What Would Hayek Say?

21 September 2008 at 9:49 pm 20 comments

| Peter Klein |

About the events of the last week? Probably the same thing he said in 1932:

Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion. . . . To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection — a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end. . . . It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression.We must not forget that, for the last six or eight years, monetary policy all over the world has followed the advice of the stabilizers. It is high time that their influence, which has already done harm enough, should be overthrown.

That’s from the introduction to Monetary Nationalism and International Stability, included in the new collection we mentioned earlier. Thanks to Jeff Tucker for the tip and links to the source material.

Entry filed under: - Klein -, Austrian Economics, Business/Economic History, Public Policy / Political Economy. Tags: , .

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20 Comments Add your own

  • 1. Inga kommentarer till krisen « Nonicoclolasos  |  22 September 2008 at 12:36 am

    […] Professor Hayek kommenterar 30-talskrisen. […]

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  • 3. Brian A'Hearn  |  22 September 2008 at 2:57 pm

    It’s hard to understand quite what Hayek is saying here. Who are “the stabilizers”, for example? I think it Is a widely shared consensus among economic historians that the Depression was mostly about monetary contraction and financial meltdown, and that policy was at best neutral, at worst directly responsible for this collapse. This view owes a lot to Milton Friedman, of course. Hayek might be able to make a good case for bad policy creating the preconditions for the Depression, but was he really saying that inaction/noninterference was the best policy once the Depression was underway?

  • 4. Peter Klein  |  22 September 2008 at 5:28 pm

    Brian, the Hayekian/Austrian analysis of the Depression shares little with Friedman’s except for a general emphasis on monetary policy. For the Austrians, the policy failure was not the contraction singled out by Friedman and Schwartz, but the monetary expansion of the previous decade. The collapse was the inevitable result of the malinvestment that took place during the 1920s. As Roger Garrison once put it, the Austrian cycle theory is not a theory about the depression, but a theory of the unsustainable boom. Most Austrians would argue that once the bubble bursts, starting a new bubble via credit expansion is exactly the worst thing to do. (Most Austrians would take the “standard” view that the various Hoover and Roosevelt structural remedies such as forced cartelization, price and wage controls, make-work schemes, and the like only added to the length and depth of the depression itself.)

    There’s a big literature on this — Rothbard’s _America’s Great Depression_ is probably a good place to start. Or, for a shorter treatment, try the _Trade Cycle_ collection here:


    And maybe the Garrison-Kirzner entry on Hayek in the _New Palgrave_:


  • 5. Matěj Šuster  |  23 September 2008 at 3:41 am

    Peter Klein:

    Perhaps you should consult this paper:

    Lawrence H. White: “Did Hayek and Robbins Deepen the Great Depression?”

    Click to access 07056.pdf


    “Contrary to some accounts, the Hayek-Robbins (“Austrian”) theory of the business cycle did not prescribe a monetary policy of “liquidationism” in the sense of passive indifference to sharp deflation during the early years of the Great Depression.”

  • 6. Brian A'Hearn  |  23 September 2008 at 3:45 am

    I have always found the international evidence pretty convincing that countries that stuck to the gold standard longer and harder had longer and harder recessions, while those that abandoned it, and in which the money supply expanded, had better recoveries. If so, it would seem to contradict Hayek’s analysis. Of course, you could say that other confounding factors created this coincidence, or that in the absence of WWII a second bubble would have burst in the countries experiencing monetary expansion. But the more natural interpretation is that monetary/credit expansion was the policy that stimulated recovery (or at least permitted recovery). What was Hayek’s take on the gold standard? Was that good policy, or more state interference in the economy? Or was it something to be judged on a case by case basis?

  • 7. Richard Ebeling  |  23 September 2008 at 3:22 pm

    Part of the issue would concern what “better recovery” means. Certainly Austrians (and most quantity theorists in general) would not disagree that if you have the government run deficits paid for with increases in the money supply, and if for a period of time wages do not rise in the face of increased “aggregate demand” and rising prices, then output will likely increase and unemployment will likely decline.

    And, of course, going off the gold standard makes it institutionally easier for the government and the monetary authority to resort to the printing press.

    The issue is whether, in the longer run, such a “recovery” is sustainable.

    Britain went off gold in September 1931. Yet the U.K still had double digit unemployment in 1937-38. And Keynes, with that level of employment, was at that time talking about the dangers of inflation in his own country.

    The U.S., in fact, went off the gold standard in 1933 as a result of the legislation of the first 100 days of the New Deal. Yet, in 1937, people were speaking of the “Roosevelt Recession,” i.e., a new decline in output and employment when unemployment was still well above 10 percent.

    Germany abandoned the gold standard, also. Its “solution” to the unemployment problem was Hitler’s National Socialist public works projects — which recent historians have pointed out created huge financial pressure on the economy, and resulted in inflation and then the imposition of Nazi “four-year” central planning in 1936.

