Archive for September, 2011

Keynes v. Hayek: Advantage Hawtrey

On Labor Day, I finally got around to watching the Keynes v. Hayek debate at  the London School of Economics on August 3 between Robert Skidelsky and Duncan Weldon on behalf of Keynes and George Selgin and Jamie Whyte on behalf of Hayek.  Inspired by the Hayek-Keynes rap videos, the debate, it seems to me, did not rise very far above the intellectual level of the rap videos, with both sides preferring to caricature the other side rather than engage in a debate on the merits.  The format of the debate, emphasizing short declaratory statements and sound bites, invites such tactics.

Thus, Robert Skidelsky began the proceedings by lambasting Hayek for being a liquidationist in the manner of Andrew Mellon (as rather invidiously described by his boss, Herbert Hoover, in the latter’s quest in his memoirs for self-exculpation), even though Skidelsky surely is aware that Hayek later disavowed his early policy recommendations in favor of allowing deflation to continue with no countermeasures.  Skidelsky credited FDR’s adoption of moderate Keynesian fiscal stimulus as the key to a gradual recovery from the Great Depression until massive spending on World War II brought about the Depression to a decisive conclusion.

Jamie Whyte responded with a notably extreme attack on Keynesian policies, denying that Keynesian policies, or apparently any policy other than pure laissez-faire, could lead to a “sustainable” recovery rather than just sow the seeds of the next downturn, embracing, in other words, the very caricature that Skidelsky had just unfairly used in his portrayal of Hayek as an out-of-touch ideologue.  George Selgin was therefore left with the awkward task of defending Hayek against both Skidelsky and his own colleague.

Selgin contended that it was only in the 1929-31 period that Hayek argued for deflation as a way out of depression, but later came to recognize that a contraction of total spending, associated with an increasing demand by the public to hold cash, ought, in principle, to be offset by a corresponding increase in the money supply to stabilize the aggregate flow of expenditure.   Larry White has documented the shift in Hayek’s views in a recent paper, but the argument is a tad disingenuous, because, despite having conceded this point in principle in some papers in the early to mid-1930s, Hayek remained skeptical that it could be implemented in practice, as Selgin has shown himself to be here.  It was not until years later that Hayek expressed regret for his earlier stance and took an outspoken and unequivocal stand against deflation and a contraction in aggregate expenditure.

I happen to think that one can learn a lot form both Hayek and Keynes.  Both were profound thinkers who had deep insights into economics and the workings of market economies.  Emotionally, I have always been drawn more to Hayek, whom I knew personally and under whom I studied when he visited UCLA in my junior year, than to Keynes.  But Hayek’s best work verged on the philosophical, and his philosophical and scholarly bent did not suit him for providing practical advice on policy.  Hayek, himself, admitted to having been dazzled by Keynes’s intellect, but Keynes could be too clever by a half, and was inclined to be nasty and unprincipled when engaged in scholarly or policy disputes, the list of his victims including not only Hayek, but A. C. Pigou and D. H. Robertson, among others.

So if we are looking for a guide from the past to help us understand the nature of our present difficulties, someone who had a grasp of what went wrong in the Great Depression, why it happened and why it took so long to recover from, our go-to guy should not be Keynes or Hayek, but the eminent British economist, to whose memory this blog is dedicated, Ralph Hawtrey.  (For further elaboration see my paper “Where Keynes Went Wrong.”)  It was Hawtrey who, before anyone else, except possibly Gustav Cassel, recognized the deflationary danger inherent in restoring a gold standard after it had been disrupted and largely abandoned during World War I.  It was Hawtrey, more emphatically than Keynes, who warned of the potential for a deflationary debacle as a result of a scramble for gold by countries seeking to restore the gold standard, a scramble that began in earnest in 1928 when the Bank of France began cashing in its foreign exchange reserves for gold bullion, a  move coinciding with the attempt of the Federal Reserve System to check what it regarded as a stock-market bubble by raising interest rates, attracting an inflow of gold into the United States just when the Bank of France and other central banks were increasing their own demands for gold.  It was the confluence of those policies in 1928-29, not a supposed inflationary boom that existed only in the imagination of Mises and Hayek and their followers that triggered the start of a downturn in the summer of 1929 and the stock-market crash of October 1929.   Once the downturn and the deflation took hold, the dynamics of the gold standard transmitted a rapid appreciation in the real value of gold across the entire world from which the only escape was to abandon the gold standard.

