When Keynes is Hayek and Menger is Schmoller

For a long time, economics felt to me to be strictly divided in schools, or at least mainstream and “weirdos”. It seems though, that wherever I thought there was a big, even war-like discrepancy between economists on some topic or person, it falls apart when I dig into it. I admit it may be my very subjective impression – of course it is nurtured by the actors strive for profiling or just popular videos, etc. However I think I have a case here. Let me give you three examples:

Exhibit “A”: Keynes is Schumpeter

You’ll see that both F.A. Hayek as well as Keynes changed their views massively over time (as well as Schumpeter did). Keynes seemed to move in direction of Schumpeter even though he would never admit it. I came to this conclusion, when I accidentally stepped over some of Keynes writings. I’ve been investigating Keynes shifting view about credit and money after 1936, meaning after the “General Theory”. A shift of such importance, that the Italian circuitist Graziani later on (1984) judged, “invalidates the General Theory in many respects“. Now Keynesian readers don’t start to yawn! This isn’t just a usual anti-Keynes-critique, as he himself seemed to be aware of (e.g. see Rochon, 1997; Dos Santos, 2006; Keynes; and many more)! Hence it’s of natural interest to all (post-/neo-/new-) Keynesians.

I recommend Rochon’s paper (1997)  for everybody interested. It bases comprehensively upon Keynes original writings and speeches from 1937 to 1945. I know (some) post-Keynesians know of Keynes’ opinion shift (e.g. Davidson, 1965). However I find it’s far away from mainstream knowledge that Keynes broke with major concepts of his General Theory. Even more so it’s in particular interest to TES since all of it has been pointed out by Schumpeter before:

  • Keynes adopted the idea of banks and entrepreneurs creating money through credit before the investment takes place (ex-ante). There are no savings “needed” anymore like in the General Theory for investment! Money became endogenous instead of exogenous!
  • Savings are just what is directed by wage earners of this invested money to deposits and hence finds its way to the investor again through asset demand (ex-post).
  • The interest rate is exogenous. The credit mechanism works at any (sufficient positive) level of rate of interest. That means he broke with the liquidity preference idea which determined interest rate in the General Theory.
  • Keynes stated that the interest rate does not need to rise and fall through cycles. Instead banks are assumed to supply all credit requests at any given rate. In the words of post-Keynesians he became “horizontalist”, referring to a horizontal supply curve of money. The credit supply at a given rate is just a function of bank’s willingness to supply credit. Keynes already wrote in 1930 (and Schumpeter in 1917, p. 709f) that if all banks were to expand credit, they would not have to fear a worsening balance sheet (1983, p. 18ff). This is so, because all newly generated credit flows in form of deposits in some other banks balance sheet. The only restriction to this process is the “institutional” arrangement. Of course Keynes had little problems here to allow for an institutional arrangement (keyword: central bank) which synchronizes commercial bank policies, allowing for such a credit expansion. Meanwhile Schumpeter pointed to the risks of this. He favoured single banks which are accountable for their balance sheet. Otherwise banks would lose their incentives to direct purchasing power in “useful” change (creation). On top, if useful or useless, change always has a destructive side to it as well.

Exhibit “B”: The Austrians are Historians

The “Methodenstreit“of the 1880’s and 1890’s was not really a clash in economics. I did extensive reading on Austrian and German Historian Scholars and found that the writers of both approaches are personally tied to each other. I mean that both intellectually and literally (marriages, teachers, scholars and buddies). Today’s story overvalues strongly what Menger said and felt. Nobody said, there is no place for the Historians approach in economics (as they agreed in the ultimate goal of economics to understand capitalism), but that it should include theoretical approaches as well. This led Schumpeter in 1954 to state that this Methodenstreit was primarily a “mutual misunderstanding” and career-narcisstic (Menger vs. Schmoller) in motive. He spoke of no big academic importance (1967, S. 814f). Again, because every Austrian scholar agrees, that historical studies are vital for understanding economic phenomena. Hence it must have been not until decades later, when this was exaggerated into a victory of an abstract, non-historian, non-observant economics as it is portrayed today. It was at the time, when the Historians were still mainstream; prior to the Second World War. Hence I’d date it somewhere there: After the Keynesian revolution hit economics and German/Austrian Economics drowned together with the lost war (1936-1940’s)…

Exhibit “C”:  Keynes is Hayek

F.A. Hayek’s concern about the nature of economics as a science seems to have been backed up by the later Keynes. Something you won’t get on the front page of an economics (history lesson). In fact, the three shared the same believe in the idea of a historic determinism of their views. That is to say, models have an expiration date! They expire as soon as the underlying assumptions change. Now why would they changes? Because economics isn’t a natural, but a human science. This means in the very essence that our object of study changes over time! True paradigm shifts (Smith, Marx, Ricardo, Schumpeter / Keynes) always portray the change of the underlying sociological structure. This is what economic theory must base upon if meaningful. Suddenly it becomes obvious, why it would be a fallacy for economists, to let sociology out of scope.

“B” & “C” spotted:

Now let’s spot some of what i mentioned in exhibit B&C in Keynes writings to Harrod in 1938. Emphasis are mine:

It seems to me that economics is a branch of logic, a way of thinking; and that you do not repel sufficiently firmly attempts à la Schultz to turn it into a pseudo-natural-science.

