Lawrence H. White describes the economic theories that arose to explain the US economy during the 1920s and the crash of 1929. White's current book project, The Clash of Economic Ideas, explores the history of economic theory and how these ideas continue to shape policy debates today. In this talk, he describes the 1929 financial crash in the United States, emphasizing the contrasting views held by economists Friedrich A. Hayek, John Maynard Keynes, and Milton Friedman. During the presentation, White also examines the economists' views on prices and production, savings and investment, monetary expansion, and the use of the gold standard.
Lawrence H. White
Lawrence H. White is an expert in banking and monetary policy. He is professor of economics at George Mason University and the F. A. Hayek Professor of Economic History in the department of economics at University of Missouri – St. Louis. His teaching and research areas include economic history, monetary theory, money and banking, and history of economic thought. White holds a PhD and a MA in economics from University of California at Los Angeles; he also received his AB in the same area from Harvard University. He is visiting professor at Universidad Francisco Marroquín.
Academic Building, E-506 Universidad Francisco Marroquín Guatemala, June 23, 2009
A New Media - UFM production. Guatemala, July 2009 Camera: Manuel Alvarez; digital editing: Claudia de Obregón; index and synopsis: Sergio Bustamante; content revisers: Daphne Ortiz, Jennifer Keller; transcript: Lucía Canjura: transcript reviser: Sofía Díaz; publication: Mario Pivaral / Carlos Petz
This work is licensed under a Creative Commons 3.0 License Este trabajo ha sido registrado con una licencia Creative Commons 3.0
Slides
Transcript
Okay, so I proposed to Giancarlo to talk about the project I´m currently working on, so here is the outline for the book. I was drafted into teaching a course in the History
of Economic Thought, and I had an idea, which I then tried to implement.
And the idea was to try to demonstrate to the students of the history of economic thought, is actually relevant to understanding current policy debates, and the biggest policy
debates of the last hundred years, I used to say twentieth century, but that´s no longer equivalent to the last hundred years.
And, so I would show the students clips from the Commanding Heights PBS series, which makes them think that Hayek is someone real because they see him on T.V.
But the short-coming of the Commanding Heights is that it sort of starts with the clash between Hayek and Keynes, and doesn´t really tell us where their ideas came from, and
what´s behind the debates that we see in the present.
So my project is, to, in each chapter, start with a real event or a real policy experiment or how economists have tried to grapple with the events of the last hundred years,
and then go back as necessary, to earlier economists to explain where the ideas came from.
So, after an initial chapter about the, sort of theme of the book, in which I show that I found a talk that Irving Fisher, the famous American economist, gave in 1907, and
another talk that Alfred Marshall, the famous English economist, gave in 1907, and they both said the same thing, which is: "we dont believe in
laissez faireanymore, we believe in the benevolent government to correct the errors of the market".
To show the students that it´s not true that all economists before Keynes believed in
laissez faire.
Then into the substance of it, I used the Bolshevik Revolution and the problem of planning the Soviet economy, as a framework for discussing the socialist calculation debate,
and I think that´s really important to begin with,
because I think it´s sort of the key to understanding the most important lessons that economics has to teach us; which is that there is a market process that creates its own
order that we ignore, override at our peril.
And it´s in the socialist calculation debates, that Mises and Hayek discovered, what separated their economics from neo-classical mainstream economics.
They had thought to themselves that they were part of the mainstream, that there really weren´t any important differences among Austrians, and Marshallians, and
Varlasians.
Until they discovered in this debate that Varlasians thought that socialism was perfectly feasible, it was just a matter of solving the same equations that the market solves
for us.
The chapter I´m going to talk about today is the Roaring Twenties, the economic boom of the 1920s, and how economists tried to make sense of it, and in particular, how Mises
and Hayek made sense of it. So that´s what I mean by Pre-Keynesian Business Cycle Theory. In order to disabuse this idea that Paul Krugman keeps spreading, that there was no explanation before
Keynes came along.
And then in subsequent chapters, I deal with the New Deal of the United States, the depths of the Depression, as the context in which Keynes´ General Theory was published and
became so popular in economics.
