vol. 3, no. 2 (Fall), 1985, pp. 7-9
Money, Capital, and Fluctuations: Early Essays
by F. A. Hayek, edited by Roy McCloughry
Chicago: University of Chicago Press, 1984, pp. xi, 194
In addition to
brief introductions both by the editor and by Hayek, this important volume
contains eight of Hayek's early essays (actually, seven articles and a
note) and two book reviews. Just now making their first appearance in English,
these essays deal with microeconomic as well as macroeconomic issues. They
are variously concerned with pure theory, monetary history, policy analysis,
and policy prescription. Chronologically, these essays form bookends around
Hayek's Monetary Theory and the Trade Cycle (translated from a 1928
German article) and his Prices and Production (1931). The first
four essays span the years 1925 to 1928; the last four, 1932 to 1936.
Three of the essays, "Some
Remarks on the Problem of Imputation" (1926), "On the Problem of the Theory
of Interest" (1927), and "Technical Progress and Excess Capacity" (1936),
deal with nonmonetary issues. The 1926 essay breathes some life into a
subject area, value imputation, that today is dealt with almost exclusively
in mathematical terms. In the 1927 essay, Hayek questions Bhm-Bawerk's
formulation of the theory of interest, but offers an even more questionable
formulation, one which violates the strict ordinality of utility: He conceives
of an increment of utility as a definite integral over a span of the marginal-utility
curve. The 1936 essay identifies economic fallacies that stem from an undue
emphasis on the technological aspect of economic progress.
Two of the essays, "Intertemporal
Price Equilibrium and Movements in the Value of Money" (1928) and "Capital
Consumption" (1932a), deal with money-macro issues. It is here that the
English-speaking audience will encounter the Hayekian themes most familiar
to them. These essays, which are the primary focus of an extended discussion
below, serve to flesh out the integration of value theory and monetary
theory first achieved by Knut Wicksell and Ludwig von Mises.
The three remaining essays,
"The Monetary Policy of the United States After the Recovery from the 1920
Crisis" (1925), "The Fate of the Gold Standard" (1932b), and "On 'Neutral
Money'" (1933), deal with institutional matters and policy issues. The
1925 essay contains Hayek's first statement of the Austrian theory of the
trade cycle in a footnote of more than 500 words (p. 27, n4). Modern-day
Hayekians will be struck by how clear and comprehensive this early formulation
is; historians of thought will benefit by comparing this footnote with
Chapter 5 of Mises's 1912 book, The Theory of Money and Credit.
The 1932b essay deals with stabilization policy, and the 1933 note makes
a distinction (discussed below) between neutral money as an analytical
tool and as a policy norm.
This volume of essays is
invaluable to the Hayekian scholar concerned with the question "What did
he think, and when did he think it?" It is equally invaluable to the modern
Austrian-oriented economist who strives for a better understanding of the
market process. Because of the essays' temporal proximity to the two Hayek
books mentioned above, this review will focus largely on the macroeconomic
issues. And rather than further summarizing the early essays, an attempt
will be made to assess them in the context of Hayek's subsequent writings
and of modern macroeconomic trends. This task is one that editor Roy McCloughry
These early essays can be
drawn upon to support three claims about Hayek's contribution: (1) that
John Stuart Mill's Fourth Fundamental Proposition serves to distinguish
Hayekian macroeconomics from Keynesian macroeconomics and that Hayek was
explicitly aware of the critical importance of this proposition early on—in
fact before the actual dawn of Keynesianism, (2) that the alleged "watershed"
in Hayek's thought can be supported only by misreading Hayek, and (3) that
contrary to a popular view, Hayek has not changed his mind in recent years
on the issue of stabilization policy.
Mill's Fourth Fundamental Proposition Probably the two most important
essays in this volume are the two (1928 and 1932a) that deal with money-macro
issues. Together, they are prerequisite to and draw implications for Hayek's
major works on monetary theory. And even before the appearance of Keynes's
major works, they highlight one of the most fundamental differences between
Austrian theory and Keynesian theory—a difference that must appear even
more striking today than it appeared a half century ago. John Stuart Mill's
Forth Fundamental Proposition captures this key difference in a cryptic
aphorism: "Demand for commodities is not demand for labor."
