controversy: Glasner Challenges Armey on Hayek vs. Keynes

“More Hayek and Less Armey”

by David Glasner

Dick Armey, an obscure economics professor who enjoyed a second career as a moderately well-known politician, does not much like President Obama’s stimulus plan.  To buttress his opposition with more intellectual heft than he can himself muster, Professor Armey, in an op-ed piece in the Wall Street Journal, (February 4, 2009) invokes the authority of the late economist and philosopher F.A. Hayek.

I do not doubt that there are good reasons for opposing the stimulus plan now on the table, nor do I presume to speak for F.A. Hayek.  Nevertheless, Professor Armey’s almost devout invocation of Hayek’s authority to the fervent plaudits of the right-wing libertarian blogosphere, for whom Hayek is an almost iconic figure, is, well, embarrassing.

First Professor Armey is plainly out of his depth as an intellectual historian.  “Hayek,” Armey informs us, “famously debated Keynes in a series of articles after the release of ‘General Theory,’ and gave . . . the most devastating critique of government action to stimulate ‘aggregate demand.’ Hayek viewed the boom and bust of the business cycle as primarily a monetary phenomenon created by governments’ artificial inflation of money and credit.”

In fact, Hayek engaged in no debate, much less a famous one, with Keynes after Keynes published his General Theory.  Hayek had written a critical review of Keynes’s preceding work, A Treatise on Money, which prompted Keynes, in a fit of pique, to respond with an ill-tempered attack on Hayek’s just-published book Prices and Production.  So egregious was Keynes’s tone that even Sir Roy Harrod, in his admiring 1946 biography of Keynes, scolded Keynes for his deplorable conduct in that exchange.  Hayek later regretted that he had not responded after the General Theory was published, but explained (somewhat lamely) that after Keynes had quickly disavowed his Treatise on Money in the face of criticism, he assumed that Keynes would change his views yet again, so why bother?

Nor is Professor Armey right to attribute to Hayek the view that the business cycle is caused by governments’ inflation of money and credit.  In his first book on the subject, Monetary Theory and the Trade Cycle, Hayek stated that he was aiming to formulate a theory of the business cycle in which the very process of credit creation within a modern banking system generates cyclical economic fluctuations.  Whether Hayek envisaged that anything like our current credit crisis would issue from the workings of a modern banking system, I seriously doubt.  But Hayek’s mind was surely capacious enough to comprehend the possibility that a capitalist economic system, built on money and credit supplied by banks, could, even without misguided government policies, be subject to serious disturbances.

Beyond misstating the basic facts of Hayek’s polemical encounter with Keynes and mischaracterizing his theory of business cycles, Professor Armey does Hayek the extreme injustice of implying that he would oppose any stimulus plan designed to bolster aggregate demand.  It is true that, after the onset of the Great Depression, Hayek did oppose proposals to “reflate” the economy, but only because he believed that a short period of sharp deflation might, as it had in the Depression of 1920-21, loosen monopolistic rigidities that were preventing the economy from adjusting on its own to the crisis and were thereby postponing the recovery.

His opposition to monetary expansion and public spending earned him an undeserved reputation, even among such kindred spirits as Milton Friedman and other Chicago School economists, as a “liquidationist” who was impervious to the horrors of the Great Depression.  Hayek later admitted that he had erred in his early policy recommendations, and he greatly regretted that he had been understood to oppose taking countermeasures to stop the deflationary spiral that enveloped the world economy in the 1930s

In a 1975 discussion at the American Enterprise Institute with his old friend and colleague Gottfried Haberler, Hayek expressed his view as follows: “The moment there is any sign that the total income stream may actually shrink, I should certainly not only try everything in my power to prevent it from dwindling, but I should announce beforehand that I would do so in the event the problem arose.”

One cannot, of course, know what measures Hayek would have favored to mitigate the current crisis, but there is no reason to believe that, Professor Armey notwithstanding, he would have opposed a stimulus plan as a matter of principle.  Hayek’s opposition to Keynes was based on Keynes’s conceit in imagining that he had arrived at a general theory when in fact he had, at best, developed a special theory applicable to periods of great depression.  But Hayek also recognized that in those exceptional circumstances, policies that might be inappropriate under normal conditions could be necessary stopgaps to stem a deflationary tide.

Today’s crop of libertarians, Professor Armey included, in their ideological zeal to resist any and every anti-deflationary policy and government spending project, need to go back to school and read Hayek a little more carefully.  They are certainly doing Hayek’s memory, which they appear to hold in such pious reverence, no service by invoking his name to support a policy stance with which he was wrongly identified and which he explicitly disavowed.


David Glasner is an economist at the Federal Trade Commission. He is the author of Free Banking and Monetary Reform and editor of Business Cycles and Depressions: An Encyclopedia.   Glasner’s publications on Hayek include “F.A. Hayek: Philosopher of the Open Society”, Michigan Quarterly Review, Vol 24, No. 4, Fall, 1985, pp. 523-543 and “Hayek and the Conservatives,” Commentary, Oct. 1992.

The views expressed by Dr. Glasner do not necessarily reflect the views of the Federal Trade Commission or the individual commissioners.

