I have set about lately to read the work of some of the key inspirations for the Post Keynesian school of economic thinking. In that vein, you may recall my appreciation for Debunking Economics by Steve Keen as a recent example from this group.
First up is Irving Fisher. He was the standard neoclassical economist until the crash of 1929 nearly wiped him out. In fact, he was quoted in the newspapers as saying that the market was at a "permanently high plateau" just three days before the crash. All of which got him to re-think his stance. The results of that pondering are summarized well in the two works that I read: Booms and Depressions (1932) and The Debt-Deflation Theory of Great Depressions (1933).
The former lists out 9 factors that contribute to the tendency towards booms and busts in a market economy. The latter focuses on a sub-set of the two most important elements: over-indebtedness and deflation. The general sequence is that debt liquidation leads to distressed selling, which leads to loans getting paid off and a declining velocity of money, which begets a deflation in prices, lowering of net worth, a fall in profits, and thus a reduction in output, causing a loss of confidence, hoarding of money, a still greater decline in the velocity of money, and then disturbances in interest rates. Generally, when the overindebtedness is great enough, the liquidation does not keep up with the fall in prices, and the cycle feeds on itself and can go on for years. It very much resembles the spiral down that Keynes describes in The General Theory.
The way to deal with this debt-deflation scenario is an effort to reflate and stabilize prices. But, Fisher is more monetarist than Keynesian, so he focuses on the MV=PT driven approach, which means monetary versus fiscal policy. And while he seems to understand how inflation is problematic, his preference to maintain price stability over time is not a gold standard, but some technocratic commission of experts to inflate and deflate as circumstances dictate. I think we have first hand evidence lately of how well those technocrats perform.
The obvious question is how he thinks everything gets out of whack from the start -- that is, what drives everyone to lever up in the first place? His answer: new investment opportunities. In other words, it is innovation and technology that get everyone all revved up to speculate on projects with dreams of huge returns. I think the problem of "hope" certainly contributes, but the idea that easy money doesn't play an even bigger role just strikes me as willful blindness. To his credit, Fisher does seem to understand the idea of uncertainty and how markets never attain equilibrium. Nevertheless, while his type get it more clearly than the typical neoclassical Keynesian, I still think there is a choice to overlook what is blatant when it comes to the Federal Reserve and managing interest rates and the money supply.
