A Tiger by the Tail - The Keynesian Legacy of Inflation docx

A Tiger by the Tail

A Tiger by the Tail

A 40-Years’ Running Commentary

on Keynesianism by Hayek

With an essay on

‘The Outlook for the 1970s:

Open or Repressed Infl ation?’

by

F.A. HAYEK

Nobel Laureate 1974

Compiled and Introduced by

Sudha R. Shenoy

Introduction by

Joseph T. Salerno

Third Edition

Published jointly by

The Institute of Economic Affairs

and the

Ludwig von Mises Institute

First published 1972

Second Impression 1973

Second Edition 1972 and 1978 © The Institute of Economic Affairs

Third Edition 2009 © The Institute of Economic Affairs

New Material 2009 © Ludwig von Mises Institute, Creative Commons 3.0

All rights reserved. Written permission must be secured from the publisher to use

or reproduce any part of this book, except for brief quotations in critical reviews or

articles.

ISBN: 978-1-933550-40-4

ACKNOWLEDGEMENTS

We are grateful to Routledge and Kegan Paul, the Editors of The

Economic Journal and Professor Hayek for permission to reproduce

extracts or articles.

— Editor

vii

CONTENTS

Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Guide to Extracts and Articles. . . . . . . . . . . . . . . . . . . . . . . . . . . xi