The second World War is the context in which Hayek wrote The Road to Serfdom, and then in the Postwar period the move toward nationalization in the British economy and its
roots in the Fabian Society and, surprising to me, the roots of the Fabian Society in the economics of Henry George and the Theory of Ricardian Rent.
When I started this project, about a year and a half ago, some people said to me, when I gave them this outline, "nobody is interested in nationalization anymore, that´s a
completely dead issue, the government will never go back to that"; so unfortunately, advance has brought that dead horse back to life.
And then in contrast the growth, the rebirth of Spontaneous Order Economics, or Smithian Economics, through the vehicle of the Mont Pelerin Society, so the contrast between
the Fabian Society and the Mont Pelerin Society is interesting.
Not only a contrast in the way they were organized, of course, the Fabian Society was a direct pamphleteering organization; whereas, the Mont Pelerin Society has never been
that, but of course the very different ideas that they promoted.
Then two case studies, the turn toward the market in Germany, the turn toward central planning in India, Germany, of course, did much better than India, but the failure of
development planning in economics is a sort of framework for examining the failure of development economics as a whole, to bring prosperity to the developing world, or the should-be-developing
world.
And then the last four chapters, which I haven´t finished writing yet, bring us up to the present with the period of the Great Inflation of the 1970s, and that is the arena in
which monetarism came to prominence;
the breakdown of the Bretton Woods system, as a result of the Great Inflation and that as a way, a context for understanding the development of international monetary
economics, the gold standard, the exchange rates and all that.
The growth of government and the mixed economy, as a way to contrast the Market Failure Theory of Pigou and Samuelson, against the Theory of Government Failure, provided to us
by public choice and then,
I´m not sure what the current state of the debate will be, but I hope to finish this up in a few months so it won´t be too different from today. But I´ll get a chance to say
all that this discussion about nationalization today, and how much control government should take over the financial sector. We should learn the lessons of the previous periods before we plunge
too far ahead with that.
So, I wanna talk about the Roaring Twenties, which of course ended with the crash in 1929, and I wanna emphasize that Mises and Hayek are not writing in a theoretical vacuum.
They´re not just working at the blackboard, they´re looking at what´s happening outside the window. And here is a simple chart of what´s happening to real output in the U.S. economy and I´ve
superimposed the dotted line as sort of normal growth.
So there´s a recession in 1921, it´s quite severe in fact, but the recovery is quite quick; it only lasts about eighteen months, the period of the recession. Then we have a
long period of above normal output and that´s the Roaring Twenties; that´s the boom period.
It begins to turn down in the middle of 1929 and the Stock market crash follows that. But the contrast between the depth of the Great Depression bottoming out in 1933 and the
recession in 1921, is quite dramatic, and if we had an even longer time series you´d see how unusual the depth of the depression in 1933.
And then the recovery, of course, takes much longer to get back to the trend line, and even in 1940, the economy was not yet back to normal growth.
Non-farm employment, if we look at the employment, we see basically the same picture. This one is industrial production, so this is where the cycle is most exaggerated, and it
used to be understood that it was something to be explained by Business Cycle Theory;
that investment swings are much bigger than consumption swings or activity at the highest stages of the production, mining, heavy equipment manufacturing.
Those sorts of industries suffer much more cyclical variation than the retail trade. So, looking at industrial production, is one way of getting a picture of that, but there
are these large swing upward in industrial production. The shaded areas represent the National Bureau of Economic Researches´ attempt to date recessions and according to them, there´s a
recession in the middle of the Roaring Twenties.
Actually two, in the middle of the Roaring Twenties, but they´re hardly noticeable in the big picture. So, there´s a spike in 1929, and then, you could see the complete
collapse of industrial production, falls to less than half of its previous level, which is much bigger than the swing in consumption or retail spending.
So that´s part of what the Austrians are trying to explain, why there´s a more exaggerated swing in the higher stages, as they call it in production, than in the lower. So
then, the stock market crashes. So, what explanations do the economists have to offer?
And here is my
bête noir, Paul Krugman, it´s always good to have a target. So he wrote a piece in 2007, just after the death of Milton Friedman, and there are other aspects of that article that are
deserving of criticism, but let´s just focus on this one.
