vol. 20, no. 2 (Summer), 1988, pp. 207-234  

Phillips Curves And Hayekian Triangles:
Two Perspectives on Monetary Dynamics

Don Bellante and Roger W. Garrison 

I. Introduction
During different phases of the Keynesian episode, the monetary theories offered first by Keynes and later by the Keynesians have been judged by changing standards. The standards changed along with the changing perceptions of what constituted the most viable alternative to the Keynesian vision. "[T]here was a time," wrote John Hicks (1967, p. 203), "when the new theories of Hayek were the principal rival of the new theories of Keynes." But times changed, and Milton Friedman (1969d), with his restatement of the quantity theory of money, became the dominant alternative to Maynard Keynes. And eventually, Friedman's Monetarism gave way to New Classicism and the idea of "Rational Expectations."
        The profession has been treated to exhaustive comparisons of Keynes and then Keynesians with the various opposing schools, but comparisons of the sequential alternatives to Keynesianism have been all but lacking. The present paper begins to fill this void by offering a critical comparison of the Monetarists and the Austrians as represented by Friedman and Hayek.⁽¹⁾
A statement by Robert Lucas (1981, p. 4) suggests how such a comparison can be undertaken: "...I see no way to account for observed employment patterns that does not rest on an understanding of the intertemporal substitutability of labor." Lucas's concise way of identifying the understanding that explicitly underlies his theories (and implicitly underlies Friedman's) hints at an alternative way of accounting for observed unemployment patterns. While Monetarism and New Classicism are based on the intertemporal substitutability within the market for labor, Austrianism is based on the intertemporal complementarity within the market for capital goods.
        Differences between the monetary theories of Friedman and those of Hayek, then, can be spelled out in terms of the markets (for labor and for capital, respectively) that serve as a focus for each.⁽²⁾ With attention to the major themes of each theorist, Sections II and III identify the relevant aspects of monetary disturbances as seen by Friedman and as seen by Hayek. Focusing on both substance and method, Section IV offers a critical comparison of the two perspectives. Section V points out some implications in terms of the conventionally defined categories of unemployment, monetary lags, and the concept of "full" employment; and Section VI provides a summary view.

II. Friedman (and the Monetarists) on Monetary Dynamics
With conventional qualifications and allowances for real growth, increases in the supply of money lead, in the long run, to proportionate increases in the general price level. This proposition, which constitutes the kernel of truth in the quantity theory of money, is not in dispute. But the nature and significance of the monetary dynamics, the market process that translates the initial cause into its ultimate effect, is and has long been a matter of much controversy. This issue, in fact, is what separates the Monetarists from the Austrians and gives scope for interpretation within both schools.
        Friedman appears to be of two minds on the issue of monetary dynamics—the transmission mechanism linking money to prices. On occasions where the focus is on long-run comparative-statics results, it is simply admitted that he (along with Anna Schwartz) has "little confidence in [their] knowledge of the transmission mechanism, except in such broad and vague terms as to constitute little more than an impressionistic representation rather than an engineering blueprint" (Friedman, 1969b, p. 222). But on occasions where the focus is on the transmission mechanism itself, such as the market process that traces out a short-run Phillips curve, there is an accounting of the the mechanism in terms of the market for labor that would rival any blueprint⁽³⁾ (Friedman, 1976). These monetary dynamics, which are used by Friedman to explain the short-run nature of the negatively sloped Phillips curve and to suggest the existence of a vertical long-run Phillips curve, can be used as a basis for evaluating the Monetarist view and for comparing it to the alternative offered by the Austrians.
        The monetary dynamics envisioned by Friedman hinge on the sequential effects of perceived relative-price changes in the market for labor. A number of heuristic assumptions about the market for capital goods and about income effects in commodity markets are invoked. These assumptions are required to narrow the focus so that the Monetarists' story can be told. The lack of discussion in this context of the allocation of capital goods or of the short-run effects of a monetary injection within the market for capital goods is evidence enough that such considerations are no part of the story.⁽⁴⁾ Implicitly, one of several alternative constructions is adopted: (1) Real capital is taken to be completely homogeneous, or—to use the fiction invented by Frank Knight—it is treated as a "Crusonia plant." (2) The structure of real capital, which admittedly consists of heterogeneous elements, is fixed. It cannot or, for some reason, is not altered—even in the short run—as a result of a monetary injection. (3) Allocations within the market for capital goods are (somehow) always governed, whether in the presence or the absence of monetary disturbances, by "real factors only." This third construct is in the spirit of the New Classicism.
        One of these three or some effectively similar construction or assumption must underlie any macroeconomic theory that ignores the allocation of resources within the capital-goods sector. Implicit assumptions of this sort about capital goods are not at all at odds with the Chicago tradition more broadly conceived. The inattention to capital theory stems from Frank Knight's grappling with the thorny issues and conceptual difficulties that inhere in this subject matter (Knight, 1934). In general, Monetarists have taken comfort in the Knightian view that the structure of capital, particularly the intertemporal structure, can be safely ignored, and that theories in the Austrian tradition, which make use of such concepts as "roundaboutness" and "stages of production," are especially misguided.⁽⁵⁾
        The Knightian view of capital permits the Monetarists to focus exclusively on the market for labor. But at least two additional assumptions are needed to limit the focus to the relative-price effects in the labor market. Distribution effects (who gets the new money) and differential income effects (how it gets spent) must be removed from consideration. Friedman's heuristic device for short-circuiting the distribution effects is to assume that increases in the money supply are brought about by a one-time dropping of money from a helicopter in such a way that each individual picks up the new money in direct proportion to the amount already in his possession.⁽⁶⁾ The differential income effects of "helicopter money"—as it has come to be called—are assumed away. This mode of theorizing reflects the implicit assumption that differential income effects are in fact negligible or the heuristic assumption that indifference curves are both identical across agents and homothetic.⁽⁷⁾
        Within this theoretical construction, the Quantity Theory holds in its strongest form, and any divergence in the pattern of prices between the initial injection of money and the eventual increase in the price level is purely stochastic. Thus, disequilibrium relative-price movements within the markets for both capital goods and final products are taken to be unsystematic. No generalizations about such movements can be made. But movements in the price of labor relative to the price of final output are systematic in the Monetarist view. And the temporal pattern of these movements depend in a critical way on differences in the ability of workers and of employers to perceive the price changes most relevant to each.⁽⁸⁾
        The spending of newly created helicopter money begins to bid up the prices of final products in unsystematic ways. The individual worker, who clearly perceives his yet-unchanged nominal wage, has no clear perception of the change in his real wage—depending, as it does, on the change in some index of final-product prices. The employer, whose perception of the general price level is no better than the workers', is motivated by a different concern. From the employer's perspective, the relevant real wage is the Ricardian real wage, which depends upon a single price—the price of the product that the employer produces. If the output price has increased, the wage that he pays to the workers—relative to the output price—has clearly decreased. Alternatively stated, workers and employers alike have no clear perception of the real wage, where real is understood in the market-basket, or Fisherian, sense; but employers have a clear perception of the real wage, where real is understood in the Ricardian sense.)
        Quantity adjustments in the labor market are made in ways that correspond to the differing perceptions in real-wage movements. The behavior of workers, who make their labor-leisure decisions on the basis of yet unchanged perceptions, is depicted by an unchanged labor supply curve; the behavior of employers who now enjoy higher output prices is depicted by a rightward shift in the demand for labor.⁽⁹⁾ The nominal wage rate rises as does the level of employment. (Figure 1 shows the corresponding movement (from A to B) along the initial Short-run Phillips Curve.) The higher nominal wages paid to a larger number of workers exert upward pressure on the prices of final products; increases in output exert downward pressure on final-product prices. And with the passage of time, workers begin to get a clearer perception of their real wage rate. A temporal pattern of the real wage rate is traced out by a series of iterative steps in which the reinforcing and counteracting forces interact. In the end, after a "long and variable"—and fundamentally indeterminate—time lag, the worker-employer perception differential is eliminated; the short-run Phillips curve shifts rightward. The level of employment, the level of output, and the real wage (both Fisherian and Ricardian) return to the levels that characterized the economy before the monetary injection. (Point C in Figure 1 differs from point A only in terms of absolute prices and wages.)

