The Bank for International Settlements Falls into a Hayekian Trap

On April 9, 1975, F. A. Hayek, having recently received the Nobel Prize in economics, was invited to give a talk to a group of distinguished economists at the American Enterprise Institute in Washington DC. He was introduced by his old friend and colleague from Vienna, Gottfried Haberler. During his talk, Hayek pointed out that although a downturn can be triggered by microeconomic factors causing a lack of correspondence between the distribution of demand across products and industries and the distribution of labor across products and industries.

These discrepancies of demand and supply in different industries, discrepancies between the distribution of demand and the allocation of the factors of production, are in the last analysis due ot some distortion in the price system that has directed resources to false uses. It can be corrected only by making sure, first, that prices achieve what, somewhat misleadingly, we call an equilibrium structure, and second, that labor is reallocated according to these new prices.

Lacking such price readjustment and resource reallocation, the original unemployment may then spread by means of the mechanism I have discussed before, the “secondary contraction,” as I used to call it. In this way, unemployment may eventually become general.

In the subsequent discussion, Haberler asked Hayek to elaborate on the concept of a “secondary contraction,” and the appropriate policy response to such a phenomenon. Haberler asked:

I was very glad you said that you find some justification in the view that depressions are aggravated by a cumulative spiral and that there is such a thing as a secondary deflation. Don’t you think that it is possible to do something about that aggravation without recreating the fundamental maladjustments which, in your opinion, caused the depression.

Hayek replied:

I hope I implied this. The moment there is any sign that the total income stream may actually shrink, 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.

Later in the discussion, Haberler again pressed Hayek on his position regarding a downward deflationary spiral such as occurred in the 1930s. Hayek responded to Haberler as follows:

You ask whether I have changed my opinion about combatting secondary deflation. I do not have to change my theoretical views. As I explained before, I have always thought that deflation had no economic function; but I did once believe, and no longer do, that it was desirable because it could break the growing rigidity of wage rates. Even at that time I regarded this view as a political consideration; I did not think that deflation improved the adjustment mechanism of the market.

In a terrific commentary on the recent annual report of the Bank for International Settlements, Ryan Avent disposes of the arguments offered by the BIS for tightening current monetary policies.

I was especially struck by the following passage, quoted by Avent, from the report.

Although central banks in many advanced economies may have no choice but to keep monetary policy relatively accommodative for now, they should use every opportunity to raise the pressure for deleveraging, balance sheet repair and structural adjustment by other means.

Here, in another, slightly less ferocious, guise, is the deflationary argument that Hayek himself disavowed nearly 40 years ago:  that secondary deflation could be used to “break the growing rigidity of wage rates,” or in updated BIS terminology could “raise the pressure for deleveraging, balance sheet repair and structural adjustment.”

Plus ca change, plus c’est la meme chose.

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9 Responses to “The Bank for International Settlements Falls into a Hayekian Trap”


  1. 1 dajeeps June 28, 2012 at 12:53 am

    I am a historian, not an economist, but from what I have read over the years about monetary economics in order to understand the context in which certain events took place, the notion that monetary disinflation/deflation is destructive and something to be avoided like the plague appeared to be universal and uncontested in modern thought. It seems like this economic disaster has caused nearly everyone to take leave of their senses over something so basic, even a historian can understand it, with some economists talking about “fiscal consolidation” here in the US, a term which seems quite out of place. When I saw that I wanted to laugh at the guy, but then gravity of the situation washed over me and I wanted to cry instead.

    I enjoyed Mr. Avent’s article. I wish more like it were written and published by people with credentials such as his because what is currently taking place at the Fed (and the ECB, but being American I have a far greater stake in what happens at the Fed) is unforgivable as well as unlawful per the Full Employment and Balanced Growth Act of 1977.

    I tried to do a survey of the social history of the 1930’s a few years ago because I had never studied that period in detail and I was curious about it. Most of the lectures and other materials I had ever encountered about the Great Depression discussed mostly the economics of the situation and government reactions, but left much to the imagination of what it was like for ordinary people. I never finished the survey because curiosity killed the cat and having the foreknowledge of what caused or prolonged it completely destroyed my objectivity. I spent most of my research time tearfully reading about broken lives, broken families, and fight for survival until I simply could not continue. It really is no wonder that kind of detail is rarely discussed in general history. It amazes me that we are nearly right back there, with the exception that we have social support programs to help keep families together and prevent starvation, at least. But it is lacking in reason that because we have these monetary policy that produces much of the same effects is justified by the ends described in the BIS report. It isn’t just lacking in reason, it’s absurd; and I can’t imagine that the cost of this policy in terms of what it is doing to society as a whole is worth paying for any kind of petty political ends.

  2. 2 Becky Hargrove June 28, 2012 at 7:12 am

    The psychological component in willing devaluation is what amazes me. It’s as though everyone is sitting there with their assets, willing to make bets that their pile can stand, while the pile of the next person falls. One would think that these people would be willing to support one another to protect what exists right now, but they don’t. What’s more, they do not want the competition of those who would serve the lower incomes, and while some say the Walmarts of the world can serve the lower classes, monetary tightening even makes that source of survival more fragile as globalization is threatened.

    By no means do I let central banks off the hook now. But they are only the latest in a long line of economic actors who have declared that the fate of the world is not really their responsibility. While such responsibility does not belong to any one set of actors, why has it been impossible for partial responsibility to be shared by all of these? Why has it been impossible for people to come together to have better understanding of the actual existing markets which could be better served?

  3. 3 nihoncassandra June 28, 2012 at 11:27 am

    There is no shortage of demagogues out there seemingly more Hayekian than Hayek. I think the word for it in Hayek’s native language would be something like schlimmbesserung

  4. 4 David Glasner June 29, 2012 at 9:46 am

    dajeeps, It might make for an interesting historical/sociological to investigate how people view inflation in periods of economic distress, e.g, the Great and Little Depressions. Is it possible that tolerance for inflation rises with the level of prosperity?

    Becky, It is remarkable that monetary policy authorities have deliberately tried to disavow any responsibility for the state of the economy. Plosser, Lacker, and Bernanke all repeat the mantra that monetary policy is not a panacea, and using slightly different words, so does the BIS report.

    nihoncassandra, Thanks for enhancing my very meager German vocabulary. It’s a wonderful word, and very apposite, indeed.

  5. 5 Tas von Gleichen June 30, 2012 at 10:40 am

    Not to mention that Central Banks are buying gold which wasn’t done for decades. Just something that should be mentioned.

  6. 6 Saturos July 3, 2012 at 11:59 am

    “… I can’t imagine that the cost of this policy in terms of what it is doing to society as a whole is worth paying for any kind of petty political ends.”

    And that’s why Scott Sumner believes that the cause is simply ignorance. His campaign is to change the views of the median economist. Wish him luck.

  7. 7 Saturos July 3, 2012 at 12:01 pm

    Ahh, I know you as Bonnie from Scott’s blog. So where does “dajeeps” come from, then?

  8. 8 Saturos July 3, 2012 at 12:04 pm

    Arrrgh, why can I post here but not on the previous post where David replied to my comment? Stupid WordPress. or Google Chrome. It’s one of you.

  9. 9 David Glasner July 3, 2012 at 7:10 pm

    Saturos, There may be more than ignorance at work. Incentives to make things better are not necessarily optimal. But I don’t know what to do about that, so Scott’s strategy is certainly the best, if not the only, approach available.

    I don’t know why you are running afoul of the WordPress spam gatekeeper, but I have tried to get you through security.


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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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