"The classical economics offered neither explanations nor solutions for the Great Depression. By the middle of the 1930s the challenges to orthodoxy could no longer be
contained."
So, the picture you get from Krugman is that all the economists between 1929 and 1936 were just throwing up their hands, they had nothing to say.
When he says classical economics that´s what he means, economists before Keynes' General Theory, and that´s the same way Keynes used the term.
Keynes at least admitted that maybe he is using the word classical in a non-standard way, but Krugman doesn´t even issue that disclaimer, just follows Keynes in this idea that
everything before Keynes is classical.
You know, serious historians of economic thought distinguish between classical and neoclassical; between the labor theory of value and the marginalist subjectivist theory of
value after 1871, but that´s not part of Krugman's concern.
In fact, there is a lot of attempt by economists before Keynes to explain business cycles, and in particular, to explain the Great Depression. The most important of the
Austrians are Mises, Hayek and Robins, but there are other British economists who have other explanations, they´re are not quite Austrian, but they do focus on the importance of the banking
system, and the credit system;
Roberts and Hawtrey and Pigou. In the United States you have Irving Fisher, who is concerned about movements in the money supply, so there´s some overlap with the concern
about the cycle in the supply credit.
So here, the most important credit cycle theorists that I wanna mention, Hayek and Mises, in the period that we´re examining; but before them, Mises draws quite a bit of
Wicksell, the Swedish economist, and Mises refers to Wicksell´s attempts to explain the business cycle, as a revival of the Currency School of the mid nineteenth century in Great Britain.
In my book, Free Banking in Britain I, try to distinguish between the Currency School and the Free Banking School and many of the ideas attributed to the Currency School, are
actually better attributed to what I call the Free Banking School;
and James William Gilbart is probably the leading theorist of that school. So, it was the free bankers actually, more than the Currency School who said: "that the problem of
our business cycles in 1839, in Great Britain is the Bank of England. The Bank of England is over expanding credit, and then has to reverse course when gold starts flowing out of the country."
So that´s sort of the earliest sophisticated Credit Cycle Theory.
And you can see Wicksell is an attempt to try to create a more rigorous version of that, and Mises and Hayek pick up on that. Maybe you are familiar with Roger Garrison's Time
and Money, but I´m just stealing these diagrams from him.
So, there are three important components to the theory; first is that there is a trade of between consumption and investment. If you want to make it more concrete, you can
either consume your corn or you can plant your corn.
George Bush of course was all about consumption, who cares if we have to borrow to finance it! You see the arrow moving along the frontier; if you want to have more
investment, you have to have less consumption today; that was the basic idea.
And so we need to talk about the trade off, between consumption and investment, and the choice the economy will make under various constellations of prices, and in particular,
the interest rate will come into the story as an important determinant of where people want to be between present consumption and investment for the sake of future consumption.
It´s a trade off between now and later, and so the time value of money, the interest rate, figures in that.
So, as a shorthand we can think of the interest rate being determined by the supply and demand for loanable funds, if you wanna call that the thing on the horizontal axis, or
savings and investment.
A loanable funds is the terminology after Wicksell, but the supply of loanable funds is coming from savers; households who are saving for retirement or saving for their
children's education, whatever it is.
And the demand for loanable funds is investment. They´re somehow sole demand for loanable funds, but primarily is business investment. And so, for the initial supply curve and
the initial demand curve, the initial supply of savings and the initial demand for investment funds, there is an equilibrium interest rate shown as I sub EQ on the left hand side, and the
intersection between those two curves is the open circle.
If there´s an increased willingness to save, more loanable funds become available, the equilibrium interest rate can fall down the I prime sub EQ. So market equilibrates
savings and investments, equilibrates the desire to consume today against the desire to consume tomorrow.
Now the funds that are invested, here is the third element of the theory, are invested at various stages of production. Production doesn´t just appear instantly, and if you
read Keynes you would think that it just appears instantly,
because the only thing that regulates the quantity of output is how much demand there is today; whereas, this view is saying no, you have to plow the ground and plant the corn
before the corn appears. People being hungry for corn, does not make the corn appear, it goes through stages of production.