III. Hayek (and the Austrians) on Monetary Dynamics
If Frank Knight accounts for the Monetarists' inattention to capital theory, Eugen von Böhm-Bawerk (1959) accounts for the Austrians' preoccupation with it. Where Friedman's treatment of monetary dynamics requires some key assumptions about the workings of the market for capital goods, Hayek's treatment⁽¹⁰⁾ requires similar assumptions about the workings of the labor market. Recognizing this symmetry allows us to describe the alternative treatments in a way that facilitates a comparison.
        More often than not, Hayek's assumptions about labor, like Friedman's assumptions about capital, are implicit. Labor skills are assumed to be non-specific. Individual occupations are defined in terms of the particular capital goods that are complementary to labor. Wage rates are flexible, but not perfectly flexible. Workers can be bid away from some occupations and into others, but not instantaneously. Adjustments in the labor market that involve a reduction in labor demand in some occupations will be characterized by temporary increases in the level of unemployment—the greater the adjustment, the greater and longer-lasting the temporary increase. With allowance for frictions of this sort, workers are able correctly to perceive and respond to changes in the pattern of real wage rates. Expectations about wage rates and prices can come into play—but not expectations whose formulation requires a theoretical understanding of economic relationships, such as (correct or "rational") expectations about the upper turning point of a business cycle.
        It might be noted at this point that Lucas (1981, pp. 215-17) sees a certain kinship between his own ideas and those of Hayek. But Lucas parts company with the Austrians when he treats knowledge of the economy's structure in the same way as knowledge within the structure. Hayek (1948b, pp. 79-81) makes a first-order distinction between theoretical knowledge and knowledge of the marketplace. Market participants can be expected to make use of information conveyed by prices along with other particular knowledge that they might have, but they cannot be expected to know—even in a probabalistic sense—the parameters of the economy's structure. That is, they cannot be expected to know, or to behave as if they know, the answers to questions that economists have been debating amongst themselves for more than two hundred years.⁽¹¹⁾
        The assumptions spelled out above about the workings of the market for labor allow the Austrians to deal with monetary dynamics exclusively in terms of the market for capital goods. The dynamics within the capital-goods market, coupled with these assumptions, will have clear implications about the corresponding pattern and time path of the employment of labor. The effects of a monetary disturbance within the market for capital goods reflect several considerations. Capital goods in the Austrian view are heterogeneous in the extreme, and the structure of capital involves multidimensional complexity. Individual capital goods are characterized by different degrees of specificity and are related to one another, both intertemporally and atemporally, with various degrees of substitutability and complementarity.⁽¹²⁾ Thus, a set of heuristic assumptions about the capital structure is required to allow the identification of its most essential features and to render the treatment of monetary dynamics tractable.
        In the Austrian view, the central problem in macroeconomics is the problem of intertemporal discoordination. (O'Driscoll, 1977, pp. 70-79; Garrison, 1984, 1985) Whether the focus is on the coordination of investment decisions with consumption decisions or on the time-pattern of macroeconomic magnitudes over the course of a business cycle, the temporal element is essential to the macroeconomic perspective. Hayek incorporated this temporal element into his monetary dynamics by focusing on the intertemporal aspects of the economy's capital structure. To avoid undue complexity, Hayek envisioned a heavily stylized production process.
        His vision gives recognition, sometimes explicitly and sometimes implicitly, to a set of corresponding heuristic assumptions. Each production process is characterized by a modifiable sequence of inputs and a point output; some production processes are more time-consuming than others. The sequence of inputs is conceived as consisting of "stages" of production. The once-
famous Hayekian triangles⁽¹³⁾ represent a stylization of the entire economy's production process (See Figure 2): The horizontal leg represents the time element in the process—the depth of the capital structure. In the simplest case this leg represents the time that sepatates the earliest stage of production from the final output; the vertical leg represents the nominal value of the final output. The height of the hypotenuse at successive points in time represents the value of semi-finished goods as they move through time from the earliest to the latest stage of production.⁽¹⁴⁾
        Capital goods can be shifted—within limits—from one production process to another in response to relative-price changes. More importantly, capital goods can be shifted from one stage of production to another in ways that modify the intertemporal pattern of output. Some types of capital goods that are employed in the earlier stages of production (or that, with some modification, can be so employed) may be needed in the later stages of production as well. That is, while competing for the use of individual capital goods, the stages themselves exhibit a certain degree of intertemporal complementarity. There is no one-to-one relationship between stages of production and business firms. Some firms may operate within one stage, some in several sequential stages, and some in different stages of different production processes.
        Spelling out the characteristics of the Hayekian structure of production is, by itself, almost enough to specify the nature of the corresponding monetary dynamics. The general pattern of events set into motion by a monetary injection can be identified as soon as the method of injecting the new money is specified. Because of the historical relevance, Hayek assumed that the new money is injected through credit markets—that the central bank, in effect, pads the supply of loanable funds with newly created money.⁽¹⁵⁾
        Clearing the market for loanable funds in the face of such a monetary injection requires that the rate of interest fall until the quantity of funds demanded matches the increased supply.⁽¹⁶⁾ In turn, this lowered rate of interest has implications for the intertemporal structure of capital. To the extent that the temporal relationship between the various types of capital goods and the ultimate output of the production processes is perceived by entrepreneurs, the prices of the capital goods will be affected in a systematic way. In the earlier phases of the market's reaction to the credit expansion, the greater the time between the use of the capital good and the emergence of the ultimate output, the greater the relative increase in the price of the capital good. This pattern of relative-price changes follows from the application of standard discounting techniques. There will be a corresponding pattern of quantity adjustments. Capital will be bid away from relatively less time-consuming production process into relatively more time-consuming processes and away from relatively late stages of production into relatively early stages of production. Marginal adjustments of these sorts will be made throughout the capital structure as firms seek to take advantage of the favorable credit conditions. In Figure 2 the shift towards more time-consuming processes is represented by a movement from A to B. (The change in the slope of the hypotenuse reflects smaller profit differentials between the stages of production, which in turn reflect cheaper credit.)
        The later phases of this dynamic process are marked by a reversal of the price and quantity movements that characterized the earlier phases (Hayek, 1967, p. 58). The passage of time takes production projects that were begun as a result of credit expansion into their later stages. Some of these later stages require the use of capital that was used up in—or irrevocably committed to—earlier stages. That is, the money-induced expansion caused more capital to be committed to the earlier stages of production without providing the additional resources—as would have been provided had the expansion been savings-induced—necessary for the completion of all the production processes. In Figure 2 the value of the production projects in their final stages is represented by a broken line, indicating that a credit-induced boom cannot be sustained.
        Capital goods complementary to the yet-uncompleted production processes are now in short supply. Their prices are bid up, and as a result of these higher prices, the demand for credit increases. The rate of interest, which had been artificially low during the monetary expansion, is now bid up. Two significant differences between the Austrian and the Monetarist views can be noted here: First, because of intertemporal complementarity, the initial investment raises the demand for capital⁽¹⁷⁾; second the resulting rise in the interest rate is separate from any Fisher effect, which depends upon a rising price level.⁽¹⁸⁾
        Both directly through the market for capital goods and indirectly through credit markets, the prices of capital goods committed to the early stages of production are bid down. Uncommitted capital goods are bid away from the earlier stages of production and into the later stages.⁽¹⁹⁾ But in this phase of the dynamic process, marginal adjustments may not be possible. Some capital goods attracted to the earlier stages of production by the monetary expansion may not be retrievable. As a consequence, many production projects may have to be abandoned; many others can be completed but only with a great delay and/or at a much higher cost than could have been anticipated. (The claim, made in the spirit of the New Classicism, that market participants will anticipate the money-induced capital shortage rings hollow. Such an anticipation would require that they know—or behave as if they know—the "real scarcities" independent of the price system which supposedly communicates that information to them. In the Austrian view, if a monetary injection distorts the price signals, market participants will be economizing on the basis of erroneous information.)
        This later phase of the adjustment process takes on the characteristics of a crisis, a sharp down-turn. But with time, some types of capital can be liquidated to accommodate the excess demands for other types. Eventually, the economy's capital can be restructured in a way that reflects real resource availabilities, and the credit market can be adjusted to reflect the supply and demand for loanable funds. Abstracting from the capital that is lost forever as a result of the credit expansion and from possible long-run effects on the distribution of income, the rate of interest and the corresponding structure of production will return to the level and configuration that characterized the economy before the credit expansion.
        Figures 1 and 2 can serve to depict the correspondence between the Monetarist and the Austrian views. Arguing respectively in terms of the wage-rate effect on the employment of labor and the interest-rate effect on capital utilization, Friedman and Hayek have traced out the consequences of a monetary injection from A to B to C, where, in both diagrams, points A and C represent identical sets of real parameters. Point B represents—in Figure 1—a rate of unemployment temporarily and unsustainably below the (Friedmanian) natural rate and—in Figure 2—a depth of capital temporarily and unsustainably maintained by a loan rate of interest kept below the (Wicksellian) natural rate.
        To this point the Austrian story has been told exclusively in terms of the market for capital goods. Yet a major purpose of the story is to account for the cyclical unemployment of labor. But filling in the blanks about how the labor market is affected by the dynamics in the capital market is not difficult. In the trivial case of perfect wage flexibility and instantaneous adjustments, there need be no unemployment at all. Labor would simply be shifted around during the unfolding of the dynamic process so as to be employed in ways consistent with the changing pattern of relative prices.⁽²⁰⁾ This is clearly not what Hayek had in mind.
        The recognition that labor is complementary to (some) capital and that frictions inherent in the market process prevent adjustments from taking place instantaneously is all that is required to translate the story about capital into a story about labor. During the early phases of the dynamic process, there is a net increase in the demand for labor. The new money injected through credit markets is used not only to bid workers away from some jobs and into others but to attract new workers as well. To use Friedman's terminology, unemployment falls below its natural rate.
        But during the late phases of the process, there are actual decreases in the demand for labor in the early stages of production. And the increases in the demand for labor in the later stages is only partially offsetting—due to the shortage of complementary capital goods. The frictions involved in the economy-wide movements of labor out of the early stages and into the late stages coupled with the net reduction in the demand for labor account for a considerable amount of supernatural unemployment during this phase of the dynamic process.
        Once the misallocated capital has been liquidated and the wage rates have adjusted to the underlying market conditions, the cyclically unemployed workers can be reabsorbed. In Hayek's story as in Friedman's, unemployment eventually returns to its natural rate. 

