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I continue to suggest that Hayek's 1936 paper "Economics and Knowledge" and his early 1940s papers "Scientism and the Study of Society" were as much about Keynes as about anything else. See the first 2 or 3 chapters of Hayek's _The Pure Theory of Capital_ for direct parallel arguments applied to the problems of macroeconomics.

In his "Scientism" essays Hayek directly takes on macro aggregates.

"Furthermore, Hayek probably should have emphasized more that his theory implied the need to avoid a “secondary deflation” during the bust period. Increases in the demand to hold money should be offset by the banking system."

Which translates into "FED should inflate money supply in order to provide a way out of depression".

It is hilarious to what extent revisionist Austrians are trying hard to reconcile ABCT with mainstream macroeconomic central planning. Rizzo is complaining why Hayek's didn't sufficiently emphasized doctrine against which he was. Hayek couldn't "sufficiently emphasize" dangers of liquidationism, because he was liquidationist:

"To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection - a procedure that can only lead to a much more sever crisis as soon as the credit expansion comes to an end.. IT is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression" (Hayek, Prices and Production).

So, if unsustainable boom is cause of the crisis, malinvestment must be liquidated in order for healthy expansion to proceed. Credit inflation as a means to avoid second wave of deflation can only worsen depression. According to Hayek, that is. In revisionist Wonderland, where ABCT holds true for boom, but not for a bust (there Keynesian-monetarist "fighting deflation" becomes "cure"), everything is possible.

This is bunk you are shoveling us Nikolaj.

It's BS propaganda to call Hayek a "liquidationist" and it is ignorance not to understand that Hayek was consistent in his view on the money supply and its relation to the structure of production.

It's amazing to see how people "counter" Hayek by being dishonest.

We've seen it with Krugman, we've seen it with DeLong, and we've seen it with countless other economists.

Pathetic.

Greg, I cited "Prices and Production". So, please prove me wrong. I hope you don't consider citing Hayek's own words to be somehow "dishonest"

To avoid further misunderstandings. I think Hayek was right and consistent in his luquidationism, and that Krugman, De Long and other noble fighters against deflation were wrong (although they are right in emphasizing that ABCT assumes liquidation of malinvestment as a cure for inflationary boom).

Rizzo simply wants to have it both ways; to eat the cake and to have it uneaten. To advocate ABCT for boom, and then credit inflationism for the bust. That's untenable. You must accept logical consequences of your choices. You cannot accept only what is popular or easy to defend, but whole package.

P.S. One correction from my part. Hayek's citation I gave was actually from "Monetary theory and trade cycle", not from "Prices and Production".

Nikolaj -- simply acknowledge this isn't so simple.

When demand for liquidity and demand for reserves changes dramatically in a bust situation, there is nothing inconsistent to saying that the supply of money should expand, not to support an unsustainable structure of production, but in order to satisfy a demand for money.

My understanding is that Hayek discussed this stuff _prior_ to 1929. I intend to find where, and would appreciate any "heads up" on where I should look.

Nikolaj said:

"Rizzo simply wants to have it both ways; to eat the cake and to have it uneaten. To advocate ABCT for boom, and then credit inflationism for the bust."

Nikolaj -- the restructuring of capital production in a bust isn't a "cure" for anything, and this sort of language is part of self-aware deception and dishonesty of Krugman and DeLong.

Greg, what happens in recession is not restructuring of "capital production", but of capital structure, by a way of liquidating unsustainable roundabout and capital intensive projects. Shrinkage of credit supply is a natural part of that process of recovery. So, liquidation is a cure for boom in that sense.

"When demand for liquidity and demand for reserves changes dramatically in a bust situation, there is nothing inconsistent to saying that the supply of money should expand, not to support an unsustainable structure of production, but in order to satisfy a demand for money."

What you, and many other revisionist Austrians, call "demand for money" original Mises/hayek ABCT calls "demand for government to continue misdirection of capital by continuation of credit inflation".

