Hawtrey, more emphatically than Keynes, who warned of the potential for a deflationary debacle as a result of a scramble for gold by countries seeking to restore the gold standard, a scramble that began in earnest in 1928 when the Bank of France began cashing in its foreign exchange reserves for gold bullion, a move coinciding with the attempt of the Federal Reserve System to check what it regarded as a stock-market bubble by raising interest rates, attracting an inflow of gold into the United States just when the Bank of France and other central banks were increasing their own demands for gold. It was the confluence of those policies in 1928-29, not a supposed inflationary boom that existed only in the imagination of Mises and Hayek and their followers that triggered the start of a downturn in the summer of 1929 and the stock-market crash of October 1929. Once the downturn and the deflation took hold, the dynamics of the gold standard transmitted a rapid appreciation in the real value of gold across the entire world from which the only escape was to abandon the gold standard.
Leaving the gold standard, thereby escaping the deflation associated with a rising value of gold, was the one sure method of bringing about recovery. Fiscal policy may have helped — certainly a slavish devotion to balancing the budget and reducing public debt – could do only harm, but monetary policy was the key. FDR, influenced by George Warren and Frank Pearson, two Cornell economists, grasped both the importance of stopping deflation and the role of the gold standard in producing and propagating deflation. So, despite the opposition of some of his closest advisers and the conventional wisdom of the international financial establishment, he followed the advice of Warren and Pearson and suspended the gold standard shortly after taking office, raising the gold price in stages from $20.67 an ounce to $35 an ounce. Almost at once, a recovery started, the fastest recovery over any 4-month period (from April through July 1933) in American history.
Had Roosevelt left well enough alone, the Great Depression might have been over within another year, or two at the most, but FDR could not keep himself from trying another hare-brained scheme, and forced the National Industrial Recovery Act through Congress in July 1933. Real and money wages jumped by 20% overnight; government sponsored cartels perversely cut back output to raise prices. As a result, the recovery slowed to a crawl, not picking up speed again till 1935 when the NRA was ruled unconstitutional by the Supreme Court. Thus, whatever recovery there was under FDR owed at least as much to monetary policy as to fiscal policy. Remember also that World War II was a period of rapid inflation and monetary expansion along with an increase in government spending for the war. In addition, the relapse into depression in 1937-38 was at least as much the result of monetary as of fiscal tightening.
I would never say forget about Keynes or Hayek, but really the true master– the man whom Keynes called his “grandparent in the paths of errancy” — was Ralph G. Hawtrey.