IV. A Critical Comparison
While the two views of monetary dynamics spelled out in the previous two sections differ in important respects, they are in several fundamental respects quite similar. Comparing the differences, then, must be prefaced by a clear recognition of the underlying similarities. Five points of commonality are noteworthy: (1) Both theories can be fully squared with the kernel of truth in the quantity theory of money. (2) Both theories deal with disequilibrium phenomena, but neither denies that equilibrating forces dominate in the end. (3) Both hinge in a critical way on the distinction between short-run effects and long-run effects. (4) Both involve a market process that is necessarily, or endogenously, self-reversing. Monetary disturbances cause certain kinds of distortions in market signals. These distortions give rise in the short run to movements in certain prices and quantities, movements which in the long run create market conditions for counter-movements in those same prices and quantities. (5) With appropriate qualifications (about what constitutes the long-run) both theories are characterized by monetary disturbances whose short-run effects are non-neutral but whose long-run effects are neutral.
        With allowance for these points of commonality, Friedman and Hayek are offering in some respects complementary views, in other respects competing views. Our comparison will attempt to separate the two kinds of differences. Comparing aspects of the two views that are at odds with one another must await a closer look at each view separately. But ways in which the two views are different but complementary can be readily identified.
        At the root of these kinds of differences is the fact that Friedman focuses his analysis on the market for labor while Hayek focuses his on the market for capital goods.⁽²¹⁾ The trade-off that gets distorted by monetary disturbances is labor vs. leisure for Friedman and goods now vs. goods later for Hayek. And due in large part to the differing natures of labor and capital (the more radical heterogeneity of capital as compared to labor⁽²²⁾), Friedman argues in terms of substitutability and Hayek in terms of complementarity.⁽²³⁾
        In an important sense there is simply no scope for conflict here. Labor-leisure preferences and intertemporal preferences interact with the perceived constraints that are relevant to each. The dimensions of the two market processes can be seen as orthogonal to one another. Trading off labor against leisure in a sequence of periods can be understood as substituting labor in some periods for labor in others. Thus, with both views laid out intertemporally, we see that Friedman is dealing with the intertemporal substitutability of labor while Hayek is dealing with the intertemporal complementarity of capital. Spelled out in these general terms, then, we have a harmony, rather than a conflict, of views.⁽²⁴⁾