In all modern macroeconomic
models, Keynesian or otherwise, the level of consumption spending and the
level of investment spending—and hence the level of spending on labor services—move
in the same direction. The demand for factors of production is strictly
a derived demand. There is no objection to the concept of derived demand,
of course, so long as it is confined to the microeconomic context of partial
equilibrium analysis. But to extrapolate from the firm or industry to the
economy as a whole and claim that the economy's demand for labor is derived—in
Marshallian fashion—from the demand for consumption goods is to commit
the fallacy of composition.1
Thinking in a macroeconomic
context, we conceive of the entire economy as consisting of consumption
activities and investment activities. By construction, then, an increase
in one of these two components of economic activities must be accompanied
by a decrease in the other. For the economy as a whole, the level of consumption
spending and the level of investment spending must move in opposite
directions. Hayek's early theorizing, which is built upon a clear recognition
of this relationship (1932a, p. 142 and p. 157, n6), was to become the
basis for his critique of Keynes, whose theorizing relegated Mill's Fourth
to what, in Keynes's view, was the special and unlikely case of a fully
In retrospect we see that,
methodologically speaking, Keynes was dealing with the special case of
resource idleness. Consumption activity and investment activity can move
in the same direction only because the level of resource idleness moves
in the opposite direction. There are no opportunity costs (forgone idleness
is not a cost) associated with having more of both components of economic
activities. In effect, it was Keynes's flouting of Mill's Fourth that caused
Hayek to refer to Keynesian economics as the "economics of abundance."3
In the 1928 essay Hayek
shows how the market's relative-price mechanisms shift resources away from
consumption activities toward investment activities in response to changes
in the intertemporal preferences of consumers. He shows how a decrease
in the demand for commodities (i.e., current consumption) can be associated
with an increase in the demand for labor and other inputs, thereby
enabling an increase in the level of future consumption. These are the
market mechanisms whose existence is either denied or ignored by Keynes.
Evaluating Hayek's early
essays in the context of the broad sweep of the history of economic thought
may remind us of Keynes's own evaluation of Robert Malthus: "If only Malthus,
instead of Ricardo, had been the parent stem from which nineteenth-century
economics proceeded, what a much wiser and richer place the world would
be today!"4 In the full light of the last half-century's economic
history, it is difficult to appreciate this Keynesian lament. But the lament
can be suitably paraphrased: "If only Hayek, instead of Keynes, had been
the parent stem from which twentieth-century macroeconomics proceeded,
what a much wiser and richer place the world would be today!
A Watershed in Hayek's Thought? Although McCloughry swears off
the task of interpreting Hayek, he identifies the 1937 article, "Economics
and Knowledge," as a "watershed in Hayek's thought" (p. viii)—almost as
if this characterization were not subject to interpretation. But should
the 1937 article be so characterized? The supposed watershed marks the
point when Hayek turned from the analysis of equilibrium to the analysis
of disequilibrium. Before the watershed, he was concerned with the economic
relationships that correspond to General Equilibrium; after the watershed,
he was concerned with the dispersion of information and with the price
system as a network for communicating that information. This bifurcation
of Hayek's contribution will not, in this reviewer's judgment, survive
a full understanding of Hayekian economics.
At best the reckoning is
overdrawn. In his early writings, Hayek was always careful to square his
theory with the General Equilibrium theory of the Lausanne School. But
the emphasis was on "General" rather than on "Equilibrium." It would be
more accurate to say that Hayek always paid explicit attention to the general
among all markets—whether or not the market forces that constitute those
interdependencies have actually achieved an equilibrium.5
In other words, Hayek had
a keen awareness of the limitations of Partial Equilibrium Analysis. When
theorizing about money, capital accumulation, or capital consumption, or
about general fluctuations in business activity, it is impermissible to
focus the analysis on one particular market while impounding all others
by way of a ceteris paribus assumption. Hayek was aware of the fallacious
doctrines and disastrous policies that could be—and were—derived from the
ill-founded use of the ceteris paribus assumption. The undue extension
of Partial Equilibrium Analysis was evident both in the unschooled thinking
of politicians and businessmen and in the theorizing of J. M. Keynes and
other British economists who were schooled in the economics of Alfred Marshall.
