“Certain dates in 1932”

There are endless interpretations of what Keynes “really meant” in the General Theory.  In my view there is no answer to this question; Keynes’ thinking was too muddled and contradictory to be understandable in terms of modern monetary theory.  But now that some of our leading macroeconomists are showing equally muddled and contradictory thinking, it might be time to revisit this famous book.  In my view page 207 holds the key to the entire book—indeed two keys.  It explains why the book is so misunderstood by modern readers, and then just a few lines later, how Keynes misunderstood his own argument.

One of the most often-cited statements in the General Theory occurs on page 207 when Keynes doubts the existence of a complete liquidity trap:

“But whilst this limiting case [absolute liquidity preference] might become practically important in the future, I know of no example of it hitherto.”

So Keynes doesn’t “believe in” liquidity traps.  And yet Hicks argued that absolute liquidity preference was Keynes’ only significant contribution in the General Theory.  And Friedman argued that the General Theory made no sense unless one assumed absolute liquidity preference.  Hicks and Friedman were both very smart, how could they have missed page 207?

Of course, it’s not that simple, we don’t just have the General Theory; we also have extensive collections of Keynes’ views on interwar policy.  There can be no question that Keynes thought monetary policy might well be ineffective during a depression.  He frequently advocated fiscal expansion, arguing that monetary policy had become ineffective during the early 1930s.  So what did Keynes really believe about liquidity traps?

In a paper that I published in 1999 (in Economic Inquiry) I wrestled with this question and came up with a few tentative findings.  I won’t try to review the entire argument here, but let me offer one observation.  Keynes thought the concept of monetary policy ineffectiveness (in terms of AD) was extremely important, indeed I agree with Friedman that the General Theory makes no sense without that assumption.  But unlike Friedman, I don’t think Keynes necessarily equated monetary policy ineffectiveness with absolute liquidity preference.  Rather, he had a much more pragmatic view of monetary policy than Friedman.  Keynes thought that real world monetary policymakers might not be able to restore full employment, but mostly because of constraints on policy (external or self-imposed.)

Just a few lines after the previous quotation is the only specific, real world, example of monetary policy ineffectiveness in the entire General Theory:

The most striking examples of a complete breakdown of stability in the rate of interest, due to the liquidity function flattening in one direction or the other, have occurred in very abnormal circumstances.  In Russia and Central Europe after the war a currency crisis or flight from the currency was experienced . . . whilst in the United States at certain dates in 1932 there was a crisis of the opposite kind–a financial crisis or crisis of liquidation, when scarcely anyone could be induced to part with holdings of money on any reasonable terms.” (p. 207-08.)

The term ‘certain dates’ refers to the spring of 1932, when an aggressive policy of open market purchases by the Fed was associated with a run on the dollar, a massive outflow of gold, falling commodity prices, and an extraordinary collapse in stock prices.   Heavy gold outflows occurred because expansionary fiscal and monetary policies led to fears of dollar devaluation, and this led to private gold hoarding, and also led European central banks still on the gold standard to exchange dollar assets for gold (they had already been burned holding pound sterling during the 1931 British devaluation.)

The heavy gold outflows during the spring of 1932 prevented the Fed’s open market purchases from expanding the broader money supply at all, and the base increased by only a small amount.  If the term ‘liquidity trap’ refers to a situation where an increase in the money supply fails to lower interest rates or expand aggregate demand, then this isn’t really a very good example.  It better illustrates the constraints of an international gold standard.

In 1999 I thought Keynes had confused the constraints of the gold standard with the concept of absolute liquidity preference.  But now I think it’s a bit more complicated than that.  In my 1999 article (which I still think is one of my best) I cited one Keynes quotation after another, vainly trying to decipher what he “really believed” about monetary policy ineffectiveness.  (Hmm, I suddenly have a feeling of deja vu.)  Each quotation seemed to contradict the previous, but a few themes emerged.

1.  Keynes absolutely loathed fiat money—seeing it as the worst possible monetary system, even worse than a rigid gold standard with no flexibility.  In his mind, fiat money was linked to the post-WWI hyperinflations.  I am fairly confident that Keynes did not intend the concept of monetary policy ineffectiveness to apply to fiat money regimes.

