Thursday, March 21, 2013

Hayek on Aggregate Demand in a Depression

Gottfried von Haberler describes Hayek’s views on the role of aggregate demand in an economy, and the two instances where Hayek admitted that aggregate demand was able to affect the level of employment:
“In later writings Hayek (1974, 1975) has clarified and somewhat modified his views, coming to grips with the problem of secondary deflation. He still rejects what he believes is the basic mistake of Keynesian economics, namely, ‘that employment is a direct and simple function of what is called aggregate demand, and that by keeping aggregate demand at a sufficiently high level we can lastingly secure full employment’ (1975, p. 4). In a later publication he goes so far as to say that ‘the whole notion that he [Keynes] has made popular, macroeconomics,’ must be ‘set aside.’

Hayek now says there are two exceptions to the rule that changes in aggregate demand do not affect the level of employment. The first one was ‘an accidental historic situation.’ In 1925 Britain made the mistake of returning to the gold standard at the prewar parity, which meant that real wages were too high. ‘In this situation,’ he wrote, ‘the restoration of employment required a reduction of real wages which could he achieved by a general rise of prices’ (1974, p. 4).

‘The second situation in which it is true that an increase of employment requires an increase in aggregate demand,’ Hayek (1974, p. 5) now maintains, ‘is found in the later stages of a depression when, in consequence of the appearance of extensive unemployment, the economy frequently is subjected to a cumulative process of contraction. … of secondary deflation, which may go on for a very long time.’”
(Haberler 1986: 426; reprinted in Haberler 1991).
Yet it seems difficult to see why an increase in aggregate demand would increase employment in a depression, but not in a recession, or indeed in any situation where extensive unemployment and idle resources exist.

One can only marvel at the inconsistency in Hayek’s thought. And what was Hayek’s explanation for the repeated instances we see in the real world in which government fiscal stimulus is followed by increased private investment and falling unemployment?

BIBLIOGRAPHY

Haberler, G. 1986. “Reflections on Hayek’s Business Cycle Theory,” Cato Journal 6: 421–435.

Haberler, G. 1991. “Reflections on Hayek’s Business Cycle Theory,” in John Cunningham Wood and Ronald N. Woods (eds.), Friedrich A. Hayek: Critical Assessments (vol. 4). Routledge, London. 249–262.

2 comments:

  1. Previous thread continued

    "Fine. You think QE needs to be tens of trillions.

    Given the US economy is about $15 trillion, would you say $20 trillion or $30 trillion is the appropriate level of QE?

    Why not just spend 2-3 trillion in the form of stimulus over a few years on badly need public infrastructure?
    "

    yes I think 20 trillion, or the credible threat to do it, would be sufficient.

    And you ask a very, very, GOOD question about infrastructure. Its why Im a Friedmanite rather than a Keynesian.

    Its simple, Infrastructure spending and AD boosting work at cross purposes. Its like mixing oil and water. When you build needed infrastructure, the aim should be to provide a high quality public product at the lowest possible price, (a bridge in an economically significant and populated area that'll enhance productivity, and reduce travel times, etc.

    Whereas when we have an AD problem, as we do now, the larger the stimulus, the more money is spent the more people are put back to work, which is the whole aim of stimulus, NOT to build a high quality product. Its more expensive, and time consuming in terms of real resources too, whereas MP involves pushing buttons on a computer screen.
    If we need infrastructure, fine, but don't call it demand stimulus call it supply stimulus. Eisenhower's interstate highway system was not built during the depression, it was built during the 50's a prosperous time if I recall for the American economy. Tax levies should be used, mixed with bond issues, and perhaps public private partnerships.

    Bottom line AD and AS problems are substantially different and we shouldn't confuse them

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  2. I forgot to add,

    monetary policy reduces the public debt burden, whereas fiscal policy, (assuming its financed with bonds and not treasury printing) increases it.

    If the Fed buys $10 trillion of Treasurys worldwide, thats $10,trillion less the US government has to pay, and the interest is also remitted back to the US Treasury department too.

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