On the Political Economy of Eurozone Bailouts – The curious bargain of Greece’s Hayekian neoliberals

Following the Crash of 1929, an epic debate began between liberals who believed in capitalism’s automatic stabilisers and John Maynard Keynes who did not. Today, in Bailoutistan (Greece and the other fallen eurozone countries), this debate has taken an interesting, sad, twist.

 

Hayek vs Keynes

In the aftermath of the Crash of 1929, Keynes famously criticised the conventional wisdom of his time (the so-called Treasury View) which held that, given sufficient time, the economy would adjust to any recession by letting wages and interest rates fall until the entrepreneurs’ animal spirits’ are stirred sufficiently to stimulate both the additional employment and investment necessary to end the recession. Keynes’ objection was that, following a massive financial crisis that manages to infect the ‘real’ economy, it is highly likely that the large diminution in output, investment and income will lead to a ‘bad’ equilibrium. To a situation where unemployment is sustainably high (and unresponsive to wage reductions that cause labour to become dirt cheap), investment is rarer than snow in the desert (even after interest rates have crashed to zero; the so-called liquidity trap) and, generally, to an economy stuck in a new underemployment equilibrium from which it will not escape even if prices are free to adjust to their heart’s content. Under those circumstances, thought Keynes, to target government budget deficits, by means of government spending cuts, is precisely wrong. His proposition was that, once an economy finds itself locked into an underemployment equilibrium, any attempt to try to “cut itself out of the slump” is tantamount to cutting one’s nose to spite one’s face. No, for Keynes the trick was to “grow out of the depression”.

At the time, the Treasury View (i.e. that automatic stabilisers would do the trick) seemed increasingly pie-in-the-sky and vulnerable to Keynes’ quip that “in the long run we are all dead”. It took an outsider’s intervention to articulate (a) the strongest critique of Keynes, and his advocacy of government intervention during a slump, and (b) the most powerful defence of the market’s superiority as a resource allocation mechanism which government meddling can only stunt and harm – with long term detrimental effects for all. That ‘outsider’ was none other than Friedrich von Hayek.

Just like Keynes, Hayek began with a diagnosis of the problem: a treatise on what caused recessions in general and the Crash of 1929 in particular. Hayek suggested that the main cause of recessions was the excessive credit creation that preceded them, leading to investments that could not possibly prove profitable in the long run. The sequence of events was, according to Hayek, as predictable as it was catastrophic: Good times generated optimism, optimism begat investments, higher investment led to higher incomes and profligate consumption, interest rates fell as bankers competed against one another to give loans to people/firms/states that lacked the capacity to repay their loans in case of the slightest of downturns, etc. The bust was thus a necessary outcome of the boom. It was, in essence, the only cure for the irrational exuberance that caused it. In one of Hayek’s famous jibes, the boom is the illusion while the bust is the reality call. And what should be done once the bust hits? Simple: Let the recession do its work; let it liquidate the bad debts by allowing them to be written off, since they can never be repaid. If this means pain for the multitude, so be it. Just like the drunk must suffer stoically the symptoms of his hangover, so must a capitalist economy wait out the recession. It hurts but its function is divine as it shrinks the mountain of uncreditworthy credit previously built up in the system. Bankruptcy is, during this phase of consolidation, unpleasant but highly necessary. A little like Hell in its symbiotic relationship with Christian dogma.

At this point it is of great interest and significance to juxtapose the Treasury View (which Keynes disparaged) with that of Hayek. Seemingly, both the Treasury apparatchiks and Hayek converged on their opposition to Keynes-inspired fiscal stimuli and on a commitment to the task of reducing government debt. In response to Keynes, both Treasury officials and Hayek jested that his proposal for curing debt by means of more debt was ludicrous. But what of the difference between Hayek and the Treasury? Was there one?

Yes, there was. And an important one to boot: Whereas the Treasury was arguing that wage and interest rate drops would restore the economy to where it was before the bust, Hayek made no such promises. To Keynesian prognoses that the liquidation of bad debts, and the general shrinkage that would follow, may never lead the economy to the state it was at before the Crash, Hayek would shrug his shoulders and say: C’est la vie. Since the boom was ‘unnatural’ anyway, it would be silly (and perhaps unethical) to expect the bust to take us back to where we were before it all went belly up. Where will it take us? Hayek’s answer was: We are damned if we know! But wherever it takes us, it will be better than where we shall land following government fiscal stimuli and more debt. Let the system be cleansed of all bad debt, via wholesale bankruptcies, and then let the market system do what it does best: produce the best of all possible available futures.

In this article, I shall desist pitting further Hayek vs Keynes. Nor will I pursue further the pros and cons of Hayek’s thinking. For my objective here is to focus on the peculiar effect eurozone bailouts (with the Greek one as my main case study) has had on the mindset of neoliberals whose inspiration has traditionally been Friedrich von Hayek.

Hayek on Greece

Were von Hayek to send us a missive from the ether regarding the Greek bailout, what would he have conveyed? He would certainly not think twice before pinpointing two major causes of the tragedy that are recently turning Greece into a wasteland.

The first cause of Greece’s predicament

The first cause that Hayek would pinpoint is, of course, the bubbles that had been building up through excessive bank credit (to both the private and the public sector of Greece) in the realms of the stock market, the real estate market, the government and, of course, the labour market. The rivers of credit that flowed into Greece had caused all ‘prices’, in each of these realms, to become massively inflated thus causing a boom which, just like night follows day, had to turn to bust. And since the boom was exorbitant, in relation to the country’s real productive capacity, the bust was terribly catastrophic.

So, Greeks must accept (I can hear Hayek pontificating) that there is no alternative to liquidating unsustainable stocks (i.e. learning to live with very low share prices in the Athens stock exchange), liquidate the farmer whose produce has never really had a market (at least not one that did not rely on the kindness of the European tax payer), liquidate real estate prices (noting the pre-2009 absurdity of Kolonaki apartments costing New York prices), liquidate government (i.e. shut down most of its departments) and, of course, liquidate labour (i.e. get rid of jobs that do not produce a value equivalent to their cost to the employer).

