Money, Capital, and Fluctuations

Early Essays

F. A. Hayek, R. K. McCloughry

• Publisher: University of Chicago Press
• Year: 2018
• Print ISBN: 9780226320922
• eBook ISBN: 9780226321271
• Topic: Business
• Subtopic: Business General
• Index: Business

PREFACE AND ACKNOWLEDGMENTS

EDITOR'S INTRODUCTION

INTRODUCTION

1. THE MONETARY POLICY OF THE UNITED STATES AFTER THE RECOVERY FROM THE 1920 CRISIS (1925)
2. SOME REMARKS ON THE PROBLEM OF IMPUTATION (1926)
3. ON THE PROBLEM OF THE THEORY OF INTEREST (1927)
4. INTERTEMPORAL PRICE EQUILIBRIUM AND MOVEMENTS IN THE VALUE OF MONEY (1928)
5. THE FATE OF THE GOLD STANDARD (1932)
6. CAPITAL CONSUMPTION (1932)
7. ON 'NEUTRAL MONEY' (1933)
8. TECHNICAL PROGRESS AND EXCESS CAPACITY (1936)

Two reviews

MARGINAL UTILITY AND ECONOMIC CALCULATION (1925)
THE EXCHANGE VALUE OF MONEY (1929)

NAME INDEX

ONE

THE MONETARY POLICY OF THE UNITED STATES AFTER THE RECOVERY FROM THE 1920 CRISIS*

Before looking in detail at the policies of the Federal Reserve Banks in the period under consideration it is important first to look at a new aspect of policy, of which they had to take particular note in the period concerned. This is the exercise of a systematic control of credit with the aim of smoothing out cyclical fluctuations and preventing economic crises. At earlier points in this essay,^† the relationship between credit policy and cyclical movements has been repeatedly emphasized so as to indicate the way in which attempts to obviate the damaging effects of gold imports necessitated deviations from the policy traditionally followed by the banks in this respect. In what follows, we shall be concerned with the efforts to replace the policy previously pursued by the banks which was an almost exclusively repressive policy directed solely towards the alleviation of a crisis that had already made its appearance, by one which sought to prevent cyclical and crisis phenomena from evidencing themselves at all.

This new tendency originated in a change in the way in which the scientific examination of cyclical movements is undertaken. During the course of the last decade, at least in the Anglo-Saxon countries, the investigation of the alternation of periods of prosperity and stagnation¹ that had been correctly observed by the representatives of the ‘currency school’ almost a hundred years ago completely displaced the analysis of the crisis viewed as an isolated phenomenon. Related to this change, the problem which had until then stood in the forefront of the discussion, i.e. the overcoming of crises regarded simply as an unavoidable phase of every wave-like movement in the economy, was replaced by that of exerting a systematic influence upon the course of the cycle in all its phases. In the United States above all, an extraordinary amount of attention has been paid to the investigation of cyclical phenomena in recent years, not least because they appear to offer a reliable predictor of future economic developments, with the hope that economic science can thus be of service for immediately practical purposes. Since the crisis of 1920, this area of research has perhaps had an excessive amount of effort devoted to it, and the results achieved have drawn the attention of the lay public to this research to an extent that has not been conferred upon any other branch of economic investigation for a long time. This is the reason why the more recent scientific views in this field became effective relatively rapidly and even the official institutions could not completely close their eyes to them.