It can fairly be said of Keynes—even of the early Keynes—that he had ventured
far away from Marshall in terms of the questions asked but had attempted
to lean on Marshall in terms of the answers given.
Hayek had witnessed the
results of this strategy and was neither surprised nor impressed. But because
he was schooled in Vienna, it is not surprising that Hayek himself did
not adopt the same strategy. Nor is it surprising that he grounded his
own thinking in the Walrasian framework. It is misleading to identify the
early Hayek as a General Equilibrium theorist, given what that term has
come to mean. But is important to credit Hayek for looking through Marshall's
assumption of ceteris paribus in order to focus attention on the
interdependencies identified by Walras. Hayek's review of Keynes's Treatise
on Money demonstrated the edge that Walrasian thinking had over Marshallian
thinking when macroeconomic relationships are at issue. And that edge was
to become sharper with the subsequent writings of both Keynes and Hayek.
It is possible to detect
a drift—but not a shift—in the focus of Hayek's writings. In the early
years he was concerned predominantly with the questions of how the market
process had to operate if the preferences of consumers were to get transformed
into the production plans of producers and how government policy, particularly
bank policy, could interfere with this process. In his later writings he
was more concerned with the question of how this same market process could
in fact operate even though the information on which the process is based
is incomplete and dispersed throughout the economy.
Hayek was fully aware of
this second question in the early 1920s. In fact, as indicated in his own
introductory remarks (p. 1), he was already working with and under the
influence of Mises when Mises's Socialism, which dealt at length
with the issue of economic calculation, appeared in 1922. Hayek may well
have believed at this early point that the economics profession had or
soon would understand the full significance of Mises's contribution. His
own efforts, then, could be directed towards developing the Misesian vision
by focusing on the intertemporal coordination made possible by unhampered
credit markets and the intertemporal discoordination caused by misguided
bank policy. If anything, the so-called watershed referred to by McCloughry
marks the period when Hayek was gradually realizing that the profession
had in fact not absorbed Mises's insights at all. Hayek's fellow economists
could not appreciate Prices and Production and related writings
because they lacked a fundamental understanding of the market economy.
In an attempt to overcome this obstacle, Hayek began to deal in a more
explicit way with the coordination of individual plans on the basis of
dispersed and incomplete information.
But both the early Hayek
and the later Hayek were Walrasian in the sense suggested above, and both
were concerned with the market process as a coordinating mechanism. The
Essays, especially the 1928 essay, provide much direct and indirect
evidence of the unity of Hayek's contribution.6
Hayek on Stabilization Policy Should prices in general be allowed
to fall in response to real economic growth, or should the money supply
be expanded to "accommodate" the increases in real output? This is a question
that separates Austrians from Monetarists in modern debate. It is also
a question, some have claimed, that separates the early Hayek from the
later Hayek. But the evidence provided in the present volume supports a
different view. It can now be argued that this question separates the Hayek
of 1928 from the Hayek of 1933—or, more plausibly, that even the early
Hayek was of two minds on the issue.
Hayek, in effect, waffles
on the neutrality issue, and he does so on the basis of a questionable
theory-practice distinction. In his 1925 and 1928 essays, he was critical
of the policies of the Federal Reserve during the 1920s when the price
level was "artificially held stable," and he argued persuasively that "changes
in the total quantity of money can never contribute to the maintenance
of equilibrium but on the contrary must always disrupt it" (1928, p. 109).
Thus, if the harmful injection effects are to be avoided, the value of
money will have to rise (the level of prices will have to fall) as the
economy grows (1928 p. 99).