2.  All his work on monetary economics and macroeconomics in general assumed a gold standard of some sort, unless otherwise indicated.  Even before WWII he described his ideal system, and it sounded a lot like the Bretton Woods regime.  He called this a managed gold standard.

Keynes was a pragmatist.  He did not think about issues the way modern macroeconomists do (or perhaps I should say did, because this crisis has made many revert back to some bad habits that I thought we had put behind us.)  See if any of this sounds like our current policy debate:

1.   Vagueness about the impact of monetary policy.  Keynes would deny that monetary stimulus could work, and then a few weeks later warn against the proposals of the “extreme inflationists.”

2.  Favoring fiscal expansion, with no clear explanation of why he opposed a highly expansionary monetary policy under a fiat money regime.

3.  Focusing on the interest rate transmission mechanism, and arguing that monetary stimulus could only work by lowering nominal interest rates.

Keynes thought about policy in terms of specifics, swapping short term bonds for long term bonds, or temporary, one-time currency devaluation.  But he never, ever, supported any monetary policy that would have been likely to generate a significant Fisher effect.  As a result, he completely denied the relevance of the Fisher effect for any sort of real world policy discussion—except for what he called a “flight from a currency,” i.e. what we would call ‘hyperinflation.’  Of course without a Fisher effect there is no way a monetary policymaker could lower interest rates once nominal rates had approached zero.

Because Keynes lived his whole life in a commodity money world, except for brief transition periods during wartime or pathological cases like hyperinflation, it is difficult for us to understand his mindset.  Those of us who grew up in a fiat money world think of central banks choosing trend rates of inflation as if they were choosing entrees off a menu.  If someone mentioned that concept to Keynes he would have been completely incredulous.  I could not find a single example of Keynes discussing the pros and cons of a fiat regime aiming for a significantly positive trend rate of inflation.  Such a policy is impossible under a commodity money regime.  (I would greatly appreciate if anyone could find such a statement by Keynes.)

Again and again in the General Theory one finds Keynes talking about “confidence.”  In many cases the meaning of the term is unclear:

“Just as a moderate increase in the quantity of money may exert an inadequate influence over the long-term rate of interest, whilst an immoderate increase may offset its other advantages by its disturbing effect on confidence”  (pp. 266-67.)

From a modern perspective, in this context the phrase “disturbing effect on confidence” seems to suggest a risk of hyperinflation.  In that case, one might say that Keynes did not really believe in monetary policy effectiveness, but rather that any effective policy was likely to overshoot.  But I think the more likely interpretation is that Keynes was worried about confidence in the exchange rate, and that he was thinking of exactly the situation faced by the U.S. in 1932.  Here is another quotation from the General Theory that supports that interpretation:

“But the long-term rate may be more recalcitrant when once it has fallen to a level to a level which, on the basis of past experience and present expectations of future monetary policy, is consider ‘unsafe’ by representative opinion.  For example, in a country linked to an international gold standard, a rate of interest lower than prevails elsewhere will be viewed with a justifiable lack of confidence” (p. 203.)

To summarize, the followers of Keynes took his statement doubting the existence of liquidity traps at face value.  As a result, many failed to see that Keynes’ General Theory was built on a foundation of implied monetary ineffectiveness.  And Keynes’ own statements were vague, confused and often downright contradictory (my 1999 paper has several such examples.)  He was trying to build an abstract macro model, without discarding all his intuitions about real world policy-making.  It led to a theoretical hodgepodge that may or may not be relevant to the gold standard world in which he lived, but has no relevance to the modern fiat money world.  Henry Simon (1936) was one of the first to notice this problem:

“Indeed, if the whole book could be interpreted simply as a critical appraisal of the traditional gold standard, implemented through central-bank operations, one’s judgment of its main ideas might be extremely favorable.”

The 1932 Open Market Purchase Program

By early 1932 the Depression had become so severe that even conservative institutions like the Fed were willing to consider “quantitative easing.”  (At least our modern Fed didn’t wait quite so long.)  Because there was perceived to be a problem of inadequate gold reserves, the administration announced a proposal to relax those standards in early February.  The Dow immediately jumped 9.5%.  The following day the bill sailed through the House and Senate banking committees, and the next trading day the Dow jumped another 9.2%, completing the largest two-day rally in modern stock market history.  (This is the sort of increase in the Dow I would have expected a few weeks ago if the Fed had announced that they were adopting the entire policy mix discussed in my petition.)