Now if that doesn’t sound like Hayek’sscientism“…

One can make [. . .] progress merely by using your axioms and maxims. But one cannot get very far except by devising new and improved models. This requires, as you say, “a vigilant observation of the actual working of our system“. Progress in economics consists almost entirely in a progressive improvement in the choice of models.

But it is of the essence of a model that one does not fill in real values for the variable functions.To do so would make it useless as a model. For as soon as this is done, the model loses its generality and its value as a mode of thought.

Assumptions may be variables.

[. . .] The object of statistical study is not so much to fill in missing variables with a view to prediction, as to test the relevance and validity of the model.

Forecasting some financial variable using a model? Well, but this is, what the majority economists are doing in today’s world Mr. Keynes!

Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the typical natural science, the material to which it is applied is, in too many respects, not homogeneous through time.

Check the assumptions of your models versus the contemporary world. Think about: Was the labour theory of value over a big time of mankind (incl. Smith) really wrong? Or: Keynesian theory usually assumes money exogeneity; Now how is that today? This may be more than a hint, why ever more trillions of stimuli have relative low effect today, compared to back then in the interwar, protectionist period of Keynes.

Good economists are scarce because the gift for using “vigilant observation” to choose good models, although it does not require a highly specialised intellectual technique, appears to be a very rare one.

You just need to pervade and soak up this “mode of thought”. This mode is alien to most people and that is why it keeps supply of “good” economists scarce and thus prices…eeehmm.. 😉

In the second place, as against Robbins, economics is essentially a moral science and not a natural science. That is to say, it employs introspection and judgments of value.

When Keynes stresses the “way of thinking aspect” all over his letter to Harrod, he ressembles strongly Schumpeters writings on Economics and mankinds fate (e.g. the closing speech at university of Bonn 1932/1952). Even more so: To recognize that economics is a certain logic we apply to the world we experience, equals crossing into sociological territory – e.g. I’m remembered of Boltanski & Chiapello (2006), Bröckling (2007), Simmel (1900/2009).

Conclusion & Some Thoughts

First: So where are the big trenches? Well they exist, I don’t doubt that. But there are  important similarities between big economic thinkers as well, but rarely mentioned.

Second: I immediately got some thoughts about the state of today’s economics. So if Keynes, Hayek and Schumpeter at least all show reluctance towards our forecasting-behaviour and scientism of our beloved profession, how did we come so far? Equally so with sociological topics, observation etc.

Let me clarify: I think this post shows that you can’t advocate today’s scientism and theoretical overweight with Keynes nor some lost battle in the 1880-90’s – from Hayek and Schumpeter you know you certainly cannot.  I would judge it neither “good” or “bad”, but the above mentioned dominance in the economic profession seems illegitimate.

Third: Of course I hold an explanation why it is like that. I’ll save this though for another post. I’m happy to hear your thoughts.


Boltanski, Luc; Chiapello, Ève (2006): Der neue Geist des Kapitalismus. Brosch. Ausg. Konstanz: UVK-Verl.-Ges (Edition discours, 38).

Bröckling, Ulrich (2007): Das unternehmerische Selbst. Soziologie einer Subjektivierungsform. Frankfurt a. M: Suhrkamp.

Dos Santos, Claudio H. (2006): Keynesian theorising during hard times: stock-flow consistent models as an unexplored ‘frontier’ of Keynesian macroeconomics. In: Cambridge Journal of Economics 30 (4), S. 541–565.

Graziani,  A.  (1984)  The debate on Keynes’s finance motive. In: Economic Notes 1, S.  15-33.

Keynes, J. M. (1937): Alternative Theories of the Rate of Interest. In: The Economic Journal 47 (186), S. 241–252. Online verfügbar unter http://www.jstor.org/stable/2225525.

Keynes, John Maynard (1983): Vom Gelde. 3. Aufl., unveränd. Nachdr. d. 1931 erschienenen 1. Aufl. Berlin: Duncker & Humblot.

Rochon, Louis-Philippe (1997): Keynes’s Finance Motive: a re-assessment. Credit, liquidity preference and the rate of interest. In: Review of Political Economy 9 (3), S. 277–293.

Simmel, Georg (2009): Philosophie des Geldes. Nachdr. [der Ausg.] Leipzig, Duncker & Humblot, 1907, 2., verm. Aufl. Köln: Anaconda.

Schumpeter, Joseph Alois (1952): Das Sozialprodukt und die Rechenpfennige;. Glossen und Beiträge zur Geldtheorie von heute. In: Joseph Alois Schumpeter: Aufsätze zur ökonomischen Theorie, Bd. 44 Heft 3. Tübingen: J.C.B. Mohr, S. 627–715.

Schumpeter, Joseph Alois (1952): Das Woher und Wohin unserer Wissenschaft. In: Joseph Alois Schumpeter: Aufsätze zur ökonomischen Theorie. Tübingen: J.C.B. Mohr, S. 589–608.

Schumpeter, Joseph Alois; Schumpeter, Elizabeth Boody (1967): History of economic analysis. 6. Aufl. London: Allen & Unwin.

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3 thoughts on “When Keynes is Hayek and Menger is Schmoller

  1. […] “Philosophie des Geldes” in 1900 [2009]. Too bad that these scholars lost their voice together with the 2. World War. After 50 years of cold war, this is now slowly rediscovered. Institutional economics describes the […]

  2. […] über die genannten Begriffe. Wo TES ansonsten allgemeine Paradigmen kontrovers betrachtet (1,2), behalten wir diese bei diesem Beitrag ganz bei, um v.a. den Begriff der […]

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