David Frum, commenting on the Keynes vs Hayek rap video released last week, makes a point that I noticed throughout the video as well:

The economic question we have faced since 2008 is not: “Shall the government of the United States dictate prices and production throughout the US economy?” Who advocates that? Not Larry Summers. Not Tim Geithner. Not Ben Bernanke. And if there’s any tiny remaining sliver of Barack Obama’s being that wishes for central planning, it to this day remains profoundly hidden beneath all his contrary appointments, policies, and pronouncements.

Throughout the video, “Keynes” asserts that in a depression, we need to start the flow of spending, to boost aggregate demand to a level in which the economy can sustain itself. Keynes, and modern Keynesians, believe(d) that fiscal policy could take up the torch of private spending while household balance sheets were mended, and that the boost in GDP would help us recover more quickly. And, while “Hayek” had some really brilliant lines throughout the video (“…if every worker was staffed in the army and fleet/we’d have full employment and nothing to eat…“, and my favorites: “…jobs are a means, not the ends in themselves/people work to live better, to put food on the shelves/real growth means production of what people demand/that’s entrepreneurship not your central plan…” and “…the economy’s not a car, there’s no engine to stall no expert can fix it, there’s no “it” at all…“), you’ll notice that through nearly all of the video, he is making a generalized argument against central planning. They’re talking past each other, or at the very least perceiving themselves as having two different conversations.

However, Frum runs into trouble with this:

The Hayek character says, “I feel for the suffering, I’m not some kind of jerk.” The Keynes character answers, “Now my old friend, I’d never reject you as if you were heartless, you know I respect you.”

But the suffering want more than “feeling.” They want a policy response. And it is precisely a policy response that our modern self-described Hayekians preclude. Monetary policy? No can’t do that – it only leads to inflation and more bubbles. Stimulative government spending then? No that’s out, it leads to inflation, bubbles, etc. Tax cuts for the ordinary working person such as the payroll tax holiday? No way – we must balance the budget. So that leaves only supply-side tax cuts aimed at the upper-income brackets. balanced by large immediate budget cuts in Medicaid, food stamps, unemployment insurance. Does anybody believe that such a policy mix will lead to rapid employment growth? The Heritage Foundation claimed so, for approximately 48 hours, but now even they have abandoned that assertion.

To the question: What do you do in a deflation, Keynes offered an answer. He intended his answer as a means to preserve exactly the kind of spontaneous order praised by Hayek. Keynes lived and died a liberal in the old sense of the term. There are many criticisms of the Keynesian answer, mostly having to do with that long term that he so famously shrugged off. But some answer is better than no answer – and much better than the answer offered by the modern self-described Hayekians.

I don’t know about “modern, self described Hayekians” (actually I do, but I don’t want to speak for them), but this wasn’t Hayek’s position at all. As Larry White has pointed out in a JMCB article:

The Hayek-Robbins (“Austrian”) theory of the business cycle did not in fact prescribe a monetary policy of “liquidationism” in the sense of doing nothing to prevent a sharp deflation. Hayek and Robbins did question the wisdom of re-inflating the price level after it had fallen from what they regarded as anunsustainable level (given a fixed gold parity) to a sustainable level. They did denounce, as counterproductive, attempts to bring prosperity through cheap credit. But such warnings against what they regarded as monetary over-expansion did not imply indifference to severe income contraction driven by a shrinking money stock and falling velocity. Hayek’s theory viewed the recession as an unavoidable period of allocative corrections, following an unsustainable boom period driven by credit expansion and characterized by distorted relative prices. General price and income deflation driven by monetary contraction was neither necessary nor desirable for those corrections. Hayek’s monetary policy norm in fact prescribed stabilization of nominal income rather than passivity in the face of its contraction.

The bolded line is important, because if you take the Sumnerian theory of the Great Recession seriously, or even the most common explanation of events leading to the Great Contraction (’29-’32), the problem is that the monetary authority (the Federal Reserve) allowed NGDP expectations to fall off a cliff in late 2008 by passively tightening monetary policy…and that is exactly the opposite of what Hayek would have considered proper macroeconomic stabilization policy. As I understand Hayek’s NGDP rule, the central bank should stabilize M for any given V, consistent with zero aggregate growth in in the price level (PY), which would result in the type of deflationary growth that Hayek (and George Selgin) advocated.

No need to take White’s interpretation, though, here’s Hayek himself, agreeing with Keynes on the matter of deflation (though not the prescription of government expenditure, which is redundant with a NGDP level target):

On the first issue — whether to use one’s money or whether to hoard it — there is no important difference between us. It is agreed that hording money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable.

Really, on the issue of monetary policy, I see Keynes and Hayek arguing together against the ever-popular real-bills doctrine

The debate about central planning was indeed contemporary in the 30′s, and today I think many libertarians don’t recognize or appreciate the extent to which we’ve won on that point…Hayek, indeed had a good (and I believe superior) answer to Keynesian fiscal policy…but you unfortunately won’t find it in the Keynes/Hayek video.

Note: I’m not foremost expert on Hayek, but I’m sure that if Greg Ransom (and others!) reads this blog, he will correct my errors in the comments!

Update: Tyler Cowen makes the same point in a single sentence…bet you wish I had put this update at the top ;].

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