Hayek's The Constitution of Liberty - Institute of Economic Affairs

h ay e k ’ s t h e c o n s t i t u t i o n o f l i b e r t y
p r e v e n t i n g i n f l a t i o n
full employment policies, combined with coercive wage pressures
by unions, lead to spiralling inflation. Hayek points out that
welfare state policies and inflation have a reciprocal relationship,
inasmuch as inflation’s effects have ‘strengthened the demand for
welfare measures’ (328).
Hayek regards inflation as ‘infinitely more dangerous’ in the
long term than deflation, so the primary goal of monetary policy
must be to prevent it. His position runs counter to ‘the existing
inflationary bias,’ which rests on the erroneous belief that deflation
is the greater danger (330). Technically speaking, inflation
is much easier to prevent than deflation, but psychological and
political factors make it difficult to adopt the proper measures.
This is because inflation is more pleasant in its immediate effects
and deflation more painful. Inflation seems to offer governments
an easy way out of deflation, but this is to disregard its longterm
disadvantages – a myopic outlook that Keynes sanctioned
by the ‘fundamentally antiliberal aphorism, “in the long run we
are all dead.”’ To maintain its stimulative effects, even mild inflation
must be ‘progressively accelerated.’ This disrupts business
planning, making it more difficult to determine real costs, profits
or income. Inflation deters investments by taxing profits more
heavily and also erodes savings. Hayek warns again, as he had
earlier, that severe inflation can eventually undermine a free
society (337–9). For these reasons, ‘the economist should always
stress the dangers of inflation’ (333).
Misguided monetary policy
Besides continually warning against inflation, Hayek pins responsibility
for it directly on government: inflation ‘is always the result
of the weakness or ignorance of those in charge of monetary policy
– though the division of responsibility may be spread so wide that
nobody is to blame’ (295). Much of the present chapter is devoted
to ways of maintaining a stable monetary system – one that can
reasonably expect to achieve ‘a high and stable level of employment’
as well as ‘the stability of some comprehensive price level’
(337).
One option would be to deprive governments of their control
over monetary policy and rely on spontaneous market forces to
correct inflation and deflation. The market-only option, while
perhaps feasible at one time, is no longer practicable or even
desirable, and this is for three reasons: first, the need for a central
agency to control rapid and disruptive changes in the relative
supply of money or the demand for it (money is ‘a kind of loose
joint in the otherwise self-steering mechanism of the market,’
hindering any direct return to a new equilibrium); second, the
need to deal with spontaneous fluctuations in the supply of money
resulting from ‘the interacting money and credit systems;’ and
third, the need to take account of government’s financial policy,
which necessarily dominates monetary policy in an era of massive
expenditures. It is thus inevitable, under modern conditions, that
control of monetary arrangements ‘should be largely exercised by
governments’ (325; cf. 324–7; see Hayek, 1941 [2007a]: 367).
Having argued that the money supply should be controlled
by some government agency, Hayek must now decide how much
discretion to allow it. One possibility is to impose some mechanical
rule that aims for long-term monetary stability but ties the
agency’s hands in the short term and insulates it from political
pressures. Some economists have advocated restrictive rules of
this kind. Others would require that currency be convertible into
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