The contribution by the Austrian economist Friedrich von Hayek to monetary theory stimulates a far-reaching debate on the role of the government in monetary management and the effects of alternative policies in regulating the issuance of money. Since the early 1930s Hayek had been concerned about the role of money in the theory of production. Influenced by Eugene Böhm-Bawerk’s theory of capital, Hayek deeply examined the effects of monetary policy on the process of capital accumulation. As regards investment decisions, Hayek considered that an inflationary credit expansion by the central bank can lead to capital misallocation over time caused by artificially low interest rates.
Indeed, the fundamental problem in economics, for Hayek, is that of coordinating the plans of many independent individuals. The main advantage of a competitive economic order, in Hayek’s view, is that rational agents respond to price signals, which convey the relevant information available in the markets, for the purpose of economic calculus. In his view, competition, through the price market system, leads to such coordination. The underlying critique relies on arbitrary interventions related to the presence of the state in economic systems (see, for example, Hayek, 1944). After the Second World War, Hayek discussed the redefinition of the legitimacy of the state and stressed the need to defeat the growing state intrusion in a democratic framework. Besides, he privileged the analysis of the values that shape the interrelations of individuals in a free society. Assessing the practical superiority of the free market dynamics over governments’ actions, Hayek believed that no government can know enough to effectively plan the future path of the economy and society. Further, central banks do not have the relevant information to correctly manage the money supply.
Frederic von Hayek restated the relevance of concepts and ideas proposed by the classical liberal philosophy so as to rebuild the foundations of constitutional governments to face the institutional decay in contemporary societies. As a result, in the 1970s, Hayek proposed the abolition of the government’s monopoly over the issue of fiat money to prevent price instability (see Hayek, 1976). His defense of a complete privatization of money supply stemmed from his disappointment with central banks’ management, which, in his opinion, had been highly influenced by politics. He warned that political interference over monetary policy and price stability is incompatible with social cohesion. At that time, Hayek’s proposal of institutional reform relied on a denationalization of money in the framework of a free market monetary regime where only those currencies that have a stable purchasing power would survive.
In Hayek’s contribution to monetary policy, although employment and price stability are not necessarily in conflict, priority should be given to monetary stability. Aware of the price stability challenges, Hayek strongly highlighted the dangers that arise from monetary financing public spending. Considering this background, Hayek’s recommendation to policy making is the dissolution of “the unholy marriage” between monetary and fiscal policy, which, in his opinion, had formally consecrated the victory of “Keynesian” economics after the Second World War ( see Hayek, 1
Hayek strongly criticized the Keynesian transformation of the discipline of economics. As of the 1970s, he condemned the role of the economists in promoting the engineering of social change through macroeconomic modeling. Under his view, for the Keynesian income expenditure model to work, the economist must know the aggregate level of current consumption, investment, and public spending, as well as the full employment level of output and the multiplier effect. As each step of the analysis presupposes that the detailed knowledge of economic life is available and that the outcomes of each policy intervention will be precise effects on economic activity, he believed that the Keynesian macroeconomic policy was mistaken.
Why do students need to read Hayek’s books? The global crisis, that began in 2007-08–caused a re-examination of the ideas of Hayek in search of answers to the questions of what caused the crisis and how governments may get out of it. On behalf of the economic and social outcomes of the crisis, Hayek’s reading is a must in the economic curriculum in order to engage the students in a pluralist discussion around free market vs. regulation; monetary policy vs. fiscal policy, austerity vs. growth.
In truth, the absence of a deep discussion about Hayek’s ideas in the economics curriculum has reinforced the ignorance of the disastrous social consequences of austerity as a political project in contemporary capitalism.
Madi, M. A. C. Dissolving the ‘unholy marriage’: Hayek’s recommendation on monetary and fiscal policy. http://www.eccf.ukim.edu.mk/Article/141
Books to read
HAYEK, F. A. von (1937a) Individualism and Economic Order, Chicago: University of Chicago Press.
———- (1937b) “Economics and Knowledge”, Economica, 4, pp. 33-54.
———- (1944) The Road to Serfdom, Chicago: University of Chicago Press.
———- (1945) “The Use of Knowledge in Society”, American Economic Review, 4, pp. 519-530.
———- (1960) The Constitution of Liberty. Chicago: University of Chicago Press.
———- (1976) Denationalisation of Money: The Argument Refined, London: Institute of Economic Affairs.
———- (1973) Law, Legislation and Liberty, Vol. 1, Chicago: University of Chicago Press.
———- (1974) The Pretense of Knowledge, Nobel Prize Speech.
———- (1995) “Contra Keynes and Cambridge: essays, correspondence”, in B. Caldwell (ed.), The Collected Works of F.A. Hayek, volume 9, Chicago: University of Chicago Press.