The Independent Market Observer

What Keynes and Hayek Can Teach Us About Economics

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Dec 11, 2015 12:30:00 PM

and tagged Economics Lessons

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economicsI shared this post in 2014, but it’s always worth another go.

As we close out the year and look ahead to a new beginning in 2016, I thought it would be fun to repost a couple of entertaining videos from EconStories that offer some surprisingly accurate lessons in economics. Let the rap battles begin! 

Hands-on vs. hands-off

During periods of economic crisis, policymakers have to decide whether to intervene in the economy (in John Maynard Keynes’s style of economics) or let the market heal itself (per F.A. Hayek’s more laissez-faire approach). The phrase “We’re all Keynesians now”—reportedly coined by Milton Friedman and often attributed to Richard Nixon—reflects the fact that the modern consensus around the world is for intervention, with governments spending in downturns to support demand.

The problem is that intervention is only half of Keynes’s prescription. The other half—to raise taxes and run a surplus in good times—is never implemented. As a result, you could say that the full Keynesian program has never actually been tried. Hayek’s prescription—leave the economy alone—is never considered seriously nowadays and hasn’t been implemented in the West since the 1930s. In fact, the Great Depression is why Keynesianism became the default economic ideology.

As usual, both sides have merit. Government plays a key role in jump-starting a recovery, as we saw at the times of the Great Depression and Recession, yet, at some point, markets have to heal themselves, which the government now seems to recognize. We watched the Fed end its multiyear bond-buying program in October 2014 and discovered that the market had the strength to carry on.

Now, as we wait to learn whether the Fed will finally raise rates, as it has been hinting at over the last month, we will have the chance to see whether the market will take the rate increase as a good thing for the future health of our economy.

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