Hayek’s apotheosis came in the 1980’s, when British Prime Minister Margaret Thatcher took to quoting from The Road to Serfdom (1944), his classic attack on central planning. But while Hayek’s defense of the market system against the gross inefficiency of central planning won increasing assent, Keynes’s view that market systems require continuous stabilization lingered on in finance ministries and central banks.
Both traditions, though, were later eclipsed by the Chicago school of “rational expectations,” which has dominated mainstream economics for the last twenty-five years (Milton Friedman, anyone?). With economic agents supposedly possessing perfect information about all possible contingencies, systemic crises could never happen except as a result of accidents and surprises beyond the reach of economic theory.
The global economic collapse of 2008 discredited “rational expectations” economics model, and has since brought both Keynes and Hayek back into posthumous contention. The issues have not changed much since their argument began in the Great Depression of the 1930’s. What causes market economies to collapse? What is the right response to a collapse? What is the best way to prevent future collapses? READ: The Austrians Have it Right
For Hayek in the early 1930’s, and for Hayek’s followers today, the “crisis” results from over-investment relative to the supply of savings, made possible by excessive credit expansion. Banks lend at lower interest rates than genuine savers would have demanded, making all kinds of investment projects temporarily profitable.
Every artificial boom thus carries the seeds of its own destruction. Recovery consists of liquidating the misallocations, reducing consumption, and increasing saving.
--Project Syndicate
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