Friedrich August von Hayek, Prices and Production (Second Edition, 1935)

Hayek’s Prices and Production develops a monetary theory of industrial fluctuations through four lectures originally delivered at the University of London in 1930–31 and published in 1931. The second edition retains that framework while adding clarifications, historical discussions, and a substantial reply to Alvin Hansen and Herbert Tout. Its central argument is that monetary disturbances alter the temporal organization of production through relative prices and interest rates, even when the general price level remains stable. The boom and crisis therefore require an explanation of how resources move between activities serving immediate consumption and those yielding goods only in a more distant future.

The first lecture reconstructs monetary theory’s development from aggregate quantity explanations through Cantillon’s account of the successive recipients of new money to theories connecting bank lending, interest, and capital formation. Hayek accepts the elementary quantity theory but rejects its dominance over monetary analysis: aggregates cannot substitute for explanations of individual decisions. Wicksell’s distinction between the money rate and the equilibrium rate of interest supplies an essential starting point, but Hayek disputes the identification of equilibrium with price-level stability. Growing productivity may warrant falling prices; credit expansion intended to prevent that fall can itself disturb production.

Not a money which is stable in value but a neutral money must therefore form the starting point for the theoretical analysis of monetary influences on production, and the first object of monetary theory should be to clear up the conditions under which money might be considered to be neutral in this sense.

Neutrality means leaving exchange relationships undisturbed by specifically monetary causes, not preserving a purchasing-power index. This shift reconnects monetary theory with the theory of value and extends its subject to intertemporal exchange: the relationship between present resources and future satisfactions.

The second lecture constructs the “structure of production” through triangular diagrams representing successive applications of resources before consumer goods mature. More capitalistic, or roundabout, methods employ resources for more distant consumption and can increase eventual output. Hayek begins from full employment because idle resources are something the cycle theory must explain, not an unexplained premise. Capital is likewise no automatically permanent stock: its maintenance depends on entrepreneurs repeatedly finding replacement and reinvestment profitable. The diagrams distinguish the flow of goods from monetary transactions, whose frequency depends on the division of production among firms.

Voluntary saving reduces consumption demand relative to demand for producers’ goods and permits a sustainable lengthening of production. Bank-created credit can initially produce a similar rearrangement, but without the corresponding decision to postpone consumption.

But now this sacrifice is not voluntary, and is not made by those who will reap the benefit from the new investments.

This is the distributive meaning of “forced saving.” Entrepreneurs receiving additional money bid resources away from other uses; consumers subsequently obtain fewer goods for their incomes. Unlike voluntary saving, the resulting restraint supplies no assurance that consumption demand will remain reduced when monetary incomes rise.

The third lecture explains this instability through price margins and the distinction between specific and nonspecific producers’ goods. Mobile resources can move among stages, whereas specialized machinery and unfinished products depend on particular complementary inputs. Saving narrows margins between successive stages, lowers interest, and makes more distant production profitable. Credit expansion initially imitates these signals. As additional expenditure becomes income, however, demand for consumer goods increases while their supply has been restricted by the diversion of resources. Unless further credit expansion sustains the altered proportions, resources move back toward production nearer consumption. Specialized equipment in earlier stages loses value, and unfinished processes become unprofitable.

It seems something of a paradox that the self-same goods whose scarcity has been the cause of the crisis would become unsaleable as a consequence of the same crisis.

Hayek resolves the paradox through complementarity and time. Resources released from abandoned long processes cannot necessarily enter shorter processes immediately: the requisite intermediate goods must first be produced. Unemployment and unused machinery thus express a mismatch within the capital structure rather than simply an insufficiency of aggregate expenditure. Consumer-credit stimulus, he argues, aggravates that mismatch. Precisely limited producer credit might prevent excessive contraction during the acute crisis, but he doubts banks can identify and enforce the necessary limits.

The fourth lecture tests the case for an elastic currency. Hayek separates changes in a country’s share of world money from changes in the total circulation, and exchanges between deposits and cash from genuine additions to purchasing power. Commercial credit complicates central control. He also qualifies monetary invariability: changes in transaction arrangements, cash holdings, or velocity may require compensating adjustments.

Hence the only practical maxim for monetary policy to be derived from our considerations is probably the negative one that the simple fact of an increase of production and trade forms no justification for an expansion of credit, and that—save in an acute crisis—bankers need not be afraid to harm production by overcaution.

The supplementary discussions make the argument more conditional. Neutral money is primarily an analytical benchmark; rigid prices, fixed monetary contracts, and imperfect expectations may require practical compromises. The reply to Hansen and Tout distinguishes completed capital structures from unfinished investments requiring further complementary expenditure. A declining saving rate need not cause collapse if existing projects can still be completed; credit-created capital may survive when subsequent voluntary saving supports it. Hayek also recognizes that hoarding and secondary deflation can counteract the initial relative-price tendencies. The preface acknowledges the simplified treatment of durable goods and velocity. The book’s enduring conceptual contribution is therefore its account of monetary influence through heterogeneous capital, timing, and resource coordination, accompanied by explicit limits on what that account establishes about depression policy.