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Secretary Geithner: Hayekian or Keynesian?

May 28, 2009D.W. MacKenzie

Tags The FedBusiness CyclesInterventionismMonetary TheoryOther Schools of Thought

US Treasury Secretary Timothy Geithner
US Treasury Secretary Timothy Geithner

Austrian economists have insisted that the Federal Reserve Bank helped cause the subprime housing boom that led to the financial crisis of 2008, and we are not alone in this opinion. According to Treasury Secretary Timothy Geithner, Federal Reserve policy was "too loose for too long." Some of us see Geithner's remark as both a mea culpa on the part of the federal government and a confirmation of Austrian business-cycle theory. A more general examination of Geithner's remarks on the subprime boom and bust, however, reveals the influence of Keynes, rather than Hayek.

Secretary Geithner believes that the subprime housing boom was caused by three factors: loose monetary policy; executive compensation that encouraged excessive risk taking by banks; and a slow, weak reaction to the subprime crisis by federal authorities last year. The excessive risk taking by banks led them to be overleveraged, and allowed Americans to assume too much debt. Geithner sees loose monetary policy as a contributing factor, but he lays most of the blame on Wall Street.

The problem with this interpretation of events is that loose monetary policy encourages risk taking and borrowing with low interest rates, but there is a deeper deficiency in his thinking. Geithner thinks of money and interest only in terms of risk. Risk-based theories of money are consistent with Keynesian economics. Modern Keynesian theories focus on risk rather than on time preference. In Austrian theory, loose monetary policy creates bias towards longer-term investment projects and away from current consumption. By focusing on risk, Geithner makes it easy to avoid discussions of capital structure.

Secretary Geithner is highly optimistic regarding our abilities to deal with the current crisis. He believes that America is "a terrifically strong country with abundant resources." Were it true, the availability of abundant resources would be cause for optimism. It is unfortunately the case that we live in a world of scarcity. Were the Treasury secretary schooled in proper economics he would know all of this. It is rather the case that Geithner embraces one of the more extreme Keynesian views: abundance. As Friedrich Hayek noted decades ago, Keynesian economics is a theory of abundance where unused reserves of resources can be brought online through fiscal or monetary stimulus. Keynes himself speculated that in a couple of generations we might "solve the economic problem" by satisfying all of our real economic needs.

Secretary Geithner thinks of the economy in Keynesian terms as "a machine without an effective steering wheel." The problem as explained by Geithner is that in the past years executive compensation diverged from reality and began to reward excessive risk taking. The private checks and balances against excessive risk were overwhelmed, and a boom ensued. But now that the undue optimisms of the boom have been revealed, we have a bust where pessimism has frozen credit markets and slowed the aggregate economy. This is strikingly similar to the waves of investor optimism and pessimism that Keynes himself saw as the cause of business cycles.

Geithner also has a very high opinion of the abilities of government to deal with crises. According to Geithner, managing a crisis is "not about ability, it's about will, it's about the will of government to do what necessary to fix things" and this is the best-managed crisis because officials have acted "earlier and stronger" than ever before.


this president is going to do what is necessary to get us through this … with the most effective, most carefully defined, most thoughtfully conceived programs that are available to us as a country.

In other words, Obama and his staff know how to plan an economy. Private bankers do not know how to structure executive compensation and manage risk, so the federal government must enact new regulations. Banks were too leveraged, so the federal government must enact new regulations. The economy was destabilized by a wave of excessive optimism followed by a wave of excessive pessimism, so the federal government must enact new regulations. These new regulations will prevent another subprime crisis because government officials know what to do.

The idea that wise statesmen actually possess the knowledge needed to manage the economy was debunked long ago. Friedrich Hayek explained the undeniable fact that modern economies are complex beyond anyone's comprehension. The idea that officials need only the will to carefully design and thoughtfully conceive regulations or other policies is absurd when you consider all the factors relevant to such policies. We live in a country with over three-hundred-million consumers, and an uncounted number of products, each the outcome of a lengthy and complex process of production. Keynesian theory simplifies the economy into easily managed aggregates, especially where capital is concerned.

Keynes also assumed that groups form expectations, rather than individuals. According to Keynes, the business community might misinterpret increased savings as reduced demand for their own goods. In reality, such aggregates have little meaning, as all human action consists of striving for individual goals, and all individuals form unique opinions and expectations on how to best achieve their goals. What this means is that supposedly carefully designed and thoughtfully conceived regulations will produce unanticipated reactions, which in turn produce unintended consequences. Unintended consequences of policies typically require further intervention to achieve the goals set by state officials.[1]

But such ideas are not obvious to a Keynesian like Geithner. If he understood the importance and unpredictability of human action he would also understand that the subprime boom was itself an unintended consequence of well-intentioned and carefully thought-out policies to promote home ownership and stimulate the economy. If he were a Hayekian, then he would see the folly in his own plans for the American economy. As a Keynesian he is unable to see these things clearly.

"Such aggregates have little meaning, as all human action consists of striving for individual goals."

The ability of Secretary Geithner to attribute at least some of the blame for the subprime crisis to the Fed was a fluke. The general character of his thinking is Keynesian, which is why he favors spending and regulation as means to alleviating the current crisis. There is little chance of any change in his thought. While he has insisted that he and Obama are open to all views and want to hear all options, what he meant was that President Obama recently spoke with Keynesians Joseph Stiglitz and Paul Krugman. If Geithner believes that his opinions plus those of Stiglitz and Krugman represent a broad spectrum, then he is hopelessly ignorant in these matters.

We can only hope that his successor will at least be aware of a broader range of economic ideas. Better still, we should hope for the spread of Hayekian ideas, as only public pressure will prompt politicians to implement sound policies. As Hayek put it, "it is not necessary, for the working of the price system, that anybody should understand it. But people are not likely to let it work if they do not understand it."[2]


[1] This is the basic idea behind the theory of intervention developed by Ludwig von Mises, and refined by Sanford Ikeda.

[2] See Individualism and Economic Order, p. 128.

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