The second cause of Greece’s predicament

Let me now turn to the second cause of Greece’s current predicament that, in my view, Hayek would highlight: The calamitous intention of the bailouts to avert a Greek default within the eurozone. Since all bad debts ought to be liquidated, according to Hayek, the Greek public debt (arguably the worst of bad debts) ought to be the first to be written off. Is this an insight that does not apply within the eurozone? Before answering, it is useful to look at Hayek’s rather ambivalent relation with the idea of a European currency union to be administered by a European Central Bank. A known sceptic of Central Banks (indeed, in a famous 1974 paper Hayek had proposed the privatisation of money; (i.e. allowing private banks to issue their own currencies, which would then compete for the public’s trust), in 1978 he had this to say about some future euro:

“[T]hough I strongly sympathise with the desire to complete the economic unification of Western Europe by completely freeing the flow of money between them, I have grave doubts about doing so by creating a new European currency managed by any sort of supra-national authority. Quite apart from the extreme unlikelihood that the member countries would agree on the policy to be pursued in practice by a common monetary authority (and the practical inevitability of some countries getting a worse currency than they have now), it seems highly unlikely that it would be better administered than the present national currencies.”

Nevertheless, Hayek extended a grudging acceptance of a euro-like currency while warning that “unchecked party politics and stable money are inherently incompatible” (italics in the original).[1] Whatever Hayek would have thought of Mrs Merkel’s, Mr Sarkozy’s and Mr Draghi’s attempt to ‘save’ the euro in a manner utterly subservient to Germany’s, France’ and Italy’s “unchecked party politics”, one thing is beyond dispute: Friedrich von Hayek would have lambasted Europe’s attempt to create new forms of toxic debt (see the EFSF bonds that are financing the bailouts) in order to ensure that boom-created, wholly unsustainable, old debts (like those of the Hellenic Republic), are preserved for as long as possible and at whatever human and economic cost.

In short, while not at all clear on whether Hayek would have recommended the preservation, disbandment or partial disbandment of the eurozone, it is beyond serious doubt that he would have campaigned vigorously for the liquidation of Greece’s (bad) debts. Fully fledged default would have been, in Hayek’s eyes, the sole course of action not in conflict with his vision of what is at stake in the eurozone today. A view that would cause him to clash with the raison d’ être of all bailouts in Europe (not to mention Mr Draghi’s LTRO that would incite him into an unending rage).

The curious case of Greece’s neoliberals

Since the crisis erupted, I have found myself in various panels opposite representatives of Greece’s tiny but highly influential community of Hayek-inspired neoliberals. It took little time to realise a most peculiar dichotomy typifying them; one which I think is instructive on the damage that the bailouts are doing to Europe’s intellectual life within but also beyond the borders of Greece. It is this: While Greek neoliberals maintain Hayek’s rage regarding the first cause of Greece’s current predicament, they are in deep (and non-intellectual) denial regarding the second one.

On the one hand they are keen to spread Hayek’s message that, within Bailoutistan (with Greece being the most prominent province of this new ‘nation’), there is no alternative to liquidating stocks, farming values, real estate prices, most government departments and much of still employed labour. However, in sharp contrast, the only one thing that they are not prepared to see liquidated is Greece’s public debt to the banks which, according to Hayek himself, created the problem in the first place! Why the exemption of Greek public debt from the list of bad debts/assets to be liquidated? And why the dearth of explanation as to why this exemption is recommended?[2] Two possible answers explain the Greek neoliberals’ schizophrenia.

First, perhaps they misunderstood what their libertarian gurus meant, possibly due to limited analytical power. Or, secondly, the Greek case is special and requires that Hayek is listened to when it comes to liquidation of everything but not of public sector debt. While not the sharpest knives in the cupboard, I do not believe that Greece’s neoliberals simply failed to understand Hayek’s message. Rather, I am of the view that it is Greece’s special circumstances that lead them to exempt public debt from the list of assets that must be liquidated. Were we to ask them to explain what these ‘special circumstances’ are, I think that, after a long discussion, we would surmise that they are driven to the exemption of public debt from the assets to be liquidated for one, simple, depressing reason: they have lost faith in the capacity of Greek national elites to see through the process of liquidation. They have lost faith in the capacity of the Greek authorities, of Greek entrepreneurs, even of themselves, to steer Greece, via Hayekian liquidation, along the path to a libertarian state of affairs. And since they do not think that Greek elites can do this, they put all their eggs in the basket of hope that Northern European elites (perhaps with the assistance of the IMF) will do it for them. And to ensure that this will happen, they are happy to sacrifice a basic Hayekian tenet in order not to antagonise Northern European partners who, for reasons of their own, are keen to keep piling unsustainable new loans on the Greek state (rather than liquidating the existing ones).

Epilogue

A Faustian Bargain seems to have been struck between Bailoutistan’s Hayekian neoliberals (with Greece’s variety the most striking example) and the statist ECB-EE-IMF bailout approach. This explains partly what I shall term the European Periphery’s Neoliberal Anomaly: neoliberals that are happy with the idea of huge new taxpayer-funded loans on insolvent state entities. However, this explanation is only partial as it fails to explain an important observation. Recalling Sherlock Holmes infamous ‘dog that did not bark’ inference, the question arises (regarding Greek but also Irish Hayekians): Why have they said nothing about the need to liquidate the nation’s bankers? (Or Irish bank bondholders for that matter?)

My point here is that, even if we accept the Faustian Bargain hypothesis above (namely that local elites have lost faith in themselves and want the troika to supervise their own odd ‘Road to Serfdom’), there is nothing in the neoliberal manual that can explain their total silence on the national (e.g. Greek or Irish) banks which played a huge, and hugely negative, role in causing the boom that led to the bust. Whereas Hayek would recommend that these bankers are liquidated forthwith (in order to teach all a lesson about the consequences of excessive credit creation), Greece’s and Ireland’s neoliberals are utterly silent on this. Why is that? In the case of Greece the answer is evident: Because of the extremely cosy relationship between the said neoliberals and the bankers. Period.

In conclusion, the eurozone’s bailouts have taken another, hidden toll: they have gutted the intellectual honesty of the very school of thought on which many of Europe’s elites supposedly rely upon for inspiration.


[1] Friedrich von Hayek, “Market Standards for Money”, Economic Affairs, April-May 1986.

[2] The best they can do is to argue that if Greece defaults it will not be able to return to the money markets; a pretty absurd argument since (A) Greece will not be returning, in any case, to the markets and (B) Hayek’s argument would be that this is a splendid thing (as it will force the Greek state to live within its means and to restore its reputation through frugality and prudence).

77 thoughts on “On the Political Economy of Eurozone Bailouts – The curious bargain of Greece’s Hayekian neoliberals

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  12. “Lastly, your quotation about rule-governed behaviour is central to his thinking. But he never believed that it was government’s role to provide these rules – only to supervise them once they have emerged/evolved spontaneously. In a purely Humean manner, Hayek suggested that people will spontaneously ‘fall into’ some social convention (either driving one the left or on the right) which then, at some point, finds itself into the statute books.”