Leaving the gold standard, thereby escaping the deflation associated with a rising value of gold, was the one sure method of bringing about recovery.  Fiscal policy may have helped — certainly a slavish devotion to balancing the budget and reducing public debt – could do only harm, but monetary policy was the key.  FDR, influenced by George Warren and Frank Pearson, two Cornell economists, grasped both the importance of stopping deflation and the role of the gold standard in producing and propagating deflation.  So, despite the opposition of some of his closest advisers and the conventional wisdom of the international financial establishment, he followed the advice of Warren and Pearson and suspended the gold standard shortly after taking office, raising the gold price in stages from $20.67 an ounce to $35 an ounce.  Almost at once, a recovery started, the fastest recovery over any 4-month period (from April through July 1933) in American history.

Had Roosevelt left well enough alone, the Great Depression might have been over within another year, or two at the most, but FDR could not keep himself from trying another hare-brained scheme, and forced the National Industrial Recovery Act through Congress in July 1933.  Real and money wages jumped by 20% overnight; government sponsored cartels perversely cut back output to raise prices.  As a result, the recovery slowed to a crawl, not picking up speed again till 1935 when the NRA was ruled unconstitutional by the Supreme Court.  Thus, whatever recovery there was under FDR owed at least as much to monetary policy as to fiscal policy.  Remember also that World War II was a period of rapid inflation and monetary expansion along with an increase in government spending for the war.  In addition, the relapse into depression in 1937-38 was at least as much the result of monetary as of fiscal tightening.

I would never say forget about Keynes or Hayek, but really the true master– the man whom Keynes called his “grandparent in the paths of errancy” — was Ralph G. Hawtrey.

Switzerland Teaches Us a Lesson

The Swiss National Bank announced today that it was committing itself to keep the euro-franc exchange rate above 1.20 francs per euro. Here is the opening of the Bloomberg story.

The Swiss central bank imposed a ceiling on the franc’s exchange rate for the first time in more than three decades and pledged to defend the target with the “utmost determination.” The Swiss National Bank is “aiming for a substantial and sustained weakening of the franc,” the Zurich-based bank said in an e-mailed statement today. “With immediate effect, it will no longer tolerate a euro-franc exchange rate below the minimum rate of 1.20 francs” and “is prepared to buy foreign currency in unlimited quantities.”

The euro had fallen to 1.11 francs per euro on Friday. Citing the deflationary threat to the Swiss economy of a massively overvalued franc, the Swiss central bank pledged to buy euros in unlimited quantities to meet its exchange rate target.

The euro is now trading at just over 1.2 francs per euro. The dollar has appreciated against both the euro and the franc, the dollar rising from $.787 on Friday to $.857 today.

The two-fold lesson that the Swiss are teaching us — not that it hasn’t been taught before, e.g., by FDR in 1933 – is simply this:

1) A country adopting a meaningful exchange rate peg against another currency surrenders control over its domestic money supply and its domestic price level to the monetary authority (or in case of a gold standard to the international gold market) controlling the currency against which the peg is established.

2) However, if a country wishes to increase (decrease) its domestic money supply and price level from their current levels, it can do so by pegging its exchange rate against another currency at a rate significantly below (above) the current exchange rate against the targeted currency.

It is therefore simply wrong to assert that the US or any country could not achieve any desired price-level target, because the US monetary authorities (i.e., the Fed and Treasury) could announce that they would peg the dollar to another currency at a rate significantly different from the current exchange rate. By making such an announcement in a credible fashion (as the Swiss have done) there is nothing to stop the US from achieving any desired level of prices (corresponding to a particular exchange rate peg). Monetary policy is never ineffectual except by the choice of the monetary authorities .

HT:  Lars Christensen

Update:  Marcus Nunes has an excellent post on the Swiss National Bank announcement

Hayek on the Meaning of “Planning”

As promised, here is a passage from Hayek’s Road to Serfdom (pp. 34-35) elucidating the meaning of “planning.”  It is only by ignoring or misconstruing Hayek’s discussion of the different significations that the word “planning” can have that central banking can be confused with central planning.

‘Planning’ owes its popularity largely to the fact that everybody desires, of course, that we should handle our common problems as rationally as possible and that, in so doing, we should use as much foresight as we can command.  In this sense everybody who is not a complete fatalist is a planner, every political act is (or ought to be) an act of planning, and there can be differences only between good and bad, between wise and foresighted and foolish and shortsighted planning.  An economist, whose whole task is the study of how men actually do and how they might plan their affairs, is the last person who could object to planning in the general sense.  But it is not in this sense that our enthusiasts for a planned society now employ this term, nor merely in this sense that we must plan if we want the distribution of income or wealth to conform to some particular standard.  According to the modrn planners, and for their purpsoses, it is not sufficient to design the most rational permanent framework within which to the various activities would be conducted by differeent persons according to their individual plans.  This liberal plan, according to them, is no plan — and it is indeed, not a plan designed to satisfy particular views about who should have what.  What our planners demand is a central direction of all economic activity according to a single plan [my emphasis], laying down how the resources of society should be ‘consciously directed’ to serve particular ends in a definite way [my emphasis].

