John Eatwell, Murray Milgate, and Peter Newman, eds.
The New Palgrave: A Dictionary of Economics
London: Macmillan Press Ltd., 1987, pp. 609-614
Friedrich August von Hayek
by Roger W. Garrison and Israel Kirzner
Friedrich August von Hayek (1899- ), a central figure in twentieth-century
economics and foremost representative of the Austrian tradition, 1974 Nobel
laureate in Economics, a prolific author not only in the field of economics
but also in the fields of political philosophy, psychology, and epistemology,
was born in Vienna, Austria on May 8, 1899. Following military service
as an artillery officer in World War I, Hayek entered the University of
Vienna, where he attended the lectures of Friedrich von Wieser and Othmar
Spann and obtained doctorates in law and political science. After spending
a year in New York (1923-24), Hayek returned to Vienna where he joined
the famous Privatseminar conducted by Ludwig von Mises. In 1927 Hayek became
the first director of the Austrian Institute for Business Cycle Research.
On an invitation from Lionel Robbins, he lectured at the London School
of Economics in 1931 and subsequently accepted the Tooke Chair. Hayek soon
came to be a vigorous participant in the debates that raged in England
during the 1930s concerning monetary, capital, and business-cycle theories
and was a major figure in the celebrated controversies with John Maynard
Keynes, Piero Sraffa, and Frank H. Knight.
During the late 1930s and
early 1940s Hayek's research focused on the role of knowledge and discovery
in market processes, and on the methodological underpinnings of the Austrian
tradition, particularly subjectivism and methodological individualism.
His contributions in these areas were an outgrowth of his participation
in the debate over the possibility of economic calculation under socialism.
In 1950 Hayek moved to the
United States joining the Committee on Social Thought at the University
of Chicago. His research there engaged the broader concerns of social,
political and legal philosophy. He returned to Europe in 1962 with appointments
at the University of Freiburg, West Germany, and then (1969) at the University
of Salzburg, Austria. Since 1977 Hayek has resided in Freiburg.
Hayek's scholarly output
spans more than six decades. Still growing in the mid 1980s, his bibliography
(Gray, 1984) includes eighteen books, twenty-five pamphlets, sixteen books
edited or introduced, and two hundred thirty-five articles. Although these
publications have brought Hayek international renown and honors in several
disciplines, his contributions to other social sciences emerged, to a significant
degree, as extensions of his scholarship in the field of economics and
its methodological foundations. The following survey refers rather narrowly
to the career and contributions of Hayek the economist.
II. Economics as a Coordination Problem
Throughout all of Hayek's writings, both the questions asked and the
answers given reflect his general conception of economics as a coordination
problem (O'Driscoll, 1977). Thoughtful observation of market economies
suggests that they are characterized by order more complex and intricate
than can be explained in terms of deliberate efforts to achieve coordination
among individual activities. According to Hayek (1952, p. 39), it is precisely
the existence of this "spontaneous order" that provides the subject matter
for the science of economics.
While market economies are
better coordinated than can be accounted for by references to deliberate
planning, they are always less than fully coordinated, hence the coordination
problem. In one important sense, coordination failures are an integral
part of an ongoing market process that iterates towards a greater degree
of coordination. An oversupply or undersupply of some particular good,
for instance, is evidence that the plans of producers and consumers of
that good are not well coordinated one with the other. But the discoordination
itself provides both an indication of the inconsistency in plans and the
incentive for producers and consumers to make the appropriate adjustments.
But market economies do
occasionally experience profound economywide coordination failures. Much
of Hayek's research has been aimed, either directly or indirectly, toward
discovering the set of circumstances or, more appropriately, the sequence
of events that could cause such failures, i. e., that could cause an economy
to collapse into economic depression. The focus of his research is intertemporal
discoordination. The coordination of activities over time is inherently
more difficult, more problematic, than the coordination of activities in
a given period. Producers must make decisions now in anticipation of decisions
that other producers and, ultimately, consumers will make sometime in the
future. The fact that production is time consuming, the more so the more
well developed the economy, figures importantly in Hayek's theorizing.