1. A Critical Retelling of Friedman's Story
But when we turn again to the specifics of the market processes envisioned by Friedman and Hayek, we see first-order differences. Some of these differences put the two views at odds with one another—or at least allow for a preference of one over the other on the basis of plausibility or fruitfulness. Identifying these differences and their significance can begin with a critical assessment of Friedman's view, which we preface with a recognition of existing criticism in the literature.
        Sketchy expositions of the Monetarist view have given much scope for misinterpretation. Gardner Ackley (1983, p. 10), for instance, sees the Monetarist dynamics purely in terms of "tricks" played on employers and workers. It is a "trick for an inflation to fool both employers and workers—in opposite directions—about the movements of the real wage paid by one and received by the other." But to call this a trick is to miss Friedman's point. The "real wage" means one thing to workers and something else to employers. Neither workers nor employers have a clear perception about what is happening to the general price level, but both are responding in conventional ways to the incentives that they face. Recognizing these incentives gives Friedman's view a microeconomic footing and insulates it against criticism of the type offered by Ackley.
        Another criticism of Friedman's view (Birch, Rabin, and Yeager, 1982) is based on a perceived contradiction between the market process envisioned and the equation of exchange.⁽²⁵⁾ The familiar identity MV = PQ implies that when M, or more properly MV, increases, the corresponding increase in PQ is split in some way between an increase in P and an increase in Q. That is, Q can increase only to the extent that P does not increase. By contrast and according to the Monetarist account of the dynamic process, it is increases in P that cause increases in employment and hence increases in Q. That is, Q increases to the extent that P does increase—hence the perceived contradiction. But what appears at first blush to be a contradiction is in fact a manifestation of a self-reversing process. There is nothing logically contradictory about a process in which P begins rising before Q but in which Q falls as P becomes fully adjusted to the increase in M. While the Ps and the Qs can be squared with the equation of exchange at each point in the process, Q's initial upturn and inevitable downturn, which reflect similar movements in the employment of labor, constitute the essential self reversal that lies at the heart of the Monetarist view.
        Our own criticism is fundamentally different from the ones identified above. While the sequence of movements in P and Q are not evidence of a contradiction, they are evidence of a certain anomaly in the Phillips Curve story. An initial rise in prices is a prerequisite to any movement along a short-run Phillips curve, but the story accounts inadequately for the nature of this initial rise. To make the story stick we must recognize that there is some other, logically prior, market process that is set into motion by a monetary injection. The process can be easily identified by drawing more broadly from the Monetarist literature. Helicopter money adds to each individual's cash balances, thereby inducing greater spending and the bidding up of prices (Friedman, 1969c, p. 5). But if buyers of labor services receive their pro-rata share of the helicopter money, they would be bidding up the price of labor at the same time. The simultaneous rise in the price of output and the price of labor would preclude the fall (as perceived by the employer) in the real wage, which itself constitutes a critical aspect of the self reversing dynamic process. The real-cash-balance effect, then, becomes the whole story rather than a prelude to the Phillips-curve story.
        The Phillips Curve story can be saved by assuming a monetary injection in which the new money falls first into the hands of consumers and only later into the hands of producers. While this kind of assumption, which highlights a particular distribution effect, violates the spirit of Monetarism, it allows in a straightforward way for a variation on the Austrian theme. We turn now to consider the Austrian alternative. 