    One could argue this is what governments are doing….supervising the rules created in the “market”….only problem is that nowadays the only market recognized is the financial one.

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  14. What is liquidation of Greece’s public debt to the banks?
    I don’t understand what you mean, professor. Could you give me an example, please ?

    • When Hayek talks of liquidation of debts he means writing them off as bad debts never to be retrieved.

  15. Your reading on Hayek has remained back to his 1929 point of view; had he not published “The Road to Serfdom” I’d too assume you’re right. But you’re not. For Hayek, in The Road to Serfdom it is crystal clear that government changing a long-standing policy was a big deal; it would affect people who had made individual choices based on the established rules of the game. A rule-based system is fundamental to a functioning market because it anchors expectations:

    “It does not matter whether we all drive on the left- or on the right-hand side of the road so long as we all do the same. The important thing is that the rule enables us to predict other people’s behavior correctly, and this requires that it should apply to all cases—even if in a particular instance we feel it to be unjust.”

    While Hayek has been a defender of the price mechanism, he recognized that immediately removing England’s wartime price controls would cause chaos and backlash against capitalism. He repeatedly states that some actions (by the governmen, or even an individual and particularly the intelectuals – see “Intelectuals and socialism” for reference), while correct in principle (like eliminating rationing and price controls), could do more harm to the long-run cause of individual liberty due to the short-run chaos (basically: the unemployment rate) it would cause. Again, in The Road:

    “However much one may wish a speedy return to a free economy, this cannot mean the removal at one stroke of most of the wartime restrictions. Nothing would discredit the system of free enterprise more than the acute, though probably short-lived, dislocation and instability such an attempt would produce.” Hayek was not only afraid of it; he later saw it happening in England when the Labor’s Party disastrous governance led to an economic catastrophe, but still most people (even nowadays) would say that it was capitalism who did that. It was this circumstance that gave Hayek a great recognition; he had not only predicted the economic decisions which led to the worst economic situation in England’s modern times, but also the backlash against capitalism and liberal ideas.

    What Hayek opposes later on is that a group of people in a collectivist system creates the need for a commonly accepted system of ends of the group and the desire to give this particular group the maximum of power to achieve these ends, over-riding any individual purpose. What remains, though we may not call it morals, at least not in the way we know morals as a set of principles, But by establishing the “rules of game” throughout a long period of time, people will tend to make individual choices based on these rules and make their short-run predictions accordingly, regardless their assumptions on being good, or bad or even if theri outcome is predicted as such.

    Sometimes we just have to make decisions which we know are no good, but we choose not do the otherway round since the alternative is a “terra incognita”:

    “Neither is the fact that in a given instance nobody may be the worse for it, nor any high purpose for which such an act may have been committed, can alter the fact that it is bad. Though we may sometimes be forced to chose between different evils, they remain evils.”

    Hayek would have not proposed a “shock therapy”; through his books we know that he would have kept on writing hundreds of articles and giving lectures against the increasing debt, he would have vacated the party that would have become unmoored from its liberal principles and so on.

    • From 1929 to 1933 Hayek’s position was precisely that which I have outlined. In other words, during the worst of the Crisis (the equivalent of our current juncture), his position was to liquidate, liquidate, liquidate. In 1933 he changed tack a little by accepting (belatedly) that there was a role for the Central Bank to replace lost liquidity by means of printing an equivalent amount of fresh cash. But he remained steadfast on the need to let insolvent entities go to the wall. Lastly, your quotation about rule-governed behaviour is central to his thinking. But he never believed that it was government’s role to provide these rules – only to supervise them once they have emerged/evolved spontaneously. In a purely Humean manner, Hayek suggested that people will spontaneously ‘fall into’ some social convention (either driving one the left or on the right) which then, at some point, finds itself into the statute books.

  16. I also wonder how Hayek would react to that severe and unequally distributer tax increase that is implemented –and is devastating to the remains of the middle class- to service an unquestionably unserviceable debt.
    Although I am not an economist, I find it hard to see any resemblance of today’s madness to the good ol’ Austrian school teachings. I don’t know who, the orchestrators of this mess say they had as their model, but I am pretty sure that Hayek would spin on his grave today! I guess that’ s also what you are implying with your article, if I got it right.
    Anyway, given that they know very well what they are doing (I think that by now this has become quite obvious) maybe it’s time to abandon any hope of a united, democratic Europe, and start working on a “plan B” that every country that is under attack today could implement on their own. This is because every people could (theoretically and after much struggle) overthrow the current regime, but it is impossible to change the minds of the modern Kings and their viceroys in Brussels, Berlin, Frankfurt, London and New York.

  17. I would rather choose the following view, trying to interpret the “conundrum” (allow me to pick a term that Alan Greenspan launched describing the flattening of the US yield curve) of neoliberal policy makers expressing reluctance to simply exercize “von Hayek’s liquidation put option”, leaving Greek public debt no alternative than to declare default:
    In my opinion, it is all about bailouts targeting commercial banks (together with the sequel of LTROs that catch up with Fed’s QE sequel) and Central Banks targeting asset prices, and NOT the real economy, in order to impose the …axiom of uncertainty (similar to Heisenberg’s foundational contribution) regarding inflation vs deflation expectations, etc).

  18. But wherever it takes us, it will be better than where we shall land following government fiscal stimuli and more debt. Let the system be cleansed of all bad debt, via wholesale bankruptcies, and then let the market system do what it does best: produce the best of all possible available futures.

    Hayek and Keynes may be compatible: Hayek says liquidate all bad debts, but under a fiat system, government can produce an unlimited quantity of currency so there is no such thing as government debt that can’t be paid back (i.e no bad debt except private debt).

  19. Keynes vs Hayek

    Remember, it’s pronounced “Ha – yek” as in “high explosives.” ;-)

    (Hat tip: “Thoughts of Cyprus and Malta”, econcyma.blogspot.com)

  20. Great readio play: The Great Squanderland Roof:

    In ‘The Great Squanderland Roof’, Julian Gough explores another puzzling area of modern economics with the help of the BBC’s Stephanie Flanders. This time Gough turns his attention to the eurozone crisis and, along with the Chancellor of Frugalia and the Head of the European Bank of Common Sense and Stability, conjures an ambitious and unorthodox plan to save Europe, the Markets and the World.

    http://www.bbc.co.uk/programmes/b01cjwtx

  21. My reaction to reading this was very similar to @logician.

    I consider myself a skeptic and while I give a lot of weight to Yannis’ arguments, I find myself converging onto the “Anti-bailout Libertarians” in principle.
    However, I grudgingly (very grudgingly) accept the “pro-bailout” view for *precisely* the reason Yannis cites.

