Hayek’s short journal reply to Nicholas Kaldor defends the continuity between Prices and Production and his subsequent accounts of industrial fluctuations. Its scope is deliberately limited: unable to supply a fuller response immediately, Hayek addresses the alleged contradictions most likely to misrepresent his position. He acknowledges that his understanding has developed and his emphasis has changed, but denies that these developments constitute an incompatible theory. The comment proceeds through two disputed changes—what governs the choice of production methods, and when the production period lengthens or shortens—before clarifying the relation between profits and investment. A postscript answers a further objection from Kaldor.
The first dispute concerns the apparent displacement of the money rate of interest by the relation between factor prices and product prices. Hayek argues that these “price margins” already performed the decisive explanatory role in Prices and Production: they governed movement toward more or less capitalistic methods. His earlier treatment recognized that margins could move independently of interest rates, but did not examine a prolonged divergence. Instead, outside the circumstances of major inflation or deflation, he expected changes in margins eventually to produce interest-rate movements in the same direction. His later analysis asks what happens when monetary policy deliberately prevents that adjustment.
The essential argument is still the same, but the assumptions under which I describe the operation of the mechanism in question are different.
This distinction between mechanism and assumptions is the reply’s organizing claim. Holding the money rate constant does not remove the price relationships affecting entrepreneurs’ production choices. It allows Hayek to isolate their operation where the interest-rate response assumed in his earlier exposition is suppressed. What Kaldor presents as theoretical reversal is thus, for Hayek, an investigation of the same process under another monetary condition.
The second dispute concerns the alternating lengthening and shortening of the investment period. Hayek rejects the suggestion that concern about excessive lengthening differs fundamentally from concern about the subsequent abandonment of investments. Both describe a mismatch between the capital equipment being constructed and the share of income people wish to receive as consumers’ goods. More capitalistic methods cannot necessarily be completed and sustained alongside the consumption people demand.
We can prevent such waste either by preventing the misdirected investment in the first stage or, if it has already occurred, by keeping down consumption in the second to the level which is compatible with the completion of the investments.
The alternatives expose the real-resource constraint underlying Hayek’s argument. Avoiding waste requires either restraining incompatible investment before it occurs or subsequently limiting consumption sufficiently to complete it. The passage does not offer an effortless monetary remedy; it identifies the intertemporal compatibility that any remedy must secure.
Hayek also contests Kaldor’s allocation of lengthening and shortening to different phases of the cycle. In the earlier account, low interest rates encouraged lengthening, but such rates characterized only the early upswing. Lengthening therefore did not continue throughout the boom: it ended as interest rates rose. Under the later assumptions, rising profit margins terminate it instead. A further distinction explains why the end of lengthening need not immediately reduce investment. Capital can also be “widened,” and investment falls only when shortening outweighs this other source of expansion. Hayek acknowledges that the interaction was not explicitly developed in the earlier version, without accepting that its subsequent articulation contradicts that account.
The final substantive section addresses the apparent paradox that high profits relative to interest rates might reduce investment. Hayek distinguishes aggregate profits from “profit margins” in his technical sense, defined through the ratio between factor and product prices. He grants that high profits encourage entrepreneurs to increase output and that profitable investment opportunities encourage borrowing. But these propositions do not establish that every effort to expand output increases investment.
But the whole point is that expanding final output and expanding the volume of investment are not necessarily the same thing, and that the endeavour to provide a large output quickly, such as may be caused by a large “profit margin”, may be the cause of a decrease in the volume of investment—in other words, that an increase of the “profit margins” may create a situation where each entrepreneur aiming to maximise his aggregate profits may result in a smaller volume of total investment.
The crucial conceptual move separates the quantity of final output sought from the production methods used to obtain it. Pressure to deliver output quickly can favor shorter methods, so profit-seeking behavior need not increase total investment. Hayek consequently rejects an inference from entrepreneurial eagerness to expand production to aggregate capital accumulation.
His return to the “island” illustration makes the monetary implication explicit. If consumer-goods prices rise, investments undertaken when those goods were cheaper may have to be abandoned. Hayek doubts that supplying enough money to prevent the interest rate from rising would overcome the islanders’ difficulties. The postscript then guards against the opposite simplification:
It is certainly not my view, or compatible with my views, to say that “the ‘period of production’ varies inversely with the level of investment.”
Lengthening initially increases investment; widening can subsequently sustain investment after lengthening ceases. The comment’s relevance lies in these distinctions rather than in a comprehensive restatement of cycle theory: monetary rates must be distinguished from relative-price incentives, investment duration from investment volume, and profitable output expansion from capital accumulation.
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