This essential time element increases the likelihood of erroneous investment
decisions and gives scope for cumulative investment errors. A spate of
intertemporally discoordinated investments, whether triggered by a real
or a monetary disturbance, can increase employment opportunities producing
an artificial boom. But the eventual realization of the discoordination
will necessitate a partial liquidation, which constitutes a bust. In this
context, the Austrian theory is differentiated from other macroeconomic
theories by its attention to the problem of intertemporal coordination
the investment sector. The more conventional treatments of macroeconomic
coordination problems focus on the general level of investment in
comparison with the level of saving or the size of the labor force.
Hayek adopted a two-tier
approach to the study of business cycles. Prerequisite to the question
of how an economywide coordination failure could occur is the question
of how any degree of intertemporal coordination can be achieved at all
in market economies. In Hayek's words, "before we explain why people commit
mistakes, we must first explain why they should ever be right" (1937, p.
34). His account first of how a market economy works to coordinate activities
over time and then of what can go wrong draws from several different fields
of study within the science of economics. In particular, it draws in fundamental
ways from price theory, capital theory, and monetary theory.
Each of these fields required
further development before becoming part of Hayek's account. Price theory
had to be recast so as to emphasize the role of the price system as a communications
network and as the most efficient means of making use of economic information.
Capital theory had to be detailed so as to give play to the individual
elements of the capital structure, which is made up of heterogeneous pieces
of capital of various degrees of specificity and durability and related
to one another by various degrees of intertemporal substitutability and
complementarity. And monetary theory had to be extended in scope so as
to allow the identification of systematic relative-price effects associated
with the process of monetary expansion or contraction.
While Hayek contributed
importantly to each of these fields of study, his ultimate achievement
consists in the integration of price theory, capital theory, and monetary
theory. Hayek integrated his own developments in these fields into a cohesive
account of a market process that tends towards intertemporal coordination
and of central-bank policies that can interfere with that process in such
a way as to cause artificial economic booms which are inevitably followed
by economic busts. Hayek's business-cycle theory provided a basis for interpreting
much of nineteenth- and twentieth-century economic history, for evaluating
alternative macroeconomic theories—especially those of John Maynard Keynes,
and for promoting institutional reform of the kind that will prevent or
minimize intertemporal discoordination.
III. Subjectivism and Methodological Individualism
The methodological norms adopted by Hayek are a direct reflection of
his perception of the subject matter: economic phenomena as spontaneous
order. Fundamental institutions in society owe their existence to no identifiable
creator. They are the "results of human action but not of human design."
The most obvious examples of spontaneous order are the use of language
and, among economic phenomena, the use of money. Money, the most commonly
accepted medium of exchange, came to be accepted, commonly accepted, and
then most commonly accepted as a result of a long sequence of actions on
the part of a multitude of individual traders none of whom intended
to create the institution of money. Other economic phenomena—from the simple
division of labor to the more broadly conceived organization of industry—are
to be understood as instances of spontaneous order.
If there were no order in
society except for what was consciously designed, Hayek argued, there would
be no scope and no need for the social sciences. The task of these sciences
in a world characterized by spontaneous order is precisely to account for
those aspects of social order that were not consciously designed. A central
methodological theme that has consistently pervaded Hayek's investigation
of spontaneous order stems from his insistence that it is inappropriate
to apply uncritically the methods of the physical sciences to the phenomena
of the social sciences. Hayek used the term scientism to refer to
the slavish imitation of the methods of the physical sciences without regard
for the innate differences between physical and non-physical reality. Scientism,
which unavoidably overlooks crucial aspects of social reality, such as
perception, intent, and anticipation, was the focus of two long and critical
articles published by Hayek during World War II. In these articles, which
constitute the central core of his 1952 book,
of Science: Studies on the Abuse of Reason, Hayek spelled out the case
for subjectivism and methodological individualism in the social sciences.
"It is probably no exaggeration," according to Hayek, "to say that every
important advance in economic theory during the last hundred years was
a further step in the consistent application of subjectivism" (1952, p.
