In the years following its publication, F. A. Hayek’s pioneering work on business cycles was regarded as an important challenge to what was later known as Keynesian macroeconomics. Today, as debates rage on over the monetary origins of the current economic and financial crisis, economists are once again paying heed to Hayek’s thoughts on the repercussions of excessive central bank interventions.
The latest editions in the University of Chicago Press’s ongoing series The Collected Works of F. A. Hayek, these volumes bring together Hayek’s work on what causes periods of boom and bust in the economy. Moving away from the classical emphasis on equilibrium, Hayek demonstrates that business cycles are generated by the adaptation of the structure of production to changes in relative demand. Thus, when central banks artificially lower interest rates, the result is a misallocation of capital and the creation of asset bubbles and additional instability. Business Cycles, Part I contains Hayek’s two major monographs on the topic: Monetary Theory and the Trade Cycle and Prices and Production. Reproducing the text of the original 1933 translation of the former, this edition also draws on the original German, as well as more recent translations. For Prices and Production, a variorum edition is presented, incorporating the 1931 first edition and its 1935 revision. Business Cycles, Part II assembles a series of Hayek’s shorter papers on the topic, ranging from the 1920s to 1981.
In addition to bringing together Hayek’s work on the evolution of business cycles, the two volumes of Business Cycles also include extensive introductions by Hansjoerg Klausinger, placing the writings in intellectual contextincluding their reception and the theoretical debates to which they contributedand providing background on the evolution of Hayek’s thought.
About the Author
F. A. Hayek (1899-1992), recipient of the Presidential Medal of Freedom in 1991 and co-winner of the Nobel Prize in Economics in 1974, was a pioneer in monetary theory and a leading proponent of classical liberalism in the twentieth century. He taught at the University of London, the University of Chicago, and the University of Freiburg.
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THE COLLECTED WORKS OF F. A. Hayek VOLUME VIIIBUSINESS CYCLES Part II
The University of Chicago PressCopyright © 2012 The Estate of F. A. Hayek
All right reserved.
Chapter OneINVESTIGATIONS INTO MONETARY THEORY
DRAFT TABLE OF CONTENTS
First Part The Nature of Monetary Influences on Price Formation
I. Original and organisational determinants of prices
II. The dogma of the stable price level as a prerequisite to a course of the economy free from monetary disturbances
III. The function of price formation as determined by the goods situation
IV. 'Correct' prices and 'necessary' price changes
V. Exchange among three, indirect exchange, and the sequence of time
VI. The system of intertemporal price equilibrium
VII. The disturbances to the intertemporal price system due to changes in the volume of money
VIII. Time and the structure of production
IX. The prices as determined by the original data changed by the use of a means of exchange. Money as 'means of deferred payment'; the demand for money as an autonomous cause of changes
IX. The relation of these price changes to economic equilibrium and their consequences for a steady course of the economy. Criticism of Say's Law of Markets
X. The meaning of the assumption of statics for the analysis of a money economy. Money as a dynamic force
Second Part The Significance of the 'General Value of Money' and the 'General Price Level'
A. Value of Money
I. Subjective and objective concepts of the value of money; general economic value of money and general purchasing power
II. Origin of the search for a general value of money
III. Untenability of the concept of a general value of money
IV. The doctrine of the 'inner value of money'; of the causal relation between money and price changes and the effects of changes in the demand for money in particular
V. Active and passive changes in the value of money
VI. The impairment of monetary theory due to the focus on changes in the value of money as the prime subject of scientific inquiry
B. The Significance of the Price Level and its Stabilisation
VII. The probability inference on monetary causes of changes in the price level and the thesis that changes in the price level must be of monetary origin
VIII. Reduction of price fluctuations to the minimal shifts of relative prices necessitated by the goods situation
IX. Maintenance of the meaning of monetary calculation
X. The meaning of building averages of prices in general; statistics and economic theory
XI. The actual meaning of index numbers
Third Part The Consequences of Artificial Stabilisation of the Value of Money
I. The various proposals for stabilising the value of money
II. Irving Fisher's proposals in particular
III. Deficiencies of previous criticism
IV. Mises' attempt at refutation
V. The difference in regulating the value of a currency, if its value base is also used as money so that changes in the demand for money influence the value of the base, compared to a currency where this is not the case. B. M. Anderson's example
VI. Stabilising the value of money can thus reinforce monetarily caused shifts in production
VII. Shifts in the distribution of wealth may also come about with a stable value of money, if the stabilising influences do not work at the same location as those which change the value of money
VIII. Incompatibility of a stable value of money with the function of money. Necessary changes in the value of money
IX. An example for the effect of preventing necessary changes in the price level
X. Stabilisation and the phases of the cycle
I do not foster any hopes that the following theoretical investigations on the various ways in which the use of money may disturb economic life otherwise than by shifts in the creditor-debtor relationship will directly pave the way for eliminating these disturbances. Even if they may contribute to a small degree to a solution of this problem—as far as there is one at all—its main purpose is a negative one. These investigations shall demonstrate that the state of the economy with an unchanged value of money, which is aimed at in order to secure the meaning of monetary calculation with regard to credit transactions, cannot be considered at all as free from monetary disturbances. Rather, the measures necessary for stabilising the value of money not only need not contribute to the elimination of a group of very important disturbances, but may as well have the opposite effect; thus, we must not exclude in advance the possibility that such an attempt may cause more harm than it may prevent.
