Fritz Machlup, Geldtheorie und Konjunkturtheorie (1929)

Machlup’s review essay examines F. A. Hayek’s identically titled book against the debate over monetary business-cycle theory at the Verein für Sozialpolitik’s Zurich meeting. Moving from German economics’ neglect of money to circulation-credit theory and its critics, it asks how elastic bank credit disrupts the coordination of investment with saving, even without rising prices or deliberate reductions in lending rates.

Machlup challenges the prestige accorded to explanations in physical or “real” terms:

Die Betonung von „Geldfragen“ war offenbar als weniger rühmlich empfunden worden als die Behandlung der „realen“ oder „naturalen“ Wirtschaftsprobleme.

English translation: The emphasis upon "monetary questions" had evidently been felt to be less creditable than the treatment of the "real" or "natural" economic problems.

Abstracting from money may clarify some relationships, but it obscures processes whose causes are monetary. Ricardo provides a precedent for incorporating money into systematic economic theory. Machlup’s principal target is the confusion of importance for welfare with causal priority:

Weil es im Wirtschaftsleben letztlich doch auf den naturalen Güterstock ankommt, weil dieser in der Wichtigkeit für unseren Wohlstand an erster Stelle steht, wird den monetären Faktoren die sekundäre Rolle zugewiesen.

English translation: Because in economic life what ultimately matters is after all the natural stock of goods, because this stands first in importance for our welfare, the secondary role is assigned to the monetary factors.

The importance of physical goods does not establish the causal subordination of monetary changes. Nor does identifying bank credit as a cause of fluctuations assign moral blame to bankers. These distinctions prepare Machlup’s exposition of Mises’s circulation-credit theory: credit expansion permits investment beyond the real capital made available through saving. Competition for productive resources raises their prices and increases financing requirements.

Die Preissteigerung der Produktivgüter führt zu erhöhten Kreditansprüchen an die Banken, wobei die Fortführung der entrierten Produktionen nur so lange möglich ist, als die Banken zur weiteren Ausdehnung des Zirkulationskredits bereit sind.

English translation: The rise in the prices of productive goods leads to increased demands for credit upon the banks, whereby the continuation of the production processes that have been entered upon is possible only so long as the banks are prepared to expand circulation credit further.

When expansion stops and lending rates rise, projects’ continued profitability is undermined. The preference for cheap money helps explain renewed expansion, but leaves questions about the recurrence and endogenous origins of cycles.

Machlup reconstructs nine objections concerning banks’ capacity to create credit, price-level movements, the origins of expansion, and the explanatory adequacy of interest-rate lags or entrepreneurial errors. Hayek’s achievement is to absorb valid criticisms without abandoning monetary causation. Taking up Löwe’s methodological challenge, he asks how an economy otherwise understood as tending toward equilibrium can systematically move away from it. Credit elasticity supplies the answer: lending becomes temporarily independent of accumulated savings, compromising the interest rate’s coordinating function.

Hayek’s first advance separates monetary causation from changes in money’s purchasing power. A stable price level does not demonstrate equilibrium between investment and saving. In a growing economy, money creation sufficient to prevent falling prices may still hold lending rates below the natural rate. A boom without visible inflation therefore does not refute circulation-credit theory.

The second advance makes expansion endogenous. The divergence between lending and natural interest rates need not begin with banks lowering the former. Improved profit opportunities can raise the latter while lending rates remain unchanged. Technical progress can thus initiate expansion without displacing its monetary explanation. The decisive question is whether the same real change would generate investment disproportion if credit kept investment dependent on saving. Machlup thereby reconciles part of Löwe’s emphasis on technical change with the Wicksell–Mises tradition: the initiating disturbance may be nonmonetary, while the failure of equilibrating adjustment remains monetary.

The banking analysis supplies the institutional mechanism. Loans made by one bank return as deposits to others and support further lending. A ten-percent reserve example illustrates this cumulative process, while cash withdrawals and interbank transfers impose constraints. The individual banker’s perspective can conceal system-wide expansion. Banks’ claim merely to accommodate business demand therefore does not answer the theory: accommodating increased credit demand at unchanged lending rates is precisely the mechanism at issue.

Machlup closes with qualified praise. Hayek avoids immediate policy prescriptions but allows that changing saving rates might produce cycles without monetary intervention. Machlup objects that reversing such an expansion requires a further change in economic data; it does not explain the boom’s necessary passage into crisis or the characteristic disproportion between capital use and capital formation. This reservation defines the essay’s ambition: monetary cycle theory explains the connected process through which credit-supported investment exceeds resources voluntarily released through saving, not every possible economic fluctuation.