[Think about all the theories that would have predicted no change in real stock prices, from real business cycle models that deny nominal shocks have real effects, to traditional Keynesian models that say monetary policy is ineffective in a depression.]

The OMPs started very modestly in late February and March; then dramatically increased in April, May, and June.  After that they tailed off sharply.  Thus the vast majority of the purchases occurred during the April-June period.  At the time, almost everyone from conservative financiers to Keynes seemed to think the OMOs had been a failure.  Friedman and Schwartz argued that the policy had been partially successful, but that the effects were delayed by the mysterious “policy lags.”  Here are the facts.

1.  During the second quarter industrial production, stock prices, and commodity prices all fell sharply.  Gold flowed rapidly out of the U.S. and into both private hoards and European central banks hoards.  The gold outflow appears to have been partially triggered by devaluation fears, which were generated by Congressional agitation for much more fiscal expansion, as well as the OMPs themselves.  The totally bond purchases exceeded $1 billion, but the base merely rose about $300 million, and the broader aggregates actually fell.

2.  By late July Congress had adjourned and the OMP program was almost over.  Now the gold outflow began to reverse.  Confidence in the dollar soared.  Stock and commodity prices increased sharply.  Industrial production suddenly reversed course and also started rising rapidly.

The boomlet in industrial production in late summer could have represented a delayed reacted to the OMPs, but that doesn’t explain why commodity prices set in auction-style markets fell during the program and only rose afterward, nor does it explain why stocks fell nearly in half during the OMPs and only started soaring when the gold flow reversed.  So although I generally prefer Friedman and Schwartz’s analysis to that of Keynes, in this case I think Keynes may have been right, the 1932 OMPs probably did fail.

Laidler (1999, 259n) calls the perceived failure of the 1932 OMPs “one of the key ‘stylized facts’ underlying the evolution of monetary economics in the 1930s and 1940s.”  So far as I know, Currie was the only economist at the time to recognize that it wasn’t so much a failure of monetary expansion to boost the economy, but rather a failure of Federal Reserve actions to produce monetary expansion.  The perceived failure entrenched Keynesian thinking, and only during the high inflation 1960s and 1970s did the profession move back to the view that monetary policy was a highly potent tool for determining AD and inflation.  Are things now swinging back the other way again?

Postscript: Any doubts about whether the gold standard had been holding back reflation were erased in 1933, when dollar devaluation resulted in sudden and very rapid inflation, despite the existence of liquidity trap-type conditions.  Lars Svensson recently called currency depreciation a “foolproof” method for escaping from a liquidity trap (and something the Bank of Japan could have used had it been serious about wanting to inflate.)  But this has always been known.  The conservative financiers who dismissed the idea that OMPs could help when nobody wanted to borrow, also warned against hyperinflation if we left the gold standard.  Keynes congratulated FDR for returning to the gold standard in 1934, and not listening to the advice of the “extreme inflationists.”  Indeed as far back as 1692, in a debate over a proposal to devalue the British currency, John Locke showed that he was aware that currency depreciation offered a foolproof escape from deflation:

“For I think no body can be so senseless, as to imagine, that 19 Grains or Ounces of Silver can be raised to the Value of 20; or that 19 Grains or Ounces of Silver shall at the same time exchange for, or buy as much Corn, Oyl, or Wine as 20; which is to raise it to the Value of 20.  For if 19 Ounces of Silver can be worth 20 Ounces of Silver, or pay for as much of any other Commodity, then 18, 10, or 1 Ounce may do the same. . . . And so a single Threepence, or a single Penny, being call’d a Crown, will buy as much Spice or Silk, or any other Commodity, as a Crown-piece, which contains 20 or 60 times as much Silver; which is an Absurdity so great, That I think no body will want eyes to see, and Sense to disown.”

Keynes may have been misguided, but he was never absurd or senseless.  He did not intend the notion of monetary policy ineffectiveness to apply to a pure fiat money regime with no nominal anchor.