    I have ZERO faith in the will and ability of the various Greek “centers of power” (I think the word “elites” is unhelpful), be they Political Parties, Government, Private Enterprise and most importantly Greek Society as a whole, to find a way out of this mess.
    I attach a lot of weight to the last point about society because I believe all the solid thinking and good will in the world has no chance when society is deeply divided and in a near-state of chaos.

    Using the statistical theory of maximum likelihood I have precisely zero evidence to support having faith in any of the above.
    So I can at least understand those who come to adapt the view that this is the lesser of two monstrous evils.

    Greece is facing a lost decade or more but a lost decade with a semblance of order is better than a lost decade of the sort suffered by Romania & Bulgaria after their “Old Order” collapsed – chaos, violence, the rise of organized crime as major force in society, lack of any real government – these are all things that must be avoided.
    With Greece having proven wholly incompetent to manage anything simple like preparing for forest fires in a dry windy August, is it any wonder many have no trust in its ability to “steer clear of the reefs”?

    I have a final point for you Yannis. You postulate a conservative conspiracy between neoliberals and bankers – forgive me but it’s much simpler than that. The truth is you’ve answered your own question: if nobody trusts any of the Greek “centers of power” to do anything other than mess things up, why would they be trusted to sort out a liquefied banking sector?

    Especially when the greed and rapaciousness of these “pillars” is well proven and even the recent banking system audit showed that state banks were the worst culprits and loans to state entities the dirtiest deals on the books?
    Loans with government guarantees without a business case or investment case, without even the signature of the minister on the ministerial approval (these were 1.3bn of last year’s budget deficit BTW – consider that against the 325m of pension cuts). Should these people be trusted to “clean-up” the banking sector?

  22. Dear Mr. Varoufakis,

    Allow me to express my views that are quite different to some of your explicit and implicit arguments and thank you by the way for this open dialogue house you are providing.

    You are arguing that Hayek would pinpoint to the credit overflow for the bubbles appeared in Greek economy both private and public. While I cannot really argue on whether Hayek would have said that or not I understand that your position holds in a similar (if not identical) place, i.e. you blame credit easiness for public and private debt skyrocketing.

    Low interest rates came in our lives in euro era and usually all the analyses are confined during this period. I think it is quite important to check also some years before euro as well to have a better insight to our case study. To make it as short as I can my view is that though interest rates were by far higher in pre euro era and the so called bubbles did not expand that much the core problems of Greek economy where apparent since decades. It is common truth that drachma devaluations have kept the competitiveness at acceptable level in terms of macroeconomic figures and the extreme state sector intervention in the markets (mainly labor and services) has covered under the carpet the inefficiencies of the private sector. Important to notice here is the technological leaps happened elsewhere while here we were unable to follow, evident at all levels of socioeconomic life from education to innovation.
    State’s dominant position has affected in an vicious spiral all other players name it banks (state controlled directly or indirectly), state dependent media, state dependent entrepreneurship leading to oligopolies in best cases, and worst of all cultivating a culture that the rationale way to go for the individuals is to acquire as many degrees as possible in order to gain as many points as possible, plus the use of social relations and exchange of vote for a job position under the extreme span of the state’s umbrella. Also the case for a highway to heaven was to set up a business to provide services or supplies to state’s organizations where the term accountability does not exist. Corruption from both sides was inevitable though after some cycles it comes difficult to determine clearly effects and causes. In the mean time we lost also justice and professors too!

    And then it came in the euro and the credit blow made it easier to pump to the extreme the previous situation. Easy money meant more money for the government to control i.e. control more people, easy money for the people meant an easy way to make consuming dreams come true.

    According to my point of view it is clear that the Greek problem should not be seen only as a macroeconomic mathematical model but we should examine deeply the collective behaviour of our society. Hayek’s and other theories can only abstractly describe and explain the mesh Greece is in. A multi disciplinary approach would be more appropriate.

    Thus, coming to some concrete useful points for the future, my understanding leads me to the following. To name debts as bad debts and get rid of them (public and private) by no means will not change the route we were following. By letting banks to fail on their own inefficiencies, which as explained was due to state’s dominant position, might conforms to some libertarian (and also leftist!) views but on the same time we should acknowledge that there is no economy without banking system. Unfortunately for Greek system letting banks go bankrupt means letting ALL banks go bankrupt. We don’t have the luxury to let Lehman, BofA and a few others to go down. Who will explain to people that their deposits have just disappeared? Greece’s bailout(s) comes for a purpose. Weird for me most of the people say it is for other banks and others nations interest. I simply cannot support that view. It only takes a good reading of the MoU I and II for someone to understand that all prerequisites for the bailouts are targeting the restructure of the state and the (re)form of the production model. I really don’t see the motive and the purpose for such an effort if only bank saving was the stake.

    We all understand for the changes to happen time is needed and timing is important. Obviously we are not ticking the clock for our fault for sure. Euro’s and EU’s structural problems are in place too and make things either worse or easier depending on the view. I follow professor’s Varoufakis views since a long a time ago and he has really helped me to see a broader view of the system. I am aligned with most of his views regarding the euro system and fully support his and Holland’s proposal for a way out of the liquidity problem for the eurosystem. But I have to say that his late persistence to sacrifice Greece, or put it differently not give Greece a chance for change, for eurosystem to decide its way ahead I cannot support. It reminds me the story with the mice looking for the mouse to hang the bells under the cat’s neck. They haven’t found it yet.

    Fianlly, though I am not an economist, I would abstractly see the current situation as a version of a Kaynesian policy, at least the main line of reasoning. Instead of spending on government budget deficits to stimulate economy growth, which means spending on loans, Greece is spending on loans to reform its economy.

    • I beg to differ. Yes, there have been credit-induced bubbles that burst and, in the aftermath, governments have tried to refloat them by means that are detrimental to social welfare. But this is an epiphenomenon. My explanation of what went wrong is that the post-1971 global surplus recycling mechanism (based in the US) has broken down. It is the main thesis in my Global Minotaur…

  23. “Και την ειωθυίαν αξίωσιν των ονομάτων ες τα έργα αντήλλαξαν τη δικαιώσει”
    (“για να δικαιολογούν τις πράξεις τους άλλαξαν ακόμα και την σημασία των λέξεων”.)
    Θουκυδίδης Γ,82,4

    • “When I use a word,” Humpty Dumpty said in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”

      “The question is,” said Alice, “whether you can make words mean so many different things.”

      “The question is,” said Humpty Dumpty, “which is to be master – - that’s all.”