2. Heuristic Assumptions and Domain Assumptions
The assumptions made by Friedman and Hayek about the nature of the hypothesized monetary injection are not just two alternative assumptions that serve the same purpose. Friedman's assumption (that money is dropped from a helicopter) is a heuristic assumption. It is a deliberate fiction whose purpose is to bypass any questions that relate directly to the actual injection of money while still allowing for the derivation of implications that can be tested empirically. (Friedman's uninhibited use of such fictions identifies his method as instrumentalism.⁽²⁶⁾)
        Hayek's assumption that money is injected through credit markets is a domain assumption.⁽²⁷⁾ In many instances money actually is injected through credit markets. Thus Hayek's story applies directly and without modification to those instances. A lower rate of interest resulting from the credit expansion increases the quantity of credit demanded. Given the relative volumes of commercial lending and consumer lending, we can say that the new money falls first into the hands of producers and only later into the hands of consumers. This disproportionate distribution of the new money is consistent with Hayek's story about the effect of a monetary injection on the structure of capital: Production for future consumption is temporarily favored over production for present consumption.
        For instances in which money is injected by some other means, Hayek's story applies only after suitable modifications are made. Suppose, for example, that a monetary expansion takes the form of increased transfer payments to consumers. This type of monetary injection would temporarily favor present consumption over future consumption. Capital goods would be reallocated accordingly. In many respects, the self-reversing market process triggered by such an injection would be a mirror image of the process triggered by a credit expansion. Capital goods in the later stages of production would be first in short supply and subsequently in surplus. The demand for labor would rise and then fall as workers were bid into the later stages of production only to become unemployed when the demand for present consumption fell to its "natural" level. The downturn associated with such a transfer expansion may be less severe than one associated with a credit expansion if only because short-term capital can be liquidated more quickly than long-term capital.
        Two observations are warranted here. First, Friedman needs to incorporate a transfer expansion, or something like it, into his theoretical construction if his Phillips curve story is to become coherent. Second, inflation-rate and unemployment data that suggest a negatively sloped short-run Phillips curve and a vertical long-run Phillips curve are consistent with Hayek's story whether the new money is lent into existence or transferred into existence.⁽²⁸⁾ Before we suggest what empirical, or historical, considerations might constitute a basis for choosing between the alternative stories offered by Friedman and Hayek, we turn to one further issue—the issue of generalizability.

3. Generalizability
Any theoretical construction that suggests how a particular market works may be more or less generalizable—adaptable to different circumstances or extendable to other markets—depending in large part upon the nature of the assumptions used in the construction. The discussion above suggests that theories based on domain assumptions are more generalizable than theories based on heuristic assumptions. Hayek's story can be adapted to apply to circumstances in which the new money favors consumption activity over investment activity even though it was first told the other way around. The story can be generalized to recognize that monetary expansion can cause intertemporal discoordination—in one direction or the other—depending upon the particular device used to inject the new money. In recent years Hayek has generalized his own story even further by recognizing that monetary expansion causes a self-reversing discoordination in many markets, whether or not it causes any intertemporal discoordination (1975a, pp. 23-24). By generalizing in this way, Hayek has not at all changed his mind about the effects of monetary expansion, he has simply recognized that the domain (credit expansion) that once dominated his subject matter is no longer so dominant. But money-induced discoordination—of one sort or another—still dominates the story.⁽²⁹⁾
        Friedman's story makes use of a monetary helicopter whose precise function is to assume away the discoordination that Hayek's story deals with. The monetary helicopter does not constitute one domain from which the theory can be extended; it constitutes the intentional neglect of all such domains. The Friedmanian helicopter, like the Walrasian auctioneer in a different story, should be seen as a "red flag," a marker where something important has been left out of account so that some other part of the story could be told. From this perspective we can admire the outrageousness of the particular fiction employed: the helicopter is a red flag that virtually no one could fail to see. But a red flag is no basis for generalization. If we go back and take into account the effects of actual monetary injections, we do not get a generalization of Friedman's story; we get Hayek's story.
        Hayek's story is generalizable in another important respect. The task of identifying the effects of credit expansion was made tractable by employing a heuristic assumption about the structure of capital-using production processes—the assumption of multi-period inputs and a point output. This particular assumption allowed for the abstraction from many complexities while it retained the essential element—the time element—in the analysis. Once the story is told in its most tractable form, then, it can be generalized and extended to take into account some of the complexities that were initially assumed away.⁽³⁰⁾ Production processes with multi-period outputs can be taken into account as well as processes that make use of capital goods of a greater or lesser degree of durability or whose final output is a durable consumer good. And by recognizing the ways in which the market for "human capital" is like the market for capital goods, Hayek's analysis can be extended in a direct way to labor markets as well (Bellante, 1983).
        Unfortunately, Hayek's attempt to tell his story in the contexts of several different circumstances was seen as evidence of confusion on Hayek's part. In response to criticism that he assumed an initial state of full employment and placed too much emphasis on changes in the terms of credit, Hayek (1975c, pp. 3-37) offered an alternative account in which widespread unemployment was assumed and the loan rate of interest was held constant. The resulting story was then criticized (Kaldor, 1942) on the grounds that it contradicted Hayek's own earlier rendition. By uncritically adopting Kaldor's assessment of what he dubbed the "concertina effect," modern critics have failed to appreciate the adaptability, the generalizability, that characterizes Hayek's formulation.⁽³¹⁾
        A similar sort of generalization and extension is not possible for Friedman's story. The essential feature on which his story depends is unique to the particular context in which it is told. For Friedman, the differing perceptions of workers and employers is what gives rise to the story; they are what "drive the system." The market process that Friedman identifies has no direct counterpart in the market for capital goods. The owner of a diverse capital stock, for instance, is unlikely to have perceptions that differ in a systematic way from those who may buy the services of that capital stock. Such perception differences are even less likely in the more prominent cases in which capital goods are owned indirectly through financial markets. Thus, independent of any empirical considerations, we have some basis for preferring Hayek's story over Friedman's. Hayek's domain assumptions and even his heuristic assumptions allow for generalization and extension in ways that Friedman's do not. Hence, Hayek's theoretical construction is the richer, the more fruitful, of the two.

