Lesson 5 of 7
A change of emphasis
In 1978 Hayek wrote that he had altered his opinion about secondary deflation. What exactly changed, what did not, and why he said the distinction mattered.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- In New Studies, published in 1978, Hayek wrote that he had altered his opinion since the 1930s, and said so in his own voice about his own argument.
- What changed was practical, not theoretical. He says the change was not about the explanation of the events but about the practical possibility of removing the obstacles in a particular way.
- What he now held: a secondary depression caused by an induced deflation should be prevented by monetary counter-measures, and the deflation has no steering function to perform.
Academic traditions rarely record a change of mind this cleanly, and the chapter where Hayek records his is worth reading for that alone.
What changed and what did not
Unchanged
- The theoretical explanation of the events.
- That deflation is not the original cause of a decline in business activity.
- That the misdirection of resources during the boom is what has to be corrected.
- That flexibility in relative wages is needed for the market to work.
Changed
- Whether a short deflation is a practical way to break downward wage rigidity.
- Whether an induced secondary deflation should be allowed to run.
- What he would do if responsible for monetary policy.
- Whether the secondary depression has any useful function.
He is explicit that the revision is practical rather than theoretical.
What he wrote
Four things, in his own account.
That a decline in business activity has a tendency to induce a process of deflation, producing what he had called a secondary deflation more than forty years earlier, whose effects may be worse, and in the 1930s certainly were worse, than the original cause of the reaction made necessary, and which has no steering function to perform.
That he has to confess he argued differently forty years earlier and has since altered his opinion, not about the theoretical explanation of the events but about the practical possibility of removing the obstacles to the functioning of the system in a particular way.
That he had believed a short process of deflation might break the downward rigidity of money wages and so restore a market determination of relative wages, that he still regards such flexibility as indispensable, but that he no longer believes it practically achievable by that route, and that he probably should have seen the last chance had gone when the British government abandoned the attempt to bring costs down by deflation in 1931.
And that a secondary depression caused by an induced deflation should of course be prevented by appropriate monetary counter-measures. He adds that he does not think he ever represented the deflationary phase as part of the curative process, and says that the accusation has been made.
Why it matters for a reader
Because the tradition is often summarised by the position Hayek abandoned. A reader who meets only the 1931 lectures, or only a secondary account of them, will carry a view that their author revised in print.
It also sharpens the boundary this whole track has been drawing. The mechanism in the boom course is one claim. What ought to be done about a contraction is a different question, and the man who built the mechanism did not think the second followed from the first in any simple way.
What this lesson is not
It is not an endorsement. Hayek's 1978 position is a policy position, Rothbard's 1963 position is a different policy position, and this academy holds neither. Both are reported because a reader who does not know that the tradition contains both will misread everything written in its name.
Check yourself
What did Hayek say had changed in his view?
- The theoretical explanation of the cycle
- The practical possibility of removing the obstacles in a particular way, not the theoretical explanation of the events
- His account of the natural rate
Show the answer
Answer: B.
He states the distinction directly in the 1978 chapter, and keeps the claim that deflation is not the original cause of a decline in business activity.What did he say about a secondary depression caused by an induced deflation?
- That it is part of the curative process
- That it should be prevented by appropriate monetary counter-measures, and that the deflation has no steering function to perform
- That it cannot occur under a gold standard
Show the answer
Answer: B.
He adds that he does not believe he ever represented the deflationary phase as curative, while noting that he has been accused of it.What had he previously believed a short deflation might achieve?
- A fall in the natural rate
- Breaking the downward rigidity of money wages, restoring a market determination of relative wages
- An increase in bank reserves
Show the answer
Answer: B.
He still regarded that flexibility as indispensable in 1978 but no longer thought it achievable that way, dating the lost chance to 1931.Sources
- Hayek, New Studies in Philosophy, Politics, Economics and the History of Ideas, 1978, the chapter 'The Campaign Against Keynesian Inflation', for the statement that a decline in business activity tends to induce a process of deflation producing what he had called a secondary deflation, that its effects may be worse than the original cause required and certainly were in the 1930s, that it has no steering function to perform, that he argued differently forty years earlier and has altered his opinion about the practical possibility rather than the theoretical explanation, that he had believed a short deflation might break downward wage rigidity and no longer thinks it practicable, that he would endeavour to prevent a threatening actual deflation, that a secondary depression caused by an induced deflation should be prevented by appropriate monetary counter-measures, and his denial of having represented the deflationary phase as curative.
- Hayek, 'Capital and Industrial Fluctuations: A Reply to a Criticism', Econometrica, April 1934, reprinted as the appendix to the second edition of Prices and Production, 1935, for the earlier statement of the same separation.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The short account in the example is invented as an illustration of a common summary. It quotes nobody.
- This lesson reports a change of position by one author and endorses neither his earlier nor his later view. No position on monetary policy is taken anywhere in this academy.
- The text read for this lesson was the 1978 collection in a later reprint. Related statements Hayek made in lectures and interviews during the 1970s were not read and nothing is attributed to them.