The 1930’s saw the emergence of Keynesian
theory along with the opposing views of Friedrich Hayek. Of particular
relevance was their differing view on the involvement of government in economic
affairs/markets, especially in times of economic depression. Keynes examined the issue and insisted that
monetary expansion and government deficit spending were needed in a great
depression, or else one ran the risk
of a great degeneration. If there was no intervention on the part of the
government, then the economy may fall into a cycle of reduced spending and high
unemployment from which it could not recover. In the opinion of John Maynard
Keynes, there was a direct relationship between aggregate demand and
employment. By infusing the economy with money, there would be an increase in
demand for goods, and subsequently spending. This increase would be reflected
in a rise in employment to meet new demand. What Keynes would later acknowledge
as a side effect to this theory would be a rise in inflation that resulted from
the introduction of new money into the economy.
Friedrich Hayek argued the complete opposite of Keynes.
The involvement of government in markets disrupted the ability to communicate
signals clearly. The introduction of new monies brought inflation that made the
value of the dollar unstable. This instability hindered the ability for prices
to properly communicate signals in markets since their value was under constant
speculation. The regulation of markets hindered the ability for markets to
communicate the signals of both the supply and demand side of the economy.
Hayek believed that the hindrance of the markets ability to communicate signals
properly would lead to capital and labor being allocated in places that they
normally would not, and subsequent bubbles of disequilibrium being created.
This disequilibrium could only be fixed by allowing the market to correct
itself (which would require a phase of decline and depression) or put off by
the government further intervening to give short-term stability. This cycle of
government intervention would only prolong and augment the disequilibrium with
each subsequent intervention that was necessary to reconcile the last.
This issue that
Keynes and Hayek argued on was one of great importance back in the 1930’s, but
even more so now. Back then it was much harder for governments to create money
because of the gold standard. Today, governments have ability to print money
and borrow debt in masses. With each intervention, the scale of each subsequent
one grows in order to resolve the last one; with this comes massive governments
that stand to regulate and intervene in so many facets of a country. The role
of government’s influence on the economy is debated around the world. There is
no doubt that government and rule of law is necessary to protect the rights of
the people, but how far should this power extend. To allow economies and
markets to correct themselves from the centuries of intervention would mean a
time of depression of unemployment for the people. Is it the government’s role
to ensure that this doesn’t happen by continuing to intervene in order to
protect the economic well being of those it serves? Even if it means more and
more to fix the very problems it may be causing? Or is it necessary for the
government to take its hands off of the economy and markets while some suffer
during the correction phase. Do we trust the concept of competition or continue
to intervene seeing how deep we’ve gotten ourselves now? I believe there is a
middle ground that must be reached but will admit that I am not sure where it
falls.
When studying Buchanan over the past month I came across an article of him and another economist discussing the Keynesian theory and how to handle the public debt. Buchanan strongly disagreed with the idea of creating money as a cyclical tool. Buchanan believed this would just continue to add debt, an already never ending cycle. Buchanan suggested a balancing of check books, which may be easier said than done.I personally feel as if the government needs to place their hands on the economy especially during such economic downfall. The issue that I raise is how far should they go. The government needs boundaries, but who will be the one to "raise these fences".
ReplyDeleteI tend to agree with the Keynesian view that we need government intervention in the economy. In times of downturns, when aggregate demand is declining as incomes, consumption, and production fall, resulting in increased unemployment, I think the government has an important role and duty to increase the aggregate demand and provide firms with the incentive to increase production and move the economy toward full-employment. In regards to monetary policy, I also think that the government has an important role in adjusting the money supply in order to change interest rates. In times of downturns, a decreased interest rate will have the effect of reducing the cost of borrowing for firms and making investment more attractive to firms who can borrow at a cheaper rate. The decrease in the interest rate will also reduce the incentive to save and lead to a further increase in aggregate demand via an increase in consumption. However, Keynes theories tend to be more applicable in times of downturns than in times of prosperity and the intervention by the government in these times of greater economic health may result in the situation such as that leading up to the bursting of the housing bubble, in which interest rates were kept too low for too long. At the same time, I do not think that the government should take a non-activist approach to intervening in the economy because, like Keynes, I think that the government is in a better position to judge economic conditions and respond accordingly. Of course the government makes mistakes but I think that these mistakes are to a lesser degree than those that would occur if a market were left free from government intervention. One of the causes of the recent recession was the decrease in government intervention that resulted as policy makers began to subscribe to the efficient markets theory, allowing banks and other institutions to increase their risk taking, which consequently had devastating results for the economy. As far as fiscal and monetary policy go, I guess I would have to say that they should be used in times of downturns and less so during peak periods. At the same time, this may result in the failure of the government to act in time when the economy begins to move away from a peak period and towards a trough. As other comments, I think that the government has an important role in the economy but I am not sure exactly how far and to what extent the government should intervene.
ReplyDeleteAfter writing my final paper on Milton Friedman and reading so much about his anti-Keynesian views, I find myself also opposing Keynes. Friedman was against government intervention whenever possible. One example that he cites is his study on government intervention was during the housing shortages that occurred in 1906 and 1946 in San Francisco. The shortage in 1906 was caused by an earthquake and fires that destroyed half of the homes in San Francisco. During this shortage, legislatures didn't impose rent ceilings and, according to Friedman, provided the condition to overcome this shortage successfully. The housing shortage in 1946 was caused by rent ceilings that were put into place by legislatures because of the war veterans returning. Friedman essentially said that without government intervention, the housing shortage in 1946 would not have occurred, and I tend to agree with him.
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