Don't forget - what is problem for ABCT is not bust, but boom. Boom needs a cure, and bust with liquidation is a solution for the problem. Every attempt to slow or suppress that natural process of recovery by additional inflation, only worsen the problem, as Hayek said. There is nothing more opposite to ABCT as that obsession with avoiding bust, under the many technical explanations and excuses (fighting the secondary wave of deflation, satisfying demand for money, etc).

nikolaj,

It is my impression, that Hayek was not averse to some monetary stimulus to avert a so-called "secondary recession". The bust is compounded by a sudden increase of fear among investors, and that creates more deflation than is necessary to offset the mistakes of the boom. Investment projects that are sustainable, that should not be liquidated, are then ended in error. A small stimulus at this point can prevent the deflation feeding upon itself.

That was my impression, at least. And it is quite different from the standard Keynesian argument.

Personally, I am not sold on the idea.

Nikolaj -- this is NOT how I understand it:

"What you, and many other revisionist Austrians, call "demand for money" original Mises/hayek ABCT calls "demand for government to continue misdirection of capital by continuation of credit inflation"."

Nikolaj -- the effort here is NOT to stop the "bust" or the re-direction of production away from unsustainably misdirected production -- the effort is to stop a pathological massive deflation, which can be as destructive as a pathological massive inflation.

Have you read Horwitz on this stuff?

Nikolaj writes:

"There is nothing more opposite to ABCT as that obsession with avoiding bust, under the many technical explanations and excuses (fighting the secondary wave of deflation, satisfying demand for money, etc)."

Lee,
I think that following paragraph gives you Hayek's interpretation of Great Depression in nutshell, where you can see that he was very averse toward monetary stimulus as a way to go. Moreover, he explained that such a stimulus would be a continuation of credit inflation policy that brought about a crisis in the first place:

"What we need is a readjustment of those elements in the structure of production and of prices that existed before the deflation began and which then made it unprofitable for industry to borrow. But, instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion."

Sigh.

Let's see if we can straighten this out. By the time P&P rolls around, Hayek is pretty clear that the rule to guide monetary policy is to stabilize MV. This means that IF the demand for money is rising (V is falling), the monetary system should react by increasing M to maintain the flow of expenditures and nominal GDP.

One can be in an Austrian "bust" in which V is not falling notably, in which case all kinds of prices adjustments need to and are taking place. In such a situation, Hayek's rule would say the monetary authority should do nothing. It should allow all of those adjustments, including firms going out of business etc, to take place.

However, if the bust includes a notable decline in velocity (as was the case in 29-33), then Hayek's rule says the money supply should be increased accordingly. This does not cause all of the distortions Nikolaj claims because those additions prevent the bust from turning catastrophic through a total collapse of the expenditure flow. Those additions supply the desired money holdings the public wishes to have, leaving them free to spend as they would have during the bust under the first scenario above.

The goal is not to get back to the inflated world of the boom, but rather to enable the corrections of the bust to take place without the deflationary death spiral kicking in.

The reason why Hayek, looking back, said he messed up during the Depression is because he didn't recognize how severe the decline in V was. Had he realized it at the time, he would have not made his criticisms of expanding the money supply. That is clear by his own admission and by the implications of the MV rule that he adopts in the 30s.

If you want to criticize modern monetary equilibrium Austrians, you'll have to forget everything Hayek wrote after the early/mid-30s when he clearly articulated that standard. He didn't apply it to the Great Depression at the time only because he didn't think, empirically, the historical reality was that V was falling so hard.

He was right on the theory but wrong on the data at the time. He also had the integrity to admit it later. ME Austrians are just trying to make sure that error isn't repeated.

Nikolaj,

I regret even commenting. I have a strong aversion to ever arguing about what another believes, especially when that other is a deceased economist.

I don't know what Hayek thought, and I am not sure I care all too much. In any case, my comment was a rather crude way of saying what I think Steve has now said much better.

Imagine that we all started arguing about what Nikolaj believes, and began quoting stuff you wrote 10 or 20 years ago. (I don't know how old you are). People are complicated, and I suspect Hayek's views on economics were especially so. I have trouble enough sorting out my own thoughts, never mind the thoughts of an economist who died when I was a child.