And so if, at the end emerges the consumable output, but how much there is to consume depends on the range of investments being made at various stages of production.
So, if you want a concrete version of that, that you have oil extraction, that´s supposed to be an oil well on the left, first extracting the oil, and then come the refineries
in the middle; and finally, it reaches the pump where the consumers can put the gasoline into their cars.
So, it´s important that the stages of production be in the right proportion to one another. And what´s on the vertical axis, there is sort of the value of the goods in
process, and they´re growing as more and more labor and machine services are being applied to the crude oil to turn it into refined oil, and turn it into consumable gasoline in the
example.
And this is again, due to Garrison, he brings the three diagrams together, so that if there is a shift in that willingness to save: that´s diagram one, that means more
investment is now possible; and so, in the second diagram, the trade off between consumption and investment,
we shift to a position along the frontier, with more investment, less consumption, and that enables us to lengthen the structure of production. Add more early stages, and in
the mediate run, you can see it means less consumption in the present, but the investment is for the sake of future consumption.
So, if you go to Garrison's website, he has an animated version where this structure production grows as a result of the investment; and in the long-run, you get more
consumption, and that´s the reason you´re foregoing consumption today.
But, if you have monetary expansion, credit expansion, make it look as though there´s more savings when there really isn´t, then, you´ve got a boom bust cycle. So, in diagram
one, the supply of loanable funds shifts out, but it´s not from genuine savings; it´s from money being printed by the central bank and lent into the system; that´s the credit expansion.
In some of Hayek´s discussions, he just talks about the banking system expanding, but I don´t think it´s coherent to talk about the commercial banks expanding, unless, the
central bank is fueling the expansion. So that´s the credit expansion.
Up in the second diagram we now have an inconsistent situation, because at the lower interest rate that the credit expansion brings about, consumers are saving less
voluntarily, they´ve move back down the savings a supply curve, and so they want to consume more.
But at the same time investors want to invest more. So, how can you have more of both consumption and investment, if there´s a scarcity constraint? Well, this production
possibility frontier between consumption and investment isn´t an absolute;
you can go above the frontier, by using unemployed resources, by working overtime, in a sense the economy can give a 110% of what is sustainable in the long-run, it can do in
the short run, but it´s a mistake.
It´s not really consistent with the underlying preferences in the economy, and when the inconsistency becomes obvious, then you can´t sustain the boom above the frontier, and
so you see the economy curling within the frontier, you have the bust.
In the third face of the diagram, in the stages of production, the boom is associated with adding new stages of production; but if at the same time consumers actually want to
consume more, then you have two ends of the diagram being inconsistent with each other.
So the two ends are pulling against the middle, or a colloquialism that, I´m also stealing from Roger Garrison; "the economy has bitten off more than it can really chew, so it
chokes",
and the choke is the bust. Or the metaphor that George Bush, the man eating the corn, used at one of his dinner speeches, after he told everyone to turn off their microphones,
somebody in the audience had a cell phone to record this; he said: "
Wall Street got drunk and now it has a hangover."Who provided the booze? Who spiked the punch bowl?
It´s the central bank expanding credit that made it look like everyone could have a good time at the party, but the hangover comes eventually.
So, we shrink the diagram, so here is the story in words, the artificially cheap credit creates the false boom, investment gets lured into projects that can´t be sustained,
that are unsustainable,
when the scarcity of resources for completing those investments finally becomes manifest. So this can go on for two or three years, in the 1920s, it was 6 or 7 years, you
finally get a crisis, and in the crisis, it becomes revealed that these projects can´t be profitably completed, and if you allow it, the market will have to liquidate and restructure.
And the recession is the period in which the mistakes are being corrected. And if the mistakes are most severe in producers-good-industries, because the false signal of the
low interest rate has the biggest impact on them, then that´s where the biggest corrections are gonna be necessary.
I already mentioned the hangover analogy, so if we wanna know why there´s a cluster of errors, especially in this one part of the economy, it´s because a signal that´s usually
accurate, that´s usually worth following, which is more savings are available,
that´s what the lower interest rate usually signals, in this instance, it´s giving a false signal, which is leading to this cluster of errors.