Awareness of this fact should bring about a thorough revision of all the principles underlying current monetary policy, which has seen its single uncontested goal in the stabilisation of the value of money, and should thus create novel foundations for the doctrine of the possibilities and goals of monetary policy. In particular, the insight of [considering]2 money as an essential and ever effective determinant of the course of an exchange economy opens up new vistas: For consequently the course of the economy will never be influenced solely by the natural determinants of the economy and of the distribution of resources, but always as well by the respective regulation of the monetary system, so that—knowing the type of these influences—it can be altered by changes in monetary policy.
It is not the subject of this work to explicitly formulate the tasks and goals of monetary policy. This would necessitate far more extensive investigations, and possibly our general knowledge of the most important relationships in question is not yet advanced enough to warrant such an attempt. What can be said preliminarily in this direction is, in my view, best put in the context of a criticism of the ruling doctrine. Yet I believe that even if this investigation cannot contribute anything to a reformulation of monetary policy, it will be justified by the fact that those ill-conceived doctrines which it tries to refute have been put forward in recent years in an extremely dogmatic fashion and have requested a far reaching subordination of policy under the goals propagated on the basis of these doctrines. In the current state of the debate the most important point to be emphasised in this regard would be the demonstration of what small a part of all the shortcomings associated with the use of money can be eliminated by 'stabilising the value of money' and that, in addition, other damages emanating from the same source of money may not only be not remedied, but instead reinforced.
Thereby the idea becomes obsolete that it must be possible to discern by means of a simple criterion whether there are influences from the side of money on the course of the process of distribution and consequently that money could be regulated in such a way as to avoid such influences. We shall have to accept that such influences will always be present and thus have to restrict ourselves to regulate money in this regard so as to make its effects as favourable as possible. With this insight in mind the postulate of leaving the economy to its own becomes obsolete.
The main task of this book is a critical evaluation of the doctrine that a constant general level of prices will make possible a course of the economic process free from monetary disturbances. Starting from the fact that any effect of money on the economy must be mediated by its influence on price formation, we will examine the function of the 'correct' price formation, undisturbed by monetary influences, the extent to which the deviations in price formation caused by the introduction of money disturb the economic process, and finally if these disturbances can be prevented by specific ties to the value of money. In order to answer these questions it is necessary first to thoroughly investigate the principal difference between the laws that govern income distribution as usually derived by neglecting the effects of money and those valid in a money economy; this will lead towards a re-examination of the justification and the range of applicability for the rules governing the economic process as derived from the former assumption. [It will turn out that these deviations due to the use of money are not incidentally caused by the particular organisation of the monetary system, but are the necessary consequence of the indispensability of indirect exchange and of the passage of time in any exchange economy. Those irregularities of the economic process in comparison with ... which are commonly attributed to the imperfection of the organisation of the monetary system must be recognised as inextricably linked to the nature of the exchange economy, even if not to the economy per se.] The analysis of the shifts in the structure of the economy due to the use of money demonstrates that the shifts in the debtor-creditor relationship, commonly considered solely or mainly as damages due to 'changes in the value of money', are but a particular phenomenon among a much greater number of unintended shifts within the economy, which disturb equilibrium of the individual as well as of the social economy and thereby the correspondence among all of its parts necessary for its steady course. Furthermore, these disturbances due to the use of money need not always be caused by prior changes on the side of money, rather, due to the use and the intermediation of a means of payment, changes on the side of goods will often cause shifts in the structure of production that do not approach the state of equilibrium and thus do not conform to the laws of static theory. Analogously, with respect to 'changes in the value of money', as far as after the criticism of the following part this term is still appropriate for denoting price changes not solely caused by the goods situation, we will distinguish between active and passive changes in the value of money. Active changes are those caused by prior changes on the side of money, while passive changes are those that result from shifts on the side of goods with the volume of money unchanged, but which due to the unchanged money incomes exceed the necessary relative shifts among the prices of individual goods. A failed attempt to construct a causal role for money even for changes of the latter group, by presenting changes in the demand for money as a causal factor, renders the opportunity for criticising the concept of the demand for money. It offers valuable hints with regard to the preconditions for maintaining a constant value of money and the consequences of such a maintenance. Active and passive changes in the value of money may mutually compensate one another, and in the case of commodity money will do so as a rule. As changes in the volume of money are the only cause of active changes in the value of money, such active changes can only be prevented by a constant volume of money. Its effects have hitherto been much too little examined. It is essential for commodity money that any change in the demand for money will be met partly by changes in the value of the commodity in question and thus cannot be fully satisfied. This makes up the crucial difference between money tied to a value base which itself is used as money and thereby is influenced by a change in the demand for money and money tied to a value base where this is not the case; in the latter case the shifts within the economy caused by changes in the demand for money will be much greater.