      Through the Looking Glass

      PS: Did you guys know that Carroll’s inspiration for the character “Alice” was none other than Alice Liddell, daughter of Henry George Liddell (yes, that Liddell — the co-editor of A Greek-English Lexicon/i>)?

  24. Yanis,
    I would like to read your view about the following article at

    http://www.ritholtz.com/blog/2012/02/a-primer-on-the-euro-breakup-2

    A Primer on the Euro Breakup by John Mauldin – February 28th, 2012
    Also, especially, this paragraph from the text
    “The euro is like a modern day gold standard where the burden of adjustment falls on the weaker countries – Like the gold standard, the euro forces adjustment in real prices and wages instead of exchange rates. And much like the gold standard, it has a recessionary bias, where the burden of adjustment is always placed on the weak-currency country, not on the strong countries. The solution from European politicians has been to call for more austerity, but public and private sectors can only deleverage through large current account surpluses, which is not feasible given high external debt and low exports in the periphery. So long as periphery countries stay in the euro, they will bear the burdens of adjustment and be condemned to contraction or low growth. “

  25. Yanis, I don’t know what herbs the so-called Greek Hayekians are inhaling but if they are like you describe them, then I think they need to reconsider what they are.

    I can’t think of any liberal opinion leader in the German-speaking countries (I purposely don’t use the term “neo-liberal”) who would defend the way the Greek bail-out’s have been structured so far. One, because they have been anything but “help for Greece” and, two, they violated from the start the all-important principle that “risk takers must remain risk carriers” (even if some bank shareholder equity gets wiped out in the process).

    So if Greek Hayekians are arguing that one must sacrifice principles to make sure that one doesn’t risk the foreign financial support life-line, then they will get both in the end: lost principles AND lost financial support.

    I am very sceptical that Keynes-type deficit spending would produce desired results in Greece. Yes, an American who got paid for digging a hole and then for closing it again probably stimulated the economy because he would have spent his money in his economy. I fear that in the present Greek system, more government spending on stimuli might have as its major consequence an increase in private bank account balances offshore.

    I am not a “believer” but I am certainly much influenced by Hayek. I guess Hayek might say “starve the inefficient (if not corrupt) public sector to death and simultaneously arrange that much more than those cuts is spent by private investors in the private sector. I would except that private investors make sure that their investment money does not end up in other people’s private accounts offshore. And the EU could provide incentives for such private investments by offering guarantees for the political risk.

    On one point, however, I can be classified as a convinced Hayekian. No civilized society will advance without a well-functioning State of Law and without a shared belief in that State of Law on the part of society. That is where I see a great challenge for Greece!

    • @Klaus Kastner

      I think your last paragraph perfectly encapsulates all that needs to be said.

      This is the be-all and end-all of Greece’s salvation.

  26. excellent article Mr Varoufakis! having read all your previous articles, I have only one question to make: if Europe leaves Greece to default like you propose for months, wouldn’t this be equally catastrophic for EU cohesion just like the existing policy through bailouts??? I mean, if Greece will default, this doesn’t mean that in the very next day markets will attack to the next victim, eg Portugal or even Italy??? wouldn’t that be very costly for Europe??? something like a ”european defeat”??? thanks

    • No I do not think so. Markets have already factored in Greece’s effective default. They are not blind. They see that Greece is bankrupt. By loaning Greece huge sums that Greece cannot repay, markets are given a grand opportunity to keep betting on when that default will be allowed to take place officially. None of this does anything to stop the contagion to other eurozone countries. The only thing that did this (and led to the fall of spreads) was the ECB’s LTRO. But that would have worked even better had Greece been allowed to call a spade a spade…

  27. Hi, Yanis:
    Very good reasoning! In my opinion there is a very simple concept to explain the apparent paradox of the people you mention: lack of integrity.
    Best wishes!

  28. Pingback: Irish Left Review · Too Close for Comfort

  29. Oh look! Irish government to hold a referendum on European fiscal pact! What on earth are you doing Ireland?? Allowing democracy to prevail?! Gray the German is going to be reaaallly pissed!

    • Not at all. This may be the last straw that stops this bailout kabuki theatre and pushes Greece into default. Without fiscal responsibility in the Eurozone, there won’t be any more German credits. You can’t expect us to pay for nations who refuse to agree to reasonable guidelines for a nation’s public finances. It will be good to have the burden of the bailout from our backs. After us, the deluge! Into the boats then, everybody’s to himself, and may god help us all.

      Btw, as a good democrat, I was generally supportive for the Papadreou idea of a referendum. But imho he had waited much too long before coming up with that. His timing, and the way he presented the idea, was simply lousy, and the other European governments couldn’t reasonably support that at this time as it would have seriously disrupted (=stalled for months) the progress of the negotiations. Btw, I don’t remember huge support for Papandreou after the proposal. Didn’t look like anybody in Greek parliament stomped for allowing the citizens to make that decision.

      But how about a German referendum on the bailout credits? 62% of the folks here are against any more money for Greece. Despite that, German parliament overwhelmingly voted for the next tranche, out of a mixture of European solidarity and fear of the consequences of a Greek default for the EU economy, but they can’t act against their constituency for much longer. There will be national elections in 2013, and it sure doesn’t look as if there is any real progress in Greece. This is the last chance for the Athens government to finally produce some good news, and I’m certain they’ll screw it up again. Maybe the elections will make a change, but I don’t really see where the necessary crisis managers that are needed at the helm now shall come from. The divisions and delusional thinking of the left wing doesn’t really inspire hope.

    • I wouldn’t hold that as any kind of true expression of democracy but on the other hand it’s better than what we get elsewhere.
      The Irish were fucked into submission and contrary to their traditions accepted the pillage of their country in favor of the banks with little or no resistance. It’s too late for them to prove they are still virgins.

    • Grey, there will lots of more German guarantees. The politicians will hold on to their EU dream untilit collapses.

      Most Germans I know will vote for radical parties in the next elections. Just liek in Greece. – The EURO will bring peace and prosperity for Europe. – What a wrong assumption that was!

    • Pedro, you seem to think that Germany is kind of a banana republic where the opinion of the voters is totally irrelevant. Well, those same voters just pushed the president of the nation into early retirement, because of an appearance (! nothing proven yet) of corruption. Well, this supports my view that you shouldn’t underestimate the power of the people. Our politicians, like those in most other democratic nations, read the polls. And they know they can’t act against the wishes of their constituency forever. So, if there isn’t a change for the better in Greece soon (so far, there isn’t any serious evidence for that), there won’t be another tranche of the bailout. German voters are not likely to accept being saddled with more and more credits to support Greece, year after year, only to get insults and more demands in return. It should be obvious that solidarity has limits, and that a bottomless pit can never be popular.