Thanks to the intensified attention devoted to this field, our understanding of the course followed by the ebb and flow of the economy and its causes have actually made such significant progress that we can hope that it will be possible quite soon to prevent a large part of the damage done by the cycle. Certainly, these advances cannot as yet be integrated into a recognized, unified theory similar to those theories of the cycle that already exist. To do so is made more difficult by the very methods of investigation themselves which most American researchers employ in this field. They do not begin from a definite, basic theoretical conception of the economic process, but content themselves with gaining as detailed as possible a picture of the typical course of a cycle with the aid of detailed statistical investigation of the behaviour of the individual factors in each phase of the cycle. It is their hope that, from the insights they thereby gain into the relative behaviour of the individual branches of production, etc., they will then be able to derive theories as to the nature of the interrelationships between them.² The result is a type of symptomatology of the course of the cycle. By tracing out the far-reaching similarities that exist between the different economic cycles, it establishes the characteristic feature of each phase of the cycle. On this basis, and hence not merely by relation to current statistical data, it makes possible the appropriate diagnosis of the current economic situation. Furthermore, as already noted, to a certain extent it enables us to forecast the behaviour ofeconomic activity that can be expected in the coming period. It may be that such a procedure will ultimately arrive at a complete description embracing all the essential characteristics of the cycle, which is the task of theory, but it must be said that being still in its early stages of development, it does not offer the comprehensive understanding attainable with a theory derived from general economic principles. It is of little help when what is at issue is not detailed interconnections but the cause of cyclical fluctuations in general. If the aim is to combat cyclical fluctuations at their root, then most researchers into the cycle also have recourse consciously or unconsciously to the explanations offered by ‘abstract’ theories.

Nevertheless, the main results of that inductive research have effected a not inconsiderable strengthening of certain generally theoretical concepts as to the cause of economic fluctuations. The statistical investigations of the relative behaviour of the individual factors in the course of economic activity, very expressively termed ‘cyclic chartology’ because of their predominantly graphical methods of presentation, have brought to our attention especially the chief bases of the most important group of business cycle theories. They have shown, firstly, that in the upswing it is the rise in prices which becomes the strongest force driving up the level of activity. They have also shown, secondly, that it is the excessive expansion of the producer-goods industries, in general terms the relatively greater expansion of the output of goods of higher order as compared to those of lower order, and the increase in the demand for consumption goods, that are the most important causes of the regularly recurring economic crises. There is not the space here for a more extensive consideration of the other linkages and interrelationships upon which these investigations have thrown new light. Similarly, only brief mention can be made of the most striking features of the depiction of what is regarded as a typical cyclical fluctuation. The greater attention paid to this can be ascribed to the fact that, in the theory of business cycles, decisive significance has for some time been attributed once again to explanations drawn from the field of the monetary and credit system.

The data which are available to American researchers in especial abundance consist mainly of comprehensive figures as to quantities of output, stocks, turnover and the level of employment in individual industries and branches of production, in addition to the particular and general price statistics which have always been available. Also there are the particularly copious banking statistics, available in monthly series but often also even on a weekly basis. After the detection and elimination of certain tendencies of movement within each of these series which are independent of the particular stage of the cycle, such as the regular fluctuations that occur within any one year, and the developments which proceed uniformly over decades with the growth of population and technical progress, their comparison then shows the relative behaviour of each of them in the individual phases of the cycle and thus permits conclusions to be drawn as to the connection which exists between them. What emerges is a quite definite, regularly recurring succession of undulating movements of production, prices, trade and credit, so that one is accustomed to speak of particular cycles in each of the factors. To explain the causal relationships existing between them must be the next task of the theory of cyclical phenomena. The most important of these empirically established regularities in the course of the individual phases of the cycle are as follows: the depression comes to an end when the existing commodity stocks have fallen to a minimum in all sectors, and the beginnings of the upswing evidence themselves first in an increase in the output of the industries producing raw materials and capital goods, while prices often still continue to fall. The further increase in productive activity and later the rise in prices is larger and happens earlier, the further removed from the stage of consumption are the goods concerned. Correspondingly, this increase comes to an end soonest in industries producing raw materials and industrial equipment which exhibit the greatest fluctuations. Then at a later stage the production of intermediate goods and semi-finished products is affected, and last of all activity in the industries producing consumption goods and goods which satisfy the needs of consumers directly. The same relationship is shown by turnover and prices in wholesale and retail trade. In general terms, the rise in prices continues beyond the rise in output in the sector concerned, but within the individual commodity groups its movement corresponds to that of output. So far as the financial aspects of the movement are concerned, it is the prices of stock market securities that are as a rule among the earliest to be affected by the general upswing, while rates of interest are among the last. The extremely rapid growth of bank credit in the later part of the upswing continues after the general peak has been reached, and its volume is extended right up to the capacity of the banks to lend. In the downturn and the downswing, the individual factors maintain much the same sequence, with what were the leading elements likewise showing the strongest declines.

