Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek

O'Driscoll, Gerald P., Jr.
(1947- )
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First Pub. Date
1977
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Kansas City: Sheed Andrews and McMeel, Inc.
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1977
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Foreword by Friedrich A. Hayek.

1. [1] Sir John Hicks, "The Hayek Story," Critical Essays in Monetary Theory (Oxford: Oxford University Press, The Clarendon Press, 1967), p. 203. (Hereafter, Critical Essays.)

2. [2] Compare Thomas S. Kuhn, The Structure of Scientific Revolution (Chicago: University of Chicago Press, 1963); see also Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), pp. 5-6. (Hereafter, Keynesian Economics.)

3. [3] On Keynes-versus-the-classics debate, see, for example, W. H. Hutt, Keynesianism: Retrospect and Prospect (Chicago: Henry Regnery Co., 1963); Robert Lekachman, The Age of Keynes (New York: Random House, 1967); Hicks, Critical Essays; J. Ronnie Davis, The New Economics and the Old Economists (Ames, Iowa: Iowa State University Press, 1971) (hereafter, The New Economics). On Keynes and the Keynesians, Axel Leijonhufvud, Keynesian Economics; Hershel I. Grossman, "Was Keynes a 'Keynesian'?" Journal of Economic Literature 10 (March 1972): 26-30; and G. L. S. Shackle, "Keynes and Today's Establishment in Economic Theory: A View," Journal of Economic Literature 11 (June 1973): 516-19.

4. [4] This shift occurred once economists were confident that they understood Keynes's message.

5. [5] See Davis, The New Economics, passim. See also idem, "Henry Simons, the Radical: Some Documentary Evidence," History of Political Economy 1 (Fall 1969): 388-94. Also relevant is the discussion in Leijonhufvud, Keynesian Economics, pp. 31-35.

6. [6] Leijonhufvud, Keynesian Economics, pp. 24ff; 37-38; and passim. Yeager argued that Keynes cannot be easily credited with what Leijonhufvud claimed for him (cf. Leland Yeager, "The Keynesian Diversion," Western Economic Journal 11 [June 1973]: 150-63).

7. [7] Hayek to Milton Friedman, commenting on the latter's Henry Simons Lecture, wrote: "I believe you are wrong in suggesting the common element in the doctrine of Simons and Keynes was the influence of the Great Depression. We all held similar ideas in the 1920's. They had been more fully elaborated by R. G. Hawtrey who was all the time talking about the 'inherent instability of credit,' but he was by no means the only one.... It seems to me that all the elements of the theories which were applied to the Great Depression had been developed during the great enthusiasm for 'business cycle theory' which preceded it" (Milton Friedman, The Optimum Quantity of Money [Chicago: University of Chicago Press, 1969] p. 88n).

Not only was Hayek an active participant in these debates, but his consummate skill as a doctrine-historian and interpreter of economic theories is above dispute. For a compliment by a contemporary historian of the institutionalist school, whose section on Hayek can otherwise only be described as a series of misinterpretations and one-sided attacks, see Ben B. Seligman, Main Currents in Modern Economics, 3d ed. (New York: Free Press of Glencoe, 1963), pp. 342-43.

8. [8] See Leijonhufvud for discussions of the continuity of Keynes's thought, for instance, the section on the relationship between the Treatise and the General Theory in Leijonhufvud, Keynesian Economics, pp. 15-31.

9. [9] Erich Streissler et al., eds., Roads to Freedom (New York: Augustus M. Kelley, 1969); but see Ludwig M. Lachmann, "Methodological Individualism and the Market Economy," ibid., pp. 89-103.

10. [10] G. L. S. Shackle, The Years of High Theory (Cambridge: Cambridge University Press, 1967), pp. 4-5. "Money is the refuge from specialized commitment, the postponer of the need to take far-reaching decisions." Yet in orthodox theory, money was but a "veil" (ibid., p. 6).

11. [11] "Their 'common denominator'...has with time become uninteresting and an obstacle to clear thought. The common denominator goes under the label of the 'Marginalist Revolution'—portrayed as the simultaneous discovery of the first derivative of practically everything (followed, after decades of hard 'neoclassical' work, in due course by the discovery of the second derivative of absolutely everything). This is a conception of the work of the 'neoclassical' giants that irreparably trivializes their contributions in the eyes of a calculus-trained student generation" (Axel Leijonhufvud, "The Varieties of Price Theory: What Microfoundations for Macrotheory?" U.C.L.A. Discussion Paper no. 44 [Los Angeles: mimeographed 1974], 3); abbreviated, "Varieties of Price Theory." See also William Jaffé, "Menger, Jevons, and Walras De-Homogenized," Economic Inquiry 14 (December 1976): 511-24.

12. [12] As an example, the paper by Leijonhufvud (see note 11), an outgrowth of his work on the microfoundations of macrotheory, demonstrated that there is "more than one 'variety of price theory'." This insight indicates why economists have been remiss in providing needed microfoundations for macrotheory and why they have often found Keynes's own efforts in this regard confusing.

Leijonhufvud's "grand conclusion" lends support to my own argument: "Let us be done with the term 'neoclassical theory'" (Leijonhufvud, "Varieties of Price Theory," pp. 2, 47).

Mark Blaug noted that the so-called marginal revolution was composed of three distinct revolutions—"the marginal utility revolution in England and America, the subjectivist revolution in Austria, and the general equilibrium revolution in Switzerland and Italy" ("Was There a Marginal Revolution?" in The Marginal Revolution in Economics, ed. R. D. Collison Black, A. W. Coats, and Craufurd D. W. Goodwin [Durham: Duke University Press, 1973], p. 14).

13. [13] Knut Wicksell, "The New Edition of Menger's Grundsätze," in Selected Papers on Economic Theory, ed. Erik Lindahl (London: George Allen & Unwin, 1958), p. 193.

14. [14] It is true that Carl Menger and Eugen von Böhm-Bawerk were read to a limited extent in the United States. Jacob Viner for one was familiar with the general Austrian approach ("Cost Curves and Supply Curves," in Readings in Price Theory, ed. George J. Stigler and Kenneth Boulding [Homewood, Ill.: Richard D. Irwin, 1952], pp. 198-226, esp. p. 200). Developments in the United States were less important at this time. The Austrians remained largely unknown in Great Britain, and to a great extent, despite the translation of Böhm-Bawerk's work and the best efforts of men like Viner, Irving Fisher, and J. B. Clark, in the United States as well. It must be remembered that the locus classicus of the Austrian school, Menger's Grundsätze, was not translated until 1950 (Carl Menger, Principles of Economics, trans. and ed. James Dingwall and Bert F. Hoselitz [Glencoe, Ill.: The Free Press, 1950]).

Credit belongs to Lord Robbins for breaking down British intellectual insularity in the 1930s and bringing Continental developments to the attention of British economists. Hayek's invitation to lecture at the London School was a by-product of these efforts.

15. [15] Hicks discussed Austrian capital theory in Capital and Time (Oxford: Oxford University Press, Clarendon Press, 1973). On Menger, see John R. Hicks, Theory of Economic History (New York: Oxford University Press, 1969), p. 63; see also Boris P. Pesek and Thomas R. Saving, Money, Wealth, and Economic Theory (New York: Macmillan Co., 1967), pp. 47-48, for an appreciation that includes Ludwig von Mises.

16. [16] James Buchanan, Cost and Choice (Chicago: Markham Publishing Co., 1969).

17. [17] Ironically, the latter-day Austrians (that is, Ludwig von Mises and those who attended his seminar at the University of Vienna, including Hayek, Fritz Machlup, and Oskar Morgenstern among the younger generation) saw themselves as members of the same school in a geographical sense only. Otherwise, they considered themselves orthodox economists and applauded the demise of the Austrian school as a distinct intellectual entity. Clearly I do not accept the view that they then held; moreover, I think the course of history argues against their view.

18. [18] On the subjective nature of economics, see Hayek, The Counter-Revolution of Science (New York: Free Press of Glencoe, 1955), pp. 25-35 and passim. See also Ludwig M. Lachmann, "Methodological Individualism and the Market Economy," in Roads to Freedom, ed. Streissler et al., pp. 91-94.

19. [19] Robert V. Eagly, The Structure of Classical Economic Theory (New York: Oxford University Press, 1974), pp. 126-38. Menger noted that: "The idea of causality...is inseparable from the idea of time. A process of change involves a beginning and a becoming, and these are only conceivable as processes in time. Hence it is certain that we can never fully understand the causal interconnections of the various occurrences in a process, or the process itself, unless we view it in time and apply the measure of time to it. Thus...time is an essential feature of our observations" (Principles of Economics p. 67). He concluded this section by discussing the significance of uncertainty in the process of man producing in time. In Menger the clash with the static/general equilibrium approach of Léon Walras is unequivocal. Erich Streissler argued that "Menger's Grundsätze was an attempt to sketch a theory of economic development" ("To What Extent Was the Austrian School Marginalist?" in Marginal Revolution, ed. Black et al., p. 164).

20. [20] George J. Stigler, Production and Distribution Theories (New York: Macmillan Co., 1941), p. 181. For a strident attack on Stigler's position, see Murray N. Rothbard, Man, Economy, and State, 2 vols. (Princeton: D. Van Nostrand Co., 1962), 1: 279, 451n.

21. [21] Lachmann, "Methodological Individualism," pp. 89-91.

22. [22] Gunnar Myrdal, Monetary Equilibrium (London: William Hodge & Co., 1939).

23. [23] Shackle, The Years of High Theory, pp. 94-128. Shackle subsequently described Myrdal's achievement as providing a "language" that renders Keynes's fundamental equations (in the Treatise) intelligible ("The 1974 Nobel Prize for Economics," Science 186 [Nov. 15, 1974]: 622).

24. [24] An incorrect inference should not be drawn from the fact that Hayek edited a volume in which Myrdal's now-famous essay appeared. Hayek, wanting to make available in German those essays "which had not been available in one of the generally understood languages," appealed to Lindahl. Lindahl was unable to supply Hayek with a new work, and instead had his student Myrdal submit an essay. In no sense then was Hayek influenced by Myrdal. And work that Hayek wrote subsequently can be understood, it will be argued, entirely in terms of his own earlier development. Hayek himself told me of the way in which Myrdal's piece came to be included in the volume in question; the information was conveyed in a letter dated 25 August 1974.

25. [25] Friedrich A. Hayek, "Reflections on the Pure Theory of Money of Mr. J. M. Keynes," part 1, Economica 11 (August 1931): 277-80; J. M. Keynes, "A Reply to Dr. Hayek," ibid., 11 (November 1931): 394-95; Friedrich A. Hayek, "A Rejoinder," ibid 11 (November 1931): 401-2; and idem, "Reflections," part 2, ibid., 12 (February 1932): 25-26.

26. [26] Many of the essays on the price system were reprinted in Individualism and Economic Order. A series of articles in Economica in the 1940s on his philosophy of the social sciences are incorporated into Counter-Revolution of Science. Generally overlooked, these articles are basic to Hayek's approach to economics. The Socialist calculation debate concerned the possibility of allocating resources by central authority, i.e., without the aid of a price system.

27. [27] For the chronology of Hayek's work, see pp. 10-11.

28. [28] Schumpeter spoke of a man's "vision." He cited Keynes as the major example of the view that a man's work evolves from a basic insight (Joseph A. Schumpeter, History of Economic Analysis [New York: Oxford University Press, 1954], pp. 41-43).

29. [29] The papers are "Economics and Knowledge" (1936), "The Use of Knowledge in Society" (1945), and "The Meaning of Competition" (1946); all are reprinted in Individualism and Economic Order.

30. [30] "Profits, Interest, and Investment," in Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970). Reprint of 1939 edition.

