Did Hayek and Robbins Deepen the Great Depression?

I always love sitting on the beach in the Caribbean post Christmas, catching up with my neglected reading and getting lots of strange stares from fellow holiday makers looking at my book titles. “Oh, how interesting”, they politely comment, when what I know they want to say is “you weirdo!” Anyway, some of you readers may well appreciate …

Caribbean Reading 1: Did Hayek and Robbins Deepen the Great Depression?

This is written by Professor Lawrence (Larry) White, one of the leading Austrian School economists of his generation. His speciality is monetary theory and economic history. Little has been said of White on this site as I and a number of my fellow writers have many problems with his views on free banking, but as we have no corporate line at the Cobden Centre, we do have writers who have great sympathy with his views who are free to “big him up,” not to mention enthusiastic commentators who blog on our site with vigour!

The article does what it says on the tin. It shows that Hayek and Robbins at the LSE in the 30’s did not have any policy application to the workings of the liquidationists in the Hoover administration. Indeed it becomes clear that the American administrations of the 30’s came under the direct influence of the Real Bills Doctrine before the Keynesian tidal wave swept all other forms of economics to the backwaters of remote and inhospitable places.

The article is a great service to economic history.

It the allows us to ask the question of ourselves as Austrian School sympathisers: in this Great Depression 2, what should we be advocating?

White shows us that Hayek and Robbins in the 20’s would have supported a real deflation due to the great productivity increases in the key world economies at the time. Instead, more fiduciary media was created that caused the roaring 20’s boom that led to the bust of the late 20’s and 30’s.

He goes on to show how Hayek, faced with the significant money deflation, advocated in his writings a policy of holding the money supply at it’s old level: the pre-bust level . The inflating of prices caused malinvestments and the deflating of it would cause unnecessary bankruptcies. In and ideal world, if wages and other key factors of production were flexible, a mild deflation would take place, prices would readjust, and we would soon get back to a productive economy. If they were not, we would spiral into a “secondary deflation.” This was akin to mass money hoarding and a Central bank could step in and provide cash for investment projects so that large parts of the productive structure would not be blown away. This would offset the irrational panic.

Both Robbins and Hayek thought a mild deflation with a fully functioning free market would clear out the past excesses in a targeted way. They both thought that post Depression 1, the deflation was too severe and advocated a money creating process by the Central Bank to prop up industry.

This has given a branch of modern day Austrian School, the Monetary Equilibrium School led by Selgin and White himself, the intellectual antecedents to develop out this theory further .

Are we at the stage today when we need a Central Bank accommodative policy to avoid a secondary deflation ? As we have had real money supply contraction (when you look at cash notes, coins, and demand deposits and not timed deposits see Baxendale and Evans on money supply definitions here) would it be time to do this now? With what great wisdom does the Monetary Equilibrium School / Demand School come to be able to gauge when a good deflation turns into a bad ? Are we in a bad deflation yet?

I can’t personally see how creating more money units to offset a demand to hold cash will achieve anything other than sowing of the seeds for the next credit induced boom.

However, lets give money creation in these circumstances the benefit of the doubt and say “yes, it will make people feel more comfortable to know their bank will be more accommodating to their needs in personal and business life.” They then start to respond again and the old patterns of spending reboot themselves and the new additional money stays in circulation and bingo, we have a mini credit boom on our hands again with the massive distortion of the structure of production this implies. I would counsel anyone interested in this interpretation of Hayek’s work to look more closely at this line of thinking, as it is not far from being as dangerous as Bernanke’s own thoughts. I would encourage people to think about what gets in the way of prices resetting themselves, allowing employers to set flexible wage and working time policies in these circumstances, for example, may well be a far better policy for Austrians to pursue. Labour is invariably the most expensive part of the cost base of most firms and this does seem to sure-fire way of avoiding a secondary wipe out deflation.

I would also look at advocating a money base fix so there could never be a deflation. Huerta De Soto advocates this in Chapter 9 of Money, Bank Credit and Economic Cycles, which you can download here. I have also advocated a similar approach, in layman’s terms, here.

