By “Secondary Deflation” We Mean that the Deflation Is INDUCED by the Maladjustment in the Structure of Production

The theory of the depression is not nearly so fully elaborated by the authors of the monetary over-investment school as the theory of the boom. The depression was originally conceived of by them as a process of adjustment of the structure of production, and was explained in non-monetary terms. During the boom, they argued, the process of production is unduly elongated. This elongation has accordingly to be removed and the structure of production has to be shortened or, alternatively, expenditure on consumers’ goods must be reduced (by retrenchment of wages and other incomes which are likely to be spent wholly or mainly on consumers’ goods) sufficiently to make the new structure of production possible. Workers are thrown out of work in the higher stages, and it takes time to absorb them in the lower stages of production. In modern times especially, with inflexible wage systems and the various other obstructions represented by all kinds of State intervention, this process of shifting labour and other means of production is drawn out much longer than is necessary for purely technological reasons.

This non-monetary explanation of the depression is, however, admittedly incomplete and unsatisfactory. The majority of the authors of the group under review were at first very reluctant to recognise that there is a cumulative process of contraction corresponding to the cumulative process of expansion. But eventually it was admitted that, in addition to the difficulties which must arise from the fact that the structure of production does not correspond to the flow of money (in other words, the disturbances which result from the deflection of the money stream from the higher to the lower stages of production), there must be a deflation—that is, a shrinkage in the aggregate flow of money. The difficulties which result from this general shrinkage in the flow of money are super-imposed on the disturbances involved in the necessary readjustment in the structure of production. Without assuming a general deflation, it is impossible to explain why the depression spreads to all stages and branches of industry, why it is not confined only to those industries which are over-developed and must therefore eventually contract (the higher stages), but extends also to those which are under-developed and must therefore eventually expand (the lower stages). It has become customary to speak of “secondary deflation,” by which it is intended to convey that the deflation does not come about independently, but is induced by the maladjustment in the structure of production which has led to the breakdown. Without the latter, it is believed, the deflation would not start at all.

—Gottfried Haberler, Prosperity and Depression: A Theoretical Analysis of Cyclical Movements, 3rd ed. (1943; repr., Lake Success, NY: United Nations, 1946), 57-58.