Prices and Production

"While the more naive forms of inflationism are sufficiently discredited today not to do much harm in the near future, contemporary economic thought is so much permeated by an inflationism of a subtler kind that it is to be feared that for some time we shall still have to endure the consequences of a good deal of dangerous tampering with currency and credit."

"I will be discussing what happened in economics in England, but these were times when, to a very considerable extent, this was what happened in economics. The first episode I will discuss is local, but the economists involved were among the best in the world. In February 1931, Friedrich Hayek gave a series of public lectures entitled 'Prices and Production' at the London School of Economics … They were undoubtably the most successful set of public lectures given at LSE during my time there, even surpassing the brilliant lectures Jacob Viner gave on international trade theory. The audience, notwithstanding the difficulties of understanding Hayek, was enthralled. What was said seemed to us of great importance and made us see things of which we had previously been unaware. After hearing these lectures, we knew why there was a depression. Most students of economics at LSE and many members of the staff became Hayekians or, at any rate, incorporated elements of Hayek's approach in their own thinking. With the arrogance of youth, I myself expounded the Hayekian analysis to the faculty and students at Columbia University in the fall of 1931."

"For all his brilliance, Hayek didn’t — at the critical time — have a good enough understanding of the dangers of deflation. He didn’t fully realize the extent of sticky wages and prices and, more deeply, he didn’t see that ongoing deflation would render the “calculation problem” of a market economy more difficult. Hayek stressed that a market calculates value in a way that a central planner cannot — but lying behind this ability to calculate is some basic macroeconomic stability. At the key moments, Hayek did not offer the proper recipe for that stability."

"Hayek's point was that, in the short run, increase in the demand for consumer goods can redirect production from longer temporal capital processes to the quick production of consumer goods, thereby entailing less capital investment in the longer temporal processes. This would discourage real investment. Hayek's basic misconception of economic production was concerning the nature of capital. His essential practical thesis in technical economic theory was that artificially lowered interest rates misshape the structure of production by encouraging production of temporarily early capital goods. This thesis was based on Boehm-Bawerkian conception of capital wherein as an economy develops, production increasingly occurs through more and more "roundabout," or long and complex, processes."

"Let me emphasize, I am an enormous admirer of Hayek, but not for his economics. I think Prices and Production is a very flawed book. I think his capital theory book is unreadable. On the other hand, The Road to Serfdom is one of the great books of our time. His writings in [political philosophy] are magnificent, and I have nothing but great admiration for them. I really believe that he found his right vocation — his right specialization — with The Road to Serfdom. His earlier works were intended to be part of the literature of technical economics as a science, and, indeed, it was that characteristic of them that impressed Lionel Robbins and led Lionel to bring him from Austria to London. I never could understand why they were so impressed with the lectures that ended up as Prices and Production, and I still can’t . . . these very confused notions of periods of production, different orders of products, and so on."

""I can date my own personal 'revolution' rather exactly to May or June 1933. It was like this. It began … with Hayek. His "Prices and Production" is one of the influences that can be detected in The Theory of Wages; it could not have been otherwise, for 1931 was a Prices and Production year at the London School of Economics … I did not in fact find it all easy to fit in with my own ideas. What started me off in 1933 was an earlier work of Hayek's, his paper on 'Intertemporal Equilibrium', an idea which I found easier to reduce to my preferred (Paretian or Wicksellian) pattern."

"I remember Robbins asking me if I could turn the Hayek model into mathematics … it began to dawn on me that … the model must be better specified. It was claimed that, if there were no monetary disturbance, the system would remain in 'equilibrium'. What could such an equilibrium mean? This, as it turned out, was a very deep question; I could do no more, in 1932, than make a start at answering it. I began by looking at what had been said by … Pareto and Wicksell. Their equilibrium was a static equilibrium, in which neither prices nor outputs were changing … That, clearly, would not do for Hayek. His 'equilibrium' must be progressive equilibrium, in which real wages, in particular, would be rising, so relative prices could not remain unchanged … The next step in my thinking, was … equilibrium with perfect foresight. Investment of capital, to yield its fruit in the future, must be based on expectations, of opportunities in the future. When I put this to Hayek, he told me that this was indeed the direction in which he had been thinking. Hayek gave me a copy of a paper on 'intertemporal equilibrium', which he had written some years before his arrival in London; the conditions for a perfect foresight equilibrium were there set out in a very sophisticated manner."

"It was from Hayek that I began."

"It is not so well known that it [Keynes's and my own move from thinking in terms of price-levels and the rate of interest to thinking in terms of inputs and outputs] is matched by a movement from Hayek to Harrod. I once asked Harrod what had put him on to the construction of his so-call 'dynamic' theory; he said, to my surprise, that it was thinking about Hayek."

"Hayek was making us think of the productive process as a process in time, inputs coming before outputs."