I should add one more thing: there's a reason why it was called a SECONDARY deflation. The point is that the "primary" adjustment of prices and reallocation of resources needs to take place, but what needs to be avoided is the velocity-induced *secondary* deflation that might or might not follow. Hayek never says, nor do any ME Austrians, that we should avoid the primary adjustments of the bust.

Steve,

whole notion of decreasing V as "justification" for further credit inflation is based on Keynesian misunderstanding of decreased velocity of money as "irrational hoarding". But, increased quantity of money "hoarded" perform a valuable role of insurance against uncertainty. Economy is not underperforming in bust, because people hold more cash as a RATIONAL insurance policy from uncertainty. So, there are very good theoretical reasons why hoarding perform useful economic function. You can not eliminate structural uncertainty by decree, which is to say, by inflating additionally. That is ridiculous. If you inflate money supply to spur credit activity you are masking real extent of the discoordination problem, and encourage people to continue with irresponsible financial decisions (just like initial lowering of the interest rate in the boom encourage people to do the same). So, stabilizing MV is clearly wrong theoretically as application of ABCT.

It is quite hubris for Austrian economist to claim he knows independently from market what the "real" equilibrium state of the economy should be and how far adjustment of production structure as a response to inflationary malinvestment should be allowed to go (!).

In 1930s stabilizing MV certainly was not Hayek's idea. That's Friedman's idea of monetary rule adopted by Hayek implicitly (and temporarily) later on, in some of his non-technical works in 1960s (i.e. Constitution of Liberty), but not conclusion following from original ABCT.

.

Nikolaj,

You are simply wrong about Hayek. In the morning, when I have my copy of P&P at hand I will present the relevant evidence.

Two other points:

1. You beg the question by calling an increase in M designed to offset a falling V as "credit inflation." That is precisely the question at issue: I claim that is not credit inflation. Hayek agreed and so did the early Mises.

2. Nowhere, repeat nowhere, have I ever said that the additional money holding is "irrational hoarding." Please stop putting words in my mouth. I do not claim to know how much money people "should" hold. I only claim that however much they wish to hold, the banking system should supply it to avoid the deflationary spiral.

If you can't think beyond people who want to stabilize MV as being inflationists and critics of "hoarding," you need to broaden your reading and your thinking.

If you think my position is in contradiction with ABCT, you need to do even some more reading. Stabilizing MV is exactly what Hayek suggested needed to be done to avoid the ABCT.

Found it online...

Here's Hayek in P&P (108-109):

"It does not seem open to doubt that the amount of money necessary to carry on the trade of a country fluctuates regularly with the seasons, and that central banks should respond to these changes in the " demand for money ", that not only can they do this without doing harm, but that they must do so if they are not to cause serious disturbances. It is also a fact which has been established by long experience, that in times of crisis central banks should give increased accommodation and extend thereby their circulation in order to prevent panics, and that they can do it to a great extent without effects which are injurious."

and better yet on 121:

"But I think that what I have already said on this point will be sufficient to justify the conclusion that changes in the demand for money caused by changes in the proportion between the total flow of goods to that part of it which is effected by money, or, as we may tentatively call that proportion, of the co-efficient of money transactions, should be justified by changes in the volume of money if money is to remain neutral towards the price system and the structure of production."

If you have an interpretation of that second quote that is other than "stabilize MV," let's hear it.

Steve,

So let me get this straight.

In principle, there needn't be a significant fall in the average price during an Austrian "bust", because relative prices can adjust independently. But, when there is a significant fall in the average price, this can set in motion a destructive deflationary spiral. In which case, banks should increase the supply of money to meet the new demand, and thereby enable the relative price adjustment to continue.

Is that right?

How will the banks know how much money to pump into the economy? And what about the benefits enjoyed by whoever receives the money first? Isn't that going to create new unsustainable imbalances?

"Nowhere, repeat nowhere, have I every said that the additional money holding is "irrational hoarding." Please stop putting words in my mouth. I do not claim to know how much money people "should" hold. I only claim that however much they wish to hold, the banking system should supply it to avoid the deflationary spiral."

