Hayek's Contribution to Business Cycle Theory: A Modern Assessment

Abstract

The manner in which resources are integrated within more or less capitalistic (or roundabout) methods of production is the key to Hayek’s analysis of business fluctuations. Any change to this structure of production has a cumulative impact. In setting Austrian capital theory within this dynamic framework, Hayek’s unique contribution was to explain how monetary expansion sets in motion incentives which initiate a boom, but which steadily disrupt the balance between production methods. The inevitable outcome is crisis and slump. Although Hayek produced a consistent set of theoretical arguments, their long and confused gestation created much controversy. His four books and their associated journal articles spanned publication of The General Theory. Hayek’s hostility to Keynes’s method added much heat to the various exchanges, but the intention is not to focus upon those debates, nor to set Hayek’s theory into the context of the history of business cycle analysis. Rather, it is to provide a retrospective interpretation of Hayek’s exposition as a coherent whole. At the risk of confusion and even some annoyance to those familiar with the original presentations, I have made extensive use of modern terminology, especially that relating to investment appraisal criteria. Nevertheless the arguments are always from Hayek, and origins may be readily traced if the quotations in closest proximity are taken as a guide. Hayek’s first major works were Monetary Theory and the Trade Cycle (1929; first English edition, 1933) and Prices and Production (193 1 ; revised and enlarged edition, 1935). Prices and Production reproduced