So, I don´t need to read this long quote from Hayek, but this is Hayek's explanation for the 1920s, as given in 1932, that the economy had real growth and in response to that
real growth, as goods become more abundant, we should see their prices falling.
So entrepreneurs who figure out less expensive ways of producing goods, are willing to sell them at lower prices, we shouldn´t cancel that, by pumping in more money. We should
let them sell at lower prices. We shouldn´t try to offset the lower prices.
But central banks try to do that by pumping in additional credit to stabilize the level of consumer prices, and Hayek says: "even though consumer prices don´t show any big
run-up, the injection of the credit when prices should have been falling created the misdirection of production."
And so, we shouldn´t be trying to maintain a stable level of prices, we should be letting prices fall when output is growing rapidly. And in the background, I mean, Hayek
doesn´t always clearly state this; but in the background, he has in mind that there´s a gold standard.
And if the output of goods is growing faster than the output of gold, then the prices of good should be allowed to fall, that fallen prices shouldn´t be cancelled by pumping
in more credit, to supplement the growth based on the growth of gold.
Now, Mises draws on Wicksell and Wicksell in turn drew on Böhm-Bawerk, an earlier Austrian economist, who had provided a theory of what determines the equilibrium interest
rate, basically from the trade off between, the productivity of investment and the impatience of consumers to consume.
So there´s a natural rate of interest, as Wicksell called it, determined by the interaction of time preferences and the productivity around about the bad investments.
But that may or may not be the interest rate that actually prevails in the market; the banking system, as lead by the central bank, conceivably all the commercial banks could
act in concert and do the same thing, but there´re good reasons to believe that they won´t do that, unless led by the central bank.
So if the central bank wants to, it can drive the market interest rate below the natural interest rate; below what would maintain the equilibrium. And when they do that,
there´s more demand for bank loans than there is genuine savings to finance those borrowings by investors.
And the way Wicksell puts it is that banks, themselves, create the money required to satisfy the borrowers, the investment borrowers. And Wicksell said:
look if the borrowers pump up prices, by spending the proceeds of their loans, and banks provide all they want to borrow at existing prices,
that will in fact start driving prices up, then borrowers will need to borrow more money to finance the same investments, since everythingcosts more; then, you get an accumulative
process meaning the expansion feeds on itself, and what limits the process is the gold standard.
And Wicksell points out that if you had a pure system of credits; that is, if you had no constraint from the gold standard, there is no limit. The system can expand without
limit. Well that, of course, is what we have today, we have a system in which gold provides no constraint at all. So this analysis is very relevant and if we want to avoid an explosion of cheap
money and credit, we need to have some limit.
What´s been offered as a way of avoiding accumulative process is the Taylor Rule. The Taylor Rule, is the idea that if you see inflation, then you need to raise the interest
rate at which the central bank is aiming, so that they don´t feed the accumulative process.
Raise the central bank´s target interest rate, more than the inflation rate goes up, and then you will dampen the expansion, rather than feeding it. Well, it´s a nice attempt
to limit the damage done by central banking.
I wanted to say a little more about the Free Banking School, I mentioned Gilbart; here are some of the other leading members Samuel Bailey, Robert Mushet, Henry Parnell,
Poulett Scrope.
But here is the theory they came up with in order to explain why they were experiencing business cycles in the 1820s and 1830s; that the Bank of England had the power to
create credit, over issue, was the way they put it because they focused on the creation of more bank notes.
But, by lending the notes and deposits into circulation they drove the interest rate too low; and this is the origins of Mises' analysis of the cycle. They made an important
distinction between the power of the central bank to over issue and the constraints placed on other banks in the system.
And in Great Britain, the Bank of England was the central bank, the other banks were called country banks, because they were outside London. But if the Bank of England created
more Bank of England notes, the country banks would come to own those; and they wouldn´t return them to the Bank of England for redemption in gold; they would treat them as reserves and so be
drawn along in the expansion.
But when prices in Great Britain rose above prices in the rest of the world, gold would flow out, my abbreviation there is PSFM for the price-specie-flow mechanism; if
domestic prices are higher than world prices, then specie, that is gold and silver, flows out.