This sequence in the movements of the individual sectors of the economy is to be attributed to the well-known circumstance that any change in the demand for finished products has a magnified effect upon the next highest stage of production, calling forth changes in that stage which are a multiple of it. It is not necessary at this point to enter into details about the intermediate steps through which this cumulative effect is mediated. The more recent American literature on the ‘business cycle’ is rich in excellent studies in this field, and the reader is referred to them.³ All that needs to be emphasized in this context is that they are all based upon the proposition that, during the upswing, the production of goods of higher order is orientated towards not merely an increased but a rising level of demand, and therefore has also to make possible the enlargement of commodity stocks, the extension of the production apparatus, etc., and so by its very nature is orientated towards a temporary demand. But the latter must come to an end as soon as the demand for final products ceases to increase. In addition, in the later stages of the upswing especially the expectation of a further rise in prices stimulates ever greater purchases in anticipation of expected future demand, which gives rise to a particularly large increase in areas of production more distant from the consumer as compared to the actual growth in demand for consumer goods. However, it is the excessive growth in the production of goods of higher order, necessary only to satisfy a rapidly growing need for finished products, which is the main reason why productive activity in general can no longer be maintained at the level it has already attained if for any reason the increase in demand comes to an end. If the tempo of the upswing flattens out, or if it even merely slows down, there must be a decline in employment in those industries and as a result a consequential diminution in the demand for finished products. The outcome must then be a general reaction, in which as in the upswing the effects of any partial retrogression are multiplied in their further repercussions ultimately leading to a general depression. Among the causes which bring the upward movement to an end, and thus make a downswing inevitable, a main role is played – in addition to the necessity to restrict credit with which the banks find themselves faced – by the differences which emerge between the situations in which the various sectors of the economy find themselves. Such differences must inevitably arise when there is a rapid rise in general prices, for such a rise is never felt equally in each of the various sectors.

The excessive development of the industries producing raw materials and capital goods, whose regular recurrence is thus to be regarded as the main cause of the periodic economic crises, necessarily arises from and is chiefly due to the much praised elasticity of our modern credit system. The cumulative effect which any increase in the demand for finished products exerts upon the output of goods of higher order finds its expression in the accumulation of excessive stocks of commodities, a disproportionate expansion of the apparatus with which they are produced, and especially a greater rise in the prices of raw materials and capital goods and thereby the elimination of profits. This can take place only because the extension of credit by the banking system is not strictly linked to the growth of savings. The banks can make purchasing power available to the entrepreneur even if no one else has refrained from exercising to a corresponding extent the purchasing power which they possess. The banks are especially prone to behave in this way if a favourable economic situation appears to reduce the risks involved in doing so. Since the increased demand thereby making its appearance in the market is confronted by an unchanged supply, it must bring about a rise in prices which is particularly great in the case of goods of higher order. The reason is that the possibility of expanding the supply of money capital to a level in excess of that of real capital also puts the banks in a position to offer the former at a rate which is cheaper then that which corresponds to the proportion which the increased demand bears to the supply of real capital. It thereby makes capital investments continue to appear to be profitable though in fact they exceed the economically permissible level⁴ and hence must⁵ sooner or later be partly lost. The most significant phenomena of the upswing, over-investment and a general rise in prices, and at the same time the causes of the crises which always follow upon the upswing, are therefore largely a result of an extension of credit which is from time to time excessive (or, to utilize Wicksell’s terminology to put the same thing in another way, of an occasional fall of the money rate of interest below the real rate). This extension of credit gives rise to a short-lived inflation and leads to the emergence of the disproportions between the individual sectors of the economy to which the accompanying stimulation of business always gives rise. The crisis then becomes the only way of eliminating these disproportions. This recurrent inflation therefore works like a drug giving rise not merely to a short-lived increase in well-being but also to an extended nightmare later.

