When some one writes that Hayek and Keynes are two sides of the same coin, you shrug your shoulders and move on. But, these guys need to be taken seriously. They do prove Hayek right:
- There is a very strong positive correlation between our measure of capital over-accumulation prior to a recession and either of our two measures of the subsequent severity of the recession.
This evidence provides support to the first premise of the liquidationist view. It shows that severe recessions have generally been preceded by periods of very high investment relative to the economy’s needs, as measure by the economy’s level of productivity (TFP).
- Severe recessions were generally preceded by high accumulation of all three classes of capital: housing, durables, and physical capital.
This pattern would be consistent, for example, with over-accumulation caused by periods of excessively lax credit. However, these ‘Hayekian’ facts do not necessarily imply that liquidation without public intervention is desirable.
They also find that Keynesian intervention might minimise the pain of liquidation that is necessary but it comes with a cost – it does prolong the recession:
We find that during liquidation periods, stimulative aggregate demand policies are generally socially optimal, as the laissez-faire economy produces a recession that is excessively deep and painful. However, the cost of this intervention is that it prolongs the recession, as suggested by Hayek, rather than stimulating a quick recovery, as some Keynesians may want to believe.
Their full paper is here.
The key is to minimise the pain (and that too only for those segments of the society that cannot handle it without assistance) without impeding the liquidation or adjustment process. Of course, it is easy to write all these but these are political economy questions. Those who do not need the pain relievers will be the most vocal in demanding them and influential in getting them.
More important, it is good to avoid getting into such excess capital accumulation. That calls for a broader remit for monetary policy than pure inflation targeting. It calls for explicit consideration of credit growth, asset bubbles in the monetary policy framework and in responding to ‘excess’ (decisions involving judgement, of course) in all of these. That is, central banks really have to remove the punchbowl when the party gets going. Again, easier said than done, even in democracies. Forget about less democratic governments, unless they are, otherwise, visionary, far-sighted and understand the value and virtue of delayed gratification over instant gratification.
All of the above assumes that central bankers believe in withdrawing the punch bowl. Fanciful thinking on my part, given the preponderantly neo-Keynesian mindset that is prevalent in Washington, D.C and in Frankfurt these days.