I thought everyone might find this interesting. Thanks to Steve Horwitz for making me aware of this.
Apparently there’s a new book out that contains an extensive interview with Hayek in 1979, in which Hayek states that he agrees with Milton Friedman about the Great Depression and admits that he is against deflation.
I’m not going to say he is right or wrong. I am merely pointing out that this was his official opinion.
(BTW, I’m new to the forum. Hello!)
Matt
This isn’t exactly a secret. Many Austrians recognize that a shrinking money supply is bad for the economy. Hayek is rather famous for his positions advocating for a free market currency that would target 0% price level changes.
Horwitz is being a little disingenuous, because in the next page Hayek says: “I do not agree with Friedman on the causes” (Deflation per se – my interpretation since I am familiar with Friedman’s explanation) and right before that he says “The authorities made things worse by a process of deliberate contraction” (as opposed to a natural contraction). It is clear that Hayek is referring to deliberate policy of tampering with the money supply. Deliberate Inflation or Deflation will both distort interest rates in opposite directions. I don’t believe that that there is anything in that quote that supports the idea that Hayek was against a natural contraction of the money supply after the boom. Horwitz, as usual is jumping the gun on this to support his (it’s a forum so I’ll say it) CRANK monetary theory. For the full quotes: (Conversations with Great Economists) pp13-14
Actually, Hayek is rather famous for debunking it.
You are getting a lot from one paragraph. As for believing in inflation or deflation as the best cure for economic depression, I like Hayek disagree with both. The core issue is not what a very interested third party should do with the price of money or the price of anything else. This is central planning at its worst. The future price of money provides signals to businesses about the viability of capital investments. When central banks using the force of government distort these prices then investors get distorted signals and make bad investments.
The core of the issue is really how to determine what money is and how to value it along with all other goods and services. That job can only be done efficiently by a free market. There is no person, computer, group of persons, group of computers, group of persons and group of computers that can set the price of anything. Prices are set by markets. Prices signal consumers on what to buy and when to buy it, as they signal producers on what to create, how to create it, how to market it, how to deliver it, etc. So in a nutshell prices govern economic activity. There is so much that goes into the computation of prices that the the total volume of data would overwhelm any computer. Prices, especially the future price of money, government economic activity in the future.
Deliberate is the key word here. I don’t know of any Austrian who has ever advocated for deliberate contraction of the money supply. Deliberate contraction is very different then the natural unwinding of the fiduciary media following the bust. But if you are against deliberate inflation or deflation, then the only natural course following a bust is for the money supply to contract. I strongly believe that this is what Hayek was saying.
Anyone who actually reads Hayek’s Denationalisation of Money cannot fail to see that Hayek does indeed offer there the view that free choice in currency will result in something close to zero inflation. Hayek had in fact already abandoned his earlier defense of falling prices by this time.
But Hayek had then long since abandoned his very early view that a constant money supply was all one needed to avoid business cycles. By '35 he was championing a constant MV, rather than a constant M, ideal. Constant MV would allow falling prices, but only in response to increased output.
Finally, concerning the great monetary contraction of the early 1930s, there was nothing deliberate about it. It occurred despite Fed open-market purchases, which were inadequate the offset the effects of cash withdrawals from the banking system and increased bank excess reserve ratios.
Before trying to engage in a debate, you should be at least familiar with the subject at hand. Clearly, you are not in this case. Here is what Hayek had to say in A Free Market Monetary System (pgs 19 & 20):
But this very fact would after a
while make it very doubtful whether gold
was for the purpose of money really a good
standard. It would turn out to be a very
good investment, for the reason that because
of the increased demand for gold the value
of gold would go up; but that very fact
would make it very unsuitable as money.
You do not want to incur debts in terms of
a unit which constantly goes up in value as
it would in this case, so people would begin
to look for another kind of money: if they
were free to choose the money, in terms of
which they kept their books, made their cal-
culations, incurred debts or lent money, they
would prefer a standard which remains sta-
ble in purchasing power.
I have not got time here to describe in
detail what I mean by being stable in pur-
chasing power, but briefly, I mean a kind of
money in terms which it is equally likely that
the price of any commodity picked out at
random will rise as that it will fall. Such a
stable standard reduces the risk of unfore-
seen changes in the prices of particular com-
modities to a minimum, because with such a
standard it is just as likely that any one com-
modity will rise in price or will fall in price
and the mistakes which people at large will
make in their anticipations of future prices
will just cancel each other because there will
be as many mistakes in overestimating as in
underestimating. If such a money were
issued by some reputable institution, the
public would probably first choose different
definitions of the standard to be adopted,
different kinds of index numbers of price in
terms of which it is measured; but the
process of competition would gradually
teach both the issuing banks and the public
which kind of money would be the most
advantageous.
In other words, a free market currency system would create currencies which attempt to establish a stable price level, or at least something close to it. As Hayek states, deflation, even if it is growth-induced price deflation, harms debtors. No debtor would want to hold debt in a currency that appreciates in value. On the other hand, no creditor, worker, or employer would want a currency that would depreciate in value. No entrepreneur would want a currency that fluctuates wildly in value (either price deflation or inflation), since that would harm their attempts at economic calculation.
Thanks for your contribution, Dr. Selgin.
