Thursday, February 6, 2014

Magliulo on “Hayek and the Great Depression of 1929”

Antonio Magliulo has an interesting paper here on Hayek’s opinion of the Great Depression, and whether he changed his mind on the policy solutions to depressions:
Magliulo, Antonio. 2013. “Hayek and the Great Depression of 1929: Did he really Change his Mind?,” The European Journal of the History of Economic Thought, Published online, 27 September, 2013.
Magliulo’s (2013: 22) conclusion is that Hayek did not change his views on the origin of depressions (as derived from his Austrian trade cycle theory), but did come to change his views on (1) the economic role of deflation in inducing wage flexibility, and (2) policy responses to depressions when “secondary deflation” had set in.

Magliulo points to Hayek’s reconsidered theory of the Great Depression that he developed in the 1970s, in which Hayek tried to maintain his business cycle theory but emphasised the role of “secondary deflation” and the possibility that government intervention could arrest his deleterious secondary phenomenon (Magliulo 2013: 15–21).

In particular, there was a change in Hayek’s view of deflation. While in the 1930s, Hayek seems to have still believed that deflation had a positive role to play in breaking general wage stickiness, by the 1970s Hayek admitted that this was “politically unachievable” and that deflation was “harmful, with the sole effect of increasing real wages” (Magliulo 2013: 16).

Magliulo draws attention to this paper by Gottfried von Haberler in which Haberler described Hayek’s new views on the role of aggregate demand in an economy, and the two instances where Hayek now 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).
Further evidence for this can be found in the published text of a talk on April 9, 1975 that Hayek gave to the American Enterprise Institute in Washington, DC:
“Once you have the kind of situation in which there already exists extensive unemployment, there is thus a tendency to induce a cumulative process of secondary deflation, which may go on for a very long time. I am the last to deny — or rather, I am today the last to deny—that in these circumstances, monetary counteractions, delib¬erate attempts to maintain the money stream, are appropriate.

I probably ought to add a word of explanation: I have to admit that I took a different attitude forty years ago, at the beginning of the Great Depression. At that time I believed that a process of deflation of some short duration might break the rigidity of wages which I thought was compatible with a functioning economy. Perhaps I should even then have understood that this possibility no longer existed. I think it disappeared in 1931 when the British government abandoned its attempt to bring wages down by deflation, just when it seemed about to succeed. After that attempt had been abandoned, there was no hope that it would ever again be possible to break the rigidity of wages in that way.

I still believe that we shall not get a functioning economy until wages again become flexible, but I think that we shall have to find different techniques for that purpose. I would no longer maintain, as I did in the early ’30s, that for this reason, and for this reason only, a short period of deflation might be desirable. Today I believe that deflation has no recognisable function whatever, and that there is no justification for supporting or permitting a process of deflation.”
(Hayek 1975: 5; see also 13).
Magliulo (2013: 17, n. 20) notes that Hayek, in a 1978 work, seems to have accepted the need for public works spending to arrest bad deflation (Hayek 1978: 210–212).

But there is evidence that already in 1937 Hayek had accepted that fiscal policy via public works was an acceptable way to end “secondary deflation.”

There is this passage in Hayek’s essay “The Gold Problem” (originally published in 1937 as “Das Goldproblem,” but available in an English translation in Hayek 1999: 169–185), where he essentially approves of the policy recommendations of Lionel Robbins’s 1937 paper “How to Mitigate the Next Slump”:
“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 postponed 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).
Moreover, in The Road to Serfdom (1944), Hayek appears to accept the possibility of public works spending even if “in experimenting in this direction we shall have carefully to watch our step if we are to avoid making all economic activity progressively more dependent on the direction and volume of government expenditure” (Hayek 2001 [1944]: 126).

I would say that already in the 1930s at some point after 1933 and before 1937, there was already a significant change in
Hayek’s thinking, in which he repudiated hard “liquidationism.”

Further Reading
“Hayek on Secondary Deflation,” January 24, 2011

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

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

“When Did Hayek Renounce Liquidationism?,” January 1, 2012.

“Steven Horwitz on Stimulus Spending and Hayek,” August 24, 2012.

“Hayek the Evil Socialist,” January 1, 2012.

“Hayek on Aggregate Demand in a Depression,” March 21, 2013.

“Hayek was originally a Liquidationist: Free Bankers are Wrong!,” August 13, 2013.

“Hayek the Stable MV Theorist?,” August 13, 2013.

“The Evidence for Hayek the Stable MV Theorist is still Feeble,” August 21, 2013.

“Hayek on ‘The Flow of Goods and Services,’” March 20, 2013.

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.

Hayek, Friedrich A. von. 1975. A Discussion with Friedrich A. Von Hayek. American Enterprise Institute, Washington, D.C.

Hayek, Friedrich A. von. 1978. “Further Considerations on the Same Topic,” in F. A. Hayek, New Studies in Philosophy, Politics, Economics and the History of Ideas. University of Chicago Press, Chicago. 209–218.

Hayek, Friedrich 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, Friedrich A. von. 2001 [1944]. The Road to Serfdom. Routledge, London.

Magliulo, Antonio. 2013. “Hayek and the Great Depression of 1929: Did he really Change his Mind?,” The European Journal of the History of Economic Thought, Published online, 27 September, 2013.

Robbins, Lionel. 1937. “How to Mitigate the Next Slump,” Lloyd Bank Monthly Review n.s. 8 (May): 238–240.

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