Hayek, Deflation, Gold and Nihilism

Hayek’s early writings on business-cycle theory and the Great Depression argued that cyclical downturns, including that of 1929–1931 were caused by unsustainable elongations of the capital structure caused by bank-financed investment exceeding voluntary saving. Believing that monetary expansion caused the crisis, Hayek opposed monetary expansion to cure the crisis. His policy advice actually contradicted his own neutral-money criterion of constant total spending, which implies that prices in general should fall when output rises and rise when output falls. This chapter suggests that Hayek made policy recommendations inconsistent with his own theory, because of (1) his early attachment to the gold standard and the apparent necessity to accept deflation to preserve the gold standard and (2) his hope that deflation would overwhelm the price rigidities that he believed obstructed a speedy recovery. By 1935, Hayek’s attachment to the gold standard weakened, and he subsequently acknowledged that his opposition to monetary expansion to stabilize total spending had been mistaken and politically motivated.