31. [31] "Twenty years ago I lost interest in monetary matters because of my disillusionment with Bretton Woods. I was wrong in my prediction that the arrangement would soon disappear" (Sudha R. Shenoy, ed., A Tiger by the Tail [London: The Institute of Economic Affairs, 1972], p. 112).

Chapter 2. The Coordination Problem

32. [32] See Imre Lakatos, "Methodology of Scientific Research Programmes," inCriticism and the Growth of Knowledge, ed. Imre Lakatos and Alan Musgrave (Cambridge: Cambridge University Press, 1970), pp. 174-75.

33. [33] The term "Walrasianly" has been appropriated from J. R. Hicks, "A Neo-Austrian Growth Theory," The Economic Journal 89(June 1970): 257-58.

34. [34] "Modern attempts to erect a general theory of money and prices on Walrasian foundations have produced a model of economic phenomena that is surprisingly reminiscent of the classical theory of a barter economy" (R. W. Clower, "Foundations of Monetary Theory," in Monetary Theory, ed. idem [Baltimore: Penguin Books, 1970], p.202). Clower specifically referred to the works of Oskar Lange, Don Patinkin, J. R. Hicks, and Paul Samuelson. I have adopted "neo-Walrasian" to avoid doctrine-history squabbles.

35. [35] Axel Leijonhufvud, "Effective Demand Failures,"Swedish Journal of Economics 75 (1973):28. According to Leijonhufvud, the question has not been debatedexplicitly in this form. What he calls "the coordination problem" has always been the real issue.

36. [36] Leijonhufvud, "Effective Demand Failures," pp. 37-41.

37. [37] The problem considered by Leijonhufvud, whether the form of a model differs according to the values for the variables, is not considered at this point (Leijonhufvud, "Effective Demand Failures," p. 27).

38. [38] See Shackle's remark on money in note 10 of the first chapter. Also see Murray N. Rothbard, "The Austrian Theory of Money," in The Foundations of Modern Austrian Economics, ed. Edwin G. Dolan (Kansas City: Sheed & Ward, 1976) pp. 171-72. Earl Thompson has suggested that while there may be perfect information in equilibrium in a model, there may not be perfect information in disequilibrium. His basic approach seems consistent with my argument (Earl Thompson, "The Theory of Money and Income Consistent with Orthodox Value Theory" [Los Angeles: mimeographed, 1972], p. 6).

39. [39] Leijonhufvud, "Effective Demand Failures," p. 30.

40. [40] Paul A. Samuelson, Economics, 6th ed. (New York: McGraw-Hill, 1964), pp. 360-61, 590.

41. [41] "Despite the several alternative ways that we have developed to make the gulf between microtheory and macrotheory seem plausible to new generations of students, the micro-macro distinction remains basically that between models with 'perfectly coordinated' solutions and models where one or more markets reach such solutions only by chance. Both sets of exercises are referred to as 'theories,' but there could be no real-world economy for which both are true at once" (italics added) (Leijonhufvud, "Effective Demand Failures," 30-31). The addition of inconsistent hypotheses to an existing theoretical edifice does not necessarily involve methodological error. Lakatos argued that progress in the "hard" sciences has resulted from this procedure (Criticism, pp. 141-43). At some juncture, however, one "programme" has to go, or theoretical progress is halted.

42. [42] Robert Eisner, "On Growth Models and the Neo-Classical Resurgence," Economic Journal 68 (December 1958): 707.

43. [43] R. W. Clower, "The Keynesian Counter-Revolution: A Theoretical Appraisal," in Monetary Theory, ed. idem, pp. 270-97. Clower dates the counterrevolution to Hicks's article (p. 270). Eisner, on the other hand, dates the "retreat" from the fifties ("On Growth Models," p. 707).

44. [44] On the milieu at Cambridge and at the London School of Economics, see Lord Robbins, Autobiography of an Economist (London: Macmillan & Co., 1971), pp. 105-6, 132-35. According to Hayek, Robbins played an important role in many of the developments that will be discussed.

45. [45] Hicks noted that the concepts for Value and Capital were nurtured by what he termed a "sort of social process" at the London School in 1930-35. (John R. Hicks, Value and Capital [London: Oxford University Press, 1939], p. vi). Robbins discussed this social process in Autobiography of an Economist, pp. 129-32. Hicks and R. G. D. Allen referred to some of these concepts in "Reconsideration of the Theory of Value," Economica, n.s. 1 (February 1934): 52-76. There is irony in this story in that it was on Hayek's suggestion that Hicks investigated Pareto's indifference curve approach to demand theory. Hayek believed that Pareto's approach was in many ways superior to Marshall's (personal communication).

One can speculate why Hayek preferred Paretian over Marshallian demand theory. Paretian-Walrasian demand theory is more explicitly "choice-theoretic" and, thus, closer in spirit to the Austrian approach. On the distinction between Walrasian and Marshallian demand theory, see Leijonhufvud, "The Varieties of Price Theory: What Microfoundations for Macrotheory?" U.C.L.A. Discussion Paper No. 44 (Los Angeles: mimeographed, 1974).

46. [46] Walras referred to his introduction of tickets (bons) as a "fiction" (Léon Walras, Elements of Pure Economics, trans. William Jaffé [New York: Augustus M. Kelley, 1969] p. 37). The classic discussion of Walras's problems with his tâtonnement process is in William Jaffé, "Walras' Theory of Tâtonnement: A Critique of Recent Interpretations," Journal of Political Economy 75(February 1967): 1-19.

47. [47] Jaffé spoke of the "quasi-anecdotal" character of Walras's narrative about the Bourse (p. 4). Walras discussed the operation of the Bourse in the Elements, pp. 83-87. Walras's "faith" in markets is evident elsewhere (p. 106). Jaffé noted, specifically with reference to the tâtonnement process, that Walras had in mind "not a replica of the infinitely complex network of the heterogeneously organized markets of the real world, but a simplification of that network idealized in the sense that it was assumed to operate as a perfectly competitive mechanism" (pp. 11-12). Jaffé also suggested that Walras sought to lend "an air of empirical relevance to his abstract mathematical model of general equilibrium" (p. 2).

Clower and Due described Marshall's concept as "a more colorful and intuitively meaningful portrait of a market economy" than Walras's (Robert W. Clower and John F. Due, Microeconomics, 6th ed. [Homewood, Ill.: Richard D. Irwin, 1972], p. 24). At this point, Clower and Due were concerned with the treatment of money in the two paradigms.

There is some resemblance between Walras's tâtonnement process and auctions. An auction bid appears to be a crie au hazard. However, in actual auctions there are reservation prices of goods, and a given auction process depends on a past history of market prices and information, which usually have been arrived at by a method other than that of auctioning. Standard price theory does not allow for differences in actual market clearing prices depending on the selling methods chosen (for example, auction or "ordinary" market). Little work has been done on the relative efficiencies of various market forms. Yet in a world where transaction costs exist, the method of contracting could be very important (that is, there could be differential transactions costs in various market situations). Markets in the boom that characterized Western Europe from the eleventh century on were in the form of great fairs held several times a year in various localities, where goods of all descriptions would be bought and sold. The market form gradually evolved, however, until by the fourteenth century the fairs were unimportant except as clearing house mechanisms. On the role of such fairs in the medieval economy, see Henri Pirenne, Economic and Social History of Medieval Europe (New York: Harcourt, Brace & World, Harvest Books, 1933), passim. Pirenne attributed their decline to the guilds; the fairs inhibited the cartellization of crafts (pp. 209-10).

Steven N. S. Cheung has done a major part of the work on the efficiency of different market forms ("Transactions Cost, Risk Aversion, and the Choice of Contractual Arrangements," Journal of Law and Economics 12 [April 1969]: 23-42; idem, "The Structure of a Contract and the Theory of a Non-exclusive Resource," Journal of Law and Economics 13 [April 1970]: 49-70).

George J. Stigler presents the orthodox case against the form of market organization affecting equilibrium. Stigler ignores any transaction cost problem (The Theory of Price, 3d ed. [New York: Macmillan Co., 1966] pp. 94-95).

48. [48] 17. Here one should remember that Hayek is the author of The Pure Theory of Capital (Chicago: University of Chicago Press, 1941).

49. [49] On Walras's precise task, see Elements, pp. 170, 241-42. Jaffé's assessment is that Walras failed in his objective to prove that the market's operation will result in the vector of prices and quantities being identical with the solution of his simultaneous equations.

50. [50] Friedrich A. Hayek, "The Use of Knowledge in Society," in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 89-91. (Hereafter, Individualism.)

51. [51] Ibid., p. 35.

52. [52] Hayek, "Socialist Calculation III: The Competitive Solution," Individualism, p. 188.

53. [53] Hayek, "The Use of Knowledge in Society," p. 91. Walras seemed aware of the point Hayek made here (Elements, p. 106). See also J. M. Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace & World, 1936), pp. 272-79.

54. [54] See, for example, K. J. Arrow, "Toward a Theory of Price Adjustment," in The Allocation of Economic Resources, ed. Moses Abramovitz (Stanford: Stanford University Press, 1959), pp. 41-51; hereafter, "Toward a Theory." See also Israel M. Kirzner, Competition and Entrepreneurship (Chicago: University of Chicago Press, 1973); hereafter: Competition. Kirzner's work has an explicitly Hayekian (Austrian) framework; Arrow's has a neo-Walrasian equilibrium framework.

55. [55] Hayek, "The Meaning of Competition," Individualism, p. 95. See also George J. Stigler, The Organization of Industry (Homewood, Ill.: Richard D. Irwin, 1968), pp. 5-16.

56. [56] Hayek, "The Meaning of Competition," p. 95.

57. [57] Lionel Robbins, An Essay on the Nature and Significance of Economic Science, 2d ed. (London: Macmillan & Co., 1935). "The book [i.e., Robbins's] has been so influential that its once challenging thesis will seem almost platitudinous to today's students. For that very reason, it should be recognized as an important part of the story of how choice-theory became the predominant—indeed, all but exclusive—paradigm of modern theoretical economics" (Leijonhufvud, "Varieties of Price Theory", 53n). Hayek convinced me that Robbins, in turn, was heavily influenced by the Austrian Richard von Strigl. Thus the earlier Austrians in part contributed to the development of a theoretical edifice they later came to reject.

58. [58] The phrase "Robbinsian maximizing behavior" is Kirzner's (Competition, pp. 32-37).

59. [59] Ibid., pp. 32-33.

60. [60] Hayek, "Economics and Knowledge," Individualism, p. 39. Modern work on the technical issues involved in alternative assumptions about the dispersal of knowledge among economic actors, although accomplished within a neo-Walrasian framework, is of interest to the theorist. See Leonid Hurwicz, "The Design of Mechanisms for Resource Allocation," American Economic Review 63 (May 1973): 1-30.

61. [61] Hayek, "The Use of Knowledge in Society," p. 77.

62. [62] Clower and Due, Microeconomics, p. 52 (emphasis in original).

63. [63] This section is based substantially on Hayek, "Economics and Knowledge," pp. 33-56, esp. pp. 35-45.

64. [64] Ibid., p. 42.

65. [65] It might be likely if the third assumption were true and we were dealing with an essentially stationary world. This possibility led Hayek to wonder whether the third assumption might imply the first.

66. [66] Hayek, "Economics and Knowledge." pp. 38-39.

67. [67] Ibid., p. 42.

68. [68] Ibid., p. 46.

69. [69] Among his writings on cycles and monetary theory the one entitled "Price Expectations, Monetary Disturbances, and Malinvestments" most clearly makes use of this conception, in Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), pp. 135-56. Significantly, that essay antedates the three aforementioned essays on the price system.