6 comments to controversy: Glasner Challenges Armey on Hayek vs. Keynes

  • Zachary Kurtz

    I’m a little confused about something you said. If Hayek’s goal was to show how credit creation in a modern (fractional reserve, I’m guessing) banking system creates economic fluctuations, how is this not just another way of saying “central bank printing money and supplying it to banks” ?

  • Conrad

    Glasner’s first point is an inane non-critique. I guess it’s supposed to be (lamely) ad hominem, but it fails at even that.

    The second: “Nor is Professor Armey right to attribute to Hayek the view that the business cycle is caused by governments’ inflation of money and credit. In his first book on the subject… Hayek stated that he was aiming to formulate a theory of the business cycle in which the very process of credit creation within a modern banking system generates cyclical economic fluctuations.” How is this not tautological? Or, again inane, from my pov…

    The third (the interesting one): Glasner is arguing that Hayek would favor stimulus at “The moment there is any sign that the total income stream may actually shrink, I should certainly… try everything in my power to prevent it from dwindling”. Would Hayek have supported THIS stimulus? Would he even consider this kind of spending “in his power”? Glasner admits he don’t know. But neither does Armey. He actually uses Hayek attempting to explain how we got into this mess, not how we should get out.

    So, what’s the point of this article? As the title suggests, it’s really just an attack on Dick Armey, while implying that Hayek’s economics can in fact be used to argue for Obama’s stimulus. And he wants more of that kind of argument. He would lose that argument were he to actually attempt it…

  • david glasner

    Both comments about my piece question my observation that Hayek’s theory of business cycles was not predicated on the government or the central bank pursuing an inflationary policy, but, instead, explained the business cycle as the result of credit (money) creation by the banking system. The way to think about this is to assume that there is a closed economy in which legal tender consists entirely of gold coin or bullion, but in which private banks are free to create deposits or banknotes that are convertible on demand into gold. These assumptions preclude any government monetary policy (inflationary or otherwise). Nevertheless, Hayek argued that the process of lending and credit (money) creation by banks would produce a cyclical process of expansion and contraction. The model is not tautological and the normative role of government policy is to “neutralize” the cyclical process generated by the banks. As a matter of pure economics, I believe that the theory was incomplete (and inadequate) because it did not consider that banks are effectively borrowing from depositors to whom they pay interest for holding those deposits, so that the amount of credit created depends not on the difference between that actual and (unobservable) natural rates of interest, as Hayek thought, but on the spread between banks’ borrowing and the lending rates. But Hayek’s theory is what it is, and if someone happens not to like it, it won’t do to blame me.

  • Dan Mahoney

    David Glasner mocks Dick Armey’s status as an intellectual historian (probably deservedly), but he himself fails to note that it was not Keynes who put forth an ill-mannered critique of Prices and Production, but rather Keynes’ acolyte, Pierro Sraffa.

  • david glasner

    Dan Mahoney is correct to point out that Piero Sraffa wrote a nasty review of Prices and Production (in the Economic Journal of which Keynes was then the editor). But he is not correct if he means to say that Keynes did not himself gratuitously attack Prices and Production in the strongest language in his own reply to Hayek. It’s all in the passage from Harrod that I cited and from which I attach the relevant portion.

    The controversy with Professor von Hayek was a sharp one. The latter, newly arrived in England, found himself terribly buffeted at this period. His book on Prices and Production had received a review of unusual acidity in the Economic Journal from Mr. P. Sraffa, who had come from Italy somewhat earlier and won Keynes’s highest esteem. In replying to Professor von Hayek’s review of his own book, Keynes went out of his way to refer to Prices and Production. “The book, as it stands, seems to me to be one of the most frightful muddles I have ever read . . . and yet it remains a book of some interest, which is likely to leave its mark on the mind of the reader. It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam.” Professor von Hayek replied with a powerful and dignified protest against this kind of behavior. . . . It may be recorded, however, that at a later date Keynes and Professor von Hayek achieved a happy relation of friendship. During the second war Professor von Hayek turned his attention away from the technicalities of banking and capital theory and wrote a book on political economy which, despite certain exaggerations that it may contain, will remain a classic — The Road to Serfdom. (pp. 435-36)

    By the way Harrod then goes on to quote Keynes’s entire letter to Hayek about the Road to Serfdom.

  • J. Cornehls

    It astonishes me that this sort of dialogue continues in the midst of the great economic problems facing the world today. These well known and established economists continue to debate what Keynes said about von Hayek and whether or not Hayek would have approved of the Obama stimulus.

    Modern economics, with the exception of its further disguise under layers and layers of useless quantitative formulations, is still mired in the 18th century philosophy of Western Europe and is pre-Darwinian and pre-psychology. It proceeds to blithely use the by now worn out and defunct theories of the economists of that age to try to explain economic events so far outside the realm of neo-classical thninking or theory that there is little or no resemblance.

    As the eminent British economic theorist, Joan Robinson wrote 40 years ago, “Economists have crept off to hide in the thickets of algebra.” What she meant of course was that modern economics was the same old neo-classical spam, only distguised in new, quantitative clothes.

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