Parts of economic theories
seem to constantly change because there is no perfect economy; however, there
are two categories in which most economists fall under: Classical and Keynesian.
Classical economists follow the theory described in Adam Smith’s Wealth of Nations regarding a
Laissez-Faire policy with no government intervention. People who are considered
to follow the Keynesian economic theory generally favor government intervention
in the economy during recessions in the business cycle (Colander p. 524). Three
well known economists fall into these categories: Milton Friedman and Friedrich
von Hayek were considered to be classical economists, while John Maynard
Keynes, developed the Keynesian theory.
Friedman was a firm believer in capitalism and that the
market’s guiding hand would help to regulate the economy. According to the Encyclopedia of World Biography,
“Friedman was also a staunch defender of the free enterprise system and a
proponent of individual responsibility and action” (2). In other words, he did
not think the government should be involved in people’s everyday lives and that
there should be a very minute amount of government regulation in the economy.
Also, if the government would be less involved, it would hold individuals more
accountable for their own living situations and actions. Friedman’s most
notable idea was his “constant monetary rule” (1). Economist Sarwat Jahan
explained in his article “What is Monetarism?” Friedman’s idea that “the Fed
should be required to target the growth rate of money to equal the growth
rate of real GDP, leaving the price level unchanged.” By increasing the money
supply as GDP grows, it will help reduce inflation during times of recession,
thus, keeping prices of good consistent.
One of Keynes’ most notable theories regarded spending
habits during recessions. He argued that when people stop spending money on
goods due to a recession, demand goes down, which in turn, reduces production
and finally, people are out of a job (Colander 524); this is a vicious cycle
that will only continue unless people spend what little money they have on
buying products. As written in the biography, “John Maynard Keynes,” “…in
mature economies, such as those in the United States and Western Europe, high
levels of income had led the public to save large proportions of their income,
while the factors that had historically provided expanding investment
opportunities were disappearing” (530). This was an integral part of Keynes
theory called “stagnation” which entails that people in developed countries
saved too much of their income instead of spending or investing it, not
allowing the economy to grow. He promoted government involvement in the economy,
whether it be through price regulations or investing, and thought that interest
levels should decrease during recessions so that people could have more money. The
only way that an economy can grow is by developing new technology and
producing, which can only be done if there is money available to do so.
Hayek, an Austrian economist who was an advocate for the
free market, was an outspoken critic of Keynes and communism. Similar to
Friedman, he promoted a Laissez-Faire style economy and figured that government
intervention during recessions would only make problems worse (Encyclopedia of World Biography 222). He also believed that the more
regulations the government had on the economy, the less freedom consumers had
when making a purchase (223). During the Cold War, many economists though the
Soviet Union’s economy would grow at such a high rate that it would be larger
than the United States’ economy; however, Hayek found holes in these arguments
and did not think this was true. According to economist David Peterson, Hayek’s
argument was, “…prices that efficiently allocate resources cannot be set by
government fiat. When an economy lacks the daily input of the individual
decisions of millions of consumers…the result is colossal waste and inefficiency
(86). This contributes to Hayek’s free enterprise view on the economy, that it
should be consumers who determine the prices of goods based on their demand,
not the government.
Keynes, and Hayek were all outspoken economists during the Great Depression and
with all the uncertainty during that time, each had their own theories as to how
it should have been handled. Friedman and Hayek were both against the New Deal
and felt as though government intervention made the depression last longer than
it had to. Hayek even warned the American government “against the dangers
inherent to a growing welfare state” (Peterson 89).
In closing, these
economists theories are still in debate today; however, aspects of each of
their ideas are intertwined in many economies around the world.