Fritz Machlup · 1937
Fritz Machlup’s conference contribution examines whether a boom can be identified, whether economists understand how to control it, and whether effective measures can be implemented. He distinguishes theoretical possibilities from institutional constraints: slowing monetary expansion may moderate a subsequent downturn without preventing it, while government deficits and central-bank support for government bonds can obstruct even this limited control.
The first difficulty is diagnostic:
Do we know what a boom is and can we clearly identify a given situation as a boom?
Machlup challenges definitions that distinguish healthy recovery from unhealthy expansion only after their consequences become apparent:
Of course, if you call "boom" the period leading to a collapse, then you can't control a boom, because if you can control it so that no collapse follows, then it is no boom.
Such retrospective classification makes preventive policy conceptually impossible. Machlup instead identifies a boom through a spectacular rise in business activity, whether concentrated in particular sectors or spread throughout the economy. This criterion requires judgment but permits assessment before a collapse. Crucially, it encompasses rising output as well as rising prices. Stable commodity prices do not establish that expansion is sustainable: technical improvements and declining production costs can mask the effects of monetary expansion while production, credit, construction, and transactions increase rapidly.
Machlup distinguishes theories attributing collapse to correctable institutional defects or policy mistakes from theories finding instability within excessive expansion itself. He places his own argument in the latter group:
A smaller group of economists—I am among them—extend the skepticism to the boom in business volume because they doubt that a very quick growth can be free from disproportionalities and maladjustments.
The central question is why bringing unemployed workers and idle machinery back into production might generate instability. Machlup contrasts re-employment through lower production costs with re-employment through credit-financed demand. He regards wage-cost reductions as less likely to produce maladjustment, while recognizing resistance to them. His distinction between wage rates and aggregate labor income matters here: lower rates need not imply lower total earnings if employment and working hours increase.
Credit-financed expansion creates a cumulative interaction between investment and consumption. Borrowing finances producers’ goods; payments to workers and other factors of production increase purchasing power; the resulting consumption encourages further investment. The accelerator magnifies these effects. In Machlup’s locomotive example, a 10 percent increase in traffic raises annual orders from fifty replacement units to one hundred and fifty. Maintaining the higher investment level therefore requires not merely sustained consumer demand but continuing growth in that demand. When investment slows, consumption grows less rapidly, inducing further investment reductions and contraction in producers’ goods industries.
Machlup presents this mechanism as one possible explanation of reversal, alongside shortages of liquid capital and rising interest and production costs. He rejects the prospect of sustaining expansion indefinitely through central-bank accommodation or credit-financed public works. These measures may postpone contraction, but continued boom-level investment requires further monetary expansion. Once expansion slows, changes in the distribution of demand expose disproportions accumulated during the upswing.
The resulting case for control is limited. Monetary expansion exceeding the counteracting effects of hoarding can misdirect production even when undertaken cautiously. Nevertheless, slower expansion may reduce forecasting errors and restrain the excessive optimism encouraged by rapid growth. Control means moderating the severity of a setback, not guaranteeing its elimination.
The final section applies this reasoning to American monetary conditions since 1933. Machlup identifies government borrowing, gold inflows, business borrowing, and increased use of liquid balances as sources of expanding circulation. Gold sterilization and higher reserve requirements address only parts of this process. Reserve requirements cannot effectively restrain expansion if reserves continue to increase, while faster deposit turnover may call for offsetting Federal Reserve security sales.
These technical possibilities confront an institutional conflict: purchases supporting government bond prices also replenish bank reserves and weaken credit restraint. Diagnosis is therefore necessary but insufficient. Even an identifiable boom and a defensible policy of moderation do not ensure implementation when fiscal borrowing and bond-market support work against monetary restraint. Machlup joins a theory of investment instability to an analysis of the commitments that limit preventive policy.
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