That forced the Bank of England to tighten and so then there would be the crisis, because now credit is contracted, interest rates rise. And the remedy was: don´t have a
central bank that´s able to drive these credit cycles; replace it with competitive issue of notes; replace it with free banking.
So that any single bank that gets out of line will, quickly find its reserves, not draining to the rest of the world; but draining to the banks in its neighborhood. The
problem in the British system was that the Bank of England didn´t have any constraint of that kind.
And Mises picks up on this remedy and that´s why I think Mises is closer to the Free Banking School than the Currency School, because the Currency School was fine with the
Bank of England´s monopoly; their remedy was to impose a rule on the Bank of England.
And Mises is saying "no, not a rule on the central bank, eliminate the central bank and have market discipline", imposing a rule on the central bank is best to the kind of
second best, to having a natural market discipline on the banking system.
Okay, so that was the Austrian view, as reflected in the writings of Mises and elaborated by Hayek. Hayek talked more about the structure of production and the sort of capital
angle.
But those, of course, are not the only views out there, Keynes does come along. Keynes starts writing about the problem of the Depression in 1930, doesn't sort of draw it all
together and provide an elaborate version; I was going to say rigorous, but it´s not really the right word, because his model doesn´t ultimately make coherent sense, but an elaborate version in
the General Theory.
But Keynes´s view is that there wasn´t any problem in the 1920s building up; everything was fine, until suddenly, in 1929, for no apparent reason, entrepreneurs lost their
nerve. And he talked about the animal spirits of the entrepreneurs collapsing and to me that just sort of begs the question, that if you´re going to appeal to some wave of pessimism, why did it
start?
And the Austrian theory provides an explanation of why the boom can't last. Milton Friedman had the same view of the 1920s, everything was fine, things collapsed after 29
because the money stock collapsed, and I think there is some important truth to that part, the second part, that the collapse of the money stock after 29 didn't help, but I think he is
overlooking the problem building up before 1929.
Keynes also has his drawing on earlier theorists, Keynes and Tugwell. Tugwell was the chief advisor to Franklin Roosevelt; and Tugwell's view was,
there wasn't enough demand for all the goods being produced, so what's the solution? Produce fewer goods.
This sounds kind of bizarre as a remedy for a depression, to produce fewer goods, but that was their program. That was the National Recovery Act and the Agriculture Adjustment
Act; plan for less output. That's what I discuss in chapter four of the book.
Both, Tugwell and Keynes, drew on an earlier cycle theorist named Hobson, John A. Hobson, and Hobson drew on the Marxists like Engels.
Famously, in Marx´s theory, the workers are not paid enough to buy back what they produce, and Engels and Hobson said;
well, if the capitalists don´t pick up the slack, with the profit they´ve extracted from the workers, if they don´t buy the rest of the product, then there´s not enough demand and the
economy collapses.
So, that´s the Marx´s theory of under rewarding of the workers, has turned into a theory that demand isn´t enough. Now this theory, never appears when things are going well,
when the economy is growing normally, it´s only trotted out in depressions, so it´s not really a theory of the business cycle, it´s just supposed to be a theory of why we are in a depression
and we ignore the fact that it doesn´t apply the rest of the time.
If I had time I could talk more about Friedman´s theory; but this is from an abet piece by Friedman, showing that in the first diagram we track the Money stock relative to the
cycle peak, and you see in the 1920s and 30s the mMoney supply declines, so that´s the collapse of the U.S. Money stock after 1920s, between 1929 and 1932, M2 fell 30%.
And I think that was important in adding to the burden of adjustment that the economy had, it already had some adjusting to do because the boom of the twenties was built on
sand, it could not be sustained.
But the burden of adjustment was added to by the deflation that was imposed on the economy. But here´s Friedman criticizing the Austrians for the policies they advocated for
dealing with the depression, once it began, and this, I quoted the outset of an article about whether Hayek and Robbins should be blamed for making the Great Depression deeper.
I think Austrian Business Cycle Theory has done the world a great deal of harm. Now there´re two things implied in that judgment; namely, that the Austrian Theory is
recommending the wrong policy, and secondly, that policy makers were listening.
