|F. A. Hayek|
ABSTRACT: Hayek’s writings on business cycle theory; the seminal work of the 1930s and 1940s and the modifications he made in the 1970s after he received the Nobel Prize, are useful starting points for understanding the cycle phenomena in the U.S. between 1995 and the present. Hayek in the 1970s abandoned his earlier condemnation of price stabilization as a goal of monetary policy. In his judgment, such a policy might be the best that could be achieved under existing monetary arrangements, and the misdirection of production resulting from such a policy would be minimal. A careful review of the writings, lectures, and interviews by Hayek in this period show that Hayek did not abandon, but consistently retained the basic elements of his “monetary theory of the trade cycle.” The period clearly exhibits a pattern of production over time consistent with the pattern predictions of Austrian business cycle theory, especially as extended by Garrison (and others). The severity of the recent crisis reinforces Hayek’s call for a significant reform of monetary institutions, a denationalization of money, to better prevent future monetary shock caused boom-busts. The current crisis illustrates that Hayek was premature in his assessment that the effects of money creation intended to keep prices stable [inflation targeting] in a growing economy would have impacts on the structure of production “too small to worry about.” Further work, both theoretical and historical, needs to be done to assess his 1970s claim that a monetary authority needs significant discretion in time of crisis to prevent a secondary deflation.