70. [70] Hayek, "The Use of Knowledge in Society," p. 82.

71. [71] This could be overdrawn, of course, but there are differences. Stigler's view is essentially different from Hayek's": "These terms ['stable' and 'equilibrium'] were obviously borrowed from physics—has the economist made sure that they really make sense in economics? The answer is, let us hope, yes. The stability of equilibrium is indeed the normal state of affairs in a tolerably stable world" (Theory of Price, p. 93). For further elaborations on the differences between the Austrian and the Schumpeterian conceptions of the entrepreneur, see Kirzner, Competition; Rothbard, Man, Economy, and State, 2 vols. (Princeton: D. Van Nostrand Co., 1962), 2: 493-94.

72. [72] Hayek, "The Meaning of Competition," p. 94.

73. [73] Ibid., p. 96.

74. [74] Much of Hayek's work on resource allocation was developed in the context of the Socialist calculation debates (Friedrich A. Hayek, ed., Collectivist Economic Planning [London: George Routledge & Sons, 1935]).

75. [75] "Profits are a permanent income flowing from ever-changing sources, like the profits of a restaurant in which a different set of customers chooses a different set of dishes from the menu card every day" (Ludwig M. Lachmann, Macro-economic Thinking and the Market Economy, Hobart Paper No. 56 [London: Institute of Economic Affairs, 1973], p. 31). Buchanan most ably demonstrated that costs are an unrealized (and hence immeasurable) alternative (Cost and Choice [Chicago: Markham Publishing Co., 1969], pp. vii-x; and 38-50).

76. [76] "To make a monopolist charge the price that would rule under competition, or a price that is equal to the necessary cost, is impossible, bacause the competitive or necessary cost cannot be known unless there is competition" (Hayek, "Socialist Calculation II: The State of the Debate (1935)," Individualism, p. 170).

77. [77] One assumes that practitioners are not unaware of the theoretical problem and have a gestalt conception of markets significantly different from Hayek's. For sources on concentration and rates of return, see John S. McGee, In Defense of Industrial Concentration (New York: Praeger Publishers, 1971), p. 151n. For a criticism of the approach of many of these statistical studies, see Yale M. Brozen, "The Antitrust Task Force Deconcentration Recommendation," Journal of Law and Economics 13(October 1970): 279-92.

78. [78] Arrow pointed out that market adjustment behavior is often confused with long-run monopolistic power, a confusion that is elementary but widespread ("Toward a Theory," pp. 45-47).

79. [79] Hayek, "Economics and Knowledge," pp. 35-37.

80. [80] "It is only by this assertion that such a tendency [toward equilibrium] exists that economics ceases to be an exercise in pure logic and becomes an empirical science" (ibid., p. 44).

81. [81] Ibid., p. 50.

82. [82] Ibid., pp. 50-51.

83. [83] Hayek, "The Use of Knowledge in Society," p. 86.

84. [84] Ibid., p. 87. His gestalt conception is evident in this passage; parameters change so often that, before the transactor can execute his plans, he is compelled to revise them.

85. [85] Hirshleifer, while acknowledging the "pioneering" quality of "The Use of Knowledge in Society," surely misinterprets the central message. The article is about the use and production of information ("Where Are We Now in the Theory of Information?" American Economic Review 63 [May 1973]: 34).

86. [86] Hayek's mentor, Mises, was even more explicit on this point: "Action is always speculation.... In any real and living economy every actor is always an entrepreneur and speculator" (Ludwig von Mises, Human Action [New Haven: Yale University Press, 1949], p. 253).

87. [87] The more finely developed the market for a commodity, the more accurately prices reflect anticipations and the better founded are anticipations. But the absence of an explicity time-dated market for a commodity is one with the absence of opera in central Iowa: the division of labor is limited by the scarcity of means.

88. [88] Hayek, "Economics and Knowledge," p. 34.

89. [89] Austrian economists have been viewed as unremitting critics of the use of mathematics in economic theory. What in fact Hayek objected to about this tool in analyzing allocation questions was the assumption that a transactor's knowledge is necessarily consistent with the facts, and with each other's plans (Hayek, "The Use of Knowledge in Society," pp. 89-91).

Chapter 3. The Monetary Theory

1. [1] Harry Johnson, "Monetary Theory and Policy," in Monetary Theory and Policy, ed. Richard S. Thorn (New York: Random House, 1969), p. 5 (hereafter, "Monetary Theory").

2. [2] Ibid., p. 5.

3. [3] A strange agglomeration of questions, ancillary to general equilibrium theory, are taken up in monetary theory. Although the term-structure of interest rates is one of these, the determination of "the" interest rate is not. This division has proved less than salutory at times, see Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), pp. 294-95.

4. [4] For a lively discussion of these controversies, see Johnson, "Monetary Theory," pp. 7-13. After the Johnson survey (1962), a great deal of interest developed in the argument developed by Boris P. Pesek and Thomas R. Saving in Money, Wealth, and Economic Theory, which may be viewed as a continuation of the Patinkin debate (New York: The Macmillan Co., 1967 [hereafter, Money]).

5. [5] Milton Friedman, "The Quantity Theory of Money—A Restatement," in Studies in the Quantity Theory of Money, ed. idem (Chicago: University of Chicago Press, 1956), pp. 3-21 (hereafter, "Quantity Theory"). On the importance of this paper, see Johnson, "Monetary Theory," pp. 18-19.

6. [6] It is of course largely because of Friedman that there was a revival of interest in the field, however narrowly defined.

7. [7] Friedman, "Quantity Theory," p. 4.

8. [8] Ibid., p. 15.

9. [9] Ibid., p. 15.

10. [10] Milton Friedman, "A Theoretical Framework for Monetary Analysis," Journal of Political Economy 78 (March/April 1970): 193-238 (hereafter, "Theoretical Framework"); and idem, "A Monetary Theory of Nominal Income," Journal of Political Economy 79 (March/April 1971): 323-37.

11. [11] "For monetary theory, the key question is the process of adjustment to a discrepancy between the nominal quantity of money demanded and the nominal quantity supplied" (Friedman, "Theoretical Framework," p. 225).

The assumption that monetary theory is coextensive with the quantity theory is implicit, for the adjustment to an excess demand for money is the crux of the quantity theory.

12. [12] Tobin juxtaposed "monetarists and neo-Keynesians" in a critique of Friedman. Tobin characterized himself as an "eclectic non-monetarist." Non-monetarists appear reluctant to call themselves simply "monetary theorists." "Keynesian" became almost synonymous with non-monetary explanation of cyclical fluctuations. Tobin characterized himself as "neo-Keynesian" or "Hicksian," apparently because he believes "that both monetary and fiscal policies affect nominal income." He pleaded: "One thing the non-monetarists should not be called is 'fiscalists'" (James Tobin, "Friedman's Theoretical Framework,"Journal of Political Economy 80 (September/October 1972): p. 852).

13. [13] "Monetary theory turns out to be simply value theory applied to a good that has the special technical characteristic of yielding real income the level of which is directly proportional to the price per unit" (Pesek and Saving, Money, pp. 135-36).

14. [14] Hicks, Critical Essays in Monetary Theory (New York: Oxford University Press, The Clarendon Press, 1967), pp. 61-82.

15. [15] Knut Wicksell, Lectures on Political Economy, ed. Lionel Robbins, 2 vols. (London: George Routledge & Sons, 1935), 2:141 (hereafter, Lectures).

16. [16] Ibid., pp. 143-44.

17. [17] "Consequently, the amount of goods and of transactions being the same, the value of money is inversely as its quantity multiplied by what is called the rapidity of circulation" (John Stuart Mill, Principles of Political Economy, ed. William Ashley [Clifton, N. J.: Augustus M. Kelley, 1973], pp. 494, 495). This is J. S. Mill's statement of the proportionality theorem, "other things being the same." Mill then went on to analyze what occurs when these "other things" are not the same.

18. [18] Schumpeter actually said that "velocity of circulation is an institutional datum that varies slowly or not at all, but in any case is independent of prices and volume of transactions." The term institutional datum is potentially misleading and associates the theory too much with the version propounded by one man, Irving Fisher.

19. [19] Joseph A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954), p. 703.

20. [20] David Hume, who in other respects is treated as a major figure by Schumpeter, surely belongs on the list. Hume argued that "the prices of commodities are always proportioned to the plenty of money, and a crown in Harry VII's time served the same purpose as a pound does at present" (David Hume, "On Money," in David Hume: Writings on Economics, ed. Eugene Rotwein [Madison: University of Wisconsin Press, 1970], p. 33). Hume's version might be considered the locus classicus (in English) for the quantity theory, as defined above. But the modernity of Hume's essay is also striking; we still apparently labor under his first formulation of the effects of money on prices and output. An incipient monetarism might be inferred in his prescription against increasing the paper credit of a nation "beyond its natural proportion to labour and commodities" (Hume, p. 36).

21. [21] Mill, Principles, pp. 490-93.

22. [22] Ibid., p. 491

23. [23] Ibid., p. 492. Mill continued: "If the whole money in circulation was doubled, prices would be doubled. If it was only increased one-fourth, prices would rise one-fourth. There would be one fourth more money, all of which would be used to purchase goods of some description."

24. [24] Ibid., p. 495.

25. [25] Ibid., p. 498.

26. [26] Ibid., pp. 523-41. According to Sowell, "The idea that the price level is rigidly linked to the quantity of money by a velocity of circulation which remains constant through all transitional adjustment processes cannot be found in any classical, neoclassical or modern proponent of the quantity theory of money" (Thomas Sowell, Classical Economics Reconsidered [Princeton: Princeton University Press, 1974], pp. 59-60).

27. [27] Schumpeter pointed out that after Mill considered the effects of credit, "there is hardly any difference left between Mill's version of the quantity theory and the views of its opponents, contemporaneous or later" (Schumpeter, History, p. 705). The reason is that Mill did not subscribe to the quantity theory as defined by Schumpeter.

28. [28] Ricardo's position is clearly stated in The High Price of Bullion, reprinted in Piero Sraffa, ed., Works of David Ricardo, vol. 3 (Cambridge: Cambridge University Press, 1951) along with a chronology of Ricardo's contributions on this question. Schumpeter remarked that "Ricardo...introduced qualifications occasionally and that, here and there, he made statements that were logically incompatible with his strict quantity theory, exactly as he did in the matters of his labour-quantity law of value. In both cases, however, he mentioned them only in order to minimize their importance.... We are...justified in attributing to him the strict quantity theory, as an approximation" (History, pp. 703-4).

29. [29] Adam Smith, The Wealth of Nations, ed. Edwin Cannan (New York: Modern Library, 1965), p. 58.

30. [30] According to Smith, laborers could hope to raise their wages above "the lowest which is consistent with common humanity" if the "scarcity of hands occasions a competition among masters, who bid against one another, in order to get workmen." Smith was explicit about the reason for such increased competition: "The demand for those who live by wages, therefore, necessarily increases with the increase of the revenue and stock of every country, and cannot possibly increase without it... It is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour" (Smith, Wealth of Nations, pp. 68-69 [emphasis added]).

31. [31] Sowell, Classical Economics Reconsidered, pp. 33-34; see also Frank W. Fetter, "The Relation of Economic Thought to Economic History," American Economic Review 55 (May 1965) :138-39.

32. [32] "Ricardian comparative statics and concentration on long run equilibrium assumed away many transitional monetary phenomena, especially in Ricardo's Principles—though his polemical pamphlets and correspondence dealt with such problems, even if sometimes somewhat grudgingly" (Sowell, Classical Economics Reconsidered, p. 53). For a cost-of-production theorist, the ultimate effects of a change in the demand for a commodity money can only be analyzed by taking into account the effects on the cost of production (Mill, Principles, pp. 499-506.) But this was too long a run even for Mill and Ricardo. Both analyzed money in terms of demand and supply. Senior remained consistent, however, and insisted on analysis in terms of the cost of production of the metal (Schumpeter, History, p. 702).