We can never know what Hayek and Robbins would be advocating today. Thanks to White’s essay, we do know what they did and did not advocate, and who was and was not listening to them in the first Great Depression. We do also know there are wide views across the modern Austrian School . I favour a “play it safe” approach, and do not think you can predict what the right or wrong level of demand for money is to offset with newly minted “counterfeit” money. There are ways to avoid deflation; a money base fix is described above . A freer market would of course prevent much of this happening anyway!

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18 replies on “Did Hayek and Robbins Deepen the Great Depression?”
  1. I forgot to say, the following has become apparent in this Depression;

    1 Staff in the private sector have be truly heroic. They have on the whole been flexible in working ours and in wages. The public sector have refused to help adjust .

    2 Banks even given levels of support that is hard to quantify as it is so large and on going, if they will not lend to offset this change in the money demanded as suggested by Hayek and the modern Money Equilibrium / Disequilibrium School of Austrian Economics, the only practical policys can be to make the public and to a lesser extent private sectors more flexible to price changes.

    Good old fashioned simple free market solutions are called for.

  2. says: Dan Mosley


    Good article.

    You state that “I would also look at advocating a money base fix so there could never be a deflation. Huerta De Soto advocates this in Chapter 9 of Money, Bank Credit and Economic Cycles, which you can download here. I have also advocated a similar approach, in layman’s terms, here.”

    However, a money base fix surely is deflationary, and that is the biggest problem I have with the idea. A fixed stock of money and growth in the economy would mean less money, chasing more goods and services. The result would be year on year deflation, assuming constant low growth in the economy.



    1. says: Current


      As Toby points out it would mean gradual deflation, as you say. Those who advocate it know that.

      Although we may not be used to gradual deflation now I think it’s something people could adjust to. Gradual deflation, or long run steady prices have happened quite often in the past

      Long run expectations can change. We may be shocked that Victorians often put up with wages that were static in monetary terms, but I think that if those Victorians knew that we modern people put up with constantly rising prices they would be shocked too.

      1. says: Dan Mosley


        Agreed that there have been long periods of deflation in the past. But that was before the advent of unionised labour!

        1. says: Current

          No, there were unions in 19th century America, in Britain and in Europe. They were often very active and there were many strikes.

          There were no pro trade-union laws at that time though. Many unions were small and associated with the workforce of one employer.

          I don’t think that unions are a very large sticking point any more. The public sector unions are the only large ones left. But, more importantly, unions base their case for action on real wages not nominal wages.

          1. says: Dan Mosley

            Having looked into it I think you are right on the union issue. However, I do think that steady deflation over time would cause problems, including the increase of debt burdens.

            Is there some reason why stability in the price level could not be pursued in 100% reserve banking? Friedman advocated a rules based (3-5% per year) expansion of the money supply- this would seem sensible in this case.

          2. says: Current

            > However, I do think that steady deflation over time would
            > cause problems, including the increase of debt burdens.

            That would only be problem initially. Once it was established that price deflation could be expected then people would take that into account. It would be incorporated in the interest rate, just as price inflation is now. Once it’s established both lenders and borrowers will “price it in”.

            In the long run the Fisher effect applies:

            Mises points to the same effect in “The Theory of Money and Credit” and several of his other books. If the shift to deflation were announced several years before it occurred then the problem would be small. Mises discusses this issue too in TOMAC and points to the problems of ever being fair.

            > Is there some reason why stability in the price level
            > could not be pursued in 100% reserve banking? Friedman
            > advocated a rules based (3-5% per year) expansion of the
            > money supply- this would seem sensible in this case.

            To be clear, I’m not advocating 100% reserve banking. However, you’re right, monetary expansion could be incorporated as Friedman suggested. But, I don’t think that it would work.

            Friedmans idea and the 100% reservists idea is that a fixed monetary stock being neutral to relative prices. But it can’t be because demand for money is a variable not a constant. In monetarist terms velocity is not fixed. So, the price level would vary inversely with money demand, which in my view would cause booms and recessions. That’s a problem whether or not there is long-run deflation or inflation.

            But, I think that long-run inflation could still cause ABCT. Some say that agents can calculate around steady inflation and get to the real figure. Maybe so, but not in all places. In my view it’s important that accounts do not have to be right in real terms, only in monetary terms. People often use accounts as indicators without examining them in great detail.

