Hayek’s supplementary essay, published in 1978 and republished in the supplied 2022 version, assembles observations developed in American lectures and discussions in 1975. Its argument moves from the relation between inflation and unemployment to investment, monetary institutions, and the limitations of aggregate economic theory. The central claim reverses the familiar justification for expansionary policy: inflation does not provide a lasting alternative to unemployment but creates employment patterns whose eventual breakdown produces it.
It seems to me that the primary duty today of any economist who deserves the name is to repeat on every occasion that the present unemployment is the direct and inevitable consequence of the so-called full employment policies pursued for the last 25 years.
This opening establishes both the essay’s polemical intensity and its temporal distinction. Hayek accepts that increased money expenditure can raise employment immediately. His objection concerns the subsequent allocation of labour: monetary expansion directs workers into occupations that cannot remain viable once the stimulus subsides. He attacks principally the Keynesian school’s policy orthodoxy, distinguishing it from Keynes’s own heterogeneous writings. Its popular appeal, he argues, derives from extending the shopkeeper’s dependence on customers’ demand into a proposition about general prosperity. What appears reasonable for an individual business becomes misleading when applied to the economy’s entire production structure.
Yet Hayek distinguishes this initial misallocation from a subsequent contraction that can aggravate unemployment independently.
Such a ‘secondary depression’ caused by an induced deflation should of course be prevented by appropriate monetary counter-measures.
Unemployment can reduce aggregate demand, inducing further unemployment in a cumulative contraction. Preventing that process is legitimate; renewing inflation to sustain misallocated employment is not. Hayek also withdraws his earlier belief that deflation might overcome downward wage rigidity, calling that method politically impossible. He proposes low-paid public works as a possible means of maintaining consumers’ demand while encouraging workers to move into better-paid, lasting employment. Direct stimulation of particular investments, by contrast, risks creating jobs mistaken for permanent opportunities.
The recollection of his disagreement with Wilhelm Röpke over German credit expansion makes the distinction between economic judgment and political necessity explicit. Hayek reports withholding a critical article because Röpke believed continued unemployment threatened political revolution. Temporary expansion could thus be justified by an emergency without becoming a sound long-term economic remedy.
His diagnosis also contains a substantial empirical admission. Earlier credit cycles appeared concentrated in capital-goods industries, whereas expansion through bank lending and budget deficits had dispersed additional expenditure more widely.
I am by no means sure where such an investigation would find the most important over-developments.
Hayek calls for country-specific investigation of monetary flows and successive price movements rather than claiming to have identified the actual locations of excessive employment. His confidence in the mechanism therefore exceeds his demonstrated knowledge of its contemporary distribution. Lasting jobs must, he argues, be discovered through market adjustment. Recovery requires profitable industrial investment, but neither subsidies, artificially low interest rates, nor higher consumer demand necessarily produce sustainable capital formation. He distinguishes investment that expands output using existing techniques from investment that equips workers with more capital and raises productivity; relatively low product prices can encourage the latter by making labour-cost savings more urgent.
The essay then shifts from economic mechanisms to the institutional conditions of policy. Governments do not simply choose whatever economists consider optimal: they face persistent pressure to supply cheaper money. Gold convertibility and fixed exchange rates mattered because they provided constraints officials could invoke against that pressure.
Central banks and ministers of finance will never be able to implement what the economist would regard as the wise policy.
Hayek’s institutional argument is qualified rather than an unconditional defence of fixed parities. He criticizes floating rates when adopted to facilitate credit expansion, but accepts their use by Germany and Switzerland to escape imported inflation once fixed rates ceased to discipline other countries. The relevant question is which arrangements effectively restrain inflationary politics, not which regime is ideally correct in isolation.
His treatment of monetarism makes a parallel distinction. He endorses the broad quantity-theory claim that excessive monetary growth enables general price inflation, while rejecting an explanation confined to aggregate quantities and the general price level.
My chief objection against this theory is that, as what is called a ‘macro-theory’, it pays attention only to the effects of changes in the quantity of money on the general price level and not to the effects on the structure of relative prices.
Drawing on Cantillon and Hume, Hayek emphasizes the paths through which new money changes relative demand, prices, and employment. Anticipated steady inflation loses its employment stimulus; sustaining that stimulus requires acceleration. He also distinguishes monetary inflation from price increases caused by scarcity and warns that controls can conceal inflation while intensifying economic disorganization.
The editorial notes qualify some of the polemical evidence: they identify imperfect quotations and explain that the Labour pension proposal’s assumed doubling of prices was one of three scenarios, rather than straightforward evidence of a plan to cause inflation. The essay’s enduring significance lies in its conjunction of relative-price analysis, employment adjustment, and political constraints. Its concluding rejection of a stable inflation–unemployment choice rests on the claim that short-run monetary relief can generate the very long-run unemployment it promises to prevent.
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