33. [33] The proportionality theorem does not follow from demand-and-supply analysis without further explanation (Schumpeter, History, p. 703; Wicksell, Lectures, 2: 141-44). On the nature of Ricardo's question, see Wicksell, Lectures, 2: 175-76.

34. [34] Henry Thornton, An Inquiry into the Nature and Effects of the Paper Credit of Great Britain, ed. F. A. Hayek (London: George Allen & Unwin, 1939), p. 241 (hereafter, Paper Credit).

35. [35] Richard Cantillon, quoted in Hayek, Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), p. 1.

36. [36] J. S. Mill was concerned with analyzing the effects of monetary disturbances on the purchasing power of money and not on relative prices (Principles, pp. 491-93). He treated credit as a substitute for money with similar effects. These effects alter the demand for "goods" (ibid., p. 514). See the text below on forced saving.

37. [37] Ibid., p. 492.

38. [38] Thornton, Paper Credit, p. 253.

39. [39] See pp. 40-41 above.

40. [40] J. S. Mill should probably be called a "modified Ricardian" in that he paid more attention to the mechanism by which monetary disturbances are transmitted to real activity than did Ricardo (Mill, Principles, pp. 532-41).

41. [41] Schumpeter, History, p. 704n. According to Sowell, "Thornton's careful separation of short-run transitional effects from long-run equilibrium contrasts sharply with Ricardo's repeated interpretation of others' doctrines in his own comparative statics terms" (Classical Economics Reconsidered, p. 58).

42. [42] See p. 38 of text.

43. [43] J. S. Mill recognized the possible distribution effects of an increase in the quantity of money. But he dismissed them as unimportant in the long run. If there were distribution effects, "then until production had accommodated itself to this change in the comparative demand for different things, there would be a real alteration in values.... These effects, however, would evidently proceed, not from the mere increase of money, but from accessory circumstances attending it. We are now only called upon to consider what would be the effect of an increase of money considered by itself." That is, he considered the long run effects (Mill, Principles, p. 492).

44. [44] See note 31 above.

45. [45] On the tendency of classical economists to recognize but underestimate the short-run effects of a monetary disturbance, see Sowell, Classical Economics Reconsidered, pp. 52-66.

46. [46] See note 32 above.

47. [47] Friedman's theoretical framework consists of an analysis of the adjustment to a monetary disturbance and not of propositions about the long-run neutrality of money. "I believe the writings of earlier quantity theorists, from Ricardo and Thornton to Keynes, were not about [the long-run neutrality of money] either" (Milton Friedman, "Comments on the Critics," Journal of Political Economy 80 [September/October 1972]: 945). I agree with Friedman on Henry Thornton, just as I disagree with him on Ricardo. Thornton and Ricardo were engaged in entirely different endeavors.

48. [48] According to Anthony Lee, department of economics, University of California at Santa Barbara, no reference to Henry Thornton can be found in any of Wicksell's works (personal communication). If so, this would confirm my hypothesis that Wicksell was not acquainted with the work of the elder Thornton. Most historians of economic thought seem to agree.

49. [49] Ricardo, Works, vol. II I, p. 91; Robbins, in Wicksell's Lectures, 1: xvi-xvii.

50. [50] Axel Leijonhufvud has suggested that Wicksell never had access to a superior library.

51. [51] Wicksell, Lectures, 2: 190.

52. [52] The marginal product of investment is Wicksell's marginal productivity of capital, or Jevons's marginal yield of capital (Wicksell, Lectures, 1: 147-57; Ralph G. Hawtrey, Capital and Employment, 2d ed. [London: Longmans, Green & Co., 1952], p. 29; and Hayek, Pure Theory of Capital, p. 189). The term marginal product with reference to capital is a misnomer; what is usually meant is the rate of increase in output attributable to an increment to capital.

53. [53] Wicksell, Lectures, 2: 192-93. According to Myrdal, Wicksell incorrectly stated the condition of monetary equilibrium as a result (Myrdal, Monetary Equilibrium, pp..126-31).

54. [54] Mises's neglect by American economists is even more egregious than Hayek's. Thus, Mises never benefited from his idea of assisting German refugee intellectuals in finding positions, and he never held a regular academic position in the United States, doubtless because of political discrimination. Mises's place in economics is such that it deserves consideration in a separate work. On Mises's role in Beveridge's plan to help European refugee intellectuals, see Robbins, Autobiography of an Economist (London: Macmillan & Co., 1971), pp. 143-44.

55. [55] Keynes is partly responsible for this neglect in Great Britain. Keynes admitted he understood in German what he already knew, yet he wrote an essentially negative review of Mises's monetary classic, though he later endorsed Mises's basic approach. As Hayek remarked, "He had reviewed L. von Mises' Theory of Money for the Economic Journal (just as A. C. Pigou had a little earlier reviewed Wicksell) without in any way profiting from it" (Hayek, "Personal Recollections of Keynes and the 'Keynesian Revolution,'" in A Tiger by the Tail, ed. Shenoy, p. 101). Keynes reviewed the Mises work in Economic Journal 24 (September 1914).

56. [56] Lionel Robbins's Introduction to the Theory of Money and Credit (Irvington-on-Hudson, N. Y.: Foundation for Economic Education, 1971). This edition is a reprint of the revised English edition (1952); the first English edition (1934) was based on the second German edition (1924).

57. [57] Mises, Theory of Money and Credit, pp. 339-66. The truly Misesian contribution commences on p. 349. If Prices and Production, a series of four lectures running over one hundred pages, was overly concise, pity the poor reader confronted with this theory explained in fewer than twenty (albeit lengthier) pages! On the "inner value of money," see Friedrich A. Hayek, Monetary Theory and the Trade Cycle, trans. N. Kaldor and H. M. Croome (1933; reprint ed. New York: Augustus M. Kelley, 1966), p. 117 (hereafter, Monetary Theory); see also translator's note in Theory of Money and Credit, p. 124.

58. [58] Mises, Theory of Money and Credit, p. 24.

59. [59] Hayek, Monetary Theory and the Trade Cycle, p. 47; and Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), p. 26.

60. [60] The period referred to antedated The General Theory, and Keynes's own criticism of the quantity-theory tradition.

61. [61] Hayek, Prices and Production, p. 4.

62. [62] Ibid., p. 2.

63. [63] Ibid., p. 4.

64. [64] Ibid., p. 7. By "prices" Hayek means relative prices. Footnote reference to Hawtrey omitted.

65. [65] See p. 42 above.

66. [66] Irving Fisher "The Business Cycle Largely a 'Dance of the Dollar,'" Quarterly Publication of the American Statistical Association, December, 1923; cited in Hayek, Monetary Theory and the Trade Cycle, p. 236n.

67. [67] Hayek, Prices and Production, p. 3. The "elementary propositions" would be the ceteris paribus, long-run connection between money and prices.

68. [68] See p. 42 above.

69. [69] See footnote 91 for the reference to Malthus's review of Ricardo's High Price of Bullion.

70. [70] Hayek, Prices and Production, p. 4.

71. [71] J. S. Mill, Principles, p. 488. "In considering Value, we were only concerned with causes which acted upon particular commodities apart from the rest. Causes which affect all commodities alike do not act upon values. But in considering the relation between goods and money, it is with causes that operate upon all goods whatever that we are specially concerned. We are comparing goods of all sorts on one side, with money on the other side, as things to be exchanged against each other" (ibid., p. 491).

72. [72] Keynes, General Theory, p. 292.

73. [73] Hayek, "Reflections on the Pure Theory of Money of Mr. J. M. Keynes," part 1, Economica 11 (August 1931): 270. Hayek was here reviewing The Treatise.

74. [74] See the text below pp. 95-96, for a discussion of whether Hayek's was a monetary explanation.

75. [75] Hayek, Monetary Theory, p. 105.

76. [76] Ibid., pp. 104-6; this work was written for a German audience.

77. [77] See Hayek, Prices and Production, pp. 28-29.

78. [78] Hayek, "Personal Recollections of Keynes and the 'Keynesian Revolution,'" p. 102.

79. [79] Ibid., p. 106.

80. [80] Friedrich A. Hayek, "Three Elucidations of the Ricardo Effect," Journal of Political Economy 77 (March/April 1969): 279-81.

81. [81] See Hayek, "Economics and Knowledge," in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), p. 45.

82. [82] Wicksell, Lectures, 2: 159 (emphasis in original).

83. [83] Keynes, General Theory, p. 293 (emphasis in original).

84. [84] Myrdal, Monetary Equilibrium, p. 45.

85. [85] Shackle, Years of High Theory (Cambridge: Cambridge University Press, 1967), p. 6.

86. [86] Piero Sraffa, "Dr. Hayek on Money and Capital," Economic Journal 42 (March 1932): 43.

87. [87] Hayek, "Money and Capital: A Reply," Economic Journal 42 (June 1932): 238.

88. [88] "[Keynes] was little concerned with relative prices" (Friedrich A. Lutz, "On Neutral Money," in Roads to Freedom, eds. Erich Streissler, et al. [New York: Augustus M. Kelley, 1969], p. 112).

89. [89] Ibid., pp. 112-14; Don Patinkin, Money, Interest, and Prices, 2d ed. (New York: Harper & Row, 1965), pp. 175-76.

90. [90] The details of his analysis of the changes in real economic activity are considered in chapters 4 and 5 of this study.

91. [91] Cited by Hayek, Prices and Production, pp. 19-20.

92. [92] Hayek, "A Note on the Development of the Doctrine of 'Forced Saving'," Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), p. 190.

93. [93] Which consumers would be expected to engage in the forced saving will be discussed in chapter 5.

94. [94] Hayek, Prices and Production, pp. 87-88. Thus, forced saving is not a sum of money that consumers are forced to save. On this, see W. E. Kuhn, The Evolution of Economic Thought, 2d ed. (Cincinnati: South-Western Publishing Co., 1970), p. 386.

95. [95] Strictly speaking, Hayek designated "forced saving" as the difference between consumption before the monetary disturbance and that after, or the difference between equilibrium saving and the higher level of investment, I1 (Hayek, Prices and Production, p. 57.) But in keeping with contemporary analysis, which focuses on planned magnitudes at current prices, I have defined forced saving somewhat differently in the text. The S function represents the supply of voluntary (i.e., planned) saving; it is not the standard "supply of loanable funds" curve. A chief purpose of this analysis is to distinguish between loanable funds composed of voluntary savings and those that are not.

96. [96] "The case most frequently to be encountered in practice [is that] of an increase of money in the form of credits granted to producers" (Hayek, Prices and Production, p. 54).

97. [97] Hayek, Monetary Theory, pp. 44-45.

98. [98] See Lutz, "On Neutral Money," pp. 105-9. The reader may detect a similarity between my analysis of the problem and that of Lutz. While I had considered these issues before reading Lutz and had arrived at a similar—though not identical—position, I was influenced by his analysis.

99. [99] Patinkin, Money, Interest, and Prices, p. 75.

100. [100] It is possible to conceive of money in this context as the numéraire of Walras's system: "Money in this latter sense is introduced, after the relative prices have been determined, in the shape of a money equation which sets the general price level while leaving relative prices unaffected" (Lutz, "On Neutral Money," p. 107). But this concept of money would do violence to the work of Wicksell, Hayek, and others.

101. [101] Ibid., p. 112.

102. [102] Ibid., p. 116.

103. [103] Keynes, General Theory, pp. 39, 59-60, 76, 79-80, 176, 183, 192-93, 214, 328-29.