Introduction to the Third Edition by Joseph T. Salerno . . . . . . xiii

Preface by Arthur Seldon. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxi

Preface to the Second Edition by Arthur Seldon . . . . . . . . . . . .xxv

The Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xxvii

I. The Debate, 1931–1971: Sudha Shenoy . . . . . . . . . . . . . . . 1

Challenge to Keynes . . . . . . . . . . . . . . . . . . . . . . . . . 2

The Approach to an Incomes Policy. . . . . . . . . . . . . . 5

‘Micro’ Dimensions Acknowledged . . . . . . . . . . . . . . 9

Is There a Price ‘Level’? . . . . . . . . . . . . . . . . . . . . . . 10

Further Implications of Hayekian Analysis. . . . . . . . 13

II. The Misuse of Aggregates. . . . . . . . . . . . . . . . . . . . . . . . . .15

1. Infl ationism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

2. No Causal Connection Between Macro Totals and

Micro Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

3. Fallacy of ‘The’ Price Level . . . . . . . . . . . . . . . . . . . . . 17

4. Economic Systems Overleap National Boundaries . . . 18

Misleading Concepts of Prices and Incomes. . . . . . . .19

5. Dangers of ‘National’ Stabilisation . . . . . . . . . . . . . . . 20

Theoretical Case Not Argued. . . . . . . . . . . . . . . . . . 21

Relative Price and Cost Structures . . . . . . . . . . . . . . 22

6. Monetary Danger of Collective Bargaining. . . . . . . . . 24

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viii

III. Neglect of Real for Monetary Aspects. . . . . . . . . . . . . . . . 27

7. Keynes’s Neglect of Scarcity . . . . . . . . . . . . . . . . . . . . 27

Investment Demand and Incomes . . . . . . . . . . . . . . 28

Final Position of Rate of Return. . . . . . . . . . . . . . . . 29

Mr. Keynes’s Economics of Abundance . . . . . . . . . . 30

Basic Importance of Scarcity . . . . . . . . . . . . . . . . . . 33

8. Importance of Real Factors . . . . . . . . . . . . . . . . . . . . . 34

Signifi cance of Rate of Saving . . . . . . . . . . . . . . . . . 35

9. Dangers of the Short Run . . . . . . . . . . . . . . . . . . . . . . 37

Betrayal of Economists’ Duty. . . . . . . . . . . . . . . . . . 39

IV. International versus National Policies . . . . . . . . . . . . . . . . 41

10. A Commodity Reserve Currency . . . . . . . . . . . . . . . . 41

An Irrational but Real Prestige. . . . . . . . . . . . . . . . . 42

11. Keynes’s Comment on Hayek . . . . . . . . . . . . . . . . . . . 43

Conditions for National Price Stability . . . . . . . . . . 44

Different National Policies Needed . . . . . . . . . . . . . 45

12. F.D. Graham’s Criticism of Keynes . . . . . . . . . . . . . . . 47

The ‘Natural Tendency of Wages’ . . . . . . . . . . . . . . 48

Gold Standard ‘Dictation’ . . . . . . . . . . . . . . . . . . . . 50

Unanchored Medium of Exchange. . . . . . . . . . . . . . .51

The Real Problem of Unemployment . . . . . . . . . . . . 53

Professor Hayek’s ‘Intransigence’ . . . . . . . . . . . . . . . 54

13. Keynes’s Reply to Graham . . . . . . . . . . . . . . . . . . . . . 56

V. Wage Rigidities and Infl ation . . . . . . . . . . . . . . . . . . . . . . 59

14. Full Employment, Planning and Infl ation. . . . . . . . . . 59

Full Employment the Main Priority. . . . . . . . . . . . . 60

Unemployment and Inadequate Demand. . . . . . . . . .61

Main Cause of Recurrent Unemployment . . . . . . . . 63

Expansion May Hinder Adjustment. . . . . . . . . . . . . 65

ix

CONTENTS

15. Infl ation Resulting from Downward Infl exibility

of Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

Importance of Relative Wages . . . . . . . . . . . . . . . . . 68

Infl ation—A Vicious Circle . . . . . . . . . . . . . . . . . . . 70

The State of Public Opinion . . . . . . . . . . . . . . . . . . 72

16. Labour Unions and Employment . . . . . . . . . . . . . . . . 73

Changed Character of the Problem . . . . . . . . . . . . . 74

Union Coercion of Fellow Workers . . . . . . . . . . . . . 78

Wage Increases at Expense of Others . . . . . . . . . . . . 80

Harmful and Dangerous Activities. . . . . . . . . . . . . . 82

Acting against Members’ Interests . . . . . . . . . . . . . . 84

A Non-coercive Role . . . . . . . . . . . . . . . . . . . . . . . . 87

Minor Changes in the Law . . . . . . . . . . . . . . . . . . . 90

Responsibility for Unemployment . . . . . . . . . . . . . . 93

Progression to Central Control. . . . . . . . . . . . . . . . . 96

‘Unassailable’ Union Powers. . . . . . . . . . . . . . . . . . . 99

17. (a) Infl ation—A Short-term Expedient

(b) Infl ation—The Deceit is Short-lived. . . . . . . . . . . .101

17. (a) Infl ation—A Short-term Expedient. . . . . . . . .101

Infl ation Similar to Drug-taking . . . . . . . . . . . . . . 102

Accelerating Infl ation. . . . . . . . . . . . . . . . . . . . . . . 104

The Path of Least Resistance . . . . . . . . . . . . . . . . . . . . . 105

17. (b) Infl ation—The Deceit is Short-lived . . . . . . . 106

Limited Central Bank Infl uence. . . . . . . . . . . . . . . 107

Weak Opposition to Infl ation . . . . . . . . . . . . . . . . 108

VI. Main Themes Restated. . . . . . . . . . . . . . . . . . . . . . . . . . .111

18. Personal Recollections of Keynes. . . . . . . . . . . . . . . . .111

Keynes Changes His Mind . . . . . . . . . . . . . . . . . . .112

Thinking in Aggregates . . . . . . . . . . . . . . . . . . . . . .114

Full Employment Assumption . . . . . . . . . . . . . . . . .115

Wide Intellectual Interests . . . . . . . . . . . . . . . . . . . .117

19. General and Relative Wages . . . . . . . . . . . . . . . . . . . .119

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x

Unpredictability and the Price System . . . . . . . . . . 120

Wage Rigidities . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

Importance of Relative Wages . . . . . . . . . . . . . . . . 123

20. Caracas Conference Remarks . . . . . . . . . . . . . . . . . . 125

VII. The Outlook for the 1970s: Open or Repressed

Infl ation?: F.A. Hayek . . . . . . . . . . . . . . . . . . . . . . . . . . 127

Long-run Vicious Circle. . . . . . . . . . . . . . . . . . . . . 127

Repressed Infl ation a Special Evil. . . . . . . . . . . . . . 129

Central Control and ‘Politically Impossible’

Changes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

Profi t-sharing a Solution. . . . . . . . . . . . . . . . . . . . . 132

Basic Causes of Infl ation . . . . . . . . . . . . . . . . . . . . 132

VIII. Addendum 1978. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .135

Introduction by Sudha Shenoy. . . . . . . . . . . . . . . . .135

Guiding Role of Individual Price Changes . . . . . . . 136

21. Good and Bad Unemployment Policies. . . . . . . . . . . 138

Maladjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

Wages and Mobility. . . . . . . . . . . . . . . . . . . . . . . . 140

Dangers Ahead . . . . . . . . . . . . . . . . . . . . . . . . . . . .141

22. Full Employment Illusions . . . . . . . . . . . . . . . . . . . . 142

Money Expenditure and Employment . . . . . . . . . . 143

An Old Argument in New Form . . . . . . . . . . . . . . 144

The Shortcomings of Fiscal Policy . . . . . . . . . . . . . .145

Cyclical Unemployment. . . . . . . . . . . . . . . . . . . . . 146

Consumers’ Goods Demand and Investment

Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148

Purchasing Power and Prosperity . . . . . . . . . . . . . . 148

Why the Slump in Capital Goods Industries? . . . . 148

23. Full Employment in a Free Society . . . . . . . . . . . . . . .151

Hayek’s Writings: A List for Economists . . . . . . . . . . . . . . . . . .157

Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159

xi

Guide to Extracts and Articles

(Chapters II to VIII)