4. Historical Applications and Policy Implications
Extensive empirical testing has favored Friedman's view of the nature of the short-run Phillips curve over beliefs or hopes that there is a more permanent trade-off between inflation and unemployment. But this same empirical testing provides no clue at all about the nature of the market process that moves the economy along a short-run Phillips curve and then shifts that curve so as to conform with the long-run vertical Phillips curve. That is, the testing allows to us choose between a Keynesian view and a Friedman-Hayek view, but not between the Friedman view and the Hayek view.
        Direct empirical evidence about the nature of the monetary dynamics involved in adjusting the economy to a monetary injection may be all but impossible. Directly substantiating Friedman's story would require data on perceived real wage rates; directly substantiating Hayek's story would require the quantification of actual changes in the complex structure of capital.⁽³²⁾ We must look for implications of the two views that allow for empirical differentiation. As it turns out, our comparison of the two views provides the needed clue about differing implications.
        In Friedman's story a general rise in prices of final output is a necessary link in the self-reversing market process triggered by monetary expansion. Without this price inflation, which has a different significance for workers and for employers, there is no story to tell. While Hayek's story allows for price inflation, his story does not depend upon it (1967, pp. 22-30; 1975b, pp. 104, 121, 196, and passim). An initially depressed interest rate followed by subsequent resource constraints within the market for capital goods can serve alone as the basis for the self-reversing market process envisioned by Hayek.⁽³³⁾ This realization that price inflation plays a leading role in one story and, at best, a supporting role in the other allows us to identify important differences in the way the two stories are used not only in the interpretation of history but also in the prescription of policy.
        Historical episodes in which monetary expansion is accompanied by an unchanging price level are interpreted differently by Friedman and Hayek. The decade of the 1920s provides the most dramatic illustration of this difference. Real economic growth during this decade, which in the absence of monetary expansion would have produced a decline in the price level, served instead to offset the inflationary effects of the monetary expansion. The self-reversing process that, in Friedman's view, characterizes other episodes of monetary expansion does not get triggered in this one. There is no Phillips-curve story to tell. Economic problems that surfaced at the end of the '20s are not, according to the Monetarist view, a result of a market process that began much earlier in the decade. The economic downturn is blamed instead on exogenous factors—the incompetence and irresponsible behavior of the central bank (Friedman, 1963, pp. 299-419).
        From an Austrian perspective, the same historical episode is seen quite differently (Hayek, 1975b, pp. 18-20; Robbins, 1934; Rothbard, 1963). The fact that there was virtually no price inflation is irrelevant. There is no scope for the idea that the monetary expansion simply accommodated real growth: real growth, in the Austrian view, must be accommodated by real saving. The credit expansion during the 1920s caused the rate of interest to be lower than it otherwise would have been and thereby triggered a self-reversing process within the market for capital goods. The actual self reversal came in 1929 causing the economic downturn. This historical episode, then, is an illustration of Hayek's story and not an exception to it.
        Interpretations of history have their counterpart in policy recommendations. Again, the differing significance of price inflation is the basis for differences in preferred policies. In the Monetarist view, so long as the price level is stable, monetary expansion is not disruptive. Monetary expansion may even be necessary to keep prices from falling during periods of real economic growth. In the Austrian view, monetary expansion is a disruptive force, whether or not the price level is changing as a result of the expansion. The particular nature of the disruption will depend upon the particular form of the expansion. The differing recommendations can be stated concisely in terms of the equation of exchange and an assumed constant velocity of money. The Monetarist recommendation: Increase the supply of money to match long-term, secular increases in real output; the Austrian recommendation: Abstain from monetary expansion even in periods of economic growth; increased credit should come only from increased saving; increasing output should be accommodated by a declining price level.⁽³⁴⁾ These policy differences suggest that the critical comparison of alternative monetary dynamics is more than an idle exercise.

V. Further Implications
Our critical comparison has important implications about the way we think about macroeconomic problems. The monetary dynamics envisioned by Hayek provide a richer understanding of the market processes that might be triggered by a monetary expansion, but the Austrian alternative may at the same time render less serviceable—or even misleading—some of the standard macroeconomic concepts. At issue, in particular, are the conventionally defined categories of unemployment, the notion of "long and variable" monetary lags, and the concept of "full" employment. 

