Don Boudreaux from Cafe Hayek riffs off a discussion on Hayek’s views on macroeconomics to discuss “liquidationism”. At the end of his post he makes the following statement:
Most people understand that a proper and useful Chapter 7 bankruptcy proceeding involves the liquidation of the firm’s assets. And they understand that, for the larger economy (if not for the owners, creditors, and workers and other suppliers of the firm) such liquidation is good. Delaying it is harmful.
So why do so many people fail to extend this understanding to the larger economy? If a particular firm can be a collection of mal-invested assets – a production plan that must be abandoned – capital goods, inventories, contracts, workers’ skills that are wasteful as currently fitted together – why cannot the same be true for many firms? At what point do we conclude that inadequate aggregate demand necessarily is the cause of too many businesses operating at full capacity to be unprofitable? Why is it so contemptible to point out at least the possibility that the economy currently has an unusually large amount of assets devoted to production plans that are not all sustainable over time? Why is it, therefore, so unacceptable to suggest at least the possibility that an unusually large number of existing incarnations of production plans (firms, parts of firms, perhaps whole industries) be liquidated?
The problem with allowing a large amount of firms or whole industries to liquidate at once is the economic shock that would ripple through the economy.
If you accept the premise of their argument, that firms need to fail after a period of mal-investment, then what the Austrians fail to see is it would be far better for the economy to have these firms fail over a period of time. Thus the worst firms would fail no matter how low the Fed sets interest rates, then as the Fed raises rates, the “stronger” weak firms would begin to fail and finally when rates are back to the “normal trend”, all the mal-invested firms would have failed, and the mal-investment would have been purged from the system.
Except unlike what Hayek and other Austrians proposed, this wouldn’t occur all at once, but over a period of time to allow the economy to adjust better.
How can the Austrians fail to at least consider the possibility that this is better than mass liquidation?
PS: Yes, I’m purposely ignoring the Austrian claims of mal-investment that would occur during the low interest rates, because frankly that argument against monetary easing never seemed very strong. Perhaps another post for another time.