Deflationary purges

"We have built deflation into an absurd ogre, and have overlooked the healthy consequences of a deflationary purgation of the malinvestments of the boom, as well as the overdue aid that fixed income groups, hit by a decade of inflationary erosion, would at last obtain from a fall in prices"
Murray Rothbard, (2005, p.182)

"I shall try to show that (a) the price level is frequently a misleading guide to monetary policy and that its stability is no sufficient safeguard against crises and depressions, because (b) a credit expansion has a much deeper and more fundamental influence on the whole economy, especially on the structure of production, than that expressed in the mere change of the price level. The principle defect of those theories is that they do not distinguish between a fall of prices which is due to an actual contraction of the circulating medium and a fall in prices which is caused by a lowering of cost as a consequence of inventions and technological improvements"
Harberler, in “The Austrian Theory of the Trade Cycle and other essay” 1996, Mises Institute (p.46-47)

"If we have, however, once realized that at the bottom of these surface phenomena lies a far-reaching dislocation of productive resources, we must lose confidence in all the economic and monetary quacks who are going around these days preaching inflationary measures which would bring almost instant relief"
Harberler, in “The Austrian Theory of he Trade Cycle and other essay” 1996, Mises Institute (p.61)

Update: Pete Boettke has initiated a discussion about deflation. He draws in George Selgin's argument regarding the productivity norm, and The Economist also weighs in,

"If prices are falling because of advancing productivity, as at the end of the 19th century, it is a sign of progress, not economic collapse. Today, though, deflation is more likely to resemble the malign 1930s sort than that earlier benign variety, because demand is weak and households and firms are burdened by debt"

In the comments to Pete's post Selgin himself makes a useful point:

"Taking "deflation" to refer to a general downward movement in prices of final goods, the Rothbardian claim that deflation is a necessary step in recovery from an Austrian-type malinvestment cycle is just plain bad economics, and bad Austrian economics at that. Consider: the boom involves a _temporary_ distortion of relative prices, including artificially low interest rates, due to excessive M growth. The boom is unsustainable because factor prices eventually "catch up" to their GE values. In other words, the corrective purge doesn't require any contraction of nominal M or absolute deflation. Such deflation (the "bad" kind, according to my prod. norm. argument) only does more harm, by putting relative prices off track again.

As Mises correctly observed, to rely on deflation to make up for damage done through inflation is like backing over your neighbor's cat to make up for running it over in the first place."

Fine. He also says "In any event, the boom ends because relative prices have adjusted, so there's no need at that point to resort to deflation to make them adjust!" But this raises the issue of time periods. To say that "prices eventually "catch up" to their GE values" is clearly operating within an equilibrium framework.  To say that "prices have adjusted" is obviously inconsistent with a view that we live in a world of disequilibrium. I think Austrians might be inconsistent on this. Is the "credit crunch" observable? Is it merely a conceptual way to view the momentary disjoint between an artificial boom and a recovery? Data limitations make it hard enough to witness the stages of an Austrian cycle, but when Austrians make empirical claims (such as the boom coincides with a buoyant stock market) these are verifiable.

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ROOSEVELT TRICK

Zehn der 19 größten US-Institute benötigen insgesamt 75 Milliarden Dollar - das ist weniger als erwartet und zeigt zugleich, dass bereits neues Vertrauen geschaffen wurde. Doch bedeutet das Ergebnis des von US-Präsident Obama verordneten Stresstests schon die Wende in der Finanzkrise?

Präsident Franklin D. Roosevelt beendete im März 1933 die größte Bankenkrise der Geschichte mit einem Trick. Er verkündete "Bankferien": Alle Kreditinstitute wurden für vier Tage geschlossen; danach durften die meisten von ihnen wieder öffnen, aber erst, nachdem Experten der Regierung die Bücher geprüft und die jeweilige Bank für überlebensfähig erklärt hatten.

Es war der Wendepunkt der Weltwirtschaftskrise in Amerika: Dank des staatlichen Gütesiegels konnte der Finanzsektor wieder Vertrauen gewinnen, das Kreditgeschäft begann sich zu normalisieren. Was für Roosevelt die Bankferien waren, das ist für Barack Obama der Stresstest. Zweieinhalb Monate lang hatten Experten des Finanzministeriums und der Notenbank Federal Reserve die Bücher der 19 größten Banken der Vereinigten Staaten geprüft.

Jetzt liegen die Ergebnisse vor. Die Regierung ordnet zwar nicht an, welches Institut bestehen bleibt und welches nicht, aber sie scheidet auf andere Weise die Starken von den Schwachen: Sie bestimmt, welche Bank wie viel Kapital braucht, um die Krise durchzustehen.

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