F. A. Hayek, Inflation’s Path to Unemployment

This 2022 republication combines Hayek’s two Daily Telegraph articles of 15 and 16 October 1974, “Inflation’s Path to Unemployment” and “What Living Standards Can We Afford?” The combined text moves from a polemical indictment of Keynesian employment policy to an account of inflation-induced economic distortion, then examines labour markets, trade unions, indexation, and the political difficulties of ending inflation. Its central claim reverses the familiar choice between inflation and unemployment: inflation used to sustain employment creates a structure of production that eventually makes more severe unemployment unavoidable.

Hayek assigns responsibility for contemporary inflation to economists who encouraged governments to finance expenditure through money creation. He attacks both the belief that deficit spending remains harmless while unemployment exists and the concession that moderate inflation is an acceptable price for full employment. Neither position, he argues, adequately considers the composition of employment. Inflation’s principal harm is not simply redistribution between those whose incomes rise and those whose purchasing power falls:

It does so by drawing more and more workers into kinds of jobs which depend on continuing or even accelerating inflation.

The crucial distinction is between employment that can persist under stable monetary conditions and employment sustained by further monetary expansion. Inflation changes the allocation of labour and resources, creating activities whose viability depends on its continuation. When slowing inflation threatens those jobs, governments face pressure to resume expansion. “Stagflation” therefore represents, in Hayek’s account, a stage at which the previously accepted inflation rate no longer supports satisfactory employment. Repeated interventions require increasingly powerful doses of the same remedy.

Neither perpetual acceleration nor price and wage controls offer an escape. Accelerating inflation ultimately disorganizes economic activity; controls repress price changes without correcting the underlying monetary expansion. They also remove the price increases on which inflation-dependent employment rests. Hayek’s argument is consequently stronger than a warning about rising prices: he maintains that governments cannot simultaneously end inflation and preserve the employment structure their earlier policies created.

This does not mean accepting a repetition of the 1930s. Hayek attributes the severity of that disaster to an unjustified contraction of total demand and insists that the coming adjustment must not become a deflationary spiral. The policy task is to mitigate suffering and facilitate temporary and permanent new employment, rather than preserve every existing job. His position distinguishes unavoidable restructuring from avoidable cumulative collapse, even while denying that adjustment can be painless.

The theoretical centre of the article is a rejection of aggregate demand as a sufficient explanation of unemployment:

But not all unemployment is due to an insufficiency of total demand or would disappear if total demand were higher.

Hayek acknowledges that deficient demand causes some unemployment and that additional spending can temporarily increase employment. His objection concerns the inference that all unemployment has this cause, or that an initial employment gain can be sustained merely by holding expenditure at its new level. Where resources have been misdirected, the problem is their distribution among activities. Workers must move from occupations with excess supply to those with unmet demand; rising aggregate expenditure can conceal or intensify that mismatch.

Relative wages therefore perform an indispensable coordinating function:

Without a functioning labour market there can be no meaningful cost calculation and no efficient use of resources.

Hayek allows that such a market can coexist with strong unions, provided unions remain responsible for unemployment caused by excessive wage demands. A government guarantee of full employment at any wage level removes that constraint. This explains his qualified agreement with Milton Friedman: inflation results from excessive demand, not an autonomous “cost-push” process, but unions can induce an employment-guaranteeing government to expand demand to accommodate wage increases. Employers likewise have less reason to resist demands when policy is expected to absorb their consequences.

His disagreement with Friedman concerns indexation. Hayek accepts that it can protect pensioners and savers and may help where inflation arises from governments’ inability to maintain adequate revenues. But generalized indexation would obstruct the reduction in real purchasing-power claims that he considers necessary in the present situation. If everyone demands enough money to purchase more than the market supplies, compensating each price increase with additional nominal income perpetuates disappointment rather than resolving scarcity.

The concluding argument shifts from monetary mechanisms to democratic incentives. Politicians’ panicked responses to unemployment, rather than wage demands alone, threaten to perpetuate accelerating inflation. The alternative danger is a command economy that assigns jobs while worsening workers’ circumstances. Hayek presents public understanding of policy’s limits as a condition of avoiding both outcomes:

One of the prime requirements of its successfully weathering this crisis is that the people are in time undeceived about the fateful illusion that there is a cheap and easy means of at the same time securing full employment and a continuous rapid rise of real wages.

The articles’ relevance lies in this connection between monetary instability, resource allocation, and political commitments. Hayek treats inflation as a process that progressively narrows future choices, not as an independent cost that can be balanced against unemployment. His proposed goal is high and stable employment through adaptation to real conditions, accompanied by protection against unnecessarily prolonged unemployment during the transition. The argument’s force rests on its distinction between sustaining expenditure and sustaining economically viable jobs; its political severity follows from his conviction that earlier monetary interventions have already made some disruption unavoidable.