Which is pretty much the same as saying that people are irrationally hoarding. You "do not claim to know how much money people should hold", but somehow you "know" that whaterver quantity they hold, if deflation occurs, then it is too much, and banks should supply more, to spur investment. Which is to say, behavior of people to hold more cash and invest and spend less was irrational hoarding, and you, as monetary central planner, knew what was "optimal quantity of money".

Further, what is praxeological distinction between "primary" and "secondary" recession/depression? Why in the first case we should let market to work, while in the second not? Again, you as a central planner know better than market, i.e. investors and traders, what is the "real" value of capital. You know exactly when market "overreacted".

"You beg the question by calling an increase in M designed to offset a falling V as "credit inflation." That is precisely the question at issue: I claim that is not credit inflation. Hayek agreed and so did the early Mises."

People voluntarily decide to hold more cash and less to invest and spend, and you as a central planner know that this was dangerous (sorry, only in "secondary", "bad" depression whatever that could mean). And what are you doing in order to "offset" that bad outcome? You increase supply of money via credit or bank-note inflation, or both. That's what exactly Bernanke is doing now by unprecedented increase in money supply, and that was exactly what Greenspan was doing back in 2001-2004, in order to "prevent" still more dangerous recession, and to offset insufficient "investment spending". Would you explain Greenspan's monetary policy 2001-2004 as an attempt to prevent secondary depression, and if not why not?

I don't understand.

If counteracting a primary recession with credit expansion is bad, then how is counteracting a secondary recession with credit expansion good?

The major criticism of artificial credit expansion is that, because it enters the economy in particular sectors, an unsustainable allocation of resources is established. When the artificial credit expansion ceases, and relative prices start adjusting, there is a recession in those sectors that had previously benefited.

Trying to prevent the recession by even more artificial credit expansion is obviously folly, (though perhaps not when you have the time horizon of a politician). Hayek seems to sing another tune when faced with a secondary recession, but is it not going to just establish another unsustainable allocation of resources?

Moreover, shouldn't the uncertainty of investors be reflected in prices? When a bust occurs, a lot of people discover they know a lot less about the economy than they previously thought, and this manifests itself in a lack of confidence. Isn't knowledge kind of important? Shouldn't credit availability reflect the fact that a lot of investors don't know what they're doing?

It seems to me that the secondary recession is really a knowledge crises, and while it may be [i]possible[/i] to restructure the economy without it, in reality it takes time for investors to figure out what they should be doing.

In any case, I have never heard these concerns addressed.

Lee,

The issue, as I understand it, is this: during the bust, if the banking system supplies the quantity of money the public wishes to hold, the public can still be engaging in all the adjustments needed in the wake of the end of the boom.

But if the public's desire to hold money increases (and there's NOTHING, repeat NOTHING, irrational about that), then their attempts to acquire greater real balances in the face of a constant nominal money supply will not only frustrate the re-adjustment process, but also run the risk of further discoordination given that prices, even in a free market, have downward stickiness to them.

Hayek's point was that it was important to avoid dramatic declines in MV so as to avoid that downward spiral. With a constant MV, all kinds of appropriate adjustments in the structure of production can take place but without the risk of the deflationary spiral.

It's important to remember the definition of deflation here: people's desired money holdings are greater than their actual ones. The result of that will be downward pressure on prices, but the originating cause is that excess demand for money. (Just as inflation is an excess supply of money that manifests, c.p., as an increase in the price level.)

The central bank will have a very difficult time determining how much money to pump in, absolutely. That's why we need to get rid of the Fed and have a free banking system.

It's a matter of empirical judgment whether one thinks that the costs of allowing a central bank to try to respond to the excess demand for money are greater than the benefits. In that world of the second best, both sides have an argument.

But, in theory, the banking system should indeed respond, and a free banking system would have the appropriate signals to know how much and where the additional money supply was needed. Of course, free banking would have avoided the boom and bust in the first place!

These are good questions, Lee.