  3. says: john in cheshire

    I read your website quite often. I don’t understand a lot of it, but on balance I find it useful. For what my view is worth, I firmly believe that the number of people working in the socalled public sector needs to be drastically reduced. The public sector need to be exposed to the forces of ‘expectation’ that seem to be lacking in their understanding of how economies work. Until their expectations are ‘modified’ then they will continue to cost us, the paymasters, more than we can afford.

  4. says: john in cheshire

    Apologies, I also meant to say, that expectations needs to be applied to Bankers bonuses too. In future everyone should expect to be paid according to their salary. If they do a good job, then perhaps they are due a raise. If they underperform, they need to be sacked. And no one should expect to be paid a bonus for doing what they have been hired to do.

  5. says: Current

    Although it may seem a bit odd given what I’ve said before I don’t agree entirely with White’s view of Hayek.

    I don’t think Hayek supported “liquidationism” or that he believed in “purging of misallocations” as the modern 100% reserve supporters do. But, on the other hand, I don’t think he was as interested in aggregate income as White is. I don’t think his understanding of price changes was the same as the modern free bankers. I don’t think that Hayek really changed his position in “Denationalisation of Money”.

    I hope to write about all that some day.

  6. Current:

    Rothbardian 100% Free Bankers do favour liquidation .

    Huerta De Soto and myself favour a fix of the money supply as you know, he suggest place cash behind all demand deposits (bank journal enteries) and then the only deflation , which is what a liquidation is , can take place if physical money is burnt etc. Then re route money in say gold. You can’t famous young gold like you can a journal entry in a bank ledger.

    I say swap out demand deposits for cash and let the owner of the cash do what he likes with it. It will not form part of the banks liabilities anymore. No deflation can happen here.

    You say people formally getting instant access and some interest in a demand deposit will move into timed deposits. If the scale of the move is sufficient enough, this will mean business formaly dependent on artificial bank credit will go bust and business that sells products that people want will get money from timed deposits lent to them. This is surely a good thing.

    Huerta De Soto and my way will be less of the liquidation and more of the controlled realignment of savers wants to their needs .

    This you know, so it would be helpful if you gave accurate comment on what 100% people want and do not want.

    We look forward to your work on Hayek. I am sure you can make a contribution here.

    I sa

    1. says: Current

      > Rothbardian 100% Free Bankers do favour liquidation

      Yes I know :)

      > We look forward to your work on Hayek. I am sure you can make
      > a contribution here.


  7. To Dan, thank you for your comments . If you fix the supply at say 100 money units, it can’t go above 100 money units or under it. Thus money inflation or deflation is not possible (leaving aside international movements). If business is more productive, then there will be the same amount of money units chasing more goods. These money units will have more purchasing power to buy these more goods. Purchasing power goes up and prices go down and vis a versa. This may well be a new way of thinking for you, but I trust you can see the merits in it.

    1. says: Dan Mosley

      Toby, thank you for your reply.

      I see what you mean about money inflation or deflation not being possible, purely on stock of money terms, but the fact remains that if there is growth in the economy with a fixed money supply, prices will decrease over time which is equivalent to a deflation. Therefore the burden of debtors will increase over time.

      A particular problem is wages. Wages would have to adjust in line with prices. Although it may be illogical, people would hardly be prepared to see their wages decrease each year, even though their purchasing power would be increased; this has been shown many times in the past.

  8. says: Gordon Kerr

    Dear Toby

    Enjoyed this one and it made me think about the potential pitch to Iceland, esp the idea of fixed money base.

    I have sympathy with ‘Dan’s’ comment. Would you agree that if an economy generates wealth then that justifies more financial media?

    For example if the universal currency was gold and central banks did not exist then it would happen naturally – the quantity of gold possessed by the members of a successful nation’s economy would rise.

    Money levels could surely therefore rise so long as they reflect actual wealth/ profit increases?



    1. says: Toby Baxendale

      Gordon, if you have a money supply fixed on day one and let’s say no more gold was ever dug out of the ground, productivity increases would mean prices would fall and the purchasing power of money would rise. What is the problem with this? If more gold is dug up then you would have an offsetting price rise mechanism. I hope this is clear.

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