1. Cyclical and Structural Unemployment
Beginning with Keynes, it has been standard practice to identify a number of categories of unemployment in order to isolate conceptually one particular component of special interest. Cyclical unemployment is the major focus of macroeconomic and monetary theory. Traditionally, theorizing about what causes unemployment of this category or about how it might be reduced or eliminated have been facilitated by impounding other categories of unemployment in a ceteris paribus assumption. Frictional unemployment, which is inherent in any market economy, is wholly attributable to the existence of search costs. Unemployed workers of this category always find employment, but not instantaneously. Institutional unemployment, such as might be caused by minimum-wage legislation, may be lamentable, but it is to be fully accounted for in terms of the legal constraints. These two categories of unemployment can be conceptually separated from cyclical unemployment, whether we accept Friedman's treatment of monetary dynamics or Hayek's.
        Structural unemployment involves a geographical or occupational mismatch of workers and employment opportunities. Unemployment of this sort could result from autonomous shifts in consumer demand or from technological innovations. In Keynesian and Monetarist formulations, structural unemployment is combined with frictional and institutional unemployment, and all three are collectively impounded in a ceteris paribus assumption. Keynes's views on unemployment of these sorts are virtually identical to the "Classical" views of, say, Cecil Pigou; they were spelled out by Keynes (1936, p. 6) only to make clear what he was not talking about. Friedman (1976, p. 217) makes use of these categories to locate the vertical long-run Phillips curve.
        The natural rate of unemployment, which is simply the market rate given frictions, mismatches, and institutional constraints, serves as the base point from which to analyze cyclical unemployment. Operationally, this last category is defined as a residual. Cyclical unemployment is calculated by subtracting an estimation of the natural rate from the measured unemployment rate. Friedman's story begins with an economy in which all unemployed workers are "naturally" unemployed. Initially, then, a monetary expansion gives rise to negative cyclical unemployment, which persists until employer/worker wage-perception differentials are eliminated. In symmetrical fashion, a monetary contraction—or disinflation—causes the actual unemployment rate temporarily to exceed the natural rate. Eventually, the natural rate is reestablished, but—more significant for the present discussion—the rate of structural unemployment remains constant all the while. The market process by which the economy deviates from and then returns to the long-run Phillips curve creates no mismatches between workers and employment opportunities. Money is neutral with respect to the structure of the economy.
        Hayek's story can begin at the same point as Friedman's, but once the economy begins to react to the monetary expansion, the strict dichotomy between structural unemployment and cyclical unemployment can no longer be maintained. The self-reversing process plays itself out in terms of changes in the structure of capital and corresponding changes in the structure of employment. Friedman's initial increase in employment becomes, in Hayek's story, an increase of some particular kinds of employment at the expense of other particular kinds. If the new money enters the economy through credit markets, the "forced saving," as Hayek uses that term, is financing production for the more remote future at the expense of production for the more immediate future. The structure of employment opportunities is modified accordingly. The unemployment that characterizes the later phase of the dynamic process, then, is structural unemployment. It differs from the structural unemployment that existed prior to the monetary expansion only in terms of the causal factors. But operationally, structural unemployment caused by autonomous changes in tastes and technology and structural unemployment caused by monetary disturbances may not be separable categories of unemployment. (Does the waning of smokestack industries reflect a technological shift towards an information-based economy, or does it represent a structural hang-over from an earlier money-induced boom?)
        Further, expansion-induced structural unemployment is likely to be long-lasting. The long run in Hayek's formulation must be long enough so that all misallocated capital can be liquidated and all capital/labor mismatches can be rectified. The amount of time required may be so great as to make any propositions about long-run neutrality highly misleading. (It would do violence to standard macroeconomic terminology to categorize the Great Depression as an instance of "short-run non-neurtality.")
        Hayek (1977, p. 282; 1975a, p. 44) does allow for the possibility that some cyclical unemployment may not be structural unemployment. The reduction in incomes during the downturn can—through the reduction in effective demand—have an aggravating effect on the problem of unemployment. This is what Hayek refers to as the "secondary deflation," or the "cumulative process of contraction." The unemployment associated with the economy's spiraling downwards is the type of cyclical unemployment dealt with by Keynes. Hayek's recognizing the possibilitly of a secondary deflation does not, as some have suggested, constitute a capitulation to Keynes. In fact, this problem was put into perspective (1975b, p. 19) well before the appearance of The General Theory. Rather, the fact that Hayek sees the Keynesian component of cyclical unemployment as a secondary effect draws attention to the primary effect which Keynes overlooked. 

2. The Long and Variable Lag
We turn now from the nature of the unemployment that is caused by a monetary disturbance to consider the length of time between the initial injection of new money and the economy's eventual adjustment to it. As an empirical summary, the Monetarist phrase "long and variable lag," (Friedman, 1969a, p. 238) is appropriate for both Friedman's and Hayek's account of the monetary injection and its ultimate effect. But further reflection on the two views of monetary dynamics reveals important differences in this respect. First, the "ultimate effect," which marks the end of the lag, refers to different things in the two views. As suggested above, the overall level of prices may become fully adjusted to the increased quantity of money long before the money-induced distortions in the structure of capital (and labor) are fully eliminated. Thus, the short-run and long-run Phillips curves may be separated by a much shorter span of time than the short-run and the long-run Hayekian triangles.
        Second, the basis for the lag differs between the two views in an important way. Friedman's lag depends upon how long it takes for workers to straighten out their misperceptions of the real wage; Hayek's lag depends upon characteristics of the capital structure—the degree of specificity and intertemporal complementarity of the capital goods that make up the structure. Hayek's story suggests that credit expansion is less disruptive (and involves a shorter adjustment lag) in underdeveloped countries than in industrialized countries. This accords with casual empiricism. Does Friedman's story suggest that workers in underdeveloped countries have better and/or more quickly adjusting perceptions of their real wage rates in comparison to workers in industrialized countries?
        Third, there is an important difference in the basis for the variability of the lag from one expansionary episode to another within a given economy. For Friedman, the length of the lag, being based on workers' misperceptions, is fundamentally indeterminate. But it is not at all clear why it should take workers so long to straighten out their misperceptions about the real wage and why it should take much longer in some episodes than in others.⁽³⁵⁾ For Hayek, the length of the lag will depend upon the particular way in which capital and labor markets are distorted, which in turn depends upon how the new money is injected. Monetary injections that discoordinate intertemporally are more likely—precisely because of the temporal nature of the discoordination—to involve longer lags than injections that discoordinate in some atemporal way. This relationship between the method of injection and the likely length of the lag helps to explain why the Austrian theorists have always seen credit expansion, which was characteristic of the 1920s' boom, as particularly troublesome, and why, in their study of this and other expansionary episodes, they are as much or more interested in how—rather than how much—money was injected.

3. "Full" Employment
Finally, we turn to the concept of "full" employment as used by Keynes and Friedman in the light of the monetary dynamics as envisioned by Friedman and Hayek. For Keynes, full employment is achieved so long as investors are sufficiently optimistic or sufficiently moved by the "animal spirits," or so long as public works takes up the slack created by any insufficiency of private spending. But the very nature of a self-reversing dynamic process—as incorporated into the visions of both Friedman and Hayek—suggests that the critical issue is whether or not a particular pattern of employment is sustainable. In either vision any level of employment above the full-employment level is clearly not sustainable. But in Friedman's formulation, full-employment is—by construction—a sustainable level of employment.
        For Hayek, the level of employment that corresponds to Friedman's full-employment may be sustainable or it may contain the seeds of its own undoing (1975c, pp. 60-62). That is, even though the real wage rate consistent with the underlying real factors is correctly perceived by both employers and workers, the existing capital structure may be inconsistent with the intertemporal pattern of consumer demand and resource availabilities. The market process through which these inconsistencies are discovered and remedied may involve a considerable period of cyclical (structural) unemployment. Again, the circumstances existing in the late 1920s can illustrate the distinction. In the Austrian view, the economy was experiencing, in those years, unsustainable full employment.
        Friedman does recognize that irresponsible monetary policies may eventually increase the natural rate of employment. In two different pieces of analysis (1976, pp. 232-33 and 1977, pp. 459-60), he suggests the possible existence of a "positively sloped Phillips curve." But in each case, new considerations not integral to his story of the adjustment process are introduced to account for such a possibility.⁽³⁶⁾ In neither case are structural considerations—as conceived by Hayek—integrated into the dynamic process envisioned by Friedman. Friedman's strict dichotomization of structural and cyclical unemployment stands in the way of his recognizing the possibility of full (in the operational sense) but unsustainable (in the Hayekian sense) employment. Hayek's formulation, which involves an interplay between structural and cyclical unemployment, allows for the recognition of such possibilities and for the prescription of policy most conducive to sustainable full employment. 