Certainly, if a gold currency exists, the banks can never create more credit in the long run than the volume which corresponds to the accumulation of real capital. But the mechanism which prevents their doing so is clumsy and delayed in its operation and does not go fully into effect before the inflation of credit has already inflicted heavy damage. If the rise in prices takes on too great a dimension, the gold currency or a currency system of the same type forces the banks to check or even to restrict any further extension of credit in order to maintain their liquidity. If the expansion of credit and thus the rise in prices is confined to one country, the outflow of gold after a time forces the banks to impose credit restrictions. If, on the other hand, the rise in prices is either international or extending to all countries with the same monetary basis, the point at which it is checked will be still later. That point will be reached when the increase in the demand for cash resulting from the rise in prices exposes the banks to the danger of being unable to maintain the ratio between their cash and their liabilities which is either legally imposed upon them or to which they traditionally adhere. Experience shows that this mechanism is not sufficient to preserve the economy from the pronounced fluctuations of prices over a few years which is characteristic of cyclical movements. It is necessary for the rise in prices to have already become rather strong, or to have persisted for some time, before those counteracting influences become operative. In the period before the latter occurs, all those characteristics develop which unavoidably produce a severe reaction when the rise in prices eventually comes to an end. In the downswing, in turn, too long a time elapses before the inflow of gold from abroad or the reflux of cash from circulation into the banks induces them to abandon their reluctance to grant credit. But it is the latter which until then has contributed to intensifying the fall in prices and hence the depression.

If the gold currency exists in connection with a developed system of bank credit, its automatic operation therefore does not suffice to obviate the possibility of a dangerous inflation caused by bank credit. In an economic system which makes extensive use of bank credit, the alien element of bank credit seems to make necessary certain elaborate precautions if even that degree of stability in economic activity is to be achieved which is automatically secured if gold is the only medium of circulation. Once such interconnections are grasped, it seems but a short step to suggest that the elimination of any disproportion which emerges between the various sectors of the economy because of an excessive creation of credit should not be left to the mechanical forces of the economy, which only works slowly, especially since this process always operates through crisis-ridden convulsions of the whole of economic life. Instead, it is concluded, a purposive intervention should be made to regulate the volume of credit as soon as it becomes evident that it has been granted excessively and therefore threatens to lead to dangerous developments. Steps to restrict the volume of credit at the right moment in the ascending phase of the cycle, before it actually becomes necessary to do so with respect to the liquidity of the banks and the maintenance of the gold standard, then appears to become the tool with which economic activity can be stabilized and crises prevented. ‘Control of credit’ has in this way become the slogan of and the sovereign remedy advanced by those who seek to combat crises. Almost all the discussion of how to prevent crises revolves around the possibilities of credit control and the forms it should take, in comparison with which only subordinate significance is attributed to all other measures which enter into consideration. It is scarcely possible to deny that, among US economists, expectations of this type have been set too high and in this respect they have probably often asked too much of a good thing. But we should certainly not underestimate the significance of this whole area of enquiry, which has scarcely ever been treated in an appropriate way on the European continent.⁶ And this may also serve as our excuse for devoting somewhat more space to this matter here than is absolutely necessary within the framework of this essay.

It must be emphasized that what has come to light in the preceding brief presentation of the evolution of thought which leads to the above conclusions (in so far as they are concerned with the connection between bank credit and crises), was in many cases theoretical views which did not originat...

Table of contents

• Cover
• Copyright
• Title Page
• Series Page
• Contents
• Preface and Acknowledgments
• Editor's Introduction
• Introduction
• 1. The Monetary Policy of the United States after the Recovery from the 1920 Crisis (1925)
• 2. Some Remarks on the Problem of Imputation (1926)
• 3. On the Problem of the Theory of Interest (1927)
• 4. Intertemporal Price Equilibrium and Movements in the Value of Money (1928)
• 5. The Fate of the Gold Standard (1932)
• 6. Capital Consumption (1932)
• 7. On 'Neutral Money' (1933)
• 8. Technical Progress and Excess Capacity (1936)
• Two reviews
• Marginal Utility and Economic Calculation (1925)
• The Exchange Value of Money (1929)
• Notes
• Name Index