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Krugman on Friedman, Hayek, and Liquidationism

In a blog post yesterday, entitled “Friedman and the Austrians” , Paul Krugman quotes Milton Friedman’s charge that in the “London School (really Austrian) view,” i.e. the view held by F. A. Hayek and Lionel Robbins,

the depression was an inevitable result of the prior boom, that it was deepened by the attempts to prevent prices and wages from falling and firms from going bankrupt, that the monetary authorities had brought on the depression by inflationary policies before the crash and had prolonged it by “easy money” policies thereafter; that the only sound policy was to let the depression run its course, bring down money costs, and eliminate weak and unsound firms.

Krugman then remarks:

I have, incidentally, seen attempts to claim that nobody believed this, or at any rate that Hayek never believed this, and that characterizing Hayek as a liquidationist is some kind of liberal libel. This is really a case of who are you gonna believe, me or your lying eyes.

One of the "attemps" Krugman may be referring to is my June 2008 article in the Journal of Money, Credit, and Banking, “Did Hayek and Robbins Deepen the Great Depression?” (Ungated pre-publication version here). Or he may be referring to subsequent discussion of the question on Brad DeLong’s blog — if you follow this link, please scroll down to see my comments on DeLong’s post.

In either case Krugman’s remarks call for a reply.

In the 2008 article I point out that Hayek enunciated a monetary policy norm of stabilizing nominal income (aka nominal aggregate demand, or MV in the equation of exchange) in the face of a declining money multiplier or declining velocity of money. Under a gold standard, a high price level driven unsustainably high (by the boom-creating inflationary policies that Friedman references) needs to return to the sustainable level, but there is no virtue in “secondary” deflation going beyond that point. Thus, according to Hayek, the central bank should expand its liabilities H to offset an increased bank reserve ratio or public hoarding that reduces M/H or V. In yet other words, it is better to remedy an unsatisfied excess demand for money balances by supplying the called-for money balances than by putting a burden of downward price adjustment on the economy.

Overlooking Hayek’s stable-MV norm, Friedman and others have mischaracterized Hayek as prescribing only “to let the depression run its course.” Hayek did oppose cheap-money policies that distort the economy, and did counsel policy-makers not to obstruct the process of correcting the mistaken investments made during the boom. But quoting such statements doesn’t show that he said nothing else about depression policy.

It’s a question of who you gonna believe, a one-sided quoting of only some bits of Hayek by people unaware of the rest, or the full story of what Hayek wrote about depression policy?

I’m sorry that Krugman didn’t call me out by name. It prevents his readers from finding and reading the other side of the debate.

I might also mention that my article treats the question of what Hayek really said as a matter of getting the intellectual history right. I do not suggest that mischaracterization of Hayek’s position is limited to left-liberals. Indeed, as Krugman’s blog post does, my article prominently quotes Milton Friedman’s criticism of Hayek for supposed liquidationism. Friedman is no left-liberal. Thus I would never call it “some kind of liberal libel.”

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