Between Wicksell and Hayek

I Introduction Any rereading of von Mises' writings on monetary theory must take earlier interpretations into account. Outside the circle of his closest Austrian followers, the best-known, most authoritative, and representative interpretation is that offered by Schumpeter. In his History of Economic Analysis, the theory "sketched out by Professor von Mises" is described in the following terms: Suppose that banks emerge from a period of recovery or quiescence in a liquid state. Their interest will prompt them to expand their loans. In order to do so they will, in general, have to stimulate demand for loans by lowering their rates until these are below the Wicksellian real rate, which, as we know, is Bohm-Bawerk real rate. In consequence, firms will invest - especially in durable equipment with respect to which rate of interest counts heavily - beyond the point at which they would have to stop with the higher money rate that is equal to the real rate. Thus, on the one hand, a process of cumulative inflation sets in and, on the other hand, the time structure of production is distorted. This process cannot go on indefinitely, however there are several possible reasons for this, the simplest being that banks run up against the limits set to their lending by their reserves - and when it stops and the money rate catches up with the real rate, we have an untenable situation in which the investment undertaken on the stimulus of an 'artificially' low rate proves a source of losses: booms end in liquidation that spell depressions (Schumpeter, 1954, p. 1120). Schumpeter adds with some irony that Mises' theory was "further developed by Professor von Hayek into a much more elaborate structure of his own, which, on being presented to the Anglo-American community of economists, met with a sweeping success that has never been equaled by any strictly theoretical book . A strong critical reaction followed that, at first, but served to underline the success, and then the profession turned away to other leaders and other interests. The social psychology of this is interesting matter for study" (Schumpeter, 1954, p. 1120). Schumpeter had suggested much the same view in Business Cycles, where he picks on "only one aspect," "though a fundamental one" of the Mises-Hayek theory. In this work he addresses the influence of banks' policies in determining the motive force and the turning points of cycles, in order to contrast it with his own model, in which it is not the "initiative of the banks" offering cheap money that fuels the upward movement, just as it is not the rise in the interest rate that marks its end. (2) We get a wholly different picture from a contemporary "Austrian," Roger Garrison. Wicksell's cumulative process is here understood as the mechanism that brings the system back into equilibrium after a monetary expansion has increased the agents' cash balances beyond the desired level. Mises' essential contribution should consist of breaking with the idyllic picture of a stable equilibrium, which is only disturbed temporarily by changes in the money supply. We are invited to notice how Mises' analysis gives center place to the disequilibrium dynamic of relative prices and to the consequent distortions in the structure of production: Most modern developments in monetary theory are based on the Swedish formulation, that is, they focus on the liquidity provided by holding money. Research typically takes the form of estimating the demand for money and investigating the stability of the demand function. But whatever the configuration of the supply and the demand for money, the operation of the real-cash-balance effect is the same in its essentials. By comparison, developments in monetary theory based on the Austrian formulation focus on the information provided by money prices. Attention is drawn to changes in relative prices and in particular to differential price changes in the various stages of production. …