Classical economists had
focused their attention on the objects being valued and had looked
for common demominators of value in terms of labor input or costs of production.
The Austrian economists, particularly Menger, Mises, and Hayek, are to
be credited with shifting attention from the objects being valued to the
subjects engaged in valuation. The value attributed to the various objects
of economic actions, Hayek emphasized, can be accounted for only with reference
to human purposes and in terms of the views that people hold about those
Hayek's thoroughly subjectivist
outlook and his adherence to the strictures of methodological individualism
were mutually reinforcing. Methodological individualism is not a prescription
of how to engage in economic research but rather a recognition of what
counts as an economic explanation. To explain the undesigned aspects of
a spontaneous order is to trace those aspects to the conciously taken individual
actions that gave rise to that order. In Hayek's own words, "it is the
concepts and the views held by individuals which are directly known to
us and which form the elements from which we must build up, as it were,
the more complex phenomena..."(Hayek, 1952, p. 38).
The contention that Hayek's
crusade against scientism has consistently informed his substantive work
is at least partly in conflict with a recent argument by T. W. Hutchison,
who has sought to establish that Hayek's 1937 article "Economics and Knowledge"
marked a sharp change in his methodology towards a "falsificationist" approach
to economic science (Hutchison, 1981). This argument has been effectively
disputed by John Gray (1984, pp. 16-21), who recognizes that the 1937 article
was intended to pursuade Mises that, contrary to Mises' own "praxeology,"
there is an essential empirical element in our understanding of economic
phenomena. Further, Hayek's 1952 commitment to subjectivism and methodological
individualism, and his emphasis on the fallacies of scientism suggest in
fact a deepening, rather than an erosion, of his recognition of the extent
to which economic theory is independent of—in fact a prerequisite to—empirical
IV. The Price System as a Communication Network
It is a short step from Hayek's appreciation of the phenomenon of spontaneous
order to his understanding of the price system as a communication network.
The key contribution of the price system to social well-being consists,
Hayek demonstrated, is the system's capacity to transmit information from
one part of the market to another. In the event of a natural disaster which
has curtailed the availability of a specific raw material, for example,
the fact of a reduced supply will be effectively communicated to potential
users through the medium of a higher price—which also provides the incentive
for the socially desirable economizing of the particular raw material (Hayek,
1945, p. 85-86). The need for such a communication network arises out of
the fact that the information to be communicated is dispersed throughout
the society. This insight into the nature of prices as signals has,
during the past decade and a half, come to be fairly widely recognized
and expounded in modern textbooks.
In his treatment of the
use of knowledge in society, Hayek made a sharp distinction between two
kinds of knowledge: (1) scientific, or theoretical, knowledge and (2) the
knowledge of the particular circumstances of time and place. The first-mentioned
category is the proper concern of the economist; the second-mentioned category
is the proper concern of the market participant. Failure to recognize this
"division of knowledge" can lead to one of two serious errors. The assumption
that economists can assimilate both kinds of knowledge leads to the conclusion
that "rational planning" can outperform—or at least duplicate—the market
itself. The assumption that market participants can assimilate both
kinds of knowledge leads to the conclusion that "rational expectations"
can nullify the systematic effects of monetary manipulation.
Hayek recognized and emphasized
that if a fully adjusted system of prices—one corresponding to attained
equilibrium—can be held to offer a system of coordinated and mutually reinforcing
signals, such a system must depend on some prior groping process of market
discovery. Hayek saw this process as consisting of market
meant for him not the state of affairs consistent with the conditions for
so-called perfect competition, but rather the rough-and-tumble process
of market agitation kept in motion by complete freedom for competitive
entrepreneurial entry. What such a competitive process can accomplish,
Hayek argued, is the discovery of possibilities and preferences that no
one had hitherto realized (Hayek, 1968).