And I think both parts are wrong. He says, if you go back to the 30s, Hayek and Lionel Robbins, are saying you just have to let the bottom drop out of the world. You´ve just
got to let if cure itself.
You can´t do anything about it, you will only make it worse". I think Friedman is blurring together two things; one is, don´t prop up in solvent firms, let them go bankrupt,
let the resources that they command be reallocated to sound or more sustainable uses.
And that part, I think is perfectly defensible, and Friedman himself, in fact, defends it elsewhere; so I don´t know why, if that´s what he is accusing the Austrians of that
would be inconsistent with his own views.
What I think he means, though is, what I think he´s referring to here is, that the Austrians are okay with any amount of deflation and monetary contraction; and there, I
think, he´s misinterpreting the Austrian theory, in the sense of doing nothing, if doing nothings means letting the money supply collapse by 30 percent, that´s not why Hayek is advocating.
So, in that sense he´s got the Austrian theory wrong, and then in saying that policy makers were listening, that´s also not true. I mean the timing is not right, Prices and
Production is published in 1931, it could hardly have influenced the Hoover administration in 1929 and 1930.
But, I actually went and tried to see if anybody in the Hoover administration was reading Hayek in 1931, 1932; when they were still in office, and I can´t find any evidence
that they were. They´re not quoting Hayek until much later.
Hoover, in his memoirs in 1952, wants to say:
I´m not responsible, it´s not my fault that the economy collapsed;so he goes looking for a theory that blames it on somebody else. The Austrian Theory blames it on the Federal Reserve,
at that point in 1952, Hoover quotes Lionel Robbins´ explanation for why the boom fell apart. But that´s in retrospect and that´s trying to shift the blame away from himself.
At the time, Hoover was not reading Lionel Robbins in 1932, Hoover was not reading Robbins 1934. It would´ve been impossible he didn´t have a time machine. And he could´ve
been reading Prices and Production but he was not. And the policy that really counted, was the policy on the Federal Reserve System and the Federal Reserve people weren´t reading Hayek and
Robbins, either.
So, it´s a misinterpretation of Hayek's advice because Hayek's policy norm, as explained in Prices and Production, is not being different to whatever amount of monetary
contraction, it´s rather to stabilize nominal income, in the equation of exchange, stabilize MV.
So, the Fed wasn´t doing that in the 20s, as why real output was growing, they should´ve been letting the price level peak drop in the same proportion and Hayek said they
weren´t doing that; they were injecting money, when there was no reason to inject it.
But there are cases in which it does, there are reasons to inject money; namely, if the money supply starts to drop, because the bank runs, that should be offset, or if
velocity starts to drop. That´s if people are holding money, provide them with the money they want to hold, don´t force the economy to deflate to provide them in real terms with the money they
want to hold.
And Hayek failed to say that in 1932, he published some newspaper letters and editorial abet pieces, in which he said:
I´m hoping that the deflation that´s going on will break the price and wage rigidity that is hampering adjustment.And so he was kind of ambivalent as to whether the deflation was a
good thing.
He did not speak out, although according to his own norm, he should have, because it was clear that both prices were falling and real output was falling. So it was clear that
the product, PY, was falling, so it was clear that MV was falling and it should´ve been offset by providing more money.
And Hayek later recognized that, in 1937, he said it clearly, and in 1975, looking backwards, he said: "
okay, I gave the wrong advice because I hoped that the deflation would do some good, I should´ve realized it would only do harm, but it wasn´t my theory that was at fault, it was just my
application of the theory."
And I think Hayek is right about that. So as I said a minute ago, it wasn´t influencing the Hoover administration, it wasn´t influencing the Federal Reserve System.
The Federal Reserve's influence came from the Real Bills Doctrine. I mean, the Real Bills Doctrine in diagrams it´s simpler. So here´s Hayek on the left, Hayek says that when
the demand for loanable funds,
that is when the investors want to invest more, so the demand curve is shifting to the right, let them get a greater quantity of savings, by moving up the supply curve for
savings, but that means letting the interest rate rise and that will ration the amount of savings,
it´ll bring forth more savings, but it´ll ration the savings to the investors who have the most productive uses for it and it will keep the economy from mal-investing in
production projects that don´t need the new higher bench mark, the new higher rate of return, you need, to me, given that there are new projects to invest in with higher rates of return as
judged by entrepreneurs.
