Hayek — against a Fed created post-bust deflation

“The moment there is any sign that the total income stream may actually shrink [during a post-bust deflationary crash], I should certainly not only try everything in my power to prevent it from dwindling, but I should announce beforehand that I would do so in the event the problem arose.”

– F. A. Hayek, in reply to a question from his old friend Gottfried Haberler in a talk given at the American Enterprise Institute in 1975.

“I agree with Milton Friedman that once the Crash [of 1929] had occurred, the Federal Reserve System pursued a silly deflationary policy.  I am not only against inflation but I am also against deflation.  So, once again, a badly programmed monetary policy prolonged the depression.”

– F. A. Hayek, interviewed by Dieg Pizano July, 1979 published in Conversations with Great Economists:  Friedrich A. Hayek, John Hicks, Nicholas Kaldor, Leonid V. Kantorovich, Joan Robinson, Paul A.Samuelson, Jan Tinbergen by Diego Pizano.

NYU economist Mario Rizzo comments:

So now we have not only the logic of Hayekian economics (both micro and macro) and the words of the man himself that deflation (of the increase in the relative demand to hold variety) should be avoided. I claim infallibly that this is the Hayekian position. We can argue about whether he was right but we cannot profitably argue about whether this was his position. QED.

Lawrence White provides an extended discussion of the Hayekian position on post-bust deflation (lacking some key passages from Hayek on the topic) in his article,  “Did Hayek and Robbins Deepen the Great Depression?”Journal of Money, Credit and Banking, Volume 40 Issue 4, (2008), pages 751 – 768.

More from Steve Horwitz on the topic here, here, and here.

I also recommend this short piece by David Glasner posted originally here on Taking Hayek Seriously.

4 comments to Hayek — against a Fed created post-bust deflation

  • Richard Schulman

    So then the bailout and monetary policies of the past two Treasury secretaries and Federal Reserve chairman Bernanke have been impeccably Hayekian, as Jonathan Wilmot et al. suggest in their paper, Long Shadows: Collateral Money, Asset Bubbles, and Inflation?

  • Lawrence H. White

    Greg, thanks for the mention. The first passage you quote is actually in my JMCB piece. What are the key statements from Hayek that I left out?

    I just discovered — maybe it’s not new to you — a germane 1934 newspaper article by Hayek on “The Fallacy of Artificial Price-Raising”. It appeared in Barron’s on 12 March, but in the Straits Times on 14 and 15 February. (online here: http://newspapers.nl.sg/Digitised/Article/straitstimes19340214.2.54.aspx and
    It’s like that it appeared somewhere else earlier. In it Hayek wrote:

    “About a year or so ago, it is true, it might have been argued with some appearance of justification that [monetary expansion] was not merely a question of speeding up recovery, but the only way out of a vicious spiral of deflation which, month by month, was carrying us into deeper depression. But whatever may have been the merits of the argument for the deliberate expansion of credit while prices continued to fall, it must be borne in mind that we have recently entered upon a new phase of the depression. The deflationary process has come to an end; as soon as a period of relatively stable prices had created hopes of further stability more definite signs of recovery became noticeable and can now no longer be mistaken. The problem now is, not what we must do to prevent the depression getting worse, but whether anything can be done to speed up the process of recovery.”

    He goes on to say that monetary expansion for the purpose of raising the price level is not a good way to speed up recovery because it provides only temporary stimulus while creating long-run inflation and investor uncertainty.

    Thus Hayek recognized in early 1934 that there had been a case in 1933 (though he doesn’t show much enthusiasm for it) for monetary expansion to stop the price level (P) from falling. He doesn’t discuss the criterion of preventing shrinkage in the total income stream (PQ).

  • Greg Ransom

    Scott Sumner makes the case that the Fed policy of paying interest on bank reserves has actually been contractionary rather than equilibrating.

    James Sweeney, Jonathan Wilmont, Matthias Klein, and Carl Lantz of Credit Suisse cite Hayek’s monetary and business cycle work in support on their claim that the malinvestment crash has caused a significant crash in what they call “shadow money”. See the article cited here:


    I would defer to those who have soaked in the numbers much more deeply than myself on these difficult issues — it’s difficult to separate apart empirical disputes from causal differences in this area, and I appreciate that honest and fair minded observers can come to different conclusions about the facts over the past years — and what the Fed has done.

    Richard writes:

    “So then the bailout and monetary policies of the past two Treasury secretaries and Federal Reserve chairman Bernanke have been impeccably Hayekian, as Jonathan Wilmot et al. suggest in their paper, Long Shadows: Collateral Money, Asset Bubbles, and Inflation?”

  • Greg Ransom

    Larry, the difficult thing is in separating out Hayek’s scientific claims from his erroneous empirical understandings in a particular historical moment — empirical errors in the American case (not Hayek’s principle focus) which Hayek recognized and spoke of after reading Milton Friedman & Anna Schwartz’s Monetary History.

    It looks like already in 1934 Hayek recognized that he was wrong about 1933 (was he focused here on any country in particular? — note well that Hayek recognized that Britain had a deflation problem causing overpriced labor and production decline from 1925 when Churchill returned the Pound to the gold standard at par, despite wartime inflation).

    There is a tendency for people to imply that failed empirical estimations at an historical moment in time — from a man producing a massive theoretical & editorial output during this period with almost no focus on empirical data — tell us something they in fact don’t tell us about his universally applicable theoretical understanding of causal economic processes. (Call this the fallacy of historicist malice — using contingent failures of empirical judgment to smear timeless theory. Imagine a creationist doing this against Darwin and the timeless theory of natural selection).

    A muddle here doesn’t help us get the scientific conceptions right — and it doesn’t help us get the history right either.

    The article you’ve discovered takes us a bit further in making these distinctions clear.

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