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Celebrating the Triumphant Return of Hayek

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2009 might have been the Year of Keynes but 2011 could be the Year of Hayek.

Certainly, last year, the consensus was that we were all Keynesians. The British economist argued that governments have the power to avoid economic meltdowns by engaging in a lot of go-go stimulating. Specifically, he encouraged deficit-financed fiscal spending as the most effective method.

But, as Ruchir Sharma, head of Emerging Markets at Morgan Stanley Investment Management recently opined, Keynesianism quickly fell out of favor: across the developed world, critics argued that government spending reached the point of diminishing returns, and was producing an anemic recovery that mainly benefited special-interest groups. The electorate listened and responded: they rewarded politicians who said they favored fiscal responsibility.

For his part, Fed Head Ben Bernanke says that he’s now doing everything Milton Friedman would have had the Fed do. Friedman argued that the Great Depression was largely the result of a major contraction in money supply, and that the downturn could have been avoided had central bankers held the money supply stable.

But Keynesianism and monetarism are now suffering a similar distortion, says Sharma. He writes that Keynes would probably never have supported big government deficits during boom times, such as those that led to our current debt crisis. Likewise, he says, Friedman would probably not have backed the new Fed use of monetary policy as a tool to engineer expansion rather than merely cushion the pain in a downturn.

“The systematic perversion of Keynes’s and Friedman’s thought is now resulting in a fall in their fortunes, leaving Hayek triumphant, once again,” Sharma concludes.

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