Caldwell on Hayek at the Soros Conference

Bruce Caldwell offers a refresher course on Hayekian economics to the economists gathered at the Institute for New Economic Thinking conference at Cambridge:

Let me begin by clearing up a misconception. Hayek is sometimes wrongly portrayed as thinking that market systems always work just fine. Now this is a man whose first book was titled Monetary Theory and the Trade Cycle. Suffice it to say that Hayek was no Dr. Pangloss when it came to the workings of a market economy. Hayek thought that a trade cycle was an unavoidable concomitant of a credit using
market economy. Hayek’s description of the unfolding of a typical cycle actually maps pretty well with at least a part of what happened in the latest meltdown, especially in terms of the Fed’s interest rate policy and its effects on the American housing sector.

In Hayek’s theory, problems start when the market rate of interest is held too low for too long. This always politically popular policy leads to malinvestment – too many investment projects get started that cannot ultimately be sustained. When people realize what has happened, investment spending collapses and a recession begins. In Hayek’s theory, recessions are the painful but necessary adjustment that returns the system back to equilibrium. His policy advice at the time, simply to let the system adjust, was as popular then as it is today. His great fear was that attempts to combat the recession with expansionary policy would perpetuate the malinvestment, delay the necessary and painful process of adjustment, and set up the prospects of future inflation. This too perhaps sounds familiar.

Perhaps of more interest than his cycle theory are Hayek’s views on regulation and on the limitations of economics as a discipline. Regarding regulation, two things should be noted at the outset. First, Hayek was not opposed to all regulation; more forcefully, he frequently criticized the concept of laissez faire. Second, he was no policy wonk. All of his observations were made at a very general level. This was in partstrategic: when he established the Mont Pelerin Society he found himself trying to keep together a coalition that ranged from Ludwig von Mises to Chicago School economists like Friedman and Stigler to ordo-liberals like Walter Eucken to people like Michael Polanyi and Karl Popper who, in this group anyway, might well be considered social democrats. He was not always successful: Mises walked out of one of the sessions at that first meeting muttering that everyone there was a damn socialist. In any event, given that we are trying in this conference to consider foundational issues about economics, a discussion of general principles may not be entirely out of place …

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