These insights concerning
knowledge and discovery articulated by Hayek in a number of profound papers
from the late 1930s to the mid-1940s (Hayek, 1948) were partly responsible
for, and partly emergent from, Hayek's participation in the celebrated
interwar debate over the possibility of economic calculation under a socialist
system. In deepening and widening the case originally presented by Mises
in 1920, which challenged the feasibility of such calculation in the absence
of market prices for factors of production, Hayek came to perceive the
market process itself as crucial for the generation of that very knowledge
which it would be necessary for a central planning authority to possess
before it could hope to achieve a successful and efficient allocation of
It was especially this Hayekian
appreciation for the market as a discovery process that has significantly
contributed to the contemporary revival of interest in the Austrian paradigm.
In this context the Austrian contribution is to be distinguished from the
more formal, or mathematically tractable, theories by its emphasis on the
role of the entrepreneurial discovery in those systematic market processes
upon which we must depend, in a world of ignorance and disequilibrium,
for any possible tendency toward mutual coordination among the market participants.
What Hayek showed was that much modern economics misconstrues the nature
of the economic problem facing society by assuming away the problems raised
by the fact of dispersed information. To imagine (as earlier critics of
Mises and Hayek had proposed) that it would be possible to run a socialist
system by simulating the market and promulgating non-market "prices" for
the guidance of socialist managers is to ignore the extent to which market
prices—both of consumer goods and of the capital goods that constitute
the economy's capital structure—already express the outcome of an
entrepreneurial discovery procedure that draws upon scattered existing
V. The Intertemporal Structure of Capital
Hayek's contribution to the development of capital theory is commonly
regarded as his most fundamental and pathbreaking achievement (Machlup,
1976). His early attention (1928) to "Intertemporal Price Equilibrium and
Movements in the Value of Money" (English translation in Hayek, 1984) provided
both the basis and inspiration for many subsequent contributions in this
area, most notably for those of John R. Hicks. The widely recognized but
rarely understood Hayekian triangles, introduced in his Prices and Production
(1935), provided a convenient but highly stylized way of describing changes
in the intertemporal pattern of the capital structure. The formal and comprehensive
analysis in The Pure Theory of Capital (1941) fleshed out the earlier
formulations and established the centrality of the "capital problem" in
questions about the market's ability to coordinate economic activities
The essential element of
time in the economy's production process coupled with the inherent complexities
of the capital structure gives special significance to the problem of intertemporal
coordination. Individual producers must commit resources in the present
on the basis of some production plan. Intertemporal coordination in the
strictest sense requires that all such plans be mutually compatible and
that they be jointly consistent with resource availabilities. The extent
to which such compatibility and consistency actually exists is determined
only through the market process in which each producer attempts to carry
out his own plan. The individual production plans take shape as non-specific
capital (e.g. raw material) is committed to a specific use (e.g. a particular
tool or machine); the passage of time and the efforts of each producer
to secure the additional capital needed to complete his own production
plans reveal the extent to which the capital structure is intertemporally
coordinated or discoordinated. The actual availability of some raw material
complementary to already-committed capital may be less, for instance, than
the amount needed for each producer to carry out his plan. As such discoordination
is revealed (by an increase in the price of the raw material), production
plans are revised. In Hayek's formulation, the capital goods that make
up the production process are neither so specific that such plan revision
is impossible nor so non-specific that it is costless.
In his Pure Theory of
Capital, Hayek provides a detailed treatment of capital goods in terms
of reproducibility, durability, specificity, substitutability, and complementarity.
These multifaceted characteristics of various capital goods and of relationships
among them cause the structure of production, taken as a whole, to be characterized
by a longer or shorter "period of production," a greater or lesser degree
of "roundaboutness." The degree of roundaboutness, the extent to which
the production process ties up resources over time, is determined by the
market rate of interest—with the "market rate" broadly conceived as the
terms of trade between goods available in the present and goods available
in the future. The market process works to translate intertemporal preferences
into production plans. For instance, a fall in the rate of interest reflecting
an increased willingness to forgo present goods for future goods creates
incentives for engaging in production processes of greater degrees of roundaboutness.
The characteristics, mentioned above, of the individual capital goods and
of the relationships among them determine the extent to which the existing
capital structure is actually adaptable to changes in intertemporal preferences.