The dispute between the modern planners and their opponents is, therefore, not a dispute on whether we ought to choose intelligently between the various possible organizations of society; it is not a dispute on whether we ought to employ foresight and systematic thinking in planning our common affairs.  It is a dispute about what is the best way of so doing.  The question is whether for this purpose it is better that the holder of coercive power should confine himself in general to creating conditions under which the knowledge and initiative of individuals are given the best scope so that they [Hayek’s emphasis] can plan most successfully; or whether a rational utilization of our resources requires central [Hayek’s emphasis] direction and organization of all our activities according some consciously constructed ‘blueprint‘ [my emphasis].   The socialists of all parties have appropriated the term ‘planning’ for planning of the latter type, and it is now generally accepted in this sense.  But though this is meant to suggest that this is the onlyrational way of handling our affairs, it does not, of course, prove this.  It remains the point on which the planners and the liberals disagree.

Central Banking and Central Planning, Again

In the last few weeks I wrote two posts arguing that, despite the attempts of some to identify them, central banking is not the same as central planning.  In my first post, I explained that central planning originally referred to attempts to allocate the resources available to society in accord with a pre-determined unitary “rational” plan rather than allow resources to be allocated according to the decisions of individuals advancing their own self-interest through market transactions.  In my second, I showed that Hayek in both The Road to Serfdom andThe Constitution of Liberty explicitly denied that central banking was a form of central planning.

Central planning in this sense is much different from what a central banker, even under the most expansive view of his responsibilities, is trying to do.  Obviously a central banker is engaged in planning, in the sense that a central banker is trying to act in a rational way calculated to achieve his purposes.  The ambiguity in the meaning of planning has long been recognized, and dismissed by critics of central planning.  Only planning designed to override the voluntary decisions and plans of private individuals and business, compelling them to conform to the central plan rather than to their own preferred courses of action, is planning of the objectionable type.  So just because a central banker has a centralized role in the banking system, and seeks to achieve his goals in a rational, planned, non-random way, does not establish ipso facto that his planning is necessarily objectionable in the same way that planning by a central planner is objectionable, inasmuch as central bankers typically do not aim to achieve any particular allocation of society’s resources.  Rather the goal of the central banker is to create the macroeconomic conditions in which people can succeed in executing their own economic plans to buy and sell, save and invest, produce and consume.

As usual, Hayek made the point about as well as it can be made.  Rather than clutter up this post which is already too long with that quote, I am going to put an extended quotation from The Road to Serfdom in a follow-up post to this one.

Obviously, there can be disputes about whether central banks adopt policies likely to achieve their stated goals generally summarized as a stable general level of prices and a high level of economic activity and employment.  But it is an abuse of language to say that by trying to create those conditions, conditions that increase the chances that individuals and businesses can fulfill their own plans for economic activity, central banks are doing anything even comparable to what central planners were trying to do.

My earlier posts elicited some lively comments on this blog and on some other blogs.  For example, Kurt Schuler at, believes that it is self-evident that central banking is a form of central planning, despite acknowledging that the nexus between central planning and central banking was not identified until the contributions of Larry White (1984) and George Selgin (1988), a remarkable statement inasmuch as the two seminal figures, Mises and Hayek, in the debates about central planning in the 1920s and 1930s, were both monetary theorists of note who supposedly missed the obvious connection between central banking and the theory of central planning that they had developed.  That huge historical gap is elided when Schuler asks rhetorically:

Central planning failed as a comprehensive economic system; why should we expect central planning limited to particular fields of economic activity to do better?

This question is less devastating to central banking than Schuler imagines;  most economists, including most of those accepting the general argument against central planning, concede that there may be times when markets do not function as efficiently as they normally do, say, because property rights to scarce resources cannot be defined or enforced, or because of informational asymmetries, or because some markets are inherently uncompetitive.  In such cases, the informational shortcomings of central direction are offset by market imperfections, so that it is at least possible for regulation or intervention to improve the outcome.  One may agree or disagree whether intervention does indeed improve the outcome, but the case for intervention cannot be dismissed simply by invoking the argument against central planning. 

