Tuesday, August 13, 2013

Hayek was originally a Liquidationist: Free Bankers are Wrong!

Paul Krugman recently pointed out that Milton Friedman rejected Hayek’s liquidationism, and points to a clear passage in Prices and Production demonstrating Hayek’s liquidationist views.

The free banker Larry White then complains that this is untrue, and that Hayek has been “mischaracterized” as a liquidationist, when he was a stable-MV man.

Daniel Kuehn then weighs in here and here.

Quite simply, White is conflating two different views Hayek held at different points in his life, and ignores the fact that Hayek did indeed originally advocate liquidationism at the time of Prices and Production in the early 1930s.

Moreover, White’s paper “Did Hayek and Robbins Deepen the Great Depression?” (White 2008) demonstrates that Hayek’s thought was not a significant influence on US Federal Reserve policy makers under Hoover, but not that Hayek in 1931 or 1932 was advocating monetary expansion to stabilise nominal spending. The only evidence adduced for the idea that Hayek wanted to stabilise money supply when velocity varied in a recession comes from Hayek’s works published years after 1931 at a time when it is clear that Hayek had changed his mind (such as in Hayek 1937 and Hayek 1933). White (2008: 763) even states that Hayek and Robbins “failed to call for central banks to do what they could to counter the sharp monetary contraction and crushing deflation during 1930–33.”

The reality of Hayek’s policy ideas is this: at some point after 1933 Hayek changed his mind and renounced hard liquidationism.

Certainly by the time of his 1937 essay “The Gold Problem” (“Das Goldproblem”; see Hayek 1999: 169–185, and 184), Hayek is found actually endorsing, not just MV stability, but deficit financed public works as a response to depression:
“Even though there are many concerns about organizing public works ad hoc during a depression, everything speaks in favour of having public agencies perform during a depression whatever investment activities need to be carried out in any case and can possibly be postposed until then. It is the timing of these expenses that presents a problem, since funds are often extremely hard to raise in the midst of a severe depression and the accumulation of reserves in good times generally faces the objections mentioned above. There is little question that in times of general unemployment the state must intervene to mitigate genuine hardship either by disbursing unemployment compensation or, as in earlier times, by legislation to help the poor. (Hayek 1999 [1937]: 184; see also Hayek 1978: 210–212).
Now Ludwig Lachmann, who was Hayek’s research assistant at the LSE in the 1930s, in an Austrian Economics Newsletter (AEN) interview explains the change in Hayek’s thinking:
AEN: In the early 30’s there had been great interest among the profession in the ‘Austrian’ or Hayekian theory of the trade cycle. Yet as the 1930’s progressed even those who had been adherents seemed to have given up their belief in its correctness. What reasons do you think were behind this?

Lachmann: Well, you presumably know about the two different letters to the London Times that appeared in October, 1932. This, of course, was before I came to London. In one of them, Keynes and some Cambridge economists who were not, in general, his friends, like Pigou and Dennis Robertson, demanded that the government should take steps against unemployment. And three days later, Hayek, Robbins and Arnold Plant sent another letter saying that anything the government did by way of public works or similar methods would only make things worse and would not have the affect that Keynes claimed it would have.

That is to say, the ‘Austrians’ seemed to be committed to a policy of continuous deflation whatever happened. Yes, I’m quite sure that the apparent insistence of the ‘Austrians’ that the depression must run its course in the sense that both prices and wages in general must fall seemed to make it increasingly difficult for most other economists to support it, because it was by then obvious that wages didn’t fall, not in the Britain of the 1930’s anyway. That is to say, there was an obvious difference between the point of view expressed by Hayek, Robbins and their letter of October, 1932, and their willingness to admit the following year that a secondary depression was possible.”
Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978), Mises.org.
Lachmann was quite clear here that the Austrian view of Hayek in 1932 was that the “depression must run its course.”

As I noted above, Lachmann was in a position to know Hayek’s opinions, as he was at the London School of Economics (LSE) as research assistant to Hayek in the 1930s, and then conducted work for Hayek on the issue of “secondary depressions.”

Hayek’s recantation was, as Lachmann says, related to his admission of the existence of “secondary depressions” or what he later called “secondary deflations.”