VI. Money and Its Effects on Prices
Hayek's contribution to monetary theory and to trade-cycle theory are
intertwined, a circumstance that reflects the nature of his contribution
in both areas. In summary terms, Hayek's monetary theory consists of integrating
the idea of money as a medium of exchange with the idea of the price system
as a communication network. His trade-cycle theory consists of integrating
monetary theory and capital theory—in which a particular aspect of the
price system, namely the system of intertemporal prices, is emphasized.
Both in his Monetary
Theory and the Trade Cycle and his Prices and Production, Hayek
argued against the then-dominant (and still-prevalent) idea that the appropriate
focus of monetary theory is on the relationship between the quantity of
money and the general level of prices. The kernel of truth in the quantity
theory of money was not to be denied, but progress in monetary economics
was to be made by moving beyond the simple proportionalities implied by
a relatively stable velocity of circulation. According to Hayek (1935,
p. 127), the proper task of monetary theory requires a thorough reconsideration
of the pure theory of price determination, which is based on the assumption
of barter, and a determination of what changes in the conclusions are made
necessary by the introduction of indirect exchange. Hayek introduced the
concept of "neutral money" in part as a means to contrast his own view
of money with the more aggregative views. By definition, neutral money
characterizes a monetary system in which money, while facilitating the
coordination of economic activities, is itself never a source of discoordination.
According to the aggregative views, money is neutral so long as the value
of money (as measured by the general level of prices) remains unchanged.
Thus, increases in economic activity require proportionate increases in
the quantity of money in circulation. According to Hayek, monetary neutrality
requires the absence of "injection effects." When the quantity of money
in increased, the new money is injected in some particular way, which temporarily
distorts relative prices causing the price system to communicate false
information about consumer preferences and resource availabilities.
The contrasting views on
the requirements for monetary neutrality had important implications for
U.S. monetary policy during the prosperous decade of the 1920s. The rate
of monetary growth during that period was roughly equivalent to the the
rate of real economic growth, a circumatance which resulted in a near-constant
price level. The absence of price inflation was taken by most monetary
economists to be a sign of monetary stability. Hayek's contrary assessment
(1925) that the injection of money through credit markets must result in
a misallocation of resources despite the price-level stability was the
basis for his prediction that the money-induced boom would eventually lead
to a bust.
It should be noted that
in other writings, both early and late in his career (e.g. 1933 and 1984),
Hayek was ambivalent about the choice between a monetary policy that avoids
injection effects (a constant money supply despite a positive real growth
rate) and a monetary policy that avoids price deflation (a money growth
rate that "accommodates" real growth).
VII. The Trade Cycle as Intertemporal Discoordination
Hayek's contribution to the theory of the trade cycle consists in his
developing the idea that monetary injections can have a systematic effect
on the intertemporal pattern of prices. The Austrian theory of the trade
cycle was first formulated by Mises (1912), who showed that money-induced
movements in the interest rate (as identified by the Swedish economist
Knut Wicksell) have identifiable effects on the capital structure (as conceived
by Eugen von Böhm-Bawerk). Hayek's major contribution to the theory
(1935), as well as many subsequent developments of it, was based on an
extremely stylized portrayal of the economy's time-consuming production
process. The relevant characteristics of the "structure of production"
were identified with the dimensions of a right triangle. One leg of the
triangle represents the time dimension of the structure of production,
the degree of roundaboutness; the other leg represents the money value
of the consumer goods yielded up by the production process. Slices of the
triangle perpendicular to the time leg represent stages of production;
the height of individual slices represents the money value of the yet-to-be-completed
Resources are allocated
among the different stages of production as a result of entrepreneurial
actions guided by price signals. But because of the distinct temporal dimension
of the structure of production, the supplies and demands for resources
associated with the different stages are differentially sensitive to changes
in the rate of interest: the demand for the output of extraction industries,
for example, is more interest elastic than the demand for the output of
service industries. Changes in the rate of interest will have a systematic
effect on the pattern of prices that allocates resources among the different
stages of production. A fall in the rate of interest, for instance, will
strengthen the relatively interest-elastic demands drawing resources into
the early stages of production. This modification is represented by a relative
lengthening of the temporal dimension of the Hayekian triangle.
