Saturday, August 7, 2010

Who said it? (no cheating)

"I believe that deflation has no recognizable function whatever, and that there is no justification for supporting or permitting a process of deflation"


  1. Probably some Austrian economist or some such.

  2. Hayek said it, yeah yeah I'm familiar with the piece. I think it's safe to say Hayek was wrong on this count. Deflation is a welcome occurrence.

  3. Jonathan M. F. CatalánAugust 7, 2010 at 11:49 AM

    Hayek is referring to a fall in the supply of money, and yes Hayek is unfortunately wrong (at least, regarding the liquidation of malinvestment).

  4. Jonathan M. F. CatalánAugust 7, 2010 at 11:59 AM

    Daniel, this might interest you:

  5. He is also wrong if he states that a fall in the supple of money is undesirable. Deflation as I have previously stated is only an undoing of a previous credit inflation. Hayek should be the first to recognize the inherent dangers of an economy built on credit money.

  6. Of course you two are right.

    I read the Larry White JMCB article on Hayek and Robbins last night on the advice of one of the reviewers for my Review of Austrian Economics article. It was a very interesting read. This wasn't a shocking sentiment from Hayek, but it was bluntly stated. I wouldn't have even said that.

    Anyway - Hayek clearly thought things through carefully over time, but there were some strange elements of the article nonetheless. First, the point that deflation would "break" wage and price rigidity?!? Was he worried about upward rigidity or something? That was extremely odd - normally when we talk about rigidity we're talking about downward rigidity and you think of inflation as breaking it, not deflation. I'm still not sure what Hayek was talking about there. I also was pretty skeptical of White's explanation of what Hayek's theory implied as a policy recommendation during the Great Depression. White argues that if Hayek were true to his own theory he would have advocated an expansion of the money supply. But that didn't seem right given White's version of Hayek's theory.

    Anyway - I have and have read much of the first Liberty Fund volume of Hayek's monetary theory. I'm eager to get a copy of the second volume now. The White article was very good if you two haven't read it. I think White was trying way too hard to force Hayek into a monetary disequilibrium theory mold, but it was still an interesting read.

  7. 2008, JMCB, "Did Hayek and Robbins Deepen the Great Depression"

  8. In 1933, Hayek wrote an article called "Saving" for the "Encyclopedia of the Social Sciences." This is, perhaps, the earliest published record of Hayek expressing views in common with monetary equilibrium theorists:

    "Unless the banks create additional credits for investment purposes to the same extent that the holders of deposits have ceased to use them for current expenditure, the effect of such saving is essentially the same as that of hoarding and has all the undesirable deflationary consequences attaching to the latter."

  9. I do not believe Hayek, nor modern ME theorists, intend to frustrate the liquidation of malinvestment by increasing the money supply. The theory predicts that the optimal environment for malinvestment liquidation is of monetary equilibrium, regardless of how it is achieved. Deflation, in this context, is seen as an overcorrection of sorts, and creating its own kind of malinvestment.

  10. Lee Kelly - on Hayek, I'm still not sure one way or another and it is honestly simply that I haven't read enough of him.

    Given what White shared in the article, he seems at least to have some major issues with the ME perspective in the way he talks about malinvestments. I'm most concerned with Hayek's criticism of the real bills doctrine, which White cites out of Hayek's "Monetary Theory and the Trade Cycle". That criticism seems to suggest quite clearly that he would not want accomodative monetary policy. My biggest criticism of the White article is that he reviews this rejection of the real bills doctrine by Hayek, but then seems to completely omit any discussion of the implications of this rejection for monetary policy. The implication, it seems to me, is that accomodative monetary policy is not good. And then White goes on to cite Hayek in Profits, Interest, and Investment with passages that I agree do seem to present an ME perspective that would allow for accomodative policy.

    But then if we come to Hayek on the business cycle and the capital structure, we're once again back to something that seems to me to reject ME theory. Again we have this same, essentially Wicksellian critique of the real bills doctrine that he presented in "Monetary Theory and the Trade Cycle".

    So which Hayek is the real Hayek? As I said, it's very possible that I might just need to read more - but even as White presented the evidence Hayek seemed quite schizophrenic on the question to me.

    (It was funny - my first reviewer suggested that I read White and basically made the "Austrians aren't liquidationists" claim, while my second reviewer explicitly embraced the view that the money supply should have remained untouched in the early 30s... I'm going to have to disappoint someone or split the baby somehow).

    ME Theory is very interesting to me. It's like the quantity theory in many ways (well duh!) - it's something that it seems like virtually everyone agrees with in some capacity. Some people just qualify it more than others I guess. I'm still trying to get a grip on what ME theory is except for simply a least common denominator.

  11. And Lee Kelly - I don't mean to sharply dispute anything you said. I'm honestly still groping my way around this stuff, and I always enjoy your comments on this.

    I just have lingering questions I suppose...

  12. Let us suppose, for example, an economy where all prices are fixed. Deflation is impossible. Whatever is not purchased at a reduced level of total spending is made idle. Any resources "saved" are not redeployed to alternative ends, but merely left to depreciate. Since all prices are fixed, this situation will persist indefinitely until total spending returns to its previous level.

    To return total spending to its previous level, and redeploy idle resources toward productive ends, either the money supply must increase, money demand must decrease, or some combination of both.

    However, REAL spending will be lower, even after nominal spending has returned to its previous level. The time that elapses between the initial drop in total spending and its eventual recovery is lost forever, and resources have been allowed to depreciate in that time. The longer it takes for monetary equilibrium to reassert itself, the more the future will pay for it.

    If deflation were a quicker means of reestablishing monetary equilibrium, and expansionary monetary policy were slow and uneven, then ME theorists would advocate deflation.

  13. I have just started reading the paper you linked to by White. He quotes the same passage that I quoted above, so it was a bit redundant. Sorry about that!

  14. Jonathan M. F. CatalánAugust 7, 2010 at 9:03 PM

    Lee Kelly,

    I think monetary equilibrium theorists accept a fall in the supply of money as a result of a default on loans, or a decrease in the total volume of loans, but believe an elastic money supply can meet an increase in demand for money.

  15. Lee Kelly - I'd be interested in hearing if you agree with me that the implications of Hayek's reaction to the real bills doctrine for monetary policy was fudged by White. Maybe I'll explain my concerns in more detail in the future.


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