Curiously, the letter which Hayek signed with Lionel Robbins and others, printed in the Times (October 19, 1932) and which can be read here, although it rejects government spending, has this qualification:
“(1) On the first issue – whether to use one’s money or whether to hoard it – there is no important difference between us. It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable.”
If one reads the full letter, one can see how there was a fundamental contradiction between (1) the recognition that deflation in itself was not desirable and (2) the policy proposal of doing nothing of any substance (apart from capital account liberalisation and the absurd idea of more free trade, as if export-led growth would have cured the depression) in an economy hit by deflationary forces in 1932.

There is also a second issue: this was a letter signed by a number of other economists, and reflects the group’s view that they wished to see expressed in public. Hayek’s personal views might have been different. In fact, Hayek tells us explicitly that he did see deflation as desirable, not for its own sake, but for the sake of breaking the downward rigidity of wages:
“… a ‘secondary depression’ caused by an induced deflation should of course be prevented by appropriate monetary counter-measures. Though I am sometimes accused of having represented the deflationary cause of the business cycles as part of the curative process, I do not think that was ever what I argued. What I did believe at one time was that a deflation might be necessary to break the developing downward rigidity of all particular wages which has of course become one of the main causes of inflation. I no longer think this is a politically possible method and we shall have to find other means to restore the flexibility of the wage structure than the present method of raising all wages except those which must fall relatively to all others. Nor did I ever doubt that in most situations employment could be temporarily increased by increasing money expenditure.” (Hayek 1978: 210–211).
Hayek also indicated that he held a different view on the role of deflation during the depression from his later years:
“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).
Hayek’s reputation for liquidationism was the result of his lectures at the LSE and his writings in Prices and Production (1st edn.; London, 1931), which must reflect his lectures.

In particular, as Krugman himself noted, from passages like this in Prices and Production:
“If the foregoing analysis is correct, it should be fairly clear that the granting of credit to consumers, which has recently been so strongly advocated as a cure for depression, would in fact have quite the contrary effect; a relative increase of the demand for consumers’ goods could only make matters worse. Matters are not quite so simple so far as the effects of credits granted for productive purposes are concerned. In theory it is at least possible that, during the acute stage of the crisis when the capitalistic structure of production tends to shrink more than will ultimately prove necessary, an expansion of producers’ credits might have a wholesome effect. But this could only be the case if the quantity were so regulated as exactly to compensate for the initial, excessive rise of the relative prices of consumers’ goods, and if arrangements could be made to withdraw the additional credits as these prices fall and the proportion between the supply of consumers’ goods and the supply of intermediate products adapts itself to the proportion between the demand for these goods. And even these credits would do more harm than good if they made roundabout processes seem profitable which, even after the acute crisis had subsided, could not be kept up without the help of additional credits. Frankly, I do not see how the banks can ever be in a position to keep credit within these limits.

And, if we pass from the moment of actual crisis to the situation in the following depression, it is still more difficult to see what lasting good effects can come from credit expansion. The thing which is needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand, it must mean that part of the available resources is again led into a wrong direction and a definite and lasting adjustment is again postponed. And, even if the absorption of the unemployed resources were to be quickened in this way, it would only mean that the seed would already be sown for new disturbances and new crises. The only way permanently to “mobilize” all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes.

(10) And so, at the end of our analysis, we arrive at results which only confirm the old truth that we may perhaps prevent a crisis by checking expansion in time, but that we can do nothing to get out of it before its natural end,
once it has come.” (Hayek 2008: 274–275).
What could be clearer than this?

Note that I have actually quoted the second edition of Prices and Production (1935) here, and it is telling that as late as 1935, the date of this second edition, Hayek was still saying that “we can do nothing to get out of ... [sc. a recession] before its natural end.”

There is an important issue open for debate: where are these alleged passages in the first edition of Prices and Production (1931) that supposedly show Hayek wanting to stabilize MV during depressions by monetary policy?

Appendix: Note on the Editions of Prices and Production
The first edition was Prices and Production. G. Routledge & Sons, London, 1931. This was 112 pages long.

The second edition was Prices and Production (2nd rev. and enl. edn.). G. Routledge, London, 1935. This was 162 pages long. So it is clear that the second edition was considerably expanded and larger than the first.

Paul Krugman, “Friedman and the Austrians,” August 11, 2013.

Larry White, “Krugman on Friedman, Hayek, and Liquidationism,” Free Banking, August 12th, 2013.

Daniel Kuehn, “Hayek said Liquidationist Things and he said Stable Nominal Income Things and the Latter Doesn’t Erase the Former,” Facts and Other Stubborn Things, August 13, 2013.

“Hayek on Monetary Stabilisation in a Secondary Deflation,” August 6, 2011.