A crucial distinction is
made between interest-rate changes attributable to changes in the intertemporal
preferences of consumers and interest-rate changes attributable to central-bank
policy. In the first instance (Hayek, 1935, pp. 49-54), entrepreneurial
actions and resulting changes in the pattern of prices allow the structure
of production to be modified in accordance with the changed consumer preferences;
in the second instance (Hayek, 1935, pp. 54-62), similar changes in the
pattern of prices induced by the injecting of new money through credit
markets constitute "false signals," which result in a misallocation of
resources among the stages of production. The artificially low rate of
interest can trigger an unsustainable boom in which too many resources
are committed to the early stages of production. The market process triggered
by the injection of money through credit markets, Hayek showed, is a self-reversing
process. More production projects are initiated than can possibly be completed.
Subsequent resource scarcities turn the artificial boom into a bust. Economic
recovery must consist of liquidating the "malinvestments" and reallocating
resources in accordance with actual intertemporal preferences and resource
Hayek (1939) recognized
that expectations about future movements in the rate of interest and entrepreneurial
interpretations of intertemporal price movements can have an important
effect on the course of the trade cycle. That is, prices are signals, not
marching orders. But Hayek did not assume, as some modern economicts do,
that falsified price signals plus "rational" expectations are equivalent
to unfalsified price signals. Such an equivalence would require that market
participants make use of knowledge of the kind that they cannot plausibly
possess; it would require that they have knowledge of the "real" factors
independent of the price system that supposedly communicates that knowledge.
VIII. Critique of Keynesianism
Hayek's critique of Keynesian theory and policy followed directly from
his own theories of capital and of money. Hayek argued that by ignoring
the intertemporal structure of production and particularly the intertemporal
complementarity of the stages of production, Keynes failed to identify
the market process that could achieve intertemporal coordination: "Mr.
Keynes's aggregates conceal the most fundamental mechanisms of change"
(Hayek, 1931, p. 227). And by shifting the focus of analysis from money
as a medium of exchange to money as a liquid asset, Keynes failed to see
the harm caused by policies of injecting newly created money through credit
markets or of spending it directly on public projects.
Hayek had emphasized that
in functioning as a medium of exchange, money "constitutes a kind of loose
joint in a self-equilibrating apparatus of the price mechanism which is
bound to impede its working—the more so the greater the play in the loose
joint." Keynesian theory and policy were the specific targets of Hayek's
criticism when he warned that "the existence of such a loose joint is no
justification for concentrating attention on that loose joint and disregarding
the rest of the mechanism, and still less for making the greatest possible
use of the short-lived freedom from economic necessity which the existence
of this loose joint permits" (Hayek, 1941, p. 408).
In the decades that followed
the debate between Hayek and Keynes, economic theory was dominated by Keynesianism,
and the corresponding macroeconomic policies consisted precisely of those
measures that Hayek had warned against: monetary manipulation for political
advantage. Monetary injections during the Great Depression, conceived as
"pump priming," soon gave way to a more broadly conceived policy of "demand
management." The short-run trade-off between inflation and unemployment
were treated in the political arena—and in some academic circles—as a societal
menu from which elected officials, and hence voters, could choose; deviations
of the economy from some conception of full-employment or from some long-run
growth path were taken as mandates for macroeconomic "fine tuning" to be
implemented by the central bank in cooperation with the fiscal authority.
clearly recognized in his critique of Keynes's theories and his analysis
of the actual effects of Keynesian policies, the political exploitation
of the monetary loose joint contains an inherent inflationary bias. Newly
created money can be used to hire the unemployed and to finance politically
popular spending programs. Monetary injections through the commercial banking
system can stimulate the economy by triggering an artificial economic boom.
