The key difference between Keynes’ and Hayek’s theories of economic crisis is in the role of the banking and financial system in general. Stylized, and simplified, versions of Keynes’ and Hayek’s explanations of recessions or depressions and their alternative policy advices could be presented in the following way:

Keynes (demand problem): Liquidity trap with involuntary unemployment that could be remedied by increased public spending.

Hayek (supply problem): Solvency problem due to bursting of a debt bubble, frictional unemployment, and no short run policy remedy.

Both approaches rely on monetary explanations of the eruption of crisis.[1] Keynes did not deal with the non-monetary or barter economy, but demand for liquidity played the crucial role in his theory of crisis. Hayek started with the barter (Walrasian, static in his words) system, which did not allow for misallocation and crisis, but then introduced money and credit to develop a monetary theory of the trade cycle (Hicks, 1967).

In both theories, interest rate plays the key role (and thus relative prices). Banks, in Keynes’ theory, tend to support the persistence of the liquidity trap by keeping the interest rate too high (in relation to the marginal rate of return on investment) and protracting the deflation, while in Hayek’s theory banks drive the interest rate too low (compared to the natural rate in the barter economy) before the crisis and too high (in the same sense) during the downturn thus exacerbating the deflationary impact.

Why is there a liquidity trap? It could be due to banking crisis, though this is not the usual Keynesian story. Friedman’s explanation is more in that vein, as he attributes the banking crisis to the restrictive monetary policy that starves the economy of money and credit.[2] Keynes attributed liquidity traps to the instability of investment and, perhaps, to a sudden surge of preference for liquidity.

Hayek’s story is that there is a bubble due to too much credit and then adjustment through deleveraging. He also thought that the first is characterised by the overexpansion of producer goods and the latter by deflationary price adjustment. Central bank’s restrictive policy in addition to banking crisis precipitates a secondary deflation, which deepens and prolongs recessions and drives it to depression.

Keynes’ theory lends itself to the obvious short term policy response: more government spending. That does not mean that private investments should be substituted or crowded out, but just an increase in spending that the government is responsible for anyway. If the distinction between what is done by the private sector and what is best done by the government is clearly drawn, then the government decides to do now what it would otherwise do later. With that, it should crowd in private sector investments, which is why it should be expected that fiscal multiplier should be greater than one.

Hayek’s theory has no obvious short term policy implications. Deleveraging can be speeded up, but there is the process of post-bubble restructuring that will take time. Secondary deflation can be avoided, but that is about not making a mistake, not designing a remedy. Targeting price stability is not a preventive measure, because bubbles do not necessarily lead to the speed up of inflation (it may be asset inflation rather than consumer prices inflation).[3] More public spending is not a measure that addresses the problem of solvency and restructuring. Industrial and other structural adjustment policies (that is subsidies and deregulation respectively) are irrelevant, though they can be good or bad on their own, because business cycles are an equilibrating process.

Long term policies were seen differently by Keynes and Hayek mainly because the former relied more on regulation while the latter preferred competition. That is in part due to the fact that Keynes mostly had in mind a closed economy while Hayek mostly thought in an open economy framework. Which is why they had different things in mind when they talked about macroeconomics (Hayek, one can argue, never really adopted the macroeconomic way of thinking about economics).

Both demand and supply problems can be seen as those of coordination in a monetary economy. Either investments are not coordinated (Keynes) or banks coordinate wrongly (Hayek). Keynes saw the public authority as being able to stabilize investments, while Hayek thought that it lacked information to do that and preferred to rely on competition. Keynes explained the failure of the state to play that role as due to commitment to wrong ideas or ideologies, while Hayek was aware of the distributional problems, though they did not play much of a role in his theory.

Both theories have clear empirical implications and are thus testable. The existence of the liquidity trap seems obvious. Bubbles are different, because they are not easy to detect ex ante, while ex post their identification is logically suspect (post hoc ergo propter hoc fallacy). The length of post financial crisis adjustments suggests that there is something to the Hayek story as the Keynesian answer tends to be counterfactual (with more public spending it would have been different).


V. Gligorov (2012), “Five Easy Pieces on Keynes”, Pescanik.
M. Friedman (1997), “Reviving Japan”, Hoover Digest No. 2.
M. Friedman (2003), “The Fed’s Thermostat”, WSJ August 19.
F. Hayek (1933), Monetary Theory and the Trade Cycle. New York: Augustus M. Kelly.
J. Hicks (1967), “The Hayek Story” in Critical Essays in Monetary Theory. Clarendon Press.

Pešč, 14.02.2013.


  1. On Keynes see Gligorov (2012). Hayek (1933) is probably the best statement of his theory.
  2. In the context of this piece, Friedman (1997) and (2003) are useful.
  3. Hicks (1976) misses that point, it seems to me. He righty points out the deficiencies in the Ricardo effect that Hayek tended to rely on. He suggests that he should have looked at the change in savings, but Hayek was closer to Keynes in that he saw savings as adjusting passively, though he used the unfortunate concept of “forced savings”. However, Hicks is right that without something like that it is hard to understand the real side of the Hayek story at least as he told it.

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Vladimir Gligorov (Beograd, 24. septembar 1945 – Beč, 27. oktobar 2022), ekonomista i politikolog. Magistrirao je 1973. u Beogradu, doktorirao 1977. na Kolumbiji u Njujorku. Radio je na Fakultetu političkih nauka i u Institutu ekonomskih nauka u Beogradu, a od 1994. u Bečkom institutu za međunarodne ekonomske studije (wiiw). Ekspert za pitanja tranzicije balkanskih ekonomija. Jedan od 13 osnivača Demokratske stranke 1989. Autor ekonomskog programa Liberalno-demokratske partije (LDP). Njegov otac je bio prvi predsednik Republike Makedonije, Kiro Gligorov. Bio je stalni saradnik Oksford analitike, pisao za Vol strit žurnal i imao redovne kolumne u više medija u jugoistočnoj Evropi. U poslednje dve decenije Vladimir Gligorov je na Peščaniku objavio 1.086 postova, od čega dve knjige ( Talog za koju je dobio nagradu „Desimir Tošić“ za najbolju publicističku knjigu 2010. i Zašto se zemlje raspadaju) i preko 600 tekstova pisanih za nas. Blizu 50 puta je učestvovao u našim radio i video emisijama. Bibliografija