Irving Fisher would have supported QE
byIf you haven’t already read Fisher’s 1933 article “The Debt-Deflation Theory of Great Depressions,” read it today. It contains his theory of booms and busts that later inspired Hyman Minsky to develop the Financial Instability Hypothesis (HM duly acknowledged his debt to Fisher in his 1986 book). Fisher’s article is unfortunately becoming more relevant by the day.
Fisher notes that the two dominant factors in all great booms and depressions are over-indebtedness and deflation. Over-investment and over-speculation with borrowed money are at the heart of the crisis. Once in a crisis, it is very hard to get out again, especially when prices start to fall (deflation). The typical reaction is to liquidate positions and repay debt. But when this becomes a generalized response to the crisis “the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe.” (p. 344)
But, according to Fisher, it need not be this way: “it is always economically possible to stop or prevent a depression simply by reflating the price level up to the average level at which outstanding debts were contracted … and then maintaining that level unchanged.” (p. 346). He notes that since the crisis is man-made, we should not leave the solution of the crisis to nature (i.e. through bankruptcies). However, “if our rulers should still insist on leaving recovery to nature and should still refuse to inflate in any way, or vainly try to balance the budget or discharge more government employees, they would soon cease to be our rulers. For we would have insolvency of our national government itself, and probably some form of political revolution without waiting for the next legal elections.” (p. 347)
Fisher was so concerned about the economic situation at the time that he even wrote a letter to President Roosevelt stating his views on what should be done to get out of the crisis: “I think balancing the budget is impossible for the present and that the effort to do so has defeated itself, being deflationary. Some have done grave harm by spreading the idea that balancing the budget is a magic formula for getting out of the depression. Balancing the budget can be readily done as soon as reflation comes.”
“The kernel of it all is that since the stock market crash we had (1) over-indebtedness, (2) consequent distress selling to try to get out of debt, (3) consequent falling prices, deflation or a swelling dollar, (4) consequently an increase in the real debt. The idea that we already are “nearly through” is wrong, we have not made any net progress whatever but our flounderings to get out of the debt bog has only sunk us deeper and deeper in terms of real things.”
“If my diagnosis is correct, it seems to me we are still in danger of going down into an almost bottomless abyss unless either there is a thorough-going debt (down-) scaling or a thorough-going and purposive rise in the price level.”
Anyone want to say history doesn’t repeat itself?