Robert Skidelsky
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Keynes versus Hayek
Robert Skidelsky
Friday, October 29, 2010

In his memoirs, the British economist Lionel Robbins called his argument with Keynes over what to do about the Great Depression “the greatest professional mistake of my life”. As a Hayekian, Robbins advocated doing nothing and leaving it to natural forces to bring about a recovery. Keynes, as we know, advocated a big stimulus. Looking back on the dispute, Robbins recanted: you don’t, he said, deny a drunk who's fallen into an icy pond blankets and stimulants on the ground that his original trouble was overheating. This was in my view both good ethics and good economics.
There’s an interest argument though to be had between the Wicksell-Hayek and the Keynesian models of the origins of the slump. According to Wicksell-Hayek the present recession resulted from a long run of cheap credit, like sub-prime mortgages; ie., the market rate of interest was held below the ‘natural’ rate of interest which equates saving with investment. The crisis was therefore caused by undersaving in relation to investment. Once the banks realised the unsustainable nature of the ‘malinvestments’ they were financing they stopped lending, and the boom or bubble collapsed.
Keynes’s view is that slumps are triggered off not by undersaving by oversaving in relation to investment – apparently diametrically opposite. But the two sets of ideas can be made consistent if one takes the world economy as a whole, with the excess saving being done by the Chinese, and the deficient investment being done by the USA. One part of the world, led by China, was earning more than it spent, another part, notably the US spent more than it earned. Cheap credit, deplored by the Hayekians, was the ‘correct’ Keynesian response to the flood of saving from the east. But because there were insufficient outlets for ‘real’ business investment in countries like the US which already had abundant capital, cheap money led exactly to a Heyekian crisis: a credit boom leading to malinvestments that ended in bust.
All of which to me means that there can be no permanent recovery from this recession until our statesmen have the guts to tackle the problem of global imbalances.
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