Monetary Theory and the Trade Cycle by Fredrich Hayek's - Book Report/Review Example

Book Review By Name Course Instructor Institution City/State Date Monetary Theory and the Trade Cycle – Book Review Introduction In his book “Monetary Theory and the Trade Cycle”, Hayek (1933, p.17) underlines the monetary causes that could result in cyclical fluctuations, which was harmonised by ‘Prices and Production’ placing emphasis more on the successive transformations in real production structure. These are the actual events of the trade cycle. At the time when Hayek was finishing his research on ‘monetary theory and trade theory’, macroeconomics set forth by Keynesian was dominating. In due course, Hayek’s monetary theory was obscured by what is commonly referred to as the Keynesian revolution. For this reason, Hayek shifted his focus on other crucial analytical is­sues, particularly, how economic activities are influenced by information. According to Hayek, all the participants in the market are pursuing their own interests on account of the knowledge of their individual conditions in addition to the information communicated to them by the means of the price system. Hayek insists that if monetary disturbance systematically distorts the price system, the actions and choices of the market participants will be based on misinformation. For this reason, there will be discoordination in the economy. In the book, Hayek asserts that the resources can be misallocated in reaction to the distorted price provided that the sale of the resources happens earlier. The author argues that it is imperative to understand that it is to monetary causes that people have to ascribe the pricing process, divergences at the time of Trade Cycle. Arguments Put Forward by Hayek Hayek argued that a number of his fellow Austrian economists were faultily emphasising too much on central banks as main inflation source. According to Hayek, the boom process described by Austrian economists has to recur under the present credit organisation. This presents a tendency intrinsic in the economic system; therefore, should be considered as an endogenous theory. Hayek argues that the forces behind the bankers’ capitalistic competition can result in inflationary expansion. For instance, an increase in demand for loans due to the brightening of the economic prospects normally result in more loans from the banks. Hayek posits that these loans are made from nothing, they never wait for new savings by the customer in order to lend out. In spite of the increased demand, the interest rates offered by the bankers are normally constant since increasing the rates could result in losing the customers to the competitors, considering that the banking industry is very competitive. When the business situation in a bank improves; Hayek argues that there is a likelihood that the number of the customers will increase. Hayek fails to understand banks charge the same interest rate as well as with the same security even when the volume of loans increases. Considering that the bank’s cash holdings is still unchanged. Hayek mentions that when a single bank expands it is often confronted by a clearinghouse deficit, which is almost the same scale as the new credit that was made at first. However, when a general expansion is performed almost at a similar rate by every bank, it would result in clearing-house claims that, even though enormous, generally compensate each other; thus, inducing cash drain that is relatively unimportant. When a bank fails to stay abreast of the expansion it would eventually be forced to do so, considering that it would still be receiving cash at the clearing house provided that the new liquidity standard does not change it. Hayek (1933, p.177) argues that while generating additional credit so as to cater for the increasing demand, and therefore laying open new improving possibilities as well as production expansion, bankers should make sure that desires towards productive apparatus expansion are not insuperably as well as instantaneously balked by the growing rates of interests. Still, the automatic adjustment mechanism is stultified by this policy considering that it ensures that the various system parts are in equilibrium and facilitate inconsistent developments which eventually have to cause a reaction. Hayek alleges that it is illogical to argue that when all units pursue their own self-interest it results in economic equilibrium. He instead argues that the self-interest of banks can result in inflationary economic expansion as well as unemployment; thus, generating contractions. These arguments according to Hayek create the need for a monetary approach towards the trade cycle theory. This is attributed to the situation adjusting demand as well as supply automatically could only be disturbed after the introduction of money into the economic system. All trade cycle explanations according to Hayek (1933, p.101), that utilise the economic theory techniques have to be initiated by taking into account the influences sourcing from the utilisation of money. Hayek (1933, p.42) stressed that if properly pursued, the logic behind the equilibrium theory could help exhibit how equilibrium disturbances could only be sourced from outside; that is to say, they depict an economic data change. Weaker Points of the Work Hayek’s work make unrealistic assumption on Equilibrium: the authors argue that saving is the same as investment and initially the economy is in equilibrium; therefore, there is disturbance from banks seeking to generate extra credit. This is unrealistic supposition since the disturbances to equilibrium could be sourced from various sources, both outside and inside the system. Another weaker point made by Hayek is with regard to the undue significance of changes in interest rate. Actually, the interest rates cannot be extremely flexible to the extent that it influences the production capital intensity. Clearly, many business organisations do disregard the small changes in the interest rate. Instead, they place more emphasis on the changes in the projected profit rate that occurs in the trade cycle phases. The concept of forced saving appears weaker, especially when Hayek’s argues that the producers goods expansion can be achieved through consumers’ forced saving during the redistribution of the income. When the group having lesser incomes is forced to limit consumption while those from the higher incomes voluntarily limit themselves from increasing consumption to a similar level, then there is no forced saving. Therefore, the forced saving concept utilised by Hayek is misleading. Hayek argument that when the consumers have higher incomes there is probability that a push for the consumer goods profitability is higher as compared to that of capital goods is completely misleading. This is because it results in the boom crash. When consumer-goods companies experience high profitability it automatically connotes a higher return rate over cost. Therefore, it encourages investment, rather than discouraging it. In addition, Hayek only focuses on the expansion phase and has no persuasive logic for the recovery following the depression. Given that the theory has not explained both the trade cycle’s turning points, it cannot describe the business cycles periodicity. To sum up, Hayek’s arguments are out of order to the extent that it unsuccessfully tried to include the real factors and the monetary factors so as to explain the complete trade cycle. The prospect of accepting remain Hayek’s arguments is dim and cannot be used as the starting point for policy prescription. Conclusion In conclusion, it is evident that Hayek supported a non-interference policy, claiming that the efficiency of the markets is distorted by the state interference, which consequently results in fascism. Certainly, the Great Depression that happened in the 1930s brought about an intense debate between Keynes supporters and those of supporters of Hayek. The significance of Hayek arguments was evidenced by the stagflation phenomenon, which was a combination of economic stagnation as well as high inflation that led to high oil prices. In order to solve the stagflation issue, score of Hayek’s supporters advocated for deregulation, freer markets, and also stressed that governments should play small economic roles through social programs that were scaled down as well as freer markets. The increasing dependence of deregulation and free markets led to new financial products, especially in the housing sector which later generated an enormous housing bubble. In late 2000s, this bubble burst leading to the Great Recession. Hayek’s arguments are related with seeing recessions as an iniquity outcome. Hayek focus on recessions can be associated with the liquidation periods that came about as a result of over accumulating capital goods. Hayek made some controversy after arguing that the spending by government intended for encouraging activity is unnecessary during a financial crisis since situation since it could the process of adjustment that is needed; therefore, postponing the recovery. Hayek asserted that sometimes central banks lower the interest rate in the market to a lower level with the objective of encouraging more investment. This extra investment is normally funded through printed money rather than increased saving. As a result, this generates an inflationary boom that is unsustainable, since the increased investment does not match the decreased consumption that would ultimately become a bust. This can be evidenced by the recent US financial crisis, which was an outcome of the government’s simple monetary policy. In order to steer clear of economic busts, Hayek suggested that governments should avoid economic booms. Reference Hayek, F.A., 1933. Monetary Theory and the Trade Cycle. London: Jonathan Cape. Read More