Reconciling Hayek's and Keynes Views of Recessions

64 Pages Posted: 14 May 2014 Last revised: 5 Jun 2022

See all articles by Paul Beaudry

Paul Beaudry

University of British Columbia (UBC) - Vancouver School of Economics; National Bureau of Economic Research (NBER)

Dana Galizia

Carleton University - Department of Economics

Franck Portier

University of Toulouse I - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ); Centre for Economic Policy Research (CEPR)

Date Written: May 2014

Abstract

Recessions often happen after periods of rapid accumulation of houses, consumer durables and business capital. This observation has led some economists, most notably Friedrich Hayek, to conclude that recessions mainly reflect periods of needed liquidation resulting from past over-investment. According to the main proponents of this view, government spending should not be used to mitigate such a liquidation process, as doing so would simply result in a needed adjustment being postponed. In contrast, ever since the work of Keynes, many economists have viewed recessions as periods of deficient demand that should be countered by activist fiscal policy. In this paper we reexamine the liquidation perspective of recessions in a setup where prices are flexible but where not all trades are coordinated by centralized markets. We show why and how liquidations can produce periods where the economy functions particularly inefficiently, with many socially desirable trades between individuals remaining unexploited when the economy inherits too many capital goods. In this sense, our model illustrates how liquidations can cause recessions characterized by deficient aggregate demand and accordingly suggests that Keynes' and Hayek's views of recessions may be much more closely linked than previously recognized. In our framework, interventions aimed at stimulating aggregate demand face the trade-off emphasized by Hayek whereby current stimulus mainly postpones the adjustment process and therefore prolongs the recessions. However, when examining this trade-off, we find that some stimulative policies may nevertheless remain desirable even if they postpone a recovery.

Suggested Citation

Beaudry, Paul and Galizia, Dana and Portier, Franck, Reconciling Hayek's and Keynes Views of Recessions (May 2014). NBER Working Paper No. w20101, Available at SSRN: https://ssrn.com/abstract=2436710

Paul Beaudry (Contact Author)

University of British Columbia (UBC) - Vancouver School of Economics ( email )

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National Bureau of Economic Research (NBER)

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Dana Galizia

Carleton University - Department of Economics ( email )

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Canada

HOME PAGE: http://www.danagalizia.com

Franck Portier

University of Toulouse I - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ) ( email )

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Toulouse, 31000
France
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+33 5 6112 8637 (Fax)

HOME PAGE: http://fpj.portier.free.fr/home

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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