Uneasy Money

I contributed a chapter entitled “Hayek, Deflation, Gold and Nihilism” to volume 13 of Hayek: A Collaborative Biography edited by Robert Leeson and published in 2018 by Palgrave Macmillan.

I have posted a preliminary draft of that chapter on SSRN. Here is the abstract.

In Hayek’s early writings on business cycle theory and the Great Depression he argued that business cycle downturns including the steep downturn of 1929-31 were caused by unsustainable elongations of capital structure of the economy resulting from bank-financed investment in excess of voluntary saving. Because monetary expansion was the cause of the crisis, Hayek argued that monetary expansion was an inappropriate remedy to cure the deflation and high unemployment caused by the crisis. He therefore recommended allowing the Depression to take its course until the distortions that led to the downturn could be corrected by market forces. However, this view of the Depression was at odds with Hayek’s own neutral money criterion which implied that prices should fall during expansions and rise during contractions so that nominal spending would remain more or less constant over the cycle. Although Hayek strongly favored allowing prices to fall in the expansion, he did not follow the logic of his own theory in favoring generally increasing prices during the contraction. This paper explores the reasons for Hayek’s reluctance to follow the logic of his own theory in his early policy recommendations. The key factors responsible for his early policy recommendations seem to be his attachment to the gold standard and the seeming necessity for countries to accept deflation to maintain convertibility and his hope or expectation that deflation would overwhelm the price rigidities that he believed were obstructing the price mechanism from speeding a recovery. By 1935 Hayek’s attachment to the gold standard was starting to weaken, and in later years he openly acknowledged that he had been mistaken not to favor policy measures, including monetary expansion, designed to stabilize total spending.