So let the interest rate rise, when investment demand rises. The Real Bills Doctrine on the other hand, says, the central bank should make sure that the credit system
accommodates all genuine demand for credit, but presumably that means at the existing interest rate,
so that if demand for investment shifts to the right, demand for loanable funds shifts to the right, have the central bank supply more credit to keep the interest rate from
rising. So that´s what the Federal Reserve was doing during the 1920s, it was keeping interest rates down when they should´ve risen by pumping in more credit.
Not because they were directly aiming at keeping the interest down, but because they were aiming at keeping the price level from falling by pumping in more credit. But it had
the same effect, so that´s the key difference between Hayek´s doctrine and the Real Bills Doctrine.
So coming back to Keynes, Keynes in 1936, had no way to equilibrate the demand for present consumption, with the demand for future consumption, and he explicitly says this,
explicitly criticizes Say´s law, which says the economy
there´s no such thing as too much output in general, the question is: do we have the right mix of different kinds of outputs? And Keynes says, no, there´s not anything that
coordinates investments with savings. Those who think that way are fallaciously supposing that there´s a nexus, which unites decisions to abstain from present consumption,
that is savings, with decisions to provide for future consumptions, that is investments. So, Keynes is saying there´s no market, in which savings and investment are
equilibrated, and Hayeks response, next slide;
Has Mr. Keynes ever reflected on the function of the rate of interest? This is about as direct an insult as Hayek is capable of.
Keynes just doesn´t understand the role of the rate of interest, and he doesn´t seem to realize that there is a market for inner temporal coordination.
And he goes on to say,
this is from the Pure Theory of Capital,
we economists have gone through a process of developing a systematic account of those forces which in the long-run determine prices and production, no coincidence that that´s the title
of Hayeks book,
but
Say´s law
,Credit Cycle Theory, Wicksell, the Austrian Theory of Capital, Böhm-Bawerk,
we have all this understanding of how the economy can coordinate and how it can fail to coordinate if the central bank jams the signals, and Keynes is saying
forget all that, and just worry about there´s enough demand today,which is what Hayek calls the Short-sighted Philosophy of the Businessman,
if I can´t sell my goods it is because there´s not enough money in the market, raised to the dignity of a science. We´re not even told that since in the long-run we are all dead,
policy should be guided entirely by short-run considerations, so to Hayek this is a renunciation of the task of the economist,
which is to point out to people, what is unseen by superficial views of the situation, what are the long-run consequences of the policies we take today. The end.
Content
Initial credits
Introduction
The Clash of Economic Ideas, Lawrence H. White
The Twentieth Century Battle for the "Commanding Heights"
Laissez-faire
The Bolshevik Revolution and the Socialist Calculation Debate
The Roaring Twenties and Pre-Keynesian Business Cycle Theory
Other chapters
The roaring 1920s
Real output in US economy, 1918-1939
Industrial production
Paul Krugman's views
Credit cycle theorists
Trade-off between consumption and investment
Supply and demand for loanable funds
Stages of production
Savings and investment
Monetary expansion
False boom
Real growth and price level, Friedrich A. Hayek
Natural rate of interest, Knut Wicksell
Gold standard constraint and cumulative process
Taylor rule
Free-banking school
Free-banking theory
Differing views from John Maynard Keynes and Milton Friedman
Deficient demand theorists
Milton Friedman's views on US money stock
Milton Friedman and the Austrian theory of the business cycle
Missinterpretation of Friedrich A. Hayek's advice
Real bills doctrine versus Hayek
Keynesian view
Hayek's response
Final words
Final credits
Todos los comentarios
Selección del Editor
No hay comentarios en esta sección.
No hay comentarios en esta sección.
Universidad Francisco Marroquín
6 Calle final, zona 10
Edificio de la Escuela de Negocios
Oficina EN-103
Guatemala, Guatemala 01010
Teléfono (+502) 2338-7700 ext. 7876
Slides