104. [104] Ibid., p. 80. Keynes continued: "This definition would make good sense, but a sense in which a forced excess of saving would be a very rare and a very unstable phenomenon, and a forced deficiency of saving the usual state of affairs" (General Theory, p. 80). It is the first two propositions (that is, that forced saving is "rare" and that it is "unstable") that are at issue. The third proposition is one of which I can make no sense, unless Keynes wished to maintain that we suffer chronic unemployment. Such cryptic remarks led Hayek to conclude that Keynes believed that unemployment was chronic and to criticize Keynes's "economics of abundance" (Pure Theory of Capital, pp. 373-75).

105. [105] Keynes here referred to Hayek's article "A Note on the Development of the Doctrine of 'Forced Saving'," reprinted in Profits, Interest, and Investment, pp. 183-97.

106. [106] Keynes, General Theory, pp. 80-81. See the caveat in note 95 above. Keynes's treatment of forced saving is an instance of how his solecistic use of "classical" led him into error. He argued that "the usual classical assumption [is] that there is always full employment" (General Theory, p. 191). What is true is that Ricardians were virtually always concerned with the long run, in which ex hypothesi there is full employment. In Keynes's terminology, forced saving theorists were "classical." Hence, the reasoning goes, they thought there was always full employment, etc. Keynes cited no reference on forced saving, except Hayek's note on the history of the concept. It is doubtful whether Keynes could have found any support for his argument.

107. [107] Hayek, "Three Elucidations," pp. 279-80.

Chapter 4. Money and Prices

1. [1] Hayek, "Three Elucidations of the Ricardo Effect," Journal of Political Economy 77 (March/April, 1969): 282. Lord Robbins gave a brief account of the favorable impact of these lectures (Autobiography of an Economist [London: Macmillan & Co., 1971], p. 127). Hayek was almost immediately offered the long-vacant Tooke Chair at the London School of Economics.

2. [2] The locus classicus for Hayek was Ludwig von Mises's Theorie des Geldes und der Umlaufsmittel (1912) (The Theory of Money and Credit, tr. H. E. Batson [Irvington-on-Hudson, N. Y.: Foundation for Economic Education, 1971]).

3. [3] Hayek recognized the similarity of enterprise among these figures. In a letter to Milton Friedman he remarked: "We all had similar ideas in the 1920s. They had been most fully elaborated by R. G. Hawtrey who was all the time talking about the 'inherent instability of credit' but he was by no means the only one" (Friedman, Optimum Quantity of Money [Chicago: Aldine Publishing Co., 1969], p. 88n).

4. [4] Irving Fisher does not fit this analysis as well as the others. His work on money is largely a restatement of the quantity theory, against which many of the other figures were reacting (Roy Harrod, Money [London: St. Martin's Press, 1969], p. 27).

5. [5] Hayek, Monetary Theory and the Trade Cycle (New York: Augustus M. Kelly, 1966).

6. [6] Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 33-56. The other articles, all reprinted in this same volume, are "The Facts of the Social Sciences," "The Use of Knowledge in Society," and "The Meaning of Competition."

7. [7] Hayek, Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), pp. 6-7.

8. [8] Hayek, Monetary Theory, p. 54 (emphasis original).

9. [9] Gottfried Haberler, Prosperity and Depression, 3d ed. (Lake Success, N. Y.: United Nations, 1946), pp. 277-78. Haberler was particularly careful to note that each business cycle is a unique historical event, and that there are dissimilarities among cycles. He only argued that there are certain characteristic features of cycles. This is an historical question, and is treated as such by virtually all concerned (ibid., pp. 274-76).

10. [10] Obviously Spiethoff influenced all Continental economists studying the business cycles at this time. Although both Mises and Hayek emphasized the monetary factors operating causally in the cycle, both mentioned Spiethoff in their works,though often to disagree with him. Also both contributed articles to Spiethoff's Festschrift (Schumpeter, History of Economic Analysis [New York: Oxford University Press, 1954], pp. 815-17, 1126-28).

11. [11] It would be more precise to speak of changes in the rate of growth of credit, as these were the analytically important changes in Hayek's Misesian (or neo-Wicksellian) theory. Thus, while he was chiefly concerned with changes in bank deposits or credit money, he did not treat the amount of credit as rigidly determined by the stock of money, even though he viewed economic fluctuations as being initiated by monetary disturbances.

12. [12] Hayek, Monetary Theory, pp. 103-6. On the attitude of the modern Austrian school toward price levels, see Schumpeter, History, pp. 701n, 1089, 1095.

13. [13] See Hayek's own justification of this procedure in Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), pp. 32-36.

14. [14] Hayek felt that Keynes, for one, was guilty of this error in The General Theory. Hayek at first appraised that work as providing theorists with "the economics of abundance." Twenty-five years later, he argued that Keynes's analytical framework was one in which "the whole price system [was] redundant, undetermined and unintelligible" (Sudha R. Shenoy, ed.,A Tiger by the Tail [London: Institute of Economic Affairs, 1972], p. 103).

15. [15] Haberler, Prosperity and Depression, p. 63n; and Fritz Machlup, "Friedrich von Hayek's Contributions to Economics," Swedish Journal of Economics 76 (1974): 506.

16. [16] One example is to J. S. Mill's exposition of the effects of a sudden conversion of circulating into fixed capital (Principles, pp. 93-97). Mill's analysis is reflected in Hayek's monetary explanations of the following century.

17. [17] W. H. Hutt, The Theory of Idle Resources (London: Jonathan Cope, 1939), p. 15.

18. [18] Hayek, Prices and Production, pp. 36-40. Throughout Hayek was concerned with the allocation of consumption over time; he did not consider the effects of a change in tastes for consumer goods to be consumed in a given time period. Thus, at times, "homogeneous consumption services" could be substituted for "consumers' goods."

19. [19] The durable-goods problem was of particular importance for the Austrian school. Wicksell was the first to point out that the durable-goods problem is identical with the Marshallian joint-supply problem (Wicksell, Lectures on Political Economy, ed. Lionel Robbins [London: Routledge & Kegan Paul, 1935], I:260). D. K. Benjamin and Roger Kormendi rediscovered this fact in "The Interrelationship between the Markets for New and Used Durables," Journal of Law and Economics 18 (October 1974): 381-401. See also Hayek, The Pure Theory of Capital (Chicago: University of Chicago Press, 1941), pp. 66-67.

20. [20] Hayek, Prices and Production, pp. x-xii; see also Hayek, Pure Theory of Capital, pp. 46-49.

21. [21] Hayek, Prices and Production, p. 40n.

22. [22] Ibid., pp. 40-41n.

23. [23] Hayek, Pure Theory of Capital, p. 48.

24. [24] Hayek, Prices and Production, pp. 38-42. Hayek said that Jacob Marshak suggested the term "Jevonian Investment Figure." Jevons as well as Wicksell and Ackerman used similar figures (ibid., p. 38n). The similarity to Wicksell's approach is particularly striking (Wicksell, Lectures, 1: 151-54). See also W. Stanley Jevons, Theory of Political Economy, ed. R. D. C. Collison Black (Baltimore: Penguin Books, 1970), p. 231.

25. [25] Hayek, Prices and Production, pp. 41-42.

26. [26] Ibid., p. 42.

27. [27] Hayek, Pure Theory of Capital, pp. 199-200.

28. [28] Ibid., pp. 3-13, 93-94. Much of this reflects the still very strong influence of Böhm-Bawerk's thinking on Hayek.

29. [29] Hayek, Prices and Production, p. 46.

30. [30] Hayek, "Price Expectations, Monetary Disturbances, and Malinvestment," Profits, Interest, and Investment, pp. 153-54 (hereafter, "Price Expectations"). In pointing out that his theory was "quite independent of any idea of absolute changes in the quantity of capital," Hayek noted that his theory did not depend on being able to measure the capital stock or (to deal with the question that concerned him at this point) on giving any determinate meaning to the maintenance of capital.

31. [31] Hayek was following his own dictum in "Economics and Knowledge" that "before we can explain why people commit mistakes, we must first explain why they should ever be right" (Individualism, p. 34).

32. [32] The two methods involve hypothetical experiments: the increase in the propensity to save assumes a constant money supply, and the increase in the money supply assumes a given propensity to save. Hayek took into account the complexities introduced by an elastic supply of trade credit (Prices and Production, pp. 115-18).

33. [33] Hayek, "Price Expectations," pp. 152-154.

34. [34] Ibid., p. 152.

35. [35] Hayek placed no emphasis on the interest elasticity of saving. "The factors which affect an individual's willingness to save are the regularity and certainty of his income, the security of the investment opportunities available to him, and the possibility of investing in his own business... It seems that in the short run the willingness to save varies very little and that it is particularly not much affected in the aggregate by changes in the rate of interest" (Profits, Interest, and Investment, p. 169). The inclusion of this essay in Encyclopedia of the Social Sciences in 1935 suggests that it must have represented the consensus of the profession, for new theories are not usually introduced in such articles. The dependence of saving on income is referred to as "self-evident commonplace" (ibid., p. 53n).

36. [36] To Wicksell, the adaptation of entrepreneurs to a changed propensity to consume is as a rule "of secondary importance in comparison with the main phenomenon," changes in the struture of production. He did assume, however, an "adaptability and a degree of foresight in the reorganization of production which is far from existing in reality" (Lectures, 2: 193).

37. [37] This analysis is from Hayek, Prices and Production, pp. 75-77. An application of resources to the early stages would allocate circulating capital to more productive operations. Production for consumption would take longer (measured from the first application of labor and land services). Fewer consumption goods would be available immediately and more would be available ultimately. This is precisely what consumers desire when they increase their propensity to save. If net value productivity is involved in extending the number of stages, the output of consumer goods will eventually increase (see note 39 below).

38. [38] An investment period is "the interval between the application of a unit of input and the maturing of the quantity of output due to that input" (Hayek, The Pure Theory of Capital, p. 69). The concept is most applicable to what Frisch called a "point input-point output" model. For a continuous input-point output, or point input-continuous output model, Hayek used joint-demand analysis (for factors in the first case) and joint-supply analysis (for the services in the second case) (ibid., p. 67). Hayek did not give the Frisch citation there.

39. [39] Hayek, Prices and Production, pp. 79-83. According to Hayek, the discounted value of the marginal product of nonspecific factors will increase for a second reason: the superiority of "roundabout," or "capitalistic," methods of production, which insures that total output of consumer goods will increase once the new process has been completed. This controversial and typically Austrian proposition is not essential for what follows, though one wonders why investment would ever become "more capitalistic" if this were not true.

40. [40] "A change in the bank-rate is not calculated to have any effect (except, perhaps, remotely and of the second order of magnitude) on the prospective real yield of fixed capital" (J. M. Keynes, A Treatise on Money, 2 vols. [New York: Harcourt, Brace & Co., 1930], 1:202).

41. [41] Hayek, "Reflections on the Pure Theory of Money of Mr. J. M. Keynes," part 2, Economica 11 (February, 1932): 25; and Gerald P. O'Driscoll, Jr., "Hayek and Keynes: A Retrospective Assessment," Iowa State University, Staff Paper no. 20, 1975), esp. pp. 24-26.

42. [42] Hawtrey, Capital and Employment, 2d ed. (London: Longmans, Green & Co., 1952), p. 31; see also Hayek, Pure Theory of Capital, p. 286.

43. [43] Hawtrey, Capital and Employment, p. 36. Wicksell spoke of the "breadth" and "height" of capital as capital accumulation occurs; he was apparently borrowing Ákerman's terminology (Lectures, 1:266).

44. [44] Hayek, Pure Theory of Capital, pp. 286-87.

45. [45] Ibid., p. 286.