VI. A Summary View
Purely as an instrumentalist's device, it could be argued, Friedman's story has served the Monetarists well. It put them onto the idea that the Phillips curve trade-off is a short-run trade-off only. After this idea was confirmed empirically (or properly, after it failed to be falsified over many trials) the story itself became superfluous. The realization that the empirically defined long-run Phillips curve is vertical is enough to carry the day. It provides a strong basis for arguing that in the long run, "nominal magnitudes do not influence real magnitudes" and for warning against all attempts to exploit the trade-off offered by the short-run Phillips curve.
        Friedman's story and Hayek's story differ sharply in methodological terms. Because of its instrumentalist qualities, Friedman's story fares poorly as a source of insights about the market process that translates a monetary injection into its ultimate consequences; it fails to increase our understanding of any actual market process. Hayek's story identifies the essential workings of the self-reversing market process triggered by a monetary expansion in a way that sheds light on the structure and timing of the pattern of unemployment caused by such monetary disturbances. The Austrian insights contained in the Hayekian triangles square with but go beyond the empirical regularities of Monetarism.
        From a broader perspective, Friedman's story represents a recognition of the intertemporal substitutability of labor and of the possibility that monetary disturbances can interfere with the intertemporal allocation of labor. Hayek's story represents a recognition of the intertemporal complementarity of capital and of the possibility that monetary disturbances can interfere with the intertemporal allocation of capital. Viewed as such, the two stories are themselves not substitutes, but complements. 

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Notes:

1. Two related contributions are Hoover (1984), who provides an insightful comparison between Old Monetarists in the style of Friedman with the New Classicists in the style of Lucas, and Butos (1985) who compares Hayek and Lucas in the context of a general-equilibrium approach to business-cycle analysis. Although not originally conceived for this purpose, the present paper can be seen as completing the trilogy by comparing Hayek and Friedman on the issue of monetary dynamics.

2. We should note that the sharpness of the labor-market/capital-market distinction that characterizes our paper is not intended to suggest that Hayek has had nothing to say about labor markets or that Friedman has had nothing to say about capital markets. Hayek (1975a, pp. 15-29) specifically addresses the relationships among "Inflation, the Misdirection of Labour, and Unemployment"; Friedman (1970, p. 24-25) includes the existence of a cash-balance effect on asset prices as one of the key propositions of Monetarism. Our paper focuses more narrowly on a comparison of Phillips Curves and Hayekian Triangles as alternatives bases for theorizing about monetary dynamics.

3. The article exhibiting Friedman's agnostic stance was first published in 1963; the "engineering blueprint" appeared in 1976 after having been presented at the Southern Economic Association meetings two years earlier. Some might argue that a dozen or so years is enough to transform vagueness into a blueprint. An alternative view is that the agnosticism persists (see, for instance, Friedman, 1969c, p. 6); the arguments in the later effort, which have their roots in his 1967 A.E.A Presidential Address (1969e), are to be understood as Friedman's willingness to take on his adversaries on their own turf. If this view is valid, a distinction must be made between Friedman and his followers. Some Monetarists (e.g. Darby, 1976, pp. 328-50) write as if Friedman's critical analysis which demonstrates the absence of an exploitable long-run Phillips curve is at the same time an exposition of the Monetarist view of the market process which transforms monetary injections into increases in the price level. Also, the formal analysis offered by Phelps (1970. pp. 124-66) is similar to Friedman's critical analysis of the relationship between long-run and short-run Phillips curves.

4. In other contexts, Friedman opts for a more broadly conceived adjustment process in which asset prices change, but he trivializes the corresponding quantity adjustments (e.g. that may temporarily alter the structure of capital) as "first-round effects." See Friedman and Schwartz (1982, ch. 2) and Friedman and Meiselman (1963, pp. 217-22).

5. Reder (1982) could be interpreted as denying the significance in this respect of Knightian capital theory for the development of the Chicago tradition. "The contribution to economic thought with which Knight is most readily identified (theory of the firm, uncertainty and profit, capital theory, social cost, etc.) are only tangentially related to the Chicago tradition" (Reder, 1982, p. 6, our emphasis). An anonymous referee has suggested that Reder's assessment is compatible with our own: "The modern Chicago school interpreted Knight so as to allow them to ignore capital theory."

6. See Friedman (1969c, pp. 4-7). Friedman clearly recognizes that the money drop has to be perceived as a one-time event. "Let us suppose further that everyone is convinced that this is a unique event which will never be repeated." This essential assumption separates Friedman from the New Classicists in terms of the issues that each is addressing. The money drop in Friedman's analysis does not constitute a "policy" in the New Classicist view. Further, Friedman's treatment of expectations creates a certain internal tension in his own view if his analysis is to explain more than a single episode of monetary expansion: Market participants have adaptive expectations (about the price level and real wages) during the period that the market is adjusting to a money drop, but static expectations about the likelihood of a future money drop.

7. As an alternative formulation, Friedman does away with both the distribution effects and the differential income effects by assuming "infinitely lived people" such that no transitory event has any effect on permanent income (Friedman, 1969c, p. 6n). This alternative, however, does not represent a net "relaxation" of simplifying assumptions; it represents the replacement of one assumption with another, analytically equivalent, assumption.

8. The exposition that follows draws primarily from Friedman, 1976, pp. 213-37.

9. As Friedman makes clