KEYNES or HAYEK?

Governments across the globe are using Keynesian stimuli to revive drooping economies. Even George Bush has presided over the greatest stimuli in
US history, with a projected fiscal deficit of $1.2 trillion and monetary injection of almost $2 trillion by the Fed. But is the recession Keynesian? Trillions of dollars of stimuli have failed to end the downswing. Keynesians argue that even trillions are not enough. Really? The current recession looks more Hayekian than Keynesian. A Keynesian recession represents a sudden fall in demand, and can be remedied within six months by pumping enough purchasing power into the economy. A Hayekian recession, however, is caused by misallocation of resources over a long period, driven by unrealistic interest rates, ending in a bust that requires years of structural adjustment. Such a recession can last a decade (as in Japan in the 1990s). The many recessions between World War II and the oil shock of 1973 proved amenable to Keynesian remedies. But 1973-80 witnessed a Hayekian recession, caused by excess pumping of money into economies in an attempt to stimulate them. Rising trade union demands meant that the stimuli translated into higher wages and inflation, not higher production. After this era of stagflation, economists could hardly utter the word ‘Keynesian’ without a snigger — it had become a joke. However, the recessions of 1991 and 2001 were mild affairs remediable by Keynesian stimuli. Keynes was back in fashion. So, when the subprime mortgage crisis hit the US in 2007, it responded with Keynesian nostrums. But to no avail. Politicians want to be seen as quick and effective. They love Keynesianism, which puts them in the driver’s seat, allowing them to portray recessions as caused by greedy business villains, and paint themselves as rescuers. But Hayekian recessions occur when politicians themselves distort the economy for years, creating misallocations of resources that ultimately prove unsustainable. The consequent bust cannot be ended by pumping in more money. Rather, the entire economic structure must change to correct the historical misallocations, and make future growth sustainable. This involves wrenching changes in individual, corporate and political behaviour. Neither the public nor politicians are quick to acknowledge a Hayekian recession. They would rather hope it is Keynesian, remediable by pumping in more money. Yet at some point somebody will surely declare that Emperor Keynes has no clothes.