I've thought about them myself, but won't attempt my own answers here.

Hayek's own ultimate answer / solution, I think, was his denationalization / decentralization of money work.

Lee,
As I understand it:

I thought that during the crisis V would fall mostly because of bank failures and the contraction of "bank created money" (with can be called V). Bank failures means that we have a credit contraction. The idea is to expand monetary base to cancel out the credit contraction. In other words, to make money neutral the monetary base should be expanded. We do not have credit expansion, only the prevention of credit contraction.

Nikolaj says:

"You "do not claim to know how much money people should hold", but somehow you "know" that whaterver quantity they hold, if deflation occurs, then it is too much, and banks should supply more, to spur investment."

No, that's actually one way of *defining* deflation: an excess demand for money; people desiring to hold more money than they actually do. It's a fair question as to whether one can know for sure this is happening. Central banks aren't very good at it, free banks are. However, IF it IS happening, then the proper response is to supply more money. And not to "spur investment" per se, but to prevent it from collapsing.


"Which is to say, behavior of people to hold more cash and invest and spend less was irrational hoarding, and you, as monetary central planner, knew what was "optimal quantity of money"."

I'm sorry, but this is just plain silly. Nothing in what I said implied their desire to hold more money is irrational, nor that I know what the optimum is. If people wish to buy more shoes, we don't call that irrational; we supply more shoes!

I don't know how much money people should hold. What I DO know, or at least believe, is that when they can't hold as much money as they'd like to, people "solve" that problem by reducing their expenditures. This, given the imperfect adjustment of prices that is part and parcel of a Mengerian discovery process, means that we'll see excess supplies of goods (including labor) to match the excess demand for money. And that means that my reduction in expenditures implies a reduction in the income of sellers, which means they cut expenditures etc. etc. The result, until prices start to unstick, is a deflationary recession *on top of* whatever else might be happening in the economy.

The goal of proper monetary policy should be to avoid these sorts of problems coming from the money side. Hayek argued, as do Selgin and I, that maintaining MV is the way to prevent those problems. (I note that you have implicitly conceded that this was indeed Hayek's position given your silence on my evidence.)

Whether central banks CAN successfully prevent them is a good question. I think they do a lousy job, which is why we need free banking. But the *theoretical* question of what they should do is clear to me.

And... there's no evidence that there was any excess demand for money post 9/11 that called for an increase in the money supply. I have never said that it's *always* necessary to increase the money supply during a bust - reread my first comment above. I've only said that it *can* be necessary to avoid bigger problems. There's no evidence that this was an issue in 2001.

As I've written elsewhere, the Fed was the major problem, just as ABCT rightly says. See:

http://myslu.stlawu.edu/~shorwitz/open_letter.htm

and http://www.csmonitor.com/2008/1022/p09s01-coop.html

I will also have a longer piece on the current recession up on the Mercatus site shortly.

Steve,

It seems to me that free banking would go some way to alleviating my concerns, but I still have misgivings.

I am going to give this some more thought over the weekend, because my intuition is screaming that something is wrong here.

Perhaps a better quote of Hayek's is p.124 from Prices & Production: "any change in the velocity of circulation would have to be compensated by a reciprocal change in the amount of money in circulation if money is to remain neutral towards prices." It is an argument for MV stabilization. But that is the goal only if there is central banking. Such a goal is not necessary with Free banking.

Let's say there is free-banking and I'm feeling uncertain. I want to hold more money. I can spend less and save. Alternatively I can go to a free bank and borrow from them, putting the money in my current account. This increases the amount of money-substitutes in circulation. It isn't though really an injection its done at the demand of the customer and supplier.

As I understand it free banks know how to do this because they see demand for money substitutes rise.

(Before Ludvig Van Der Hauwe jumps in.... I know you disagree with this, I haven't read his papers on this yet.)

Free banking doesn't need to consciously aim at MV stabilization as a goal because stabilizing MV is the emergent outcome of that well-ordered system. But in the world of the x-best, where we have a central bank, what is the least bad rule to guide it? Stabilize MV works for me.

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