  30. Allow me to say, this is one of the best posts I have read in a long while. Please carry on exposing hypocrisy on behalf of us all!

  31. Dear Prof.

    as the humblest and least of the Greek ‘neoliberals’, and one unlikely to ever join you in the rarefied air of the panels you spar on, I should like to inform you that some of us are aware of the contradiction http://lolgreece.blogspot.com/2011/06/conscience-of-libertarian.html

    and indeed have called for bank liquidations and bail-ins as the solution: http://lolgreece.blogspot.com/2011/03/we-no-does-modesty-at-lolgreece.html

    And indeed examined how the Greek bond bubble built up and what perverse incentives on the part of the banks contributed to this:

    http://lolgreece.blogspot.com/2011/12/lolgreece-christmas-carol.html

    You forget, perhaps too conveniently, that libertarianism is a great fig leaf for corporatism and that we’re forced to share many platforms with people we don’t agree with. Perhaps the real problem lies in the way the panels you’re on are selected.

  32. I should be in Frankfurt more often. I was always wondering why the ECB accepts Greek bonds as collateral. But today, thanks to S&P, the stopped doing just that :-)

  33. Excellent piece. Always a pleasure to read yours posts.

    Just add a famous Hayek quote:

    “the curious task of economics is to demonstrate to men (eurocrats & euro leaders?) how little they really know about what they imagine they can design” (p.76 The Fatal Conceit)

    and to be very irritating, re-title Hayek’s book warning of the dangers of tyranny to “EuroZone: The Road to Serfdom”

  34. not believing Keynes is like not believing in the moon; the latter influences the tides, the waves, floods even. since economics is all about waves, be in short term or long term, somehow we need protection, we need to topple the big ones and harness the huge ones.

    people, say, American people not believing in Keyens have a tendacy believing in God, let me refrase that: in God and firearms. how sick is that: believing in an old man with a beard yyet without genitals, somehow preordaining this world, yet fond of shooting your fellow man. pledging to help the poor, yet without government to put in place some social safety net, let alone the economic framework making economics work the way it should: without too many big waves, with some more social equallity.

  35. Yani:

    Two observations. Whether it’s Hayek or Von Mises and the Austrian School Of Economics the result is the same. Such policies can not be labeled neoliberal; rather neoconservative to accurately pin point the ideological foundation of such approaches.

    The so called “solutions” spun by the Merkeloids are identical to the self serving policies of US Republicans (a group with direct lineage to British Crown loyalists which went through the American Revolution as collaborators to the enemy and by allowing other Americans to risk life and property, while preserving their own).

    Therefore I suggest we call these economic policies, neocon so that they ideologically rhyme with the political class spawning them.

    Secondly, I believe that your own bias against “banksters” is not serving you well at all. Since it is precisely such populist notions that have allowed German production of nonsense on an industrial scale. This is the bait and switch of the entire German approach. Bait you with a misdirected mistrust of a banking system (which lead to the German crash of 1929) and then eat your lunch by infecting you with this intellectual virus and turning you into a carrier of aiding and abating the German game.

    Let’s make it abundantly clear once and for all: there are two types of banks: Greek banks and all other banks. If it gives you pleasure to attack banks as a hobby then concentrate on all other banks versus the few left as an integral part of the Greek economy. By attacking Greek banks at this stage you are destroying the whole foundation of recovery in Greece and by doing so you are a collaborator of this exogenous effort to harm Greece. After all, there are thousands upon thousands of foreign banks to go after to satisfy your lust for retribution. Can I keep the 3 Greek banks left out of this undeserved witch hunt and if need be I can explain latter why?

    • After your usual rants against Germany, that last paragraph actually made at least some sense to me. Indeed, no modern economy can compete under the harsh conditions of globalization without some kind of a financial sector. Barter trade on a national scale is just wishful thinking in the 21st century. There have to be some banks, preferrably of the traditional type that serves the industry and the savers, but doesn’t engage in risky speculations. And in case of a Greek default, saving some banks, to assure the flow of money in the economy, will be a major challenge.

      However, in defense of Prof Varoufakis (what a crazy world, but, damn, truth shall prevail), I have to say that news like the reports about the Proton bank / Lavrentiadis crookery make it a very difficult and unrewarding endeavour to defend the Greek banking system. It should be saved, of course, but it has to be reformed from the bottom up. So, yes to banking in general, but no false tolerance for the bankers!

    • Gray:

      So, there are not all shades of gray with you?

      There is actually some hope that sunlight can penetrate through?

      That’s very encouraging. Unexpected for Deutschland weather conditions but very encouraging. :-)

      Let me ask you this simple question:

      Other than:

      a. artificially lowering the euro value for export purposes (via continuous and unending fabricated mini-crises a la Germania).
      b. draining the entire European system of liquidity through flight of capital into geriatric Bunds( for circa 1% returns)

      is there any other brilliance to the German game I missed?

      So, your Northern recipe is: Germany wins and everybody else loses?

      Oh, and I forgot. You want my business plan for saving Greece ASAP because Sarkozy is about to lose his marbles in Frankreich elections, so we only have about one month left and the whole matter is now of the outmost urgency?

  36. Come gather ’round people
    Wherever you roam
    And admit that the waters
    Around you have grown
    And accept it that soon
    You’ll be drenched to the bone
    If your time to you
    Is worth savin’
    Then you better start swimmin’
    Or you’ll sink like a stone
    For the times they are a-changin’.

    Come writers and critics
    Who prophesize with your pen
    And keep your eyes wide
    The chance won’t come again
    And don’t speak too soon
    For the wheel’s still in spin
    And there’s no tellin’ who
    That it’s namin’
    For the loser now
    Will be later to win
    For the times they are a-changin’.

    Come senators, congressmen
    Please heed the call
    Don’t stand in the doorway
    Don’t block up the hall
    For he that gets hurt
    Will be he who has stalled
    There’s a battle outside
    And it is ragin’
    It’ll soon shake your windows
    And rattle your walls
    For the times they are a-changin’.

    Come mothers and fathers
    Throughout the land
    And don’t criticize
    What you can’t understand
    Your sons and your daughters
    Are beyond your command
    Your old road is
    Rapidly agin’
    Please get out of the new one
    If you can’t lend your hand
    For the times they are a-changin’.

    The line it is drawn
    The curse it is cast
    The slow one now
    Will later be fast
    As the present now
    Will later be past
    The order is
    Rapidly fadin’
    And the first one now
    Will later be last
    For the times they are a-changin’.

