Friedrich A. Hayek, “Inflation Resulting from the Downward Inflexibility of Wages” (1967)

This file is a short single-author economic essay, reprinted from a 1958 policy volume and later collected as a chapter. Its scope is not a full treatise on money but a compact polemic about the wage premise Hayek thinks postwar policy has absorbed from Keynes. The Keynesian Revolution, he argues, matters less as a formal theory than as a practical conviction: substantial reductions in money wages are treated as impossible because they would produce unemployment. Once that premise governs policy, excess wages are not corrected directly; they are corrected indirectly by lowering the value of money.

A society which accepts this is bound for a continuous process of inflation.

Hayek’s first conceptual move is to shift the problem from the general wage level to relative wages. Economic development constantly alters the needed wage relations among regions, industries, and occupational groups. If no important group can accept a nominal cut, then every required downward relative adjustment must be achieved by raising other groups’ money wages. The aggregate wage level therefore rises not because all real wages have become more productive, but because rigid nominal wages make relative adjustment inflationary.

The effect must be a continuous rise in the level of money wages greater than the rise of real wages, i.e., inflation.

The essay then explains why inflationary prosperity cannot be self-sustaining. Hayek concedes that the postwar West has enjoyed a long boom accompanied by inflation, but he denies that rising prices as such create prosperity. Inflation stimulates business only when it surprises firms and leaves them with profits above what their cost calculations had anticipated. As soon as suppliers, workers, and entrepreneurs expect it, costs rise in advance; to have an expansionary effect, inflation must exceed expectations and thus tend to accelerate.

The point which tends to be overlooked in current discussion is that inflation acts as a stimulus to business only in so far as it is unforeseen, or greater than expected.

This expectations argument is the hinge of the essay. Constant inflation loses its power, while progressive inflation becomes socially and economically intolerable: calculation deteriorates, fixed payments are unjustly eroded, and pressure mounts for a halt. More importantly for Hayek, inflation postpones necessary reallocations and creates new distortions. Firms and investments kept viable by monetary expansion will be exposed once expansion slows; investment booms financed by new money cannot all be maintained by voluntary saving.

The middle section attacks the Keynesian image of demand management as a permanent remedy. Hayek rejects the hope that policy can keep final demand just ahead of costs, because costs are not independent of demand expectations. Employment depends not only on total spending but also on the composition and sustainability of investment; beyond a point, excessive final demand may undermine rather than support investment.

The conception that we can maintain prosperity by keeping final demand always increasing a jump ahead of costs must sooner or later prove an illusion, because costs are not an independent magnitude but are in the long run determined by the expectations of what final demand will be.

The policy conclusion follows from this structure. Hayek allows that disinflation may still be gradual and need not produce a major depression, but he expects some unemployment because inflation has delayed adjustments. The danger is political: any rise in unemployment will invite renewed inflation, temporarily successful but cumulatively destabilizing. Against the postwar division of responsibility, he argues that unions cannot demand maximum money wages while monetary authorities are expected to supply enough spending to validate those wages.

The long-run problem remains the restoration of a labour market which will produce wages which are compatible with stable money.

The essay’s relevance lies in its early combination of wage-rigidity criticism, expectations, and Austrian worries about misdirected production. Hayek’s final move reverses the Keynesian accommodationist premise: the money stream must be the constraint to which wages and prices adjust, not the passive instrument used to ratify wage bargains. This is why his monetary argument becomes a political argument about union power and responsibility for inflation.

Stable monetary conditions require that the stream of money expenditure is the fixed datum to which prices and wages have to adapt themselves, and not the other way round.