Hayek changed his mind regarding monetary policy in a business recession: ‘I took a different attitude forty years ago’. At that earlier time, he believed that a short period of deflation during the first stages of the Great Depression would have had the beneficial effect of breaking ‘the rigidity of wages which I thought was incompatible with a functioning economy’. That view changed to the position that ‘there is no justification for supporting or permitting a process of deflation’. Moreover, Hayek acknowledges that, once extensive unemployment exists, there is ‘a tendency to induce a cumulative process of secondary deflation’. For those circumstances, his new recommendation is that ‘monetary counteractions, deliberate attempts to maintain the money stream, are appropriate’ (Hayek 1975a: 5; see also Hayek 1978b: 210).

Hayek’s change of mind should not be exaggerated. Both views are necessarily pragmatic, because no monetary policy guidelines had emerged from Hayek’s theoretical analysis of the link between monetary policy and business fluctuations. In the 1930s, he had argued that bankers must weight the advantages and disadvantages of meeting rising demands for bank credit: the only practical maxim . . . 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 over-caution. (Hayek 1935b: 125). Even though Hayek came to a different view on deflation, he was constant in the opinion that it is never appropriate to counter depression by monetary reflation; [f]or forty years I have preached that the time to prevent a depression is during the preceding boom; and that, once a depression has started, there is little one can do about it. My advice was completely disregarded as long as the boom lasted. Now suddenly, when my prediction has come true and we have reached the stage where . . . little can be done about the inevitable reaction which has set in, people suddenly turn to me and ask for my opinion. (Hayek 1975a: 8)

Whether initiated by fiscal or monetary measures, Hayek’s business cycle theory shows how a monetary stimulus to boost demand is inevitably selfdefeating. If prices and wages rise pro rata, there is no net stimulus; but if prices rise faster than wages (as from the situation of Keynes’s involuntary unemployment), the Ricardo effect tells cumulatively against capitalintensive processes. As yields on the latter are driven downwards, investment eventually proves unprofitable. A Keynesian investment boom inevitably fails.

Hayek’s business cycle analysis has additional relevance to risk control and risk externalisation (see Garrison 1994). Together with a time discount and an inflation premium, the risk premium is one of the three elements to the market rate of interest. In creating discrepancies between risks willingly and actually borne, policy interventions can disrupt the market allocation of risks. When risk is concealed from lenders (or shifted to others) risk-taking becomes excessive: initially manifest as a boom, the ultimate macroeconomic manifestations are losses and slump.

The limited nature of the guidance that is afforded by theoretical analysis is unsurprising. Hayek is consistent in emphasising the complex time-lapse relationships that exist between the provision of bank credit, interdependent capital investments, the production of final goods and the level of employment.

As a general feature, ‘all money at all times . . . [is] . . . a kind of loose joint in the otherwise self-steering mechanism of the market’ (Hayek 1960: 325). In particular regard to Keynes, Hayek insists that The General Theory misled the authorities onto the path of monetary debasement and chronic inflation. From his own analysis, Hayek insists that there are no direct causal relationships between consumers’ expenditure and capital investment; nor between consumers’ expenditure and employment. Yet these features remain widely believed so that, even though aspirations for Keynesian demand management have been undermined by events, Keynes’s notions relating to expenditure upon capital investment, aggregate demand and employment remain in vogue.

The agenda of Keynes’s General Theory can be placed into three categories. The first category comprises the remedial action that Keynes considers appropriate for the period: ‘my suggestions for a cure . . . are subject to all sorts of conditions of the time’ (Keynes [1937a] 1973b: 112). Given the extent and severity of economic malaise in the 1930s, it was imperative to boost aggregate demand and no sophistication was necessary in regard to the means: to build cathedrals, mansions or pyramids, to endow monasteries, or ‘“[t]o dig holes in the ground”, paid out of savings, will increase, not only employment, but the real national dividend of goods and services’ (Keynes [1936] 1973: 220). Such means to raise employment are acceptable ‘if the education of our statesmen on the principles of the classical economics stands in the way of anything better’ (Keynes [1936] 1973: 129). Keynes’s primary concern is not humanitarian. It is the fear of Bolshevism that rests behind the defence of his recommendations as ‘the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative’ (Keynes [1936] 1973: 380).

The second category comprises the attention Keynes gives to more general social developments. Allied to his belief in the long-term decline of yields on capital investment, Keynes is concerned that second and third generation industrialists lack the ‘sanguine temperament and constructive impulses’ (Keynes [1936] 1973: 150) that are fired by ‘the spontaneous urge to action rather than inaction’ (ibid.: 161); and that, when ‘animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die’ (ibid.: 162). Out of those concerns, Keynes considers it to be of ‘vital importance’ to establish ‘certain central controls’ over consumption and investment activity which he accepts would ‘involve a large extension of the traditional functions of government’ (ibid.: 378–9).

The third category contains the theoretical aspirations of The General Theory. It is here that Keynes’s work may be compared with that of Hayek. In this regard it is recognised that Keynes’s preoccupation with pressing matters of state allowed others to direct his academic project; but the conclusion is supported that the Keynesian revolution took off upon and continued along the wrong track. Leijonhufvud criticises the macroeconomic theory developed after Keynes for its failure (1) to accommodate the interactive feedback of price and quantity adjustments across a multi-market system and (2) to acknowledge the twin function of prices in providing incentives and in disseminating information. By its chosen methodology, Keynesian macroeconomics dispenses with individual agents who are utility maximisers and profit maximisers, and who respond rationally to intertemporal price incentives.

Yet the emphasis of Keynes’s General Theory is upon individuals’ anticipation and assessment of future events and the impact of those assessments upon their present behaviour. By Leijonhufvud’s exegesis, it is possible to see how Keynes’s analysis is concerned with short-term price signals that can disrupt the economic system through their impact upon income-constrained expenditures; and how the current value of durable capital equipment is an important link between the present and the future. The more durable the capital, the more volatile (with respect to interest rate changes) the relative valuation of capital to earnings.

These are the aspects of The General Theory – those that feature in Hayek’s own research programme – that needed to be analysed more closely. Here, Leijonhufvud favours Hayek’s Gestalt-conceptualisation of business cycle phenomena over Keynes’s unclear mix of static and dynamic analysis. Leijonhufvud points to the key aspect: the financial arrangements that accompany long-term commitments to capital investments in a money economy. When Hayek abandoned his work on pure capital theory, he left those aspects – the financial counterparts to the use of capital in production – undeveloped; and so they remain. Thus, the unfulfilled requirement is for a capital-based macroeconomics in which individuals’ expectations have a central role.