In the world of economics today, there are two opposing sides of economic theory that have prevailed, yet continue to be debated about: Keynesian and Classical economics. Keynesian economics derives from the English economist John Maynard Keynes, while Friedrich Hayek, an Austrian, founded what would eventually become the modern Classical theory of economics. Both men were contemporaries of each other, and both continued to debate on the reliability of each other’s economic theory.
Both men were economists during the Great Depression, which sets the stage for how each of their ideas came to fruition. This specific context made the opposition of their ideas particularly volatile. John Maynard Keynes believed that increased spending and controlled monetary policy was needed to revitalize the economy. On the other side of the debate, Hayek believed that this would only continue to propagate bad economic policies that could have brought about the Great Depression in the first place, and that trying to manipulate the free hand of the market would bring about growth that couldn’t be sustained, and thus was destined to fail.
Keynes’ General Theory
While a capitalist, John Maynard Keynes believed that there were no invisible recovery forces built into the natural disposition of capitalism, and that the free market economy couldn’t revitalize itself. He believed that, if left to its own devices, the economy would only be able to stabilize itself at a much lower level than it existed at before. He called this “under-employment equilibrium.” This idea came from a belief that as general spending power decreased, so too would the output of the entire economy. This would cause the economy to contract, making it unable to gain its former strength. Because of this, Keynes believed that you had to grow your way out of an economic recession with increased spending, not with stagnation
Hayek’s Prices and Production
Hayek believed in the exact opposite of Keynes’ conclusion. He believed that the increased spending would only further prolong the faulty economic institutions that caused recession in the first place, which would set the economy up for only further failure later on. He believed that the liquidation of such firms was necessary in the case of a depression, in order to restructure the entire system. This led to his point that economic booms from spending policies were an illusion, because the slumps that they lead to are inevitable. This meant that the slump of a depression was necessary, in order to accomplish real growth that could be indefinitely sustained.
It’s worth noting that Hayek and Keynes became good friends over the course of their life, despite disagreeing with the other’s economic policies until the end of their days.