15 Responses to ““Certain dates in 1932””

  1. Gravatar of pushmedia1 pushmedia1
    4. April 2009 at 09:48

    You might enjoy this review by Richard Posner of Akerlof and Shiller’s new book. Its somewhat on topic and Posner discusses the General Theory.

  2. Gravatar of ssumner ssumner
    4. April 2009 at 11:03

    Thanks pushmedia1, I agree with Posner about rationality, and about wages, but I don’t really think he understands monetary policy. (But then I’m not sure most other economists do either.) It isn’t “monetary policy” that failed, it is the current monetary policies of the current central banks. The Fed is still paying banks interest to encourage them to hoard reserves. If Milton Friedman heard that described as “expansionary monetary policy” he’d role over in his grave.

    He description of Keynes as a pragmatist, not an abstract theoretician, certainly matches my view.

  3. Gravatar of septizoniom2 septizoniom2
    5. April 2009 at 01:25

    this site is most interesting. the wrting and style is sublime. reading the arguments and theories you advance are comforting in that we now know that original thinking may in fact save us from our problems. i recall some of your monetariest thoughts and keynes criticisms from graduate economics courses over i took over 30 years ago.
    please though do explain to us two things in a future post if you can: 1. any concern that success in devaluing the dollar is viewed as default? 2. if policymakers err and incite too much inflation, how do they get things under control without causing painful or sharp or sudden recession?

  4. Gravatar of david glasner david glasner
    5. April 2009 at 03:37

    For a different take on open market operations by the Fed in 1932 see Hawtrey’s The Art of Central Banking discussion of French monetary policy (chapter one, pp. 39-40). Here’s an extended quote.

    The absorption of gold by France in the first six months of 1932 had serious reactions on the American credit situation.
    In the first three months the amount of gold lost by the US was relatively small. When the pound sterling depreciated (and with it the rupee), a large and unexpected supply of gold was tempted out of hoards in India and England by the quotation of a premium. This supply. with the current output of hte mines,met the greater part of French demand.
    From April to June, however, the release of gold from hoards fell off, and the French demand was supplemented by purchases of gold for the Bank of England as well as for Belgium, Holland and Switzerland. The US lost no less than $480 million of gold,and the effect of the purchases of securities by the Federal Reserve Banks was largely offset. Indeed in the last few weeks of the period their sales of gold actually exceeded their purchases of securities, so that the progress achieved towards expansion was less than nothing. There was thus a conflict of policies between Paris and New York. The American policy of credit expansion was being counteracted by the French policy of credit contraction. There was no sign of revival, and doubts were expressed as to the efficacy of the expansive policy.

    So in 1932 there was an international dimension to the deflationary pressure that we luckily do not have to cope with in the current crisis. Just the foolishness of the Fed

  5. Gravatar of ssumner ssumner
    5. April 2009 at 04:22

    septizoniom2, Thanks for the comment. I hope to do a future post compare the U.S. in 1933 to Argentina 2001. Both cases involved what was perceived as a default (although in the U.S case the characterization is slightly more debatable.)
    For your second point, the key is to not let inflation expectations rise to high. As long as inflation expectations stay well-behaved, so will wages, and then it will not be difficult to nip any actual inflation in the bud, without a recession. Thus the Fed needs to watch inflation expectations in places like the indexed bond market, which currently signals far below target inflation over the next 5 years (indeed less than 1% per year.)

    David, I should first mention to readers that David is the author of “Free Banking and Monetary Reform,” which I recommended in an earlier post–and his views on the problem of gold hoarding in the Depression are similar to mine. (And he studied under Earl Thompson.) In addition, we both like Hawtrey’s take on the issue, and I should do a future post on Hawtrey.
    I entirely agree with the points you mention, and would like to make one additional point. In addition to looking at gold flows, I also had data on the total world monetary gold stock. Because the supply of gold from mines is pretty stable on a month to month basis, one can see shifts in private gold hoarding by looking at total monetary gold stocks. All the sudden decreases in total monetary gold stocks during the 1930s corresponded to periods where the newspapers were talking about fears of devaluation and private hoarding. Because world gold stocks fell in the spring of 1932 we know that private hoarding was increasing. In fact, for several reasons it was probably increasing even more than I estimated. During the early 1930s the real value of gold rose sharply in world markets, this should have brought forth more gold supply from mines (and did to some extent) but more importantly should have reduced industrial (jewelry) use of gold. As David points out, India did dishoard a lot of it’s now more valuable gold jewelry as the real value of gold rose. Thus the fact the the world stock of monetary gold fell in the spring of 1932, indicates that gold hoarding in the West (on devaluation fears) rose by more that both the newly mined gold and the gold dishoarded from India. This prevented the forces which normally stabilize prices under a gold standard (more supply as the real price rises) from working in the short run. Thus the flows to countries like France explain part of the problem, but not all.