I. Original and Organisational Determinants of Prices
All the influence that money can exert on the economic process is by its effect on price formation. Yet, as not merely the prices in the narrower sense, the equivalents of money exchanged for goods, are, by definition, brought about only with the assistance of money, but also the prices in a wider sense, the exchange ratios of goods (their objective exchange value), money will thereby influence all economic processes. In the following, it will be demonstrated that such a determinate influence on the course and the structure of the economy actually always exists. However, in the presentations of the driving forces of an exchange economy offered by economic theory this influence has been almost completely neglected. This is due to the fact that a determinate system of exchange ratios can be derived from the original determinants of human economic activity even without taking account of these influences exerted by money. Consequently, whenever a strong influence of money on price formation is perceived, it is considered an abnormal disturbance of the 'normal' formation of prices.
The respective investigations have for good reasons put particular emphasis on those original data, of which it is usually assumed that under normal circumstances they alone will determine the formation of prices, and they have been presented in isolation with great benefit. The needs of the members of an exchange economy, their endowment with goods of all types, and the distribution of these goods among them—these are the 'data' in question. And these data would suffice for completely determining men's activity directed towards the satisfaction of their needs, and also for deriving what the best economic outcome would be that each of them could realise, if all perfectly pursued their interests and if the mechanism of the exchange economy could work without frictions and devoid of other determining influences. These determinants of economic activity are necessary in a specific sense: they are given at once with the causes that compel men to act economically; and they alone, among all the factors that affect prices and thereby direct economic forces, must make themselves felt in those prices in order to maintain an exchange economy based on the division of labour, such that it becomes possible for the individual not only to produce for his own needs, but for the market. Since Adam Smith all descriptions of the mechanism of the exchange economy—whether they endorse or condemn it—agree in two respects: the working of these forces is seen, on the one hand, as a necessary consequence of the preconditions on which the exchange economy is built and, on the other hand, as an indispensable precondition for its sustained existence. It is due to these forces that without being guided by an overall plan and without mutually knowing beforehand the activities of others the efforts invested by the individual economic subjects are in accordance one with another. Therefore, every individual may venture to produce things in excess of his own needs and to refrain from producing those goods necessary for the satisfaction of his most urgent needs without ever being punished for this behaviour by starvation. It is the basic assumption both of all theoretical considerations and of every political judgment of the existing economic system that this self-steering of the economy by the price mechanism, as determined by those original economic driving forces, is a prerequisite for the economy's steady course. One may subscribe to the belief of economic liberalism that the free play of economic forces will secure the feasible optimum, or to the contrary that the outcome of the automatic direction of the economy can be improved upon by conscious interventions. In any case there will be consensus that these automatic forces will at least bring about a relative optimum, beyond which the economic outcome may be boosted by authoritarian interventions into the process of exchange, yet, that as long as there are no such interventions, the realisation of this optimum must be safeguarded by eliminating all disturbances.
The significance of this type of price formation, which can be derived from the original economic driving forces, for the steady evolution of the economy, free from disturbances, will be more closely examined in the third chapter. These original determinants have been characterised preliminarily only to the extent necessary to distinguish them from other forces which also affect the formation of prices, yet without having the same function attributed to the original forces. The existing mechanism, which serves the implementation of the relations necessitated by the original data, does not work in such a way that these necessities are realised to the exclusion of modifying influences of other factors. Rather the mechanism itself actively affects the economic process and thereby prevents the pure implementation of those forces which it serves. For within this mechanism intermediate links have been inserted, which although destined to serve the original goals of economic action have risen beyond this subservient role and acquired an independent and decisive influence on the course of the economy often counteracting these original goals.
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Table of Contents
One Investigations into Monetary Theory
Appendix: The Exchange Value of Money; A Review
Two The Purchasing Power of the Consumer and the Depression
Three A Note on the Development of the Doctrine of ‘Forced Saving’
Four The Present State and Immediate Prospects of the Study of Industrial Fluctuations
Five Restoring the Price-Level?
Appendix: Excerpt from a Letter, F. A. Hayek to Gottfried Haberler, December 20, 1931
Six Capital and Industrial Fluctuations: A Reply to a Criticism
Seven Investment that Raises the Demand for Capital
Eight Profits, Interest and Investment
Nine The Ricardo Effect
Ten Professor Hayek and the Concertina-Effect, by Nicholas Kaldor
Postscript, by Nicholas Kaldor
Eleven Three Elucidations of the Ricardo Effect
Twelve The Flow of Goods and Services