46. [46] It is questionable whether we want to measure market value when we try to measure capital. A number of writers (for example, Robert Dorfman and Abba Lerner) questioned this procedure, noting that we do not follow it with other factors, and that, if we did, some results would be paradoxical. For instance, were the demand for labor to be inelastic, an increase in supply would diminish the value of labor employed in production (Kirzner, Essay on Capital [New York: Augustus M. Kelley, 1966], p. 135).

47. [47] Hayek, The Pure Theory of Capital, pp. 69-70, 76-78.

48. [48] Ibid., pp. 69-70.

49. [49] Ibid., p. 70.

50. [50] Ibid., p. 76.

51. [51] Hayek, Prices and Production, p. 53.

52. [52] Hayek, Pure Theory of Capital, p. 31.

53. [53] Two points are implicit here. First, in a barter world, there is no medium of exchange by definition. Thus one commodity will be demanded in equilibrium in a money economy, that will not be demanded in a barter economy. Second, no alternative mechanism for attaining equilibrium is specified in barter constructions (Pure Theory of Capital, p. 31). See Ludwig von Mises, Human Action, 3d ed. (Chicago: Henry Regnery Co., 1963), pp. 249, 398-99, 416-19.

54. [54] "Monetary changes are...in a peculiar sense self-reversing and the position created by them is inherently unstable.For sooner or later any deviation from the equilibrium position—as determined by the real quantities—will cause a swing of the pendulum in the opposite direction" (Hayek, Pure Theory of Capital, p. 34).

55. [55] He made the simplifying assumption that the entire increase in the money stock took the form of "credits granted to producers"; this was "the case most frequently to be encountered in practice" (Hayek, Prices and Production, p. 54). In fact Hayek's assumption is not unrealistic, even today. Most loans granted by commercial banks are for productive purposes. Consumer and personal loans are of growing importance in commercial bank portfolios (from approximately 18% in 1947 to approximately 25% in 1970). But even for this category of loans, shifts in consumer spending are induced by interest rate changes. For the portfolio statistics, see Colin D. Campbell and Rosemary G. Campbell, An Introduction to Money and Banking (New York: Holt, Rinehart & Winston, 1972), pp. 84, 89.

56. [56] Wicksell demonstrated that the following analysis is no less valid if the changes in the money stock are induced by changes in the natural rate of interest, the money rate being constant (Lectures, 2:202-18). Hayek at one point chided Mises for emphasizing the autonomous nature of changes in the money stock (Monetary Theory, pp. 148-52). Machlup was too generous in crediting Hayek with an amendment to Wicksell in this issue. Machlup would have Hayek correcting Wicksell by pointing out that a cumulative process can be initiated by a rise in the natural rate of interest (Machlup, "Friedrich von Hayek's Contributions to Economics," p. 501). Yet Wicksell treated this case as typical (Lectures, 2:205).

57. [57] Hayek, "Price Expectations," p. 143.

58. [58] Ibid., p. 141. For a similar argument, see Ludwig von Mises, "'Elastic Expectations' and the Austrian Theory of the Trade Cycle," Economica, n.s. 10 (August 1943): 252.

59. [59] Hayek, "Price Expectations," p. 141.

60. [60] Shenoy, A Tiger by the Tail, p. 8.

61. [61] Hayek, Prices and Production, p. 57.

62. [62] Haberler called the class of theories of which Hayek's is an instance "Monetary Over-Investment Theories" (Prosperity and Depression, p. 33). Malinvestment is both illuminating and descriptively more accurate. The cyclical process in Hayek's work is generated when appropriate investments (given the equilibrium rate of interest) are made. Whether in some sense more capital is purchased with the increased investment expenditures is of secondary importance.

63. [63] Hicks, "The Hayek Story," in Critical Essays in Monetary Theory (New York: Oxford University Press, Clarendon Press, 1967), p. 208.

64. [64] Hicks, "A Neo-Austrian Growth Theory," Economic Journal 80 (June 1970): 277. Sir John is speaking here about Prices and Production. It must be pointed out that he amended his views in successive reassessments of Hayek and the Austrian school. But I believe that Hayek and Hicks still disagree about the role of Hayek's monetary considerations.

65. [65] Hicks, "The Hayek Story," p. 210. Hicks characterized this approach as downright "un-Hayekian."

66. [66] Ibid.

67. [67] Ibid., p. 211. Streissler, in reinterpreting Hayek, follows a path similar to that taken by Hicks (Roads to Freedom [New York: Augustus M. Kelley, 1969], pp. 245-85).

68. [68] Hicks, Critical Essays, p. 211.

69. [69] Ibid., pp. 211-15. Hicks subsequently became intrigued with Ricardian analysis of the effects of excess investment in fixed capital, and his approach to capital theory must be seen as part of a general retrogression toward Ricardian macroanalysis. It is particularly unfortunate that Hicks subtitled his book "A Neo-Austrian Theory." It could be more aptly described as "neo-Ricardian" (Capital and Time, pp. 97-99). On the radical dissimilarities between the neo-Ricardian macro approach and the Austrian micro approach to capital theory, see Ludwig M. Lachmann, Macro-economic Thinking and the Market Economy.

70. [70] "Of course, if the expenditure of the additional money in investment were a single non-recurrent event, confined to a single month, the effects would be of transient character" (Hayek, "Three Elucidations," p. 279).

71. [71] Ibid., p. 280. Even if a given rate of increase in the money supply, and hence prices, came to be correctly anticipated, relative prices would not be at their equilibrium values. This situation would then not be one of equilibrium. More will be said on this in the next chapter.

72. [72] Hicks, "The Hayek Story," p. 206.

73. [73] Hicks emphasized that prices in Prices and Production were "perfectly flexible, adjusting instantaneously, or as nearly as matters" ("The Hayek Story," p. 206). This flexibility is not a necessary condition for Hayek's theory, and I do not think he assumed any such thing. Even if prices were perfectly flexible, his conclusions would not change. But Hicks did not appreciate the analogy Hayek employed ("Three Elucidations," pp. 281-82).

74. [74] Hayek and Hicks apparently parted company over their interpretations of Wicksell. Hicks interpreted Wicksell's system as being in neutral equilibrium ("The Hayek Story," pp. 205-7). I believe that most students of Wicksell would have to disagree with Hicks's interpretation. In any case, the difference in interpretations may be reduced to disagreement over the importance of monetary analysis.

Chapter 5. The Ricardo Effect

1. [1] "Hayek is perhaps at his best as a historian of economic doctrine, but his impact on political philosophy has been much more powerful" (Kuhn, Evolution of Economic Thought, 2d ed. [Cincinnati: South-Western Publishing Co., 1970].

2. [2] "Prices and Production was in English, but it was not English economics. It needed further translation before it could be properly assessed" (Hicks, "The Hayek Story," in Critical Essays in Monetary Theory [New York: Oxford University Press, Clarendon Press, 1967] p. 204). However, some of the economics in Prices and Production was classically British; these parts seemed to engender an equal amount of controversy. Ironically, Hicks was later to make the very same point: "The 'Austrians' were not a peculiar sect, out of the main stream; they were in the main stream; it was the others who were out of it." And: "The concept of production as a process in time...is not specifically 'Austrian.' It is just the same concept as underlies the work of the British classical economists, and it is indeed older still—older by far than Adam Smith" (Capital and Time [Oxford: Oxford University Press, Clarendon Press, 1973], p. 12).

3. [3] Hayek, Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), pp. vii-ix.

4. [4] Hayek was the editor of Collectivist Economic Planning (London: George Routledge & Sons, 1935).

5. [5] Hayek, Profits, Interest, and Investment (New York: Augustus M. Kelley, 1970), p. vii. The first essay, from which the title was taken, was the new contribution. Reprints of articles on capital theory and business cycle theory were also included.

6. [6] Leijonhufvud argued that misinterpretations of Keynes may be attributed in part to this same process (On Keynesian Economics and the Economics of Keynes [New York: Oxford University Press, 1968], pp. 15-24).

7. [7] Nicholas Kaldor, "Professor Hayek and the Concertina Effect," Economica, n.s. 9 (November 1942): 359 (hereafter, "Professor Hayek").

8. [8] Ludwig M. Lachmann, "A Reconsideration of the Austrian Theory of Industrial Fluctuations," Economica, n.s. 7 (May 1940): 180.

9. [9] Friedrich A. Hayek, "A Comment," Economica, n.s. 9 (November 1942): 383-85.

10. [10] Hayek, "Profits, Interest, and Investment," p. 3.

11. [11] Ibid., p. 3.

12. [12] Ibid., p. 6.

13. [13] Ibid., p. 5.

14. [14] Hayek, Prices and Production, pp. 89-91. The rise in the interest rate was precipitated by the cessation in the expansion of bank credit.

15. [15] Ibid., pp. 94-95, 106.

16. [16] Leijonhufvud, Keynesian Economics, pp. 50-54.

17. [17] See Hayek, Prices and Production, pp. 85-96.

18. [18] Hayek dealt with the effects of changes in the rate of increase in the money stock, not just changes in the money stock. But since he started from a position of a zero rate of growth in Prices and Production, he at times talked of absolute changes (ibid., pp. 54-55, 149-50).

19. [19] Hayek, Monetary Theory and the Trade Cycle (New York: Augustus M. Kelley, 1966), p. 41n. He also distinguished between underconsumption explanations and malinvestment theories. A reading of this work is essential for an understanding of Hayek's theory of economic fluctuations.

20. [20] Machlup, "Friedrich von Hayek's Contributions to Economics," Swedish Journal of Economics 76 (1974): 504.

21. [21] In the 1939 work, Hayek employed the term time rate of profit to refer to the various rates of return on real capital. He subsequently dropped this terminology.

22. [22] Wicksell, Lectures on Political Economy, ed. Lionel Robbins (London: Routledge & Kegan Paul, 1935), 1: 154 (emphasis in original).

23. [23] Hayek, "Profits, Interest, and Investment," p. 8. Footnote reference omitted.

24. [24] Ibid., p. 8. There is a correction in the table as reproduced, along with minor changes in wording.

25. [25] Ibid., p. 6.

26. [26] Ibid., p. 10. Footnote reference omitted.

27. [27] "We are here concerned with the relations between the costs of labor and the marginal product of that labor" (Hayek, "The Ricardo Effect," in Individualism and Economic Order [Chicago: University of Chicago Press, 1948], p. 253).

28. [28] Haberler's judgment is that capital and labor are usable only in fixed proportions in the short run (Prosperity and Depression, 3d ed. [Lake Success, N. Y.: United Nations, 1946], p.489).

29. [29] After the General Theory appeared, numerous studies focused on whether changes in the nominal wage rate are correlated with changes in the purchasing power of these wages or move in opposite directions. Lorie Tarshis finally pointed out that employers are not interested in the purchasing power of the workers' wage, but in the impact of a given wage on a firm's rate of return (that is, the real cost of a given wage) ("Changes in Real and Money Wages," Economic Journal 49 [March 1939]: 150-54).

30. [30] Hayek, "A Comment," p. 383; see also idem, Prices and Production, pp. 72-92.

31. [31] For example, see J. Hirshleifer, Investment, Interest, and Capital (Englewood Cliffs, N.J.: Prentice-Hall, 1970), p. 35.

32. [32] The assumption of one good with two uses (consumption and investment) means there are no relevant effects of a change in the interest rate. The pure substitution between consumption and investment that occurs in a schmoo model is more characteristic of a pure exchange economy than of a production economy.

33. [33] See pp. 70-79.

34. [34] Hayek usually referred to output specificity of capital. But the analysis in Prices and Production and subsequent work in capital theory draws attention to the fact that capital goods are used in specific combinations. This aspect of Austrian capital theory received special attention from Ludwig M. Lachmann in Capital and Its Structure.

