Hayek in 1931 on Post-Bust “Secondary” Deflation

Just to set the record straight, I’d like to point out that Friedrich Hayek was well aware of the problem of the sort of “secondary” deflation which often occurs after the onset of an economic bust made inevitable by a prior credit induced artificial boom.  In part 2 of Hayek’s “Reflections on the Pure Theory of Money of Mr. J. M. Keynes”, written in 1931 and published Feb. 1932, Hayek writes:

the very fact that processes of investment have been begun but have become unprofitable as a result of the rise in the price of factors and must therefore be discontinued, is, of itself, a sufficient cause to produce a decrease of general activity and employment .. without any new monetary cause (deflation).  In so far as deflation is brought about — as it may well — by this change in the prospects of investment, it is a secondary or induced phenomenon caused by the more fundamental, real, disequilibrium which cannot be removed by new inflation, but only by the slow and painful process of readjustment of the structure of production.

And similarly:

I do no deny that, during this process [of re-coordination across relative prices and the time structure of production], a tendency towards deflation will regularly arise; this will particularly be the case when the crisis leads to frequent failures and so increases the risks of lending.  It may become very serious if attempts artificially to “maintain purchasing power” delay the process of readjustment .. This deflation is, however, a secondary phenomenon in the sense that it is caused by the instability of the real situation; the tendency will persist so long as the real causes are not removed.

In other words, the suggestion of some commentators that Hayek discovered the phenomena of the “secondary deflation” occurring during the bust phase of the the cycle only in old age, or only after the experience of the Great Depression, or only after the publication of Keynes’ General Theory, etc. is purely fictional.

The two quoted passages are from pages 194 and 196-197 of F. A. Hayek’s Contra Keynes and Cambridge:  Essays, Correspondence.

Hayek even indicates as early as 1931 that he has no problem with efforts to counter-act such post-bust problems as the “secondary deflation”, going so far to say that John Maynard Keynes in his 1930 book A Treatise on Money had “made valuable suggestions for treating these secondary complications [such as the secondary deflation].”

Hayek didn’t oppose blocking the secondary deflation, he opposed going far beyond such a policy,  into the completely different realm of policies which by accident or design would block, jam, or delay the re-adjustment process working to bring the time structure of production and consumption closer to sustainable reality.

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2 Responses to Hayek in 1931 on Post-Bust “Secondary” Deflation

  1. Lee Kelly says:

    It seems to me that “blocking the secondary recession” is a poor metaphor.

    The problem for a central bank is that expanding the money supply is not enough. If the new money is injected into the same malinvestments that brought the bust, then such action would not be dissimilar from simply reinflating the boom, but just a little. A central bank needs to allocate money in a way that complements the emerging relative price adjustments–in other words, without propping up failed banks or car manufacturers.

    A free market in banking and money would achieve this easily, I think, since by the nature of the beast, new money would be created by successful institutions who avoided the malinvestments in the first place.

  2. Pingback: http://hayekcenter.org/wp-login.php?action=logout&_wpnonce=d08a1d000aJustin Fox — More B*llsh*t On Hayek « Taking Hayek Seriously

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