Professor Hayek left his opus in 1992. It seems to reflect a unity in the development of the nature of problems, methods and theoretical answers even if the latter are keyed to different fields of knowledge. This inner consistency of Hayek's research programme will be shown here by dealing with some of his major works.
The theory of business-cycles
Already within the theory of business-cycles under aspects of monetary theory the process of co-ordination of production plans of enterprises in the consumer and capital goods industries emerges as the central complex of questions; that means the use of the already existing factors of production on the different levels of production (vertical relations) in a dynamic process (Hayek, 1931, 1933).
These are the questions Hayek was dealing with in the 1920s and 1930s based on the US economy of the 1920s: a short recession was followed by an upswing of the economy characterized by an increase of money supply, credits, investments and employment at a comparatively stable price level.
In this situation, Hayek pointed out that, below the surface of this comparatively stable price level, a production process can develop which is expected to result in an economic crisis and a consequent decrease in economic activity (Hayek, 1925).
The process of adaptation of production is explained with the help of the following simplified hypotheses:
H1. An increase in the money supply based on support by the banking system (i.e. an offer that exceeds the voluntary level of savings) causing a process of adaptation in the credit and monetary markets. This results in a decrease in the interest rate below the particular interest rate which would balance saving and investment (moving away from the equilibrium interest rate) and cheapens and stimulates investments (Hayek, 1933, pp. 56-95).
H2. The available money and the other productive factors (work, etc.) are used relatively more often in the capital goods industry than in the consumer goods industry owing to: the relatively higher demand for investment goods or rather production goods; capital-intensive productions, extension of "production detours" or rather the levels of production and the production time; maintaining the size of production of companies, which would not be able to compete without an increase in money supply, increase in loans or rather loans at a lower interest rate (than the equilibrium interest rate) (Hayek, 1931, pp. 40-55).
H3. This change in the composition of the relative levels of production of investment (I) and consumer goods (C) (I [greater than] C) during the economic upturn causes, as a result of the shortage, a relatively high cost of consumer goods in comparison with the costs of capital goods. A relative decrease of an offer of consumer goods is connected with an increase in the demand of consumer goods, because those households, which are in the expanding capital goods industry, obtain an additional income (Hayek, 1931, pp. 69-86).
H4. This intensifies the pressure of a renewed reaction of households (consumers, savers), banks (credit and loan institutions) and companies (producers, investors). For a short time households must spend a relatively higher portion of their income for maintaining consumption and therefore have fewer savings at their disposal. As a result the decrease in the amount of savings in a bank increases the pressure pertaining to loans. (Convergence of money and loans with savings.) Companies expect higher profits and increase medium-term production of consumer goods, while production in the capital goods industry decreases.
H5. Because there is a limit to the expansion of the amount of money and loans, a process of adjustment is triggered, which introduces an economic downturn and causes the opposite composition of the production of consumer and capital goods (C [greater than] I): less capital-intensive productions, shortening of the production levels and of the production time; limitation of the production capacity in those companies which were able to maintain their production as a result of earlier increases in the money supply and low interest loans and are now no longer competitive (Hayek, 1933, p. 101). For the reactions of households and banks mentioned above, see Zarnowitz (1985).
This leads to a reduction of production factors: capital and complementary work forces, especially in the capital goods industry, but also in the consumer goods industry, because there fewer capital goods are used. At least here there is danger of an intensive economic downturn.
Hayek tries to explain the process of adjustment in the economic cycle with the help of a market model, which will be applied to the core of the Austrian microtheory. This means: a rational behaviour hypothesis for companies, households and bankers with an implied subjective process of learning in setting up a plan and correcting a plan; and a hypothesis regarding the trend-oriented alignment of single economic plans and of the production factors which are connected to their use. Since the relationship between the quantity of money, the interest rate, and loan activity was disturbed by the banking system (creation of money, more loans than savings), the relative changes in costs on the consumer goods and capital goods markets and on the derived market factors cause quantity adjustments. Finally, from here again the reaction on the money and loan market follows. The most difficult question then is how far can you let the economic downturn take its own path (or rather the necessary production adjustment), without starting the implied further decrease of economic activity? This problem was the main one in the discussion of the 1930s.
Hayek and Keynes
When the conditions of the economic model by Hayek are compared with the historical conditions of the time when his books about the theory of business cycles were published (1929 and 1931), then it becomes clear why Hayek's explanations did not find the same response as that of Keynes' explanations.
During this period the Western industrialized countries were in the middle of a "crisis". The trust in the adjustment process of markets and prices was shattered. The discussion was therefore divided into two directions:
(1) What explanation and political-economic answer is suitable for the economic situation (short-term problem)?
(2) Is the adjustment process in a free enterprise system still able to function and what alternatives are there (long-term problem)?
Hayek offers, as an answer to the first question, a long-term (micro-economic) explanation for the process of the economic upturn regarding over-investment, an increase in consumption and employment as well as the succeeding crisis and adjustment of the production structure (consumer goods - capital goods).
If the theoretical arguments are transferred to the 1920s, then the origin of the crisis and the downturn can be explained plausibly in which the "causes" are found in the money and loan area. An increase in money supply …