The undesirable effects of inflating the money supply, the eventual collapse
of the artificial boom and the general increase in the level of prices,
are removed in time from the initial, politically desirable effects and
are less conspicuously identified with the elected officials who engineered
the monetary expansion (Hayek, 1960, pp. 324-39). As the political process
continues, elected officials face the choice of monetary passivity which
would permit the market to undergo the painful adjustments to earlier monetary
injections or further monetary injections which would reproduce the desirable
effects in the short run while staving-off the eventual adjustment. The
cumulative effects of the play-off between political advantage and economic
necessity is the theme of Hayek's critique of Keynesianism. Excerpts of
"a forty years' running commentary on Keynesianism by Hayek," compiled
by Sudha Shenoy, is appropriately entitled A Tiger by the Tail (1972).
IX. Denationalization of Money
Hayek as a monetary reformer is interested in minimizing the potential
for discoordination that is inherent in monetary mechanisms and precluding
the manipulation of money for political advantage. He has long doubted
that the government has either the will or the ability to manipulate the
money supply in the public interest.
In his early writings Hayek
took for granted the existence of a central bank and focused his analysis
on the consequences of different policy goals, e.g. the goal of stimulating
economic growth or the goal of stabilizing the general price level. In
his later writings, he began to see the monopolization of the money supply
as the ultimate cause of monetary disturbances. As early as 1960, though
still "convinced that modern credit banking as it has developed requires
some public institutions such as central banks, [he was] doubtful whether
it is necessary or desirable that they (or the government) should have
the monopoly of the issue of all kinds of money" (1960, p. 520, n2).
In the mid 1970s Hayek's
interest in the denationalization of money (1976) was renewed. Having lost
all hope of achieving monetary stability through the instruments of highly
politicized monetary institutions, Hayek suggested—by his own account,
almost as a "bitter joke"—that the business of issuing money be turned
over to private enterprise. Soon taking this suggestion seriously, he began
to explore the feasibility and the consequences of competing currencies.
Hayek's proposal for competition
in the issue of money is not subject to the standard objection based on
the so-called common-pool problem. The proposal is not that private issuers
should compete by issuing some generic currency. Clearly, competition on
this basis would produce an explosive inflation. The proposal, rather,
is that each competitor issue his own trade-marked currency. Under this
arrangement, each issuer would have an incentive to maintain a stable value
of his own currency and to minimize the difficulties of using this currency
in an environment where other currencies are used as well.
In spelling out just how
such a system of competing currencies would or could work, Hayek has had
to walk the fine line between constructivism on the one hand and blind
faith the the market process on the other. His discussions of possible
outcomes of the market process should not be taken as prescriptions for
the provision of competing currencies, but rather as a basis for believing
that competition between private issuers is feasible. Individuals may choose
one currency over another on the basis of the issuer's demonstrated ability
to achieve purchasing-power stability for that currency. Their choice may
be influenced, Hayek has suggested, by what particular price level serves
as the issuer's guide for managing the currency. Or it may be that public
confidence can be maintained only by a currency that is convertible at
a fixed rate into some stipulated commodity or basket of commodities. Hayek
does doubt that a gold standard would re-emerge as result of the competitive
process, largely because the confidence and stability of gold was based
upon beliefs and attitudes on the part of the public that no longer exist
and cannot easily be recreated. But if gold did prevail in a competitive
environment, there would be no basis for objection.
More importantly, Hayek's
proposal for monetary reform should be seen not as an aberation from but
as thoroughly consistent with his view of economics as a spontaneous order.
Markets serve to coordinate the activities of individual market participants.
The use of money, while greatly facilitating economic coordination, contains
an inherent potential for discoordination. Competition in the market for
money holds that potential in check and allows market participants to take
the fullest advantage of the remaining elements of the spontaneous order.
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________. (1928 in German). "Intertemporal Price
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________. (1931). "Reflections on the Pure Theory
of Money of Mr. J. M. Keynes," Part 1, Economica, 11, August.
________. (1933 in German). "On 'Neutral Money',"
in F. A. Hayek. Money, Capital, and Fluctuations: Early Essays,
edited by Roy McCloughry, Chicago, University of Chicago Press, 1984.
________. (1933). Monetary Theory and the Trade
Cycle, New York, Augustus M. Kelley, 1975.
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