A Free Market Monetary System was presented in the Fall of 1979, which makes it a more recent insight into what Hayek’s thoughts were. In it, he clearly states that consumers “would prefer a standard which remains stable in purchasing power.” A stable price level would make economic calculation easier, while it would do no harm to debtors or creditors.
I think it’s important to remember that if there were some kind of economic crisis under a free market monetary system, then money-producers would have an incentive to print more money, in order to bring about a stable price level (as opposed to a falling one).
According to your paper “Keynes versus Hayek on How the Price Level Ought to Behave,” Hayek’s change of heart began after '31.
In his 1933 article “Saving,” prepared for the Encyclopedia of the Social sciences, Hayek further emphasized the desirability of expanding the stock of money to offset “hoarding,” including attempts to “hoard” bank deposits: “Unless the banks create additional credits for investment purposes to the same extent that the holders of deposits have ceased to use them for current expenditure, the effect of such saving is essentially the same as that of hoarding [of currency} and has all the undesirable deflationary consequences attaching to the latter.”
By the way, I am presently reading Good Money and thoroughly enjoying it.
Your use of the term “targeting” was why I was referring to him debunking any monetary policy that attempted to target the constant price level. Hayek explained that any injection of new money via credit markets would artificially lower the interest rate and generate an artificial boom. He explained this in reference to the fact that prices were relatively stable in the 20’s during the boom.
Where does Hayek mention “would target 0% price level”? Hayek isn’t saying anybody would target anything. He’s just theorizing that people would tend to choose between competing currencies, such that there would be a tendency for the currency of choice to hold its value stable. Perhaps he’s right, perhaps he’s not. But he’s not talking about any “targeting”. I fail to see what possible failure of policy of the Fed Hayek could be talking about other then not staying neutral.
Clearly, regulating the money supply in such a way to ensure a stable price level is targeting zero percent price inflation.
This isn’t relevant at all. What makes you think that a free market monetary system would inject money through the financial and credit markets?
And how exactly do you think a currency would achieve stable value? The supply of it would have to expand in response to an increase in demand while it would have to contract in response to a fall in demand. That would require some kind of price level targeting. This isn’t a difficult concept to grasp.
Are you saying that debtors would prefer to pay back more in debt than they absolutely had to? Are you saying that entrepreneurs would enjoy having a harder time in making economic calculation decisions?
Targeting zero percent price inflation = keeping a stable purchasing power of a currency.
?
Is that comment even relevant to anything we are discussing?
So why does Hayek not agree with Milton Friedman regarding the cause of the Great Depression? This is noted in the following page of that interview.
As I understand Friedman, since he did not recognize that the bust was the consequence of the previous monetary expansion, he merely attributed the depression to bank failures caused by an unnecessary panic due to the obvious reality of low reserves in the banks. Providing liquidity was a means of simply calming the public and avoiding the bank-runs. If one avoids the causes of the boom, then it is understandable that one can think that with providing liquidity, a depression can be avoided. But then what does Hayek have in mind with respect to policy with that comment? What could the Fed possibly have done better other then to let the previous expansion unwind? Is it not impossible (calculation problem) for a central authority to “plan” for the optimal money supply?
In a free market, nobody would target anything except their own profits. If stable prices is the consequence, so be it. But nobody is going to target it.
I don’t. I actually don’t believe that a free market system would inject money through the financial and credit markets. Producers of commodity money such as Gold, silver is more likely. I don’t believe that banks could expand much, if at all, without distorting interest rates.
Again, No targeting! Only different individuals who care about their own financial books each “targeting” for his own profits. If the consequence is some constant price level, then so be it, but there is no price level targeting.
If you have a problem with price deflation, then you also have a problem with Horwitz and Equilibrium theory, since Equilibrium theory doesn’t talk about price stability, but demand to hold cash. The theory still predicts a price deflation. So maybe you should ask Prof. Horwitz how entrepreneurs would calculate?
This is the same "problem "you would have today in the inflationary process only in reverse (Are you saying that creditors would prefer to get paid…?), so obviously this must be a fallacy.
First, you are exaggerating with respect to the drop in the price level over time. Entrepreneurs can calculate with 4-5% annual inflation today, they can surely calculate with a 1-2% annual price deflation. That’s still very stable money.
Second, you are not considering the influence on interest rates due to the deflationary expectations by the market. Just as banks today factor this into the interest rate, so will they factor it with a deflationary expectation.
Third, you are also not considering the influence of speculators in the money commodity, who will smooth out the deflationary process.
Good points, especially the second one, which I pondered as well. If a currency had a deflationary bias (as Robert Murphy would say), then banks would indeed adjust the interest rate in accordance with the expected rate of deflation.
Another problem I have with some economists is how they assume that deflation means negative growth (or a reduction in possible growth). I think that would be a fallacy as well, just how the Keynesians thought that stagflation wasn’t possible.
Come to think of it…is there a term that means the opposite of stagflation? [^o)]
Oh, and on my original post, I was focusing on Hayek’s view of deflation, rather than him agreeing with Milton Friedman. I know he didn’t agree with Milton on everything, so I think I should have been a bit more clear on my intent.
I think it may be true that Horwitz might be jumping the gun a bit, but even Mario Rizzo seems like now it can be official what Hayek’s view was. I’m guessing it has been debated in the past, alas, I am not a Hayek scholar.