Abstract
In his early writings on business cycle theory and the Great Depression Hayek argued that business cycle downturns including the steep downturn of 1929–1931 were caused by unsustainable elongations of capital structure of the economy resulting from bank-financed investment in excess of voluntary saving. Because monetary expansion was the cause of the crisis, Hayek argued that monetary expansion was an inappropriate remedy to cure the deflation and high unemployment caused by the crisis. He therefore recommended allowing the Depression to take its course until the distortions that led to the downturn could be corrected by market forces. However, this view of the Depression was at odds with Hayek’s own neutral money criterion which implied that prices should fall during expansions and rise during contractions so that nominal spending would remain more or less constant over the cycle. Although Hayek strongly favoured allowing prices to fall in the expansion, he did not follow the logic of his own theory in favouring generally increasing prices during the contraction. This chapter explores the reasons for Hayek’s reluctance to follow the logic of his own theory in his early policy recommendations. The key factors responsible for his early policy recommendations seem to be his attachment to the gold standard and the seeming necessity for countries to accept deflation to maintain convertibility and his hope or expectation that deflation would overwhelm the price rigidities that he believed were obstructing the price mechanism from speeding a recovery. By 1935, Hayek’s attachment to the gold standard was starting to weaken, and in later years he openly acknowledged that he had been mistaken not to favor policy measures, including monetary expansion, designed to stabilize total spending.
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Notes
- 1.
The position was secured for Hayek by his mentor, Ludwig von Mises, who was secretary of the Vienna Chamber of Commerce, one of the sponsoring institutions of the Institute.
- 2.
The equilibrium of an economy with n real commodities corresponds a price vector consisting of n-1 relative prices per time period. That equilibrium price vector is invariant to scalar multiplication over all time period but also to exponential multiplication representing the expected rate of inflation across time periods.
- 3.
Hayek (1934) actually understood the point in a different context noting in his reply to a review of Prices and Production by Hansen and Tout (1933) that a steady rate of monetary expansion would cease to have any effect on the capital structure of an economy once the public came to expect that rate of monetary expansion to persist over time, thereby anticipating by over 30 years Friedman’s (1968) argument that the long-run Phillips Curve is vertical.
- 4.
J. L. Caton (2018) documents that in essay in the Economist, Hayek (1935) acknowledged that the demand of central banks for gold reserves was in fact a source of instability in the value of gold and that without some mechanism of international cooperation to limit the monetary demand for gold sufficiently to preserve a stable value of gold, restoring the widely abandoned gold standard could lead to renewed deflation. Thus, by 1935, Hayek seems to have accepted the Cassel-Hawtrey view that international cooperation was necessary to ensure that a gold standard would be consistent with international price stability, precisely the view that he had criticized so severely in his 1932 essay on the gold standard.
- 5.
White uses this distinction to absolve Hayek from the charge that Hayek was a liquidationist, who was provided intellectual support for the liquidationist policies supposedly pursued by Andrew Mellon, Secretary of the Treasury. Following Eichengreen (1992), White suggests that insofar as the liquidationist position enjoyed any intellectual support, that support was derived from supporters of the real-bills doctrine in the Federal Reserve such as Adolph Miller, a former academic economist, and a member of the Fed Board of Governors. Eichengreen and White are quite probably correct in identifying the Fed as the source of liquidationist sentiment that was influencing administration and Fed policy. And White is also correct in noting that Hayek was an outspoken critic of the real-bills doctrine. However, disagreement about the real-bills doctrine does not establish any substantive difference between the liquidationist position of Miller and of his associates on the Fed and the liquidationist position espoused by Hayek in 1933. Presumably, Miller et al. were not unaware of the distinction between bankruptcy and liquidation in the economic sense; White provides no evidence that Miller et al. did not understand that distinction.
- 6.
However, I am not aware of any evidence that Hayek in 1933 understood the full implications of the argument of his 1937 paper acknowledging that there is no market mechanism for achieving equilibrium when, given the lack of a complete set of markets, independent plans are coordinated only insofar as economic agents share identical expectations. Unless there is a market mechanism by which expectations are reconciled—and Hayek acknowledged the lack of such a mechanism—price and wage flexibility does not ensure a tendency toward equilibrium. At most, Hayek conceded, there is an observed, but not theoretically established, empirical tendency towards equilibrium.
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Glasner, D. (2018). Hayek, Deflation, Gold, and Nihilism . In: Leeson, R. (eds) Hayek: A Collaborative Biography. Archival Insights into the Evolution of Economics. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-91358-2_4
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