Keynes v. Hayek: Advantage Hawtrey

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.


21 Responses to “Keynes v. Hayek: Advantage Hawtrey”

  1. 1 Floccina September 7, 2011 at 6:39 am

    Wow excellent post. The puzzle in my mind that remains is what happened in the 1970s and 1980s. In the 1970s there was accelerating inflation along side of rising unemployment and in the 1980s there was decelerating inflation and falling unemployment. That makes me feel unsure that monetary policy can do the job. Of course I also do not see how fiscal policy could help much at all. We seem to still be groping in the dark with those who favor more generous welfare calling for fiscal policy, those against calling for more monetary policy and some conservative big savers sitting on cash (gold bugs and such a couple that I know well) saying liquidate so that they can buy up all the assets on the cheap.


  2. 2 Greg Ransom September 7, 2011 at 10:01 am

    Hayek endorsed the idea of below productivity norm, post-bust anti-deflation conter-measures explicitly in 1931 … including the new ones invented by Keynes in his _Treatise_. See part 2 of Hayek’s review of Keyne’s Treatise.

    Bloggers & professors with utterly amateur status as Hayek scholars are confused by Hayek’s view on what to do about British policy, policy opinions coming _seven_ and _eight_ years after Churchill’s fatal mistake of returning the massively inflated Pound back to the gold standard at the pre-war parity. In other words, Hayek was considering what to do in Britain 7 and 8 years after the British economy had already mostly re-equilibrated to Churchill’s forced deflation of the Pound.

    Often, this confusion is intentional .. e.g. on the part of dishonest & partisan Democrat “scholars” like Brad DeLong.

    There is a good video interview with Hayek on-line discussing all this on YouTube. Google Keynes & Hayek.


    “Hayek later disavowed his early policy recommendations in favor or allowing deflation to continue with no countermeasures.”


  3. 3 Greg Ransom September 7, 2011 at 10:04 am

    Here is that Hayek video on the post-1925 British deflation:


  4. 4 John September 7, 2011 at 11:51 am

    There was actually another Austrian vs Keynesian debate with Bob Murphy and Karl Smith (from a few days ago. I think it went better.


  5. 5 Benjamin Cole September 7, 2011 at 1:21 pm

    “hair-brained scheme” should be “hare-brained scheme.”

    Some people are anal about money. Others about the English language.

    I am afflicted with the latter curse.


  6. 7 W. Peden September 7, 2011 at 4:45 pm

    Another example of Hawtrey’s view being correct would be the British experience during the 1930s: sound finance and easy (but not too easy) monetary policy produced an astounding recovery. Only Keynesian mythologising has prevented it from being well known.


  7. 8 Lars Christensen September 8, 2011 at 1:09 pm

    David, What Hawtrey did for the UK Cassel did for Sweden…David, lets get a tribute to Cassel;-)


  8. 9 João Marcus Marinho Nunes September 8, 2011 at 1:28 pm

    This is another “view” from the period, being “followed” by present day “conservatives”!


  9. 10 Richard W September 8, 2011 at 5:31 pm

    ” It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam. ”

    From your paper maybe some US readers will not know what Keynes meant by saying Hayek could end up in Bedlam.

    Bedlam is the oldest psychiatric hospital in the world.


  10. 11 Lorenzo from Oz September 9, 2011 at 1:12 am

    Great post: clear and nicely explanatory.


  11. 12 John Lawson September 10, 2011 at 9:12 am

    I’m a total babe in the woods when it comes to economic theory, but unlike many economics blogs, yours is so beautifully written that it justifies itself on the level of style alone. Part of that stylistic sophistication lies in the structure of your arguments, the way you integrate supporting evidence, and the balanced a witty persona your writing creates. I look forward to each new post, enjoy browsing the archives, and I think I’m actually learning a lot. Thanks so much for doing this. I hope you’ll consider publishing a lot of this material in book form.


