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Knut Wicksell's classic Interest and Prices was written, as is well known, under the influence of the so-called great depression of 1873-96, when prices fell continuously (30 percent over a span of twenty-three years) with no significant negative effects on output. During the early 1920s, a much shorter and intense deflation1 took place in the United States, Great Britain, Sweden, and other countries, this time with strong effects on aggregate activity. As Wicksell ([1925b] 1936, 211) put it, "This severe deflation, in which many countries . . . were gradually involved, is undoubtedly a unique phenomenon in monetary history." The present article examines Wicksell's interpretation of the deflationary episode of 1920-22 and some of his other contributions to the debate on monetary policy that followed the First World War, as documented in his statements to monetary committees, several papers in the Swedish press, and unpublished manuscripts.
The distinctive characteristic of Wicksell's approach vis-a-vis his contemporaries' is the assumption that a previously announced deflationary policy has no real effects, since it would be taken into account in all economic contracts. The mild effects of the long 1873-96 deflation, together with the possibility of carrying out an announced monetary policy, are behind his suggestion-put forward between 1918 and 1920-that it would be feasible to bring prices gradually back to the prewar level in order to correct the massive wealth transfer caused by inflation during the First War. When prices started to fall swiftly in the second half of 1920, with the ensuing sharp depression in activity, both Gustav Cassel (1922a) and J. M. Keynes (1923) argued against the notion of an announced gradual deflation. According to Cassel, a gradual planned deflation is impossible, since economic agents would postpone spending and precipitate a violent price fall. Keynes, on the other hand, suggested that, because of the time interval between incurring production costs and receipts from sale, a downward expected price level movement would necessarily bring about losses for traders and producers. Keynes's point, however, is based on a confusion between accounting (or nominal) losses and economic (or real) losses, which he apparently did not realize. (Wicksell sometimes made the mistake, particularly before 1920.) Cassel's criticism, although he did not seem to be fully aware himself, relates to a...