  6. Gravatar of Bill Stepp Bill Stepp
    5. April 2009 at 04:24

    No less an authority on what “Keynes really meant” than Minsky pointed out that the real balance effect was part of the pre-Keynesian analysis, and that “standard theory shows that the market mechanism is not inherently flawed: market processes will achieve and sustain full employment” [if they are allowed to work!], “John Maynard Keynes,” p. 55.
    Speaking of liquidity traps, would would you choose to spend an hour talking about them with Krugman or anyone else?
    That just shows you have way too much time on your hands.
    Far better to spend a few minutes reading Murray Rothbard, “Man, Economy, and State,” pp. 791-92.

  7. Gravatar of david glasner david glasner
    5. April 2009 at 06:20

    Scott, thanks for your kind words about my book. I shared Hawtrey’s comments about the open market purchases, written in 1932 just after the program had run its course, because your discussion seemed to me to suggest that the program was a failure that cut against a monetary interpretation of the depression (or at least that that is how it was perceived). Hawtrey’s reaction shows that the failure of the open market purchases was understandable in terms of the more comprehensive global monetary view shared by Hawtrey, Cassel and a few others, but not by Keynes and Friedman.

    Your discussion of Keynes is very interesting for two reasons. First on the Keynesian liquidity trap, which I have not really thought about for a very long time, I think that my take was (when I was thinking about it) that Keynes was being cagey in suggesting a liquidity trap was a realistic possibility while at the same time hedging about whether a liquidity trap actually ever existed. This allowed him to argue both sides. His formal model (if we call it that) presumed a liquidity trap, and his theoretical discussion based on the model proceeded as if the trap existed, but the trap was “a limiting case” which had not necessarily ever been realized. And in the context of the early 1930s, it was plausible to view the liquidity trap as a limiting case that was relevant to actual experience even if it could not be established that such a case obtained in fact.

    On Keynes and the gold standard, I would observe that Keynes’s model does not provide for determination of the price level, so that the gold standard could be viewed as filling that gap in the Keynesian model. However, Keynes’s simple model is a closed economy, so the interesting price level dynamics that we are concerned about in explaining the 1930s deflation are completely abstracted from in his model. Interestingly, it was just this Keynesian closed economy perspective that Friedman embraced with such enthusiasm in his monetary theory and history and why his monetary theory represented such an unfortunate retrogression from the work of pre-Keynesian monetarists like Hawtrey.

  8. Gravatar of Rafael Rafael
    5. April 2009 at 06:21

    Hi Scott,

    What REALLY determines the long interest rates? Is it expectations about what the Fed would do? Or is it something else?

    If its the expectations about what the Fed would do (and NOT a savings glut, for example), I don´t understand why longer interest rates are so high, since the Fed has already announced that it will persue the zero bound for some time.

  9. Gravatar of ssumner ssumner
    5. April 2009 at 15:31

    Bill, I am not a fan of either Minsky or Rothbard.

    David, No, I did not intend to argue that monetary forces did not cause the GD. I certainly believe that it was caused by tight money. Elsewhere I argued that money was very tight in 1929-30, and if in the later years the Fed was constrained by the gold standard (which is debatable), the obvious solution was to leave the gold standard (or at least devalue.) My point was that the OMOs did not cause the late summer boomlet, as F&S argued, rather it was a reversal of gold flows that caused that boomlet. You are right that Hawtrey and Cassel understood the international nature of the crisis better than Keynes or Friedman.

    You are right that Keynes was very cagey about the liquidity trap–I think he feared getting caught making a logical error. But he was not at all cagey about monetary policy ineffectiveness–during the Depression he frequently argued that because monetary policy was now ineffective, we needed fiscal stimulus. The mystery is why? He never fully answered that question. Or perhaps he had too many answers, which were contradictory.