    The argument of “Austrians” like Hayek in the 1930s (but not only Austrians at that time) was that the previous boom of the 1920s was built on a monetary inflation that was hidden from view due to a generally stable price level.

    During this period interest rates had been kept artifically low; the lower interest rates had made the present value of longer-term investments seem more profitable (even though “real savings” was not there to maintain them), which resulted in a malinvestment of capital. The monetary expansion stimulated a stock market boom and a real-estate boom.

    Finally, the boom came to an end in 1929, and the economy then needed to go through an adjustment and correction to bring the market back into balance. This necessitated appropriate wage, price, production, and resource adjustments and reallocations.

    But first the Hoover administration and then the Roosevelt administration imposed taxes, regulations and restrictions that made it institutionally difficult if not impossible for markets to find their coordinating, market-clearing levels.

    Thus, the 1930s was not a “crisis” and “failure” of capitalism, as many came to think at that time. Rather, it was a crisis and failure of the interventionist state that prevented markets from “working.”

    I fear that we are about to get another painful lesson in a crisis of the interventionist state.

    Richard Ebeling

  • 8. Lawrence H. White  |  23 September 2008 at 6:09 pm

    Hayek today would presumably notice that there wasn’t much credit expansion by the Fed last week. Over the last six months, the Fed’s extraordinary loans to non-banks have been almost entirely sterilized. The Fed’s portfolio mix of assets has shifted from all Treasuries to mostly junk-collateralized loans, but the total has grown relatively little: the St. Louis Adjusted Monetary Base (NSA) is up 2.3%, 2008-09-10 over 2008-03-12. Year over year, it’s up 2.7%.

    The Fed’s foolish policy at present is the non-market allocation of credit rather than overall credit expansion.

    Let me try to address Brian A’Hearn’s several good questions.

    (1) Who were “the stabilizers” Hayek was criticizing? They were economists who wanted the Fed to stabilize a consumer price index (call it P). Some failed to recognize the inconsistency between stabilizing P and continuing on the gold standard; others wanted to ditch the gold standard. Hayek’s list of “stabilizers” included Irving Fisher, Gustav Cassel, J. M. Keynes (of the 1923 Tract), and Ralph Hawtrey. Hayek’s preference was to stabilize MV or Py, allowing P to fall as real output y grew with increased productivity.

    (2) “Hayek might be able to make a good case for bad policy creating the preconditions for the Depression, but was he really saying that inaction/noninterference was the best policy once the Depression was underway?” Hayek was saying that noninterference in bankruptcies and liquidations was the best policy. As I discuss in the article that Matěj Šuster kindly cites, that’s not the same as calling for noninterference in the contraction of nominal income. Hayek’s monetary policy norm called for stabilization of nominal income (MV). If Hayek had applied the norm consistently, he would have called for the Fed to offset the dramatic decline in the money multiplier (below its sustainable level), and in that way to prevent the declines in M and MV. (In practice Hayek’s public statements in 1931-32 were more ambiguous, for reasons I discuss in the paper, which he later regretted.)

    (3) “What was Hayek’s take on the gold standard? Was that good policy, or more state interference in the economy? Or was it something to be judged on a case by case basis?” In brief, Hayek’s take was somewhat ambivalent. The gold standard wouldn’t exactly stabilize MV (world gold stocks were slow to respond to changes in V), so it wasn’t ideal. But it would come close in the long run, and its constraint on central banks would prevent badly unsustainable monetary policy. On the international level it would effectively equilibrate interregional trade. So it was the best we could hope for.

  • 9. Richard Ebeling  |  23 September 2008 at 9:20 pm

    Larry White, as usual, has explained things in a very clear and concise manner.

    But the problem even with Hayek’s belief in the early 1930s about stabilizing nominal income (MV) is, how do you do this without generating similar non-neutral monetary effects that earlier monetary expansion caused in setting the stage with misdirections of resources that originally created the conditions for the downturn?

    The Fed’s tools then, and mostly now, is to increase general bank reserves and pushing down interest rates. The same process that causes the problem to begin with.

    This problem is why, I think, some of the Austrians at this time (I’m thinking of Mises and Robbins in particular in, say, 1931 and 1932) were critical of “reflation.”

    Even A.C. Pigou, in one of a series of lectures that he delivered at the LSE in 1934, was critical of “reflationary” expansion of the money supply because he believed that it would interfere with the necessary downward adjustments in the relative price and wage structures that were needed to restore balance in the economy.

    Richard Ebeling

  • 10. Lawrence H. White  |  24 September 2008 at 1:13 pm

    Richard Ebeling, as usual, has identified the key issue clearly.

