Debunking the 'Liquidationist' Myth

Lawrence H. White has a forthcoming article in the JMCB where he debunks several important myths about the 'liquidationist' view (or what Paul Krugman calls the "hangover theory") during the Great Depression era.

First, he shows that Treasury Secretary Andrew Mellon was not an advocate of the liquidationist view, but actually supported stabilization policies. This may come as a surprise to you, as it did to me, given Mellon's famous liquidationist line: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." White shows, however, that these words were attributed to him by Herbert Hoover in an attempt to salvage his own reputation by making Mellon appear as an indifferent "leave-it-alone-liquidationist." Moreover, White shows that Mellon actually called for monetary easing and some expansionary fiscal policy to stimulate the depressed economy.

Second, and more importantly, White shows that F.A. Hayek and Lionel Robbins were not the ardent liquidationists during this time that they are made out be by many contemporary observers. In White's own words:

The Hayek-Robbins (“Austrian”) theory of the business cycle did not in fact prescribe a monetary policy of “liquidationism” in the sense of doing nothing to prevent a sharp deflation. Hayek and Robbins did question the wisdom of re-inflating the price level after it had fallen from what they regarded as anunsustainable level (given a fixed gold parity) to a sustainable level. They did denounce, as counterproductive, attempts to bring prosperity through cheap credit. But such warnings against what they regarded as monetary over-expansion did not imply indifference to severe income contraction driven by a shrinking money stock and falling velocity. Hayek’s theory viewed the recession as an unavoidable period of allocative corrections, following an unsustainable boom period driven by credit expansion and characterized by distorted relative prices. General price and income deflation driven by monetary contraction was neither necessary nor desirable for those corrections. Hayek’s monetary policy norm in fact prescribed stabilization of nominal income rather than passivity in the face of its contraction.

This was interesting to learn because my understanding had been that Austrians love deflation no matter what form it takes (i.e. negative aggregate demand shock-driven or the 'malign' form versus the positive aggregate supply shock-driven or 'benign' form). That Hayek and Robbins believed in a monetary policy that aimed to stabilize nominal income means that they did differentiate between types of deflation. However, with that said White also reports

[t]he germ of truth in [Milton] Friedman’s and [Brad] DeLong’s indictment [of Hayek and Robbins as liquiditationists]... is that Hayek and Robbins themselves failed to push this prescription in the early 1930s when it mattered most.

So Hayek and Robbins should have pushed their nominal income stabilization views more forcefully during the Great Depression. However, even had they been more vocal they would have run up against the influential real bills doctrine that did not stabilize nominal income. So how the outcome would have differed is any one's guess.

Check out the entire article and the related post by Lawrence H. White.