    Your point about the gold standard anchoring the price level in the Keynesian model is a good one. It is similar to what I argued in my 1999 paper, but I didn’t put it so clearly. BTW, even in a closed economy model, the gold standard can anchor the price level. Indeed in the late 1930s the “international gold standard” was the U.S. and Belgium, and the gold market was still determining the U.S. rate of deflation. I partly agree with you about Friedman, but also partly disagree. He developed his model during the Bretton Woods era. I view that regime as a quasi-gold standard. But many viewed it as a fiat money regime. I think Friedman is an excellent fiat money monetarist, but his work on the Depression is flawed by the implicit assumption of a closed economy model. (Yes, F&S did discuss gold flows, but their international analysis was deficient.)

    The reason I am not quite so negative about Friedman as you are, is that just as we moved into the fiat money era (in 1968) Friedman was ready with a devastating critique of the Keynesian model, which was woefully unprepared for that new era. Friedman immediately saw the problems with nominal interest rates as policy indicators, stable Phillips curves, etc. In this respect he went far beyond the interwar economists.

    But we are not far apart. Hawtrey’s book on the Depression is much more accurate than F&S’s book. Hawtrey had a much better understanding of the underlying forces at work.

    Rafael, The long term rate has two components. The real rate is determined by savings and investment (such as the savings glut you mention.) The Fed has no control of those forces. The expected inflation rate reflects market expectations of future Fed policy. This reflects their inflation target, plus the degree to which the policy is credible.

    The expectation that the zero bound will be pursued for some time, is already embedded in the yield curve—that’s why rates are so low for maturities of several years. They are not zero because there is some chance that recovery will be unexpectedly strong, and the Fed will have to raise rates.

  10. Gravatar of david glasner david glasner
    5. April 2009 at 17:32

    Scott, I did not think that you meant to deny that monetary forces were causing the great depression, but it was not clear to me what significance you were attaching to the “failure” of open market purchases in 1932. That’s why I thought that Hawtrey’s discussion would be of interest, especially because it placed monetary forces in the context of the global crisis.

    Keynes somehow got off track after the Treatise and instead of developing a workable monetary theory seemed to think that the global crisis could not be explained by monetary forces even though there was a perfectly good explanation already available. There was an uneasy relationship between Hawtrey and Keynes (I think that Keynes called Hawtrey his grandparent in heresy or something like that), but he seemed to feel the need to go beyond Hawtrey in establishing his reputation as a heretic.

    You are right that I am very negative about Friedman, though I don’t deny that he did some very fine work. However, even his natural rate of unemployment model (is that what you were referring to?) was not original. Hayek and others had already made essentially the same point in the 1950s, so Friedman was merely recycling and restating somewhat more rigorously an idea that he had certainly run across previously without giving any credit to earlier expositors, just as he unaccountably passed off his “methodology of positive economics” without a single reference to Karl Popper whose work he must have been aware of. Harry Johnson and Don Patinkin were both rightly scathing in their criticism of his creation out of whole cloth of a “Chicago Oral Tradition” that had almost nothing to do with the repackaged version of the cambridge theory of the demand for money that constituted his 1956 restatement of the quantity theory. Aside from that sloppiness verging on dishonesty, his consistent denigration, or at best failure to mention except to dismiss, any non-Keynesian monetary/macro theories (Hawtrey, Pigou, Robertson, Hayek, take your pick) suggests to me a deliberate strategy to make himself the only alternative to Keynesian macrotheory. I would not be so strident in my criticism if it were not for my own personal experience after publishing my book, which I need not go into, with Friedman. But I can refer you to Perry Mehrling’s fine biography of Fischer Black which documents the nasty and abusive intolerance that Friedman displayed toward Fischer Black when Black was at Chicago and dared to express ideas about money that didn’t conform to Friedman’s prejudices. Friedman was unable to intimidate Black into silence and he kept showing up at the money workshop and kept asking Friedman tough questions for which he had less than convincing answers. Coming from a self-avowed libertarian, Friedman’s intolerance for opposing views is especially hard to swallow.

    So I am gratified, but not all surprised, to read that you prefer Hawtrey to Friedman, and I agree that our substantive views on monetary theory are very close indeed. But I guess that we disagree about whether Friedman had a positive or negative influence on the development of monetary theory.