    Here is how I would briefly defend Hayek’s constant-MV norm, given a central bank, as opposed to the Currency School norm of a constant monetary base B (absent external gold flows). I would distinguish between (a) central bank expansion of B that creates an excess supply of money and thereby temporarily distorts interest rates through a liquidity effect (the Fed in the 1920s), and (b) central bank expansion of B that counters an excess demand for money and thereby avoids distortions in interest rates from a liquidity effect. The former creates a disequilibrium, the latter avoids one. The excess demand for money in 1929-32 came from M shrinkage due to a collapse in the money multiplier (M/B). Offsetting the fall in M/B by expanding B does not push interest rates down below equilibrium, but rather prevents them from rising above equilibrium.

    Of course, we would be better off relying on a free banking system to automatically act this way, than relying on a central bank to choose the right policy at the right time.

  • 11. Peter Klein  |  24 September 2008 at 1:23 pm

    Larry, a quick clarification: Wouldn’t option (b) involve injection effects or Cantillon effects that could be masked by looking at aggregate data? In other words, wouldn’t the increase in the monetary base affect not only the allocation of investment between long-term and short-term projects (the length of the Hayekian triangle), but also between firms and industries competing for investment goods at the same place in the time-structure of production? Wouldn’t the expansion of B also involve a distortion or disequilibrium in the relative prices of capital goods of the same “order” (in Menger’s terms) and the relative incomes of firms that are closer or farther away from the credit markets in which the central bank intervenes? Thanks.

  • 12. Lawrence H. White  |  24 September 2008 at 2:55 pm

    Peter, option (b) presumably would unavoidably involve some kind of non-systematic injection effects or Cantillon effects, some kind of “noise”. The banks that first get excess reserves presumably lend to a set of firms than that is not perfectly representative of the economy as a whole. But since the expansion of B doesn’t distort the interest rate (under the assumption that that it is correctly calibrated and timed), there’s no reason to think that it would systematically distort the allocation of investment between long-term and short-term projects, or between higher and lower stages of production (as your “not only” suggests).

    Decentralizing the monetary system would help avoid such noise effects, as well as the systematic distortions associated with disequilibrating monetary policy.

  • 13. Peter Klein  |  24 September 2008 at 4:18 pm

    Right, sorry, I was typing faster than I was thinking. I meant to write that in general, we should worry not only about the allocation of investment between long-term and short-term projects (the length of the Hayekian triangle), but also that between firms and industries competing for investment goods at the same place in the time-structure of production. In other words, even if an increase in the monetary base doesn’t distort the intertemporal structure of production, it still interferes with the allocation of resources across firms and industries. I take it you’re saying the effects of introducing such noise are second-order relative to the effects of a B that’s too low for a given demand for money.

  • 14. Financial Crisis/Bailout Linkfest « The Everyday Economist  |  24 September 2008 at 10:11 pm

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  • 15. Hayek sobre a crise financeira « O Insurgente  |  25 September 2008 at 4:23 am

    […] sobre a crise financeira Arquivado como: Economia, Teoria — Miguel @ 10:23 am “What Would Hayek Say?”, uma discussão iniciada por Peter Klein com contribuições de Richard Ebeling e Lawrence […]

  • 16. Bogdan Enache  |  25 September 2008 at 4:47 pm

    Dear professor White,

    What are the reasons to believe in the assumption that the interest rate during the contraction phase is “correctly calibrated and timed”? Being the result of a previously expansionist phase, it doesn’t seem clear what the right level of interest should be.

  • 17. Less Antman  |  26 September 2008 at 7:26 am

    As I understand it, the deflation of the money supply was the result of the widespread bank failures, and these were largely the result of the laws against branch banking that caused so many banks to be “measly one-horse institutions” (h/t It’s A Wonderful Life) which had horribly undiversified portfolios of loans. Am I correct that Canada had no bank failures during this time, and had no restrictions on branch banking?

    Did Hayek (or other free market economists) address the branch banking prohibitions during the contraction?

  • 18. Lawrence H. White  |  26 September 2008 at 11:31 am

    In reply to Bogdan Enache: As a thought experiment, I was imagining a central bank “offsetting the fall in M/B by expanding B” in a way that is “correctly calibrated and timed”. I argued that such an action “does not push interest rates down below equilibrium” because it does not create an excess supply of money. The imagined action targets M or MV, not the interest rate. The market determines the interest rate. I am not assuming that a central bank can target the correct interest rate.

  • 19. Kaz  |  9 September 2010 at 11:05 am

    Hayek did NOT argue for a gold standard, but AGAINST them.

    He was showing how the government imposing gold as a system of barter inevitably destroyed any economy. The fact that those who stuck to their fiat gold standards longer failed harder is entirely consistent with Austrian views.

    Forcing people to use gold is socialism, same as anything else, and just as bad as the rest.

  • […] bailout? 6. For Greenwich, ‘This is our Katrina’. Oh please. – Ed. 7. What would Hayek say about recent interventions in the economy? 8. John Paulson is listed as the biggest short seller […]

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