35. [35] In a situation of less than full employment, consumption output will undoubtedly expand. But it will expand too little, that is, there will be a "disproportionality" in production.

36. [36] Hayek, Prices and Production, pp. 89ff. The implication is that the purchasing power of the wages of at least some labor would fall in this latter part of a cyclical expansion. Hayek did not pursue the matter since it was not important theoretically ("The Ricardo Effect," p. 242n).

37. [37] Of the changing demand for labor of different types, Hayek remarked: "Even if aggregate demand for labour at the existing wage level (if to express it as an aggregate has any meaning under the circumstances) continues to increase, it will be an increase in the demand for kinds of labour of which no more is available, while at the same time the demand for other kinds of labour will fall and total employment will consequently decrease" ("Profits, Interest, and Investment," p. 26).

38. [38] Nicholas Kaldor, "Capital Intensity and the Trade Cycle," Economica 6 (February 1939): 40-66; see also Tom Wilson, "Capital Theory and the Trade Cycle," Review of Economic Studies 7 (June 1940): 169-79.

39. [39] The process will continue until "the rise in the rate of profit becomes strong enough to make the tendency to change to less durable and expensive types of machinery dominant over the tendency to provide capacity for a larger output" (Hayek, "Profits, Interest, and Investment," p. 33).

40. [40] Hayek, Pure Theory of Capital (Chicago: University of Chicago Press, 1941), p. 396.

41. [41] Hayek, "The Ricardo Effect," p. 240, 242.

42. [42] More precisely, the product of the money supply and velocity (that is, M.V) must continue to expand at the same rate (or higher).

43. [43] Hicks, "The Hayek Story," p. 206.

44. [44] Hayek, "Price Expectations, Monetary Disturbances, and Malinvestments," Profits, Interest, and Investment, p. 155. Hayek responded here to an earlier criticism by Myrdal.

45. [45] This lecture ("Price Expectations, Monetary Disturbances, and Malinvestments,") was reproduced in Profits, Interest, and Investment. As far as I can ascertain, it was not available in English until 1939.

46. [46] Hayek, "Price Expectations," p. 142.

47. [47] Ibid., pp. 142-43. Hayek assumed that capital goods can only be used in specific combinations (though not necessarily only one combination). This point was emphasized by Lachmann; see note 34 above.

48. [48] "Actions of a person can be said to be in equilibrium insofar as they can be understood as part of one plan." And "For a society, then, we can speak of a state of equilibrium at a point of time—but it means only that the different plans which the individuals composing it have made for action in time are mutually compatible" (Hayek, "Economics and Knowledge," pp. 36, 41).

49. [49] Hayek, "Profits, Interest, and Investment," pp. 16-18.

50. [50] Mises's theory of the entrepreneur has been amplified by Kirzner in Competition and Entrepreneurship.

51. [51] Hayek, "Profits, Interest, and Investment," p. 14.

52. [52] "On the principle of 'making hay while the sun shines,' provision for the profits to be made in the near future will take the precedence" (Hayek, "The Ricardo Effect," p. 250). Hayek was attempting to ascertain the relevant rate of discount—the market interest rate or the rate of return on real capital in different stages—when the market rate is not an equilibrium rate.

53. [53] This analysis is similar to that of William P. Yohe and Denis S. Karnosky, "Interest Rates and Price Level Changes, 1952-69," Federal Reserve Bank of St. Louis Review 51 (December 1969): 31-32. Indeed, in a neo-Wicksellian theory such as Hayek's, if i were not less than n there would be no inflation to anticipate!

54. [54] Axel Leijonhufvud, "Costs and Consequences of Inflation," mimeographed (Los Angeles, April 1975) pp. 10-19.

55. [55] Hayek, "Economics and Knowledge," p. 46.

56. [56] It is dubious that transactors seek to dispose of one subset of nominal assets (that is, money) in an anticipated inflation, though it is perfectly plausible for the category "nominal assets" taken as a whole. Robert Clower criticized the argument to the contrary at a UCLA Money Workshop in the 1972-73 academic year. See also Leijonhufvud, "Costs and Consequences of Inflation," pp. 43-46.

57. [57] Hayek, "Profits, Interest, and Investment," p. 33.

58. [58] Hayek, Prices and Production, pp. 92-93.

59. [59] This model must be amended to take into account capital heterogeneity and complementarity. Particular durable capital goods may be used in otherwise labor-intensive methods of production to meet current consumption demand. Nonetheless, either less durable reproductions or new less durable machines will be used for replacements of these capital goods. In either case the replacement demand will be for a different type of machine and will cause production and employment effects, which is the crucial point for Hayek.

60. [60] Mill, Principles of Political Economy, ed. Sir William Ashley (Clifton, N. J.: Augustus M. Kelley, 1973), pp. 91-100; this chapter is the sixth chapter of book 1 and comes after Mill's fundamental propositions on capital. Of the three sections in this chapter, two (eight out of ten pages) deal with the proportion between fixed and circulating capital.

61. [61] Ibid., p. 94.

62. [62] Mill apparently discovered the forced-saving doctrines relatively late; he added a footnote in 1865 to the sixth edition of Principles (Principles, p. 512). See also Hayek, "A Note on the Development of the Doctrine of 'Forced Saving'," Profits, Interest, and Investment, pp. 193-94.

63. [63] Hayek, Prices and Production, pp. 22-23.

64. [64] Hayek, "Profits, Interest, and Investment," p. 24.

65. [65] Ibid., pp. 25-26; see also note 37 above. Hayek was reluctant to aggregate the demand for labor, just as he was reluctant to aggregate the demand for investment. In an analysis of the process of adjustment in a cyclical expansion, the changing pattern of demand is important. The analysis would be impossible in terms of the "aggregate demand for labor" or the "aggregate demand for capital."

66. [66] Ibid., pp. 62-63.

67. [67] Speaking of Keynes, Hayek remarked: "His final conceptions rest entirely on the belief that there exist relatively simple and constant functional relationships between such 'measurable' aggregates as total demand, investment, or output, and that empirically established values of these presumed 'constants' would enable us to make valid predictions. There seems to me, however, not only to exist no reason whatever to assume that these 'functions' will remain constant, but I believe that microtheory had demonstrated long before Keynes that they cannot be constant but will change over time not only in quantity but even in sign. What these relationships will be, which all macro-economics must treat as quasi-constant, depends indeed on the micro-economic structure, especially on the relations between different prices which macro-economics systematically disregards. They may change very rapidly as a result of changes in the micro-economic structure and conclusions based on the assumption that they are constant are bound to be very misleading" ("Personal Recollections of Keynes," in Shenoy, A Tiger by the Tail (London: Institute of Economic Affairs, 1972), pp. 101-2).

68. [68] "The existence of...unused resources is itself a fact which needs explanation. It is not explained by static analysis and, accordingly, we are not entitled to take it for granted" (Hayek, Prices and Production, p. 34).

69. [69] "If, however, the deflation is not a cause but an effect of the unprofitableness of industry, then it is surely vain to hope that, by reversing the deflationary process, we can regain lasting prosperity" (Hayek, Monetary Theory, p. 19).

70. [70] According to Ludwig M. Lachmann, Hayek observed as early as 1933 that while maladjustments bring on depressions, the disequilibrium process results in secondary deflationary processes. Hayek did not pursue this issue, though, if he had, it would have made communication easier (personal communication).

71. [71] D. H. Robertson, "Industrial Fluctuations and the Natural Rate of Interest," Essays in Monetary Theory (London: P. S. King & Son, 1940), pp. 83-91.

72. [72] See C. A. Phillips, T. F. McManus, and R. W. Nelson, Banking and the Business Cycle (New York: Macmillan Co., 1937), pp. viii, 115-16. See also G. L. S. Shackle's Foreword to Knut Wicksell, Value, Capital, and Rent, trans. S. H. Frowein (London: George Allen & Unwin, 1954), pp. 7-8.

73. [73] Both Keynes's and Hayek's analyses were Wicksellian in character and relied on inappropriate rates of interest. But in Hayek's analysis the boom is caused by a market rate below the natural rate. The crisis occurs when high consumer demand makes it unprofitable to maintain the current investment structure. In Keynes's analysis the crisis occurs when market rates lag behind a falling natural rate. Thus, at the turning point, market rates of interest may be too low in Hayek's analysis and too high in Keynes's. See also Robertson, Essays.

74. [74] Robertson outlined a scenario in which the rate that in the short run equilibrates the supply of voluntary savings and the demand for investable funds falls below the natural rate of interest during the deflation process. An expansionary monetary policy at this point merely brings the market rate down to the short-run equilibrium rate. Clearly this short-run equilibrium rate is not the natural rate of interest (Robertson, Essays, pp. 83-91).

75. [75] Any fiscal policy that directly stimulates consumption is the least desirable: "The scarcity of capital, which, of course, is nothing else but the relatively high price of consumers' goods, could only be enhanced by giving the consumers more money to spend on final products" (Hayek, Prices and Production, p. 154). See also Hayek, "Profits, Interest, and Investment," pp. 62-63.

76. [76] Hayek, "Profits, Interest, and Investment," pp. 63n-64n.

77. [77] Hayek, Prices and Production, pp. 161-62.

78. [78] Hayek, "Profits, Interest, and Investment," pp. 70-71. The "steering wheel" is the rate of interest on loans. He was not advocating "fine tuning" with monetary policy, but permitting (instead of impeding) the adjustment of market rates to natural rates of interest.

79. [79] F. A. Hayek, "Inflation, the Misdirection of Labour and Unemployment," Full Employment at Any Price? (London: Institute of Economic Affairs, 1975), p. 15.

80. [80] Hayek, Prices and Production, pp. 89-90.

81. [81] Hayek, "Three Elucidations of the Ricardo Effect," Journal of Political Economy 77 (March/April, 1969): 282.

82. [82] The relationship between changes in wages and unemployment was observed by A. W. Phillips in "The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957," Economica 25 (November 1958): 283-99.

83. [83] Hayek, Profits, Interest, and Investment, pp. 135-56; and idem, "Economics and Knowledge," pp. 33-56.

84. [84] In "The Use of Knowledge in Society."

85. [85] The static quality of most of The Pure Theory of Capital has often been noted. What is generally ignored, however, is that this was to be the first of two volumes, the second being a volume on dynamic capital problems—Hayek's real interest. But when it came time to write it, his interests had turned elsewhere. It might be argued that Lachmann's Capital and Its Structure has served in its stead.

86. [86] Full Employment at Any Price? which contains Hayek's Nobel Lecture, is one example.

87. [87] Kaldor, "Professor Hayek," p. 364; and C. E. Ferguson, "The Specialization Gap: Barton, Ricardo, and Hollander," History of Political Economy 5 (Spring 1973): 6.

88. [88] David Ricardo, Principles of Political Economy, ed. F. W. Kolthammer (New York: E. P. Dutton, 1948), p. 27. Also: "In proportion as fixed capital is less durable it approaches to the nature of circulating capital" (ibid., p. 24).

89. [89] Hayek, "Profits, Interest, and Investment," pp. 13-14; see also table on p. 131.

90. [90] For a fuller exposition of the argument, see O'Driscoll, "The Specialization Gap and the Ricardo Gap: Comment on Ferguson," History of Political Economy 7 (Summer 1975): 261-69.

91. [91] Mark Blaug, Economic Theory in Retrospect, rev. ed. (Homewood, Ill.: Richard D. Irwin, 1968), p. 546.

92. [92] Ibid.

93. [93] Hayek, "Profits, Interest, and Investment," p. 14.

94. [94] Hayek, "The Ricardo Effect," pp. 235-38, 238-43.