But in his 1933 note he
sees two conflicting aims of monetary policy: (1) the avoidance of injection
effects that necessarily accompany changes in the quantity of money and
(2) the avoidance of "excessive frictional resistances" that would accompany
price deflation. Hayek insists that the concept of neutral money, which
underlay his earlier writings, "was designed to serve as an instrument
of theoretical analysis, and should not in any way be set up as a norm
for monetary policy...(1933, p. 159). He insisted that avoiding the injection
effects is desirable only in a hypothetical world in which prices are perfectly
flexible. But in the real world, in which frictions are the governing concern,
stabilization policy comes into its own. Hayek even suggested a particular
policy: "[I]t seems to me that the stabilization of some average of prices
of the original factors of production would probably provide the most practicable
norm for a conscious regulation of the quantity of money" (1933, p. 161).
Compare this suggestion with the one recently advanced by Hayek that "the
closest approach to a general stability of the purchasing power of a monetary
unit would probably be the stabilization of an index number of prices of
[the more widely traded standardized] raw materials."7
The 1933 note ends with
a reassertion of the theory-practice distinction. "For the reasons already
given, however, I would regard it as a regrettable confusion of two different
problems if this problem of monetary policy were to be dealt with within
the context of neutral money" (1933, p. 162). But surely Hayek himself
has done violence to the theory-practice distinction when he associates
friction with a change in some price average and when he suggests
that the "original factors" should be the target of stabilization policy.
The concept of original factors is every bit as abstract as the concept
of neutral money. Neither has a clear and direct referent in the real world.
Hayek's discussion of stabilization
in theory and in practice does not settle any of the controversies that
have long surrounded these issues. It does demonstrate that, except for
his relatively recent advocacy of competing monies, Hayek of the 1980s
is pretty much the same as Hayek of the 1920s and 1930s. And read in conjunction
with his later writings, his early arguments provide support, in this reviewer's
judgment, for those who associate monetary stability with the absence of
any government-devised stabilization policy.
The issues treated in the
present review have, of necessity, been selective. These fertile essays
will undoubtedly serve as the basis for raising—and possibly resolving—many
more issues in time to come. English-speaking scholars are much indebted
to Mr. Roy McCloughry for his undertaking of this publication project.
Roger W. Garrison
The author wishes to thank Donald J. Boudreaux of George
Mason University and Gerald P. O'Driscoll, Jr. of the Federal Reserve Bank
of Dallas for their helpful comments on an earlier draft.
1. Keynes is clearly guilty of committing this very fallacy.
See John Maynard Keynes, The General Theory of Employment, Interest,
and Money (New York: Harcourt, Brace and World, Inc., 1964), p. 280.
On the page cited, the clause "if we are entitled to assume" might well
be replaced with "if we allow ourselves to commit the fallacy of composition."
2. Passages in the 1928 and 1932a essays substantially
anticipate the arguments in Hayek's Pure Theory of Capital (Chicago:
University of Chicago Press, 1941), Appendix III, pp. 433-39.
3. Hayek, Pure Theory of Capital, p. 374.
4. John Maynard Keynes, Essays in Biography (New
York: W. W. Norton and Co., Inc., 1951), p. 120.
5. For an insightful comparison of Hayek and the New Classicists
in terms of their respective uses of General Equilibrium theory, see William
N. Butos, "Hayek and General Equilibrium Analysis," Southern Economic
Journal, 52(2), October 1985.
6. A case for the unity of Hayek's thought is provided
by Gerald P. O'Driscoll, Jr., Economics as a Coordination Problem: The
Contribution of Friedrich A. Hayek (Kansas City: Sheed, Andrews and
McMeel, Inc., 1977), pp. xix, 9-11, and passim. Bruce J. Caldwell
has argued the continuity of Hayek's views on methodology in his yet-to-be-published
"Disentangling Hayek, Hutchison, and Popper on the Methodology of Economics."
7. F. A. Hayek, "The Future Monetary Unit of Value," in
Barry N. Siegel, ed., Money in Crisis: The Federal Reserve, the Economy,
and Monetary Reform (Cambridge, MA: Ballinger Publishing Co., 1984),