  12. 13 David Glasner September 10, 2011 at 10:36 pm

    Floccina, My take is that inflation in the US accelerated in the late 1960s and early 70s because of monetary expansion first to promote faster growth, then to help finance Vietnam War spending, and finally to get Nixon reelected. Just as the Fed was moving to counter inflation in 1973, the first oil shock hit after the Yom Kippur War, which caused both inflation and unemployment to rise just as unemployment was rising anyway because of the withdrawal of monetary stimulus. That’s when stagflation started. Inflation was brought down under 5% by the start of the Carter administration in 1977, but rapid monetary expansion raised inflation again, when the second oil shock hit after the Iranian Revolution in 1978-79. When Reagan came into office in 1981 on a pledge to reduce inflation he backed Fed chairman Volcker in bringing down inflation even though unemployment rose above 10%.

    Greg, I am sorry, but I can’t figure out what your description of the proposal that Hayek endorsed in 1931 is supposed to mean. Could you provide a page reference to Hayek’s review of Keynes either in the original or in his collected works? Your description of the British economy after the restoration of the dollar-sterling parity in 1925 seems way off to me. The British economy actually grew at a respectable pace with modest deflation of about 1-2% a year between 1925 and 1929 even though unemployment stayed above 10% for most of the period. It was only after the start of the Great Depression in late 1929 that deflation sped up and the economy contracted sharply (though not as sharply as in the US) while unemployment rose to about 20%. So I have no idea what you mean by this:

    In other words, Hayek was considering what to do in Britain 7 and 8 years after the British economy had already mostly re-equilibrated to Churchill’s forced deflation of the Pound.

    The British economy obviously had not “re-equilibrated” to the old parity in 1931 (6 years after the old parity was restored, not 7 or 8 ) is obvious from the fact that a recovery started in Britain in 1932 only after Britain abandoned the gold standard in September 1931, allowing the pound to fall from $4.76 to about $3.20 (a decision, I am sorry to say, that Hayek condemned, ipso facto demonstrating that Hayek favored deflation inasmuch as the British price level was governed by the rising value of gold until the gold standard was abandoned).

    John, Thanks for the link. I still haven’t had a chance to look at it, but I definitely will do so.

    W Peden, Correct! Have you looked at my piece on Keynes to which I provided a link above?

    Lars, Yes by all means let us do so. I felt a bit guilty for not mentioning Cassel more prominently in this post. He deserves as much credit as Hawtrey for having foreseen the disastrous consequences of a poorly managed restoration of the gold standard and having given the correct advice on how to manage that restoration and the correct advice on how to get out of the depression by abandoning what had become a hyper-dysfunctional gold standard. So let’s hear it for Cassel as well as for Hawtrey!

    Marcus, Thanks for the reference. I actually have a book by Palyi called the Twilight of Gold. I tried reading it many years ago, but found it incomprehensible. There are other books that I have tried to read only to find them incomprehensible. Sometimes such books do become comprehensible on the second or third try, but I don’t think that Palyi’s book would be one of them (though it might be the case that I would now have a better handle on what his mistakes were than when I tried reading it the first time.)

    Richard, Thanks for providing that bit of clarification.

    Lorenzo and John, I greatly appreciate your kind words. When I started blogging a couple of months ago, a couple of people warned me against writing long posts and I have not yet mastered the art of writing short posts, though I occasionally do write shorter ones. It’s good to know that I have some readers who are willing to put up with my verbosity. Actually, John, I do have hopes of writing a book comparing the Great and Little Depressions and assessing the various economic models that have been advanced to explain them. But so far that is just a gleam in my eye.


  13. 14 W. Peden September 11, 2011 at 8:49 pm

    David Glasner,

    I missed that among all the other links. I’ll definitely have a look at it.


  14. 15 Amanski March 29, 2012 at 9:35 pm

    “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.”

    You realize this is no argument, right ?

    That this is only debating by smearing :/


  15. 16 David Glasner April 1, 2012 at 9:28 pm

    Amanski, You are half right. I was not arguing; I was asserting that there was no inflationary boom in 1928-29. I believe the assertion is supported by the evidence, but you are free to draw your own conclusions. I absolutely deny that I was smearing Hayek and Mises, for the former of whom I have the utmost admiration. My feelings about Mises are somewhat ambivalent, but I certainly consider him to have been a great economist and scholar despite his extremism and dogmatism and intolerance of disagreement. And if you consider my description of Mises a smear, you obviously have not studied his work closely enough.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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