But even to frame it in this way mischaracterizes the argument against central planning, for what that argument says is that the very attempt to allocate resources by way of a central plan is irrational, the central planner lacking any rational basis for comparing the costs and benefits of the alternative allocations of resources that he is considering.  With no functioning price system to provide a way of evaluating the resources used in those alternatives, the planner is unable to make a rational choice between alternatives.  On the other hand, when there is a functioning — even an imperfectly functioning — price system, the valuations reflected in those prices provide at least some basis, however imperfect, for choosing between alternative uses of resources for competing ends and alternatives means of achieving the same end.  But the more that central planning supplants market decisions, the more tenuous the connection between “prices” and valuations and costs. 

So even though there is an argument that central direction of a single sector in a functioning market economy is inefficient, the argument is an order of magnitude weaker than the argument against central planning of the whole economy.  The argument about a single sector is at least potentially rebuttable in the face of a strong reason to suspect market failure.  The argument against central direction of the entire economy is not rebuttable even in the presence of market failure.  And it is a clear conceptual error to treat the two sorts of arguments as if they were equivalent.

Schuler goes on to assert: 

Central banks are government monopolies that consciously try to steer the economy. If that is not central planning, nothing is.

Central banks are government monopolies, but their monopoly power is not unlimited inasmuch as the vast majority of all money in the economy is created by private banks in the form of deposits.  Now it is true that banks have to make their deposits convertible into government money, but in the US reserve requirements are now very low, so the government is now extracting only a very modest rent from its monopoly.  As for steering the economy, the Fed does indeed try to do so, but only in the sense that it tries (not always successfully) to create stable economic conditions.  It does not aim to achieve any particular allocation of resources.  The Fed tries to steer the economy in the way that a captain tries to steer his boat toward a destination chosen not by him, but by the passengers.  The objective of the captain is to choose a route that is safe, economical, pleasant, and speedy.  His decisions may not always be correct, but his objective is not to override the wishes of his passengers but to find the most satisfying route for their journey. 

Finally, Schuler, referring to my post quoting from both The Road to Serfdom and The Constitution of Liberty documenting that Hayek held that the conduct of monetary policy by a central bank was not planning in a sense incompatible with a market economy, concludes with this statement:

And by the way, it will not do to cite the younger Hayek in support of central banking when the older Hayek in Denationalisation of Money wrote about “the obvious corollary that the abolition of the government issue of money should involve also the disappearance of central banks as we know them” [page 105].

I will just note in passing that “the younger Hayek” was 62 years old when he published The Constitution of Liberty from which I quoted, so his remarks can hardly be dismissed as an intemperate youthful outburst.  But leave that point aside.  Schuler omits the rest of the passage from Denationalization of Money in which Hayek wrote the following:

The need for such an institution [i.e., a central bank] is, however, entirely due to the commercial banks incurring liabilities payable on demand in a unit of currency which some other bank has the sole right to issue, thus in effect creating money redeemable in terms of another money.  This, as we shall have still to consider, is indeed the chief cause of the instability of the existing credit system, and through it of the wide fluctuations in all economic activity.  Without the central bank’s (or the government’s) monopoly of issuing money, and the legal tender provisions of the law, there would be no justification whatever for the banks to rely for their solvency on the cash to be provided by another body.  The ‘one reserve system’, as Walter Bagehot called it, is an inseparable accompaniment of the monopoly of issue but unnecessary and undesirable without it.

So Hayek’s dismissal of central banking was crucially and explicitly dependent on an argument that private competitive banks would issue their own currencies defined in terms of units of their choosing not redeemable in terms of any outside asset not under the control of the issuing bank.  In my book, Free Banking and Monetary Reform (p. 176), I explained that Hayek’s argument overlooked the network effects (though I didn’t use the term, which was then only just beginning to be used by economists) associated with using a money denominated in a unit already widely accepted as money.  This implies that there are powerful market forces leading banks not to try to compete by offering a different monetary standard from that already in use, but to make their monies “compatible” with the existing monetary standard by making their own monies convertible into a money already widely accepted as such.  To my knowledge, most advocates of free banking have not followed Hayek in supposing that, under a free-banking regime, banks would compete by issuing inconvertible monies defined in terms of some standard of their own choosing.  So unless Schuler wants to defend the older Hayek’s dubious premise in Denationalization of Money, he can hardly rely on the authority of the older Hayek to dismiss the younger Hayek’s acceptance of central banking as being fully consistent with a market economy.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. 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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