95. [95] "The Ricardo Effect" (1942) should not be read apart from "Profits, Interest, and Investment" (1939), as Blaug evidently did (judging from his criticisms and his bibliography). The 1942 work is a virtual amendment to the 1939 work and is not completely understandable by itself. Significantly, Blaug did not mention "Profits, Interest, and Investment" in his bibliography on the Ricardo effect; he did, however, cite Kaldor's "Capital Intensity and the Trade Cycle" (1939), but as though it were a criticism of work that postdated it by three years (Blaug, Economic Theory, pp. 571-72).

96. [96] William J. Baumol, Economic Theory and Operations Research, 2d ed. (Englewood Cliffs, N.J.: Prentice-Hall, 1965), pp. 431-33.

97. [97] William J. Baumol, "The Analogy between Producer and Consumer Equilibrium Analysis, Part II: Income Effect, Substitution Effect, and Ricardo Effect," Economica 17 (February 1950): 69-80.

98. [98] Mill, Principles, p. 79 (emphasis in the original).

99. [99] Leslie Stephen, History of English Thought in the Eighteenth Century, p. 297; quoted in Hayek, The Pure Theory of Capital, p. 434.

100. [100] James H. Thompson, "Mill's Fourth Fundamental Proposition: A Paradox Revisited," History of Political Economy 7 (Summer 1975): 188.

101. [101] Thompson offered a good summary of the various interpretations that have been put on the proposition (ibid.).

102. [102] Hayek, Pure Theory of Capital, pp. 435-36. For an exposition of Hayek's use of "pure input" and other concepts integral to a complete discussion of these issues, see ibid., pp. 51-57, 65-66.

103. [103] Ibid., p. 436.

104. [104] J. S. Mill did not rely on changes in relative prices in elucidating the fourth proposition. (See Thompson, "Mill's Fourth Fundamental Proposition," p. 188).

105. [105] Mill, Principles, p. 87.

106. [106] Ibid., p. 88.

107. [107] Hayek, Pure Theory of Capital, p. 439.

108. [108] Robert Eagly, Structure of Classical Economic Theory (New York: Oxford University Press, 1974), pp. 126-38.

Chapter 6. Was the Marginal Revolution Aborted?

1. [1] See Hayek, "Reflections on the Pure Theory of Money of Mr. J. M. Keynes," part 1, Economica 11 (August 1931): 270.

2. [2] Hayek, The Pure Theory of Capital (Chicago: University of Chicago Press, 1941), pp. 369-76.

3. [3] See Hayek, The Pure Theory of Capital, p. 3;also, verbal communication.

4. [4] See Hayek, "Reflections," part 1, 277-80.

5. [5] Don Patinkin, "Keynes Monetary Thought: A Study of Its Development," History of Political Economy 8 (Spring 1976): 57.

6. [6] Some of the issues involved in this subject are covered in Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), pp. 157-85.

7. [7] On Keynes's treatment of capital, see Leijonhufvud, Keynesian Economics, pp. 187-314. Noteworthy is Keynes ambivalence on Austrian capital theory: "It is significant that whereas Keynes (like Cassel) was quite critical of Böhm-Bawerk, his 'observations' on capital stress the roundaboutness notion of the Austrians" (Leijonhufvud, Keynesian Economics, p. 250n).

Keynes's unsettled and ambivalent feelings toward capital-theoretic questions show in a letter to R. F. Kahn (1 February 1932) about his correspondence with Hayek: "What is the next move? I feel that the abyss yawns—and so do I. Yet I can't help feeling that there is something intersting in it [Hayek's theory]" (Donald Moggridge, ed., The Collected Writings of John Maynard Keynes, 25 vols. [London: St. Martin's Press, 1973] 13: 265).

8. [8] See Harcourt's remarks on Solow's approach in G. C. Harcourt and N. F. Laing, eds., Capital and Growth (Baltimore: Penguin Books, 1971), p. 17.

9. [9] See Ludwig M. Lachmann, Capital and Its Structure (London: London School of Economics, 1956).

10. [10] See Emil Kauder,A History of Marginal Utility Theory (Princeton: Princeton University Press, 1965), pp. 15-57.

11. [11] "Classical economics is essentially macro economics" (Robert Eagly, The Structure of Classical Economic Theory [New York: Oxford University Press, 1974], p. 21).

12. [12] Thomas Sowell, Classical Economics Reconsidered (Princeton: Princeton University Press, 1974), p. 33. The dynamic problems of macrotheory were the chief focus in classical economic theory. This is in contrast to contemporary macrotheory.

13. [13] John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace & World, Harbinger Books, 1965), p. 32.

14. [14] Mark Blaug, "Was There a Marginal Revolution?" in The Marginal Revolution in Economics, eds. R. D. Collison Black, A. W. Coats, and Craufurd D. W. Goodwin (Durham: Duke University Press, 1973), p. 14.

15. [15] Keynes acknowledged this in the Treatise, reprinted as Moggridge, ed., The Collected Writings of John Maynard Keynes, 25 vols. (London: St. Martin's Press, 1971) 5: 178n.

16. [16] Hayek, "The Pretence of Knowledge," in Full Employment at Any Price? (London: Institute of Economic Affairs, 1975), pp. 30-42.

17. [17] Two recent attempts to begin this much-needed reassessment are Ludwig M. Lachmann, "Sir John Hicks as a Neo-Austrian," South African Journal of Economics 41 (1973): 195-207; and Robert Clower, "Reflections on the Keynesian Perplex," Zeitschrift für Nationalökonomie 35 (1975): 1-24; esp. 5-12.

18. [18] Hayek, Prices and Production, 2d ed. (London: Routledge & Kegan Paul, 1935), pp. 4-5.

19. [19] An explicit example of such an argument is Charles W. Baird, Macroeconomics (Chicago: Science Research Associates, Inc., 1973), pp. 176-80.

20. [20] On this point, see also the editorial introduction in Sudha R. Shenoy, ed.,A Tiger by the Tail (London: Institute of Economic Affairs, 1972), p. 8.

21. [21] Axel Leijonhufvud, "Effective Demand Failures," Swedish Journal of Economics 75 (1975): 28-29.

Chapter 7. An Alternative Research Program

22. [22] The theoretical connection between Ricardian classical political economy and Walrasian neoclassical economics has been recently noted by Robert Eagly: "Janus-like, the Walrasian system is situated between two great systems of economic theory. It forms the capstone to classical theory on the one side, and on the other the cornerstone to the modern post-classical theory. It provided answers to questions posed by the normal progression of theoretical inquiry within the classical framework. But at the same time it posed new questions that were to occupy the attention and time of economists during the following century" (Eagly, Structure of Classical Economic Theory [New York: Oxford University Press, 1974], p. 134).

23. [23] New York: Cambridge University Press, 1960.

24. [24] Nuti has recently characterized the approach of Sraffa and others as "a general equilibrium approach with the preference side chopped off." And he argued that "the approach...has no overwhelming advantages over the general equilibrium approach" (Dominco Mario Nuti, "On the Rates of Return on Investment," Kyklos 27 [1974]: 357). Nuti likewise identifies the Sraffa approach as "'classical'" (Nuti, 357-58).

25. [25] The term "Neo-Ricardian" is borrowed from L. M. Lachmann, Macro-economic Thinking and the Market Economy (London: The Institute of Economic Affairs, 1973).

26. [26] Philip H. Wicksteed, "The Scope and Method of Political Economy," in Readings in Price Theory, George J. Stigler and Kenneth E. Boulding, eds., (Homewood, Ill.: Richard D. Irwin, 1952), p. 19n.

27. [27] Recent works articulating this view are James M. Buchanan, Cost and Choice (Chicago: Markham Publishing Co., 1969); and James M. Buchanan and G. F. Thirlby, eds., L.S.E. Essays on Cost (London: Weidenfield Nicolsen, 1973).

28. [28] Leijonhufvud has recently made a persuasive case that the use of "neoclassical" is more confusing than illuminating. As much separated the "'neoclassical' grants" as bound them together. He argued that we dispense entirely with the term. See Axel Leijonhufvud, "The Varieties of Price Theory: What Microfoundations for Macrotheory?" U.C.L.A. Discussion Paper Number 44 (Los Angeles: mimeographed, 1974). William Jaffé has taken up the same theme recently in "Menger, Jevons, and Walras De-Homogenized," Economic Inquiry 14 (December 1976):511-24. In my defense, I would note that I have tried to limit the use of the term to those cases where the similarities of the various neoclassical schools are greatest. I recognize, however, that these similarities have been greatly exaggerated in recent years.

29. [29] Mises, Theory of Money and Credit, new ed., trans. H. E. Batson (Irvington-on-Hudson, N. Y.: The Foundation for Economic Education, 1971).

30. [30] See Don Patinkin, Money, Interest, and Prices, 2d ed. (New York: Harper & Row, 1965), pp. 79, 574-75.

31. [31] See Joan Robinson, "What Has Become of the Keynesian Revolution?" in Essays on John Maynard Keynes, ed., Milo Keynes (New York: Cambridge University Press, 1975), p. 125.

32. [32] See Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (New York: Oxford University Press, 1968), p. 24. On the other hand, Patinkin apparently sees little role for changes in relative prices in Keynes's theoretical vision. (Don Patinkin, "Keynes' Monetary Thought," History of Political Economy 8 [Spring 1976], 45).

33. [33] For the methodological subjectivist, it is an essential feature of human affairs that this be so. And the social scientist must take account of this, as Hayek long ago noted: "In the social sciences the things are what people think they are. Money is money, a word is a word, a cosmetic is a cosmetic, if and because somebody thinks they are" ("The Facts of the Social Sciences," in Individualism and Economics Order [Chicago: University of Chicago Press, 1948], p. 60).

34. [34] Some papers in this development appear in Edwin G. Dolan, ed., The Foundations of Modern Austrian Economics (Kansas City: Sheed & Ward, 1976). More will appear in a forthcoming proceedings of a conference on Austrian Economic Theory held at Windsor Castle in 1976.

35. [35] See Hayek, "Personal Recollections of Keynes," in A Tiger by the Tail, ed. Sudha R. Shenoy (London: Institute of Economic Affairs, 1972), pp. 101-2.

36. [36] On this, see Roger Garrison's, "Austrian Macroeconomies," a paper prepared for the 1976 Symposium on Austrian Economics at Windsor Castle (Menlo Park, Calif., 1976). Forthcoming.

37. [37] For a synopsis of Shackle's views, see his "Keynes and Today's Establishment in Economic Theory: A View," Journal of Economic Literature 11 (June 1973): 516-19.

38. [38] The American Geographical Society is currently engaged in a study of the spatial diffusion of inflation in the United States. This is very much a topic of the kind that I am discussing.

39. [39] See Gerald P. O'Driscoll, Jr., "Spontaneous Order and the Coordination of Economic Activities," a paper prepared for the 1976 Symposium on Austrian Economics at Windsor Castle (Menlo Park, Calif., 1976). Forthcoming.

40. [40] Hayek, "The Place of Menger's Grundsätze in the History of Economic Thought," in Carl Menger and the Austrian School of Economics, J. R. Hicks and W. Weber, eds. (Oxford: Oxford University Press, The Clarendon Press, 1973), p. 13.

41. [41] See the references cited in note 6.

42. [42] Two works written in this tradition are Ludwig M. Lachmann, Capital and its Structure (London: London School of Economics, 1956); and Israel M. Kirzner, An Essay on Capital (New York: Augustus M. Kelley, 1966).

43. [43] Professor Lachmann first offered this analysis in a talk at the University of Delaware in June 1976.

44. [44] Some of these can be found in the seected bibliography of the Dolan book cited in note 13.

End of Notes

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