F. A. HAYEK:

Prices and Production (1931)

Monetary Nationalism and International Stability (1937)

The Pure Theory of Capital (1941)

‘A Commodity Reserve Currency’, Economic Journal (1943)

Studies in Philosophy, Politics and Economics (1967)

The Constitution of Liberty (1960)

‘Personal Recollections of Keynes and the “Keynesian

Revolution”,’ The Oriental Economist (1966)

‘Competition as a Discovery Procedure’, New Studies in

Philosophy, Politics and Economics (1978)

‘Caracas Conference Remarks’, Mont Pèlerin Conference (1969)

‘Good and Bad Unemployment Policies’, Sunday Times (1944)

‘Full Employment Illusions’, Commercial & Financial Chronicle

(1946)

‘Full Employment in a Free Society’, Fortune (1945)

J. M. KEYNES:

‘The Objective of International Price Stability’, Economic

Journal (1943)

‘Note by Lord Keynes’, Economic Journal (1944)

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xii

F. D. GRAHAM:

‘Keynes vs. Hayek on a Commodity Reserve

Currency’, Economic Journal (1944)

xiii

INTRODUCTION TO THE THIRD EDITION

The small book you are holding in your hands is unique. It is perhaps

the fi nest introduction to the thought of a major thinker ever published

in the discipline of economics. What makes it unique is the fact that it

comprises selections and short excerpts from a broad range of Hayek’s

works written over a span of forty years. Despite its broad coverage

the book is amazingly compact and coherent, seamlessly integrating

the main themes from Hayek’s writings on money, capital, business

cycles, and international monetary systems. Furthermore, although

it mainly uses Hayek’s own words, some from his more technical

works, it has been compiled and arranged by the late Sudha Shenoy

in a way that makes it comprehensible to the layperson and student

but can also be read with profi t by the professional economist and

teacher. Because of Shenoy’s brilliant choice and arrangement of the

twenty-three separate excerpts and her own illuminating, but never

intrusive, introductions to each separate selection, the book stands as

a work in its own right and gives new insight into Hayek’s thought.

In a real sense, it is as much Shenoy’s book as it is Hayek’s.

The publication of the new edition of this classic could not have

come at a better time, moreover. For it is not merely an outstanding

contribution to intellectual history, but also a tract for our times. The

U.S. has been mired in an offi cially-recognized recession for more

than a year now with no end in sight. Our current downturn is fast

becoming the lengthiest and most severe of the post-World War II

era. Entering its fourteenth month, it has already surpassed the aver￾age length of the last six recessions and is rapidly approaching the

postwar record of sixteen months. The net decline in employment

A TIGER BY THE TAIL

xiv

of 2.6 million recorded for 2008 represents the greatest absolute

decline in the number of jobs since 1945. With over a half-million

workers losing their jobs in December 2008 alone, the unemploy￾ment rate unexpectedly spiked from 6.8 percent in November 2008

to 7.2 percent, the highest level in sixteen years. The 4.78 million

Americans now claiming unemployment insurance is the highest

since 1967, when this statistic began to be recorded and represents

the highest proportion of the work force since 1983. Adding to the

dismal employment picture, the average work week for the month

plummeted to 33.3 hours, the lowest level since 1964, while part￾time jobs shot up by 700,000, or nearly 10 percent, from the previous

month, indicating that many part-time workers counted as offi cially

employed were either previously terminated from full-time jobs or

reduced from full-time to part-time employment by their current

employers. Other indicators of the severity of recession besides

employment reveal that the current recession has been deeper than

the average recession, including industrial production, real income,

and retail sales. As one Fed economist concluded, “Main recession

indicators tend to support the claim that this recession could be the

most severe in the past 40 years.”1

Indeed the dread word “depression” is now being used by some

economists and media pundits to portray our current diffi culties,

conjuring up the specter of the prolonged mass unemployment amidst

idle industrial capacity and unsold piles of raw materials that marked

the 1930s. For most recognized experts and opinion leaders, how we

got into our current diffi culties is now a moot question. Everyone

is clamoring for a way out. A massive government bailout involving

$700 billion to purchase risky assets and to subsidize troubled fi nancial

service and domestic automobile fi rms has proven spectacularly inef￾fective in reversing or even slowing the contraction of the economy,

1 Charles Gascom, “The Current Recession: How Bad Is It?” Federal Reserve Bank

of St. Louis Economic Synopses 4 (January 8, 2009): 2, available at http://research.

stlouisfed.org/publications/es/09/ES0904.pdf.