“Did Hayek Advocate Public Works in a Depression?,” September 25, 2011.

Hayek, F. A. von. 1931. Prices and Production (1st edn.). G. Routledge & Sons, London.

Hayek, F. A. von. 1975 [1933]. “Savings,” in F. A. von Hayek, Profits, Interest and Investment. Augustus M. Kelley Publishers, Clifton, NJ. 157–170.

Hayek, F. A. von. 1935. Prices and Production (2nd rev. and enl. edn.). G. Routledge, London. reprinted in Hayek 2008.]

Hayek, F. A. von. 1937. Monetary Nationalism and International Stability. Longmans, Green, London.

Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas. Routledge & Kegan Paul, London.

Hayek, F. A. von. 1999. “The Gold Problem” (trans. G. Heinz), in S. Kresge (ed.), The Collected Works of F. A. Hayek. Volume 5. Good Money, Part 1. The New World. Routledge, London. 169–185.

Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard. Ludwig von Mises Institute, Auburn, Ala.

White, Lawrence H. 2008. “Did Hayek and Robbins Deepen the Great Depression?,” Journal of Money, Credit and Banking 40.4: 751–768.


  1. "The only evidence adduced for the idea that Hayek wanted to stabilise money supply when velocity varied in a recession comes from Hayek’s works published years after 1931 at a time when it is clear that Hayek had changed his mind (such as in Hayek 1937 and Hayek 1933)."

    False. Hayek did have a change of mind, from a stable M to a stable MV norm, but this dating of the change is incorrect. Hayek calls for stable M in a 1928 article and in _Monetary Theory and the Trade Cycle (1929), but he calls for stable MV in the first edition of Prices and Production (1931). See Hansjoerg Klausinger's definitive Introduction to Hayek, _Business Cycles_, vol. 7 of the Collected Works, p. 34, fn. 123. See also George Selgin's HOPE (1999) article cited there.

    "White (2008: 763) even states that Hayek and Robbins “failed to call for central banks to do what they could to counter the sharp monetary contraction and crushing deflation during 1930–33."

    Correct. As I noted in my article, Hayek in failed to enunciate his own stable-MV norm on occasions when he should have. As I also noted, he later expressed regret about that.

    1. Lawrence H. White@August 20, 2013 at 9:00 AM:
      "but he calls for stable MV in the first edition of Prices and Production (1931). See Hansjoerg Klausinger's definitive Introduction to Hayek, _Business Cycles_, vol. 7 of the Collected Works, p. 34, fn. 123."

      Let us see what your reference says:

      "In his early writings, including Geldtheorie (1929), Hayek advocated a constant M instead of MV (cf. also the respective revisions in Monetary Theory and the Trade Cycle); the first recognition of the effects of changes in velocity may be dated with "Investigations", p. 135, and the necessity for compensation is confirmed in Prices and Production, this volume, pp. 274 77. Cf. on this George Selgin, “Hayek versus Keynes on How the Price Level Ought to Behave”, History of Political Economy, vol. 31, Winter 1999, pp. 714-15."

      Klausinger, Hansjoerg. 2012. "Introduction," in Hansjoerg Klausinger (ed.). 2012. The Collected Works of F. A. Hayek. Volume 7. Business cycles. Part I. University of Chicago Press, Chicago. 1-45, at 34, n. 123.

      First, no precise reference is given for Geldtheorie und Konjunkturtheorie (1929) for where Hayek "advocated a constant M instead of MV."

      Secondly, yet again no specific reference is given for Investigations into Monetary Theory (1925-1929), which, anyway, was never even completed or published
      (see Hansjoerg Klausinger (ed.). 2012. The Collected Works of F. A. Hayek. Volume 8. Business cycles. Part II. University of Chicago Press, Chicago. p. 45, n. 1).

      Thirdly, we have a reference to Prices and Production. But I have already cited the relevant passage from Prices and Production and demonstrated that it does not say what either you or Klausinger thinks it says :


  2. LK, if you wanted to observe that Hayek's public statements (or lack thereof) in the early 30s contradicted his theoretical arguments for stable MV, you'd be on relatively solid ground. But in his published theoretical works, as Larry has pointed out, Hayek in numerous places, and as early as 1928, specifically allowed that M should expand to offset declines in V. Sometimes he made the concession awkwardly, almost as an afterthought. But it's there repeatedly, and there is an unfortunate appearance of selective citation in your attempts to insist otherwise.

  3. Sorry: I meant to say "from 1931" (not "from 1928").