    (Scott, I leave it to you whether you want this diatribe against Friedman which is really way off topic to go on the blog. I won’t take it amiss if you delete it in whole or part.)

  11. Gravatar of Alex Golubev Alex Golubev
    6. April 2009 at 08:42

    Ssumner, thanks for this promised post (and David for the great discussion)! I’m trying to draw some parallels to the present environment. Wouldn’t changing the reserve ratio be similar to the gold devalation done in ’33? Also, can you suggest any potential “international dimension” to the current easing attempts? It seems like europe isn’t being nearly as agressive as the US, while UK is. It seems like China’s desire (or lack thereof) to hold the dollar will play an important role in potentially offsetting any QE attempts. Also, what about magnitudes? Seems like the current QE isn’t nearly on the same scale as what was done in the GD particularly when looking at a major devaluation in ’33. Aren’t we destined to turn Japanese considering the Chinese constraint to our monetary problem?

  12. Gravatar of ssumner ssumner
    6. April 2009 at 17:19

    David, I welcome any and all comments as long as they are on topic (and not off color), so I welcome your thoughts on Friedman. I don’t know enough about the items you mention to have much to add, although it certainly sounds like you know what you are talking about. (I have read his piece on methodology, and there is certainly a Popper influence.) One thing really perked my interest–your statement about Hayek and the natural rate model. Are you sure he got there first? I’d be very interested in the Hayek piece. I know that Irving Fisher (and even Hume to some extent) understood the idea of a natural rate, but neither addressed the distinction between price level changes and changes in the rate of inflation. Did Hayek?

    Alex, I am still thinking about Europe, but will do a piece on Europe soon. I agree that we haven’t done anything yet comparable to the 1933 devaluation.

  13. Gravatar of david glasner david glasner
    7. April 2009 at 06:47

    Scott, I was afraid that my comments about Friedman may have been a bit more personal and biting than I was comfortable with ex post, but I will try to get over it. For Hayek’s anticipation of Friedman, see The Constitution of LIberty p. 331, where the point seems quite explicit to me. He made the point already in 1958 two years before the Constitution of Liberty was published in a paper “Inflation Resulting from the Downward Inflexibility of Wages” published in a volume called Problems of United States Economic Development and reprinted in Studies in Philosophy Politics and Economics (1967). See p. 296 for the following passage.

    The point which tends to be overlooked in current discussion is that inflation acts as a stimulus to business only in so far as it is unforeseen, or greater than expected. Rising prices by themselves, as has often been seen, are not necessarily a guarnatee of prosperity. Prices must turn out to be higher than they were expected to be, in order to produce profits larger than normal. Once a further rise of prices in expected with certainty, competition for the factors of production will drive up costs in anticipation. If prices rise no more than expected, there will be no extra profits, and if they rise less, the effect will be the same as if prices fell when they had been expected to be stable. (In other words, an expectations-augmented Phillips Curve).

    The next page or so in my view reasonably anticipates the important analytical contribution in Friedman’s natural rate paper, but I would be interested to hear what others think.

  14. Gravatar of ssumner ssumner
    7. April 2009 at 17:29

    Thanks David, I wonder why this passage hasn’t received more attention, it is certainly very well put. Indeed, I like this version (which Friedman also used) much better than the NAIRU. This is such an obvious point that I don’t know why others didn’t see it. It is hard to believe that Friedman himself wouldn’t have made a similar observation before 1968. Does anyone know if he did?

    I will try to publicize Hayek’s contribution in the future. When combined with his advocacy of NGDP targeting, my admiration for Hayek is steadily rising.

  15. Gravatar of web design web design
    20. February 2011 at 20:40

    Thanks Brian, I wonder why this specific passage hasn’t received more attention, it is certainly well put. In fact, I like this specific version (which Friedman also utilized) much better than the particular NAIRU. This is this obvious place that I don’t know why other folks didn’t see it. It is hard to believe Friedman himself wouldn’t made a similar observation before 1968. Does anyone know if he or she did?

    I will try to advertise Hayek’s contribution later on. When along with his advocacy of NGDP aimed towards, my admiration for Hayek is progressively rising.

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