Friedrich August von Hayek, “Monetarism and Hyper-inflation”

Published in The Times on March 5, 1980, and republished in the supplied 2022 version with editorial notes, Hayek’s letter argues for immediate, decisive action against inflation. Its two substantive paragraphs move from the validity and limitations of the quantity theory of money to the economic and political costs of disinflation. Hayek defends the monetary explanation of inflation while rejecting both Milton Friedman’s fixed money-growth rule and gradual inflation reduction. The letter’s central distinction is between accepting that excessive monetary supply causes inflation and accepting a particular monetarist prescription for controlling it.

Hayek opens by treating “monetarism” as a new name for the quantity theory associated with Irving Fisher and reformulated by Friedman. Recalling his own earlier defence of its elementary propositions, he blames Keynes’s influence for undermining public acceptance of them. Yet his defence is qualified: the theory identifies an indispensable causal relationship without supplying an adequate operational measure of money.

The problem is that in its crude form it provides no adequate measure of what is the supply of money and that not only the supply of all kinds of money but also the demand for them determines its value.

This qualification matters because Hayek does not regard every monetary aggregate as a straightforward instrument of control. He locates effective restraint in the “basic cash” supplied by the central bank. Under the institutional arrangements he describes, government therefore bears responsibility for inflation:

Since this is a government institution, all inflation is made by government and nobody else can do anything about it.

The categorical attribution is tied to the existing monetary system, rather than developed as a general account of every possible monetary institution. Hayek then rejects Friedman’s proposal to legislate a fixed rate of monetary expansion, warning that it would probably cause an unprecedented financial panic. The letter asserts this danger without working through its mechanism in detail. Its conceptual move is nevertheless clear: the necessity of monetary restraint does not establish the feasibility of a mechanical money-growth rule.

The second paragraph shifts from monetary control to the dynamics of employment and business activity. Hayek’s case for abrupt disinflation rests on the claim that inflation’s stimulus depends on continuing acceleration, not merely on prices continuing to rise:

The reason is that the artificial stimulus which inflation gives to business and employment lasts only so long as it accelerates, that is so long as prices turn out to be generally higher than expected.

Unexpected price increases generate windfalls that sustain otherwise unprofitable activities. Once inflation stops accelerating, those windfalls disappear, bringing business failures and unemployment. Hayek thus presents a “stabilisation crisis” as unavoidable: gradual restraint cannot remove the adjustment cost but can stretch it into prolonged misery. His argument is simultaneously economic and political, since he doubts that a government could survive a lengthy depression.

If we want to stop inflation we must do it here and now. It can be done.

To support this urgency, Hayek invokes the United States’ sharp price decline between August 1920 and February 1921, followed, in his account, by renewed expansion six months later. He acknowledges severe suffering but distinguishes that historical deflation from his present objective: stopping further price increases, not reversing the price level. The closing warning raises the stakes from unemployment to currency collapse, predicting that delay and an ineffective resort to price controls would ultimately destroy the pound.

The accompanying editorial notes place the letter’s prescription against the Thatcher government’s preference for gradual disinflation. They also qualify Hayek’s political prediction: despite prolonged high unemployment, the Conservatives reduced inflation and retained power. The work’s significance lies in this sharp internal disagreement among advocates of monetary restraint. Hayek accepts the quantity theory’s core proposition but disputes both rule-based monetary management and gradualism, arguing that a shorter, openly acknowledged adjustment crisis is preferable to an extended contraction that might exhaust the political capacity to stabilize money.