    Bob Dylan The Times They Are A-Changin’

  37. The look at Hayek’s and Keynes’ analyses and proscriptions for the 1929 crash is interesting but not very relevant to the current situation. We now live in a very different monetary world where debt-based fiat currencies have swallowed up virtually the entire money stock (approaching 97 to 98%). The only solution to the current systemic problem is a radical sift in the monetary system to a sustainable debt-free basis – a surprisingly easy process to enact if politics could be weaned off the the poisonous direction offered by the financial leaches currently running to show.

  38. What you economists time after time seem to ignore is the fact that the credit expansion boom is founded on criminal behaviour. And thr elite criminals will pick and choose economists and parts of economic theory which suits them. As long as the criminal elite is in control you can post humble proposals all you like, they will only allow what makes and keeps them rich and in control.

  39. To debate about the difference between Hayek and John Maynard Keynes is to miss the point entirely. All any of you are saying is that; on the one hand there is a need to commit to the rapid write-off of the overhanging government/banking system debt; and on the other, that draconian reduction of employment of the people quickly becomes an unworkable solution.

    Yet, the one aspect of the debate remains precluded from discussion; the regeneration of ordinary job creation; as I see it for the very simple reason that in a world of gigantic feudal mercantile or feudal government enterprise; there are now so few with real world experience of real, honest, private sector, free enterprise job creation; particularly right down at the grass roots of your respective nations.

    Which is precisely why I have proposed that the debt is, instead of being written off, (which seems to be an impossible solution to the leaders of the banking system and their governments); it is instead converted into vanishing bonds to be used as free enterprise equity capital for capitalisation of new, small, private sector, free enterprise job creation; right down at the grass roots of any nation so affected.

    That the solution is to reduce the overhanging debt by transferring the value back into new job creation, which in turn becomes new business banking deposits. Debt thus becomes risk capital banking system deposits; moreover, deposits that can only occur through the process of new private sector job creation.

    Yanis on the other hand, believes that the only solution is through the use of the European Investment Bank, EIB funding of new employment. My argument against that is that the EIB has no track record of job creation right down at the grass roots. That if it had been successful in the past; none of what has transpired would have occurred in the first place.

    Neither economic model worked; all have their detractors.

    The debate must now be turned towards solutions. Continually debating the reasons for failure does not posit any solution to the now desperate need for new private sector job creation; right down at the grass roots of the affected nations.

  40. Ade bravo! Isn’t it strange, that we rarely read about the “success story” of Iceland, where they did exactly what you said? Let the banks go bust, guarantee a minimum deposit, put bankers even to jail … in essence told all the creditors to f… off?

    And – as a consequence and reward – Iceland has been put back to investment grade recently by Fitch.

    But it must not be, what people must not know. Why do I think of my fellow Germans, sitting on 1,2 life insurance on average, paying thousands of Euros each year in order to have a decent life as a pensioner (because they have been told, state pension would not be sufficient anyway, brave Germans bought into it and make Allianz & Co happy each month). If all (or most of) bad bank (and insurance) debt is written off – then all of a sudden, we will see a new poorhouse in Europe arise. And it will not be Greece, Spain, Portugal. It will be Germany itself. Demografics are brutally clear. Plus: Germany has already a true public debt of approximately seven trillion Euros (not the official two), if you encounter the pensions, that need to be paid within a decades period – but for which no money has been put back.

    • @Gaby

      Iceland (and Ireland) are not really comparable cases. You have two countries that had relatively healthy economies and in both cases the banking sector ran amuck, creating liabilities many times higher than GDP (In Iceland due to exposure to foreign risk and Ireland with a real estate bubble).

      In Greece you have a corrupt state that ran amuck creating a “public sector bubble”, granted with the tacit cooperation of the international banking sector. The problems are different and in Greece’s case far more difficult to solve. See Klaus Kastner’s comment above, especially the last paragraph…

    • Gaby, those are reasonable points, but don’t forget that all pension systems essentially rely on future economic activity to provide the means to pay for those who retire! Doesn’t matter if the pensions are paid through taxes or capital investment, someone has to do productive work to support the elderly. And Germany isn’t alone with it’s demographic problem, it’s more or less the same in alll industrialized nations. So, in a worst case scenario, when all of Europe falls into even deeper recession, we won’t be alone in the poorhouse.

      Which is why there should be much more discussion about how to create a new retirement system that accomplishes the task in a sound, responsible and socially fair way. And we really shouldn’t fool ourselves: Population growth ain’t a sustainable solution on a planet that already suffers under the impact of 7 billion human beings!

  41. Great analysis. I either never realised or had forgotten the sense there is to be had from Hayek; clearly the obfuscation you refer to has something to do with this.
    This “silence of the dog” on _particular_ kinds of debts – those of financial institutions – is the most revolting and obviously unjust aspect of what’s been going on since Northern Rock (or even before).
    You’re on the same bench as Michael Hudson in your conclusion.

  42. Yanis, It’ a mistake to think of present-day libertarianism (aka neo-liberalism) as an honest economic theory which is based on reality and experience.
    It is not. Hayek’s thinking may have been sincere at his time, but not the current adaptation by his neo-liberal followers. It’s a theory of convenience that suites the banks and other powerful actors to perpetrate economic violence and pretend it’s necessary and natural. The libertarian gurus including their Greek adherents are far from truthful.

    George

    • You will not find many libertarians among bankers. If you read Hayek you will find that his thinking is very beneficial for the people, not for banks.

  43. Article from La Tribune:
    Draghi buries European social model
    27 February 2012 La Tribune Paris

    At a time when the ECB is preparing to write a further €500 billion cheque for the banks, the ECB President has declared that over-indebted countries will have no option but to implement draconian austerity policies if they are to overcome the crisis.
    “The European social model has already gone”. Never has a central banker spoken with such brutality about the ongoing crisis. The remarks made by Italian Mario Draghi who has succeeded Jean-Claude Trichet at the head of the ECB, in a long interview with the Wall Street Journal on Friday 24 February, are so overwhelming in their implications that they probably could not have been published elsewhere than in the newspaper revered as the “bible” of global finance. Even Jean-Claude Trichet chose his words more carefully when attempting to explain what the future holds for the peoples of Europe.

    For Mario Draghi, a former Goldman Sachs banker who now commands the fate of Europe’s single currency, the bid to save the euro will come at a high cost. Specifically, there will be “no escape” from tough austerity measures in all of the over-indebted countries; and this will necessarily involve giving up a social model based on job security and generous safety nets.

    The model that provided the basis for European prosperity since the Second World War “has gone,” argues Mario Draghi who reminds the WSJ journalist that the situation described in the famous quote from German economist Rudi Dornbusch – “the Europeans are so rich they can afford to pay everybody for not working” – no longer applies.