"I did not begin from Keynes: I began from Pareto, and Hayek (footnote 10: There is evidence for this, in the paper 'Equilibrium and the Cycle')"

"There were four years, 1931-1935, when I was myself a member of [Hayek's] seminar in London; it has left a deep mark on my thinking. … At the end of the discussions in that seminar … we were, I believe, on the point of taking what now seems to me to be a decisive step. I was, at least, on the point of taking it myself. There is evidence for that in my "Value and Capital", much of the groundwork for which was done before I left London."

"[Hayek] did contribute toward an important conceptual development in his reflections on the problems raised by extending the analysis of equilibrium in time. In a key article of 1928 published in the 'Weltwirtschafliches Archiv,' he observed that it was not possible to ignore the element of time in the simultaneous determination of prices if analysis was to be extended to monetary phenomena. {quotes Hayek} Hayek defined the problem concisely as one of an intertemporal system of prices. {quotes Hayek}."

"Hayek made a suggestion that was to be of great importance in the theory's [i.e. General Equilibrium Theory or 'GET'] subsequent history, that the same goods available at two different moments of time should be treated as distinct goods whose relations of exchange were to be examined, although they might, 'technically speaking,' be one and the same product."

"[Hayek's] equilibrium theory offered a wealth of suggestions that were to be taken up in the literature of the 1940s and 1950s. The idea of intertemporal equilibrium, which was to be precisely defined in axiomatic terms by Arrow and Debreu, took shape in his writings of the 1920s and 1930s."

"Although Hayek did not provide any formalization of his theories, his equilibrium theory offered a wealth of suggestions that were to be taken up in the literature of the 1940s and 1950s. The ideas of intertemporal equilibrium, which was to be precisely defined in axiomatic terms by Arrow and Debreu, took shape in his writings of the 1920s and 1930s."

"Hicks elaborated the concept of temporary equilibrium, perhaps the most original contribution of "Value and Capital", following the path laid down by Hayek and the Swedish school."

"If Hayek believes that the spending of newly-printed currency on employment and consumption will worsen our current terrible depression, then Hayek is a nut."

"Very few people these days know the works of the Mises-Hayek school; unfortunately, I am old enough to have been an early follower of Professor Hayek, and even translated one of his books, and there is nothing like having to translate a book, particularly from the German language, to force you to come to grips with an argument."

"My later years at L.S.E. in the 1930s were not altogether happy. Though the place never lacked intellectual stimulus – and there was plenty of opportunity to expound one’s views in Lionel Robbins’ weekly seminars – I felt out on a limb as an early and enthusiastic supporter of Keynes, and out of sympathy with the rigid neo-classicism of Robbins, Hayek and most of the senior members of the economics department."

"The book, as it stands, seems to me to be one of the most frightful muddles I have ever read, with scarcely a sound proposition in it beginning with page 45, and yet it remains a book of some interest, which is likely to leave its mark on the mind of the reader. It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in bedlam."

"I am in full agreement, also, with Dr. Hayek's rebuttal of John Stuart Mill's well-known dictum that "there cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money," which he expresses admirably in the following passage from his last lecture: "it means also that the task of monetary theory is a much wider one than is commonly assumed; that its task is nothing less than to cover a second time the whole field which is treated by pure theory under the assumption of barter, and to investigate what changes in the conclusions of pure theory are made necessary by the introduction of indirect exchange. The first step towards a solution of this problem is to release monetary theory from the bonds which a too narrow conception of its task has created.""

"Professor Mises and Dr. Hayek have advanced theories which, though they fall into the general category of monetary explanations, yet seem altogether free from those deficiencies which have marked monetary explanations in general. They explain the effects of fluctuations in the supply of money not so much in terms of fluctuations of the general price level as in terms of fluctuations of relative prices and the consequent effects on what may be called the ‘time-structure’ of production."

"I very well remember Hayek's visit to Cambridge on his way to the London School. He expounded his theory and covered a black-board with his triangles. The whole argument, as we could see later, consisted in confusing the current rate of investment with the total stock of capital goods, but we could not make it out at the time."

"Hayek’s analysis, with its theory of ‘real’ economic equilibrium, rests on the concept of ‘period of production’ and the thesis that the ‘capital intensity’ of production processes is a decreasing function of the interest rate. This thesis comes in for destructive criticism from Sraffa in chapters 6 and 12 of his 1960 book, but in the 1932 article his attention focuses on Hayek’s monetary analysis. [...] We may well imagine Hayek’s dismay faced with a position such as Sraffa’s must have seemed to him. Here we are, in a world where monetary factors exert an evident influence on real variables, and where the marginalist theory of value is universally accepted. What, then, could the outcome possibly be of rejecting out of hand what seemed to be the only possible way to reconcile faithfulness to the theoretical foundations of marginalism with the realities of unemployment and cyclic trends in the economy? Today it appears quite clear to us that what to Hayek seemed like nihilism on Sraffa’s side (much like the attitude shown towards Marshallian theory in the 1930 article) was simply rejection of the marginalist approach –not as a ‘leap into the dark’, but in favour of the reconstruction of political economy based on the alternative approach of the classical school."