    The ECB President’s remarks could be construed as provocative at a time when the European Central Bank is about to write a further €500 billion cheque for the banks, which, on Wednesday 29 February, will be offered unlimited credit as part of a further scheme to save the euro. In the light of such statements, how can he expect to face down increasingly vocal criticism of measures that sacrifice populations in order to save financial institutions?

    However, the argument put forward Mario Draghi is incontrovertible: any “backtracking on fiscal targets [for debt reduction] would elicit an immediate reaction by the market” that would push up interest rates for sovereign states, making it even more difficult, or even impossible for them to clean up their books. This is what happened in Greece, and what almost happened in Portugal, Spain, and Italy.

    An immediate and unflinching clean-up
    We should also bear in mind that Mario Draghi’s remarks are obviously linked to the electoral schedule in Europe: in April in Greece, in May in France, and in the spring of 2013 in Italy, voters will be called on to choose their destiny. In explaining, like a modern-day Margaret Thatcher, that regardless of the outcome of these votes, new governments will have no alternative but to adopt stringent austerity policies, push through structural labour market reforms and further dismantle welfare systems, the ECB President aims to put an end to any ambiguity.

    He further refuses to be swayed by any assertion that the current calm on the markets indicates that the crisis is over. Proof that this is not the case will be evident on Wednesday 29 February, when the banks will seek to obtain the ECB support without which the financial system would no longer be sustainable. Without cash injections from central banks – in the form of quantitative easing (QE) and a federal funds rate that is close to zero in the US, and the ECB’s Long Term Refinancing Operation (LTRO) in Europe – the entire financial system would collapse. Even China has been forced to bailout beleaguered banks. Welcome to the cruel realities of the new “QE world.”

    In adopting this harsh position, Mario Draghi intends to raise awareness of the fact that it is in our interest to accept an immediate and unflinching clean-up of balance sheets and the structural reforms required to restore market confidence rather than to embark on another decade fraught with the terrible pressure that results from the absence of that confidence. This is the strategy that has been adopted by Mario Monti, which has proved to be highly successful. In less than 100 days, the former Goldman Sachs advisor has permanently changed the face of Italy, which he has steered out of the eye of the storm. Other countries would do well to follow his example.

    • Draghi ain’t a magician. There’s increasing evidence that the stabilization is only accomplished by essentially the ECB stepping in for private investors. It’s under the radar quantitative easing which only increases the imbalance between the north and the South. And eventually all that excessive money will spill over into the real economy, and all Eurozone citizen will have to pay for it through higher inflation. Also, this doesn’t work as an ersatz for improving the competitiveness of the GIPS economies, and here’s hoping this won’t reduce the pressure on the governments to modernize their states!

      So, less naive cheerleading for Draghi, and a more reasonable approach towards his actions, please! Especially in the light of his connection with Goldman Sachs, which aren’t known for their concerns about the problems of ordinary people, but only for their successful endeavours to make rich bankers and investors even richer.

  44. Initially I’d like to say that I’ve never met a single person that self identifies as a neoliberal.
    Its ambiguous definition on the different sides of the Atlantic has led to a more popular term,that of libertarian. I’m certain I know the people you are referring to, and your explanation is with a high probability true.But you fail to mention a part of the libertarian movement here in Greece that is against bailouts(see former MP Andrianopoulos,or this group http://www.blemilo.com/2012/02/blog-post_12.html) and in favor of bail-ins for banks.

    Yet public debt is the symptom, not the disease.It is true that there is positive feedback between the symptom and the disease, but treating the symptom will fail to cure the real disease, our twin deficits.The libertarian approach is probably the only approach that can turn things around,taking into consideration of course that no parliamentary party has provided any sort of coherent strategy(that doesn’t rely on handouts) to get us out of this mess.

    ps:This blog post http://lolgreece.blogspot.com/2012/02/trade-deficit-data-win-part-i.html pretty much disproves the claim that Germany ran higher trade surpluses with Greece since the introduction of the Euro.Any thoughts?

    • The reason you’ve never met anyone who self identifies as “neoliberal” is because in the 20+ years I’ve seen and heard the term used, it has always referred to a theory of political economy, not persons. That said, there are plenty neoliberals around as you can deduce from the article I posted on Draghi’s approach to labor and markets.

    • @logician, in fairness my figures only suggest that Germany’s dependence on Greece as a trading partner (our share of their total exports) fell while we’ve been in the Euro – our deficit with Germany did grow during this time, although it’s been falling rapidly ever since austerity took hold.

  45. Why didn’t Hayek and Robbins call for counter-deflationary measures?

    Hayek and Robbins can be seriously faulted for failing to take their own policy norm seriously: they failed to call for central banks to do what they could to counter the sharp monetary contraction and crushing deflation during 1930-33. Each later faulted himself. In a 1975 talk Hayek noted that “the inherent instability of credit” could turn a recession with extensive unemployment into a self-feeding deflationary contraction. He then commented (Hayek 1975, p. 5):
    “I am the last to deny – or rather, I am today the last to deny – that,in these circumstances, monetary counteractions, deliberate attempts to maintain the money stream, are appropriate.I probably ought to add a word of explanation: I have to admit that I took a different attitude forty years ago, at the beginning of the Great Depression. At that time I believed that a process of deflation of some short duration might break the rigidity of wages which I thought was incompatible with a functioning economy. Perhaps I should have even then understood that this possibility no longer existed. … I would no longer maintain, as I did in the early ‘30s, that for this reason, and for this reason only, a short period of deflation might be desirable. Today I believe that deflation has no recognizable function whatever, and that there is no justification for supporting or permitting a process of deflation.

    Hayek went on (pp. 12, 13) – in response to questions from Gottfried Haberler about whether more could have been done to prevent deflation in the 1930s – to reiterate his support for the norm of stabilizing nominal income, and to point out that this had always been his theoretical policy norm:

    “The moment there is any sign that the total income stream may actually shrink, I should certainly not only try everything in my power to prevent it from dwindling, but I should announce beforehand that I would do so in the event the problem arose.… You ask whether I have changed my opinion about combating secondary deflation. I do not have to change my theoretical views.

    As I explained before, I have always thought that deflation had no economic function; but I did once believe, and no longer do, that it was desirable because it could break the growing rigidity of wage rates. Even at that time I regarded this view as a political consideration; I did not think that deflation improved the adjustment mechanism of the market.”

    LAWRENCE H. WHITE
    Did Hayek and Robbins Deepen the Great Depression?

    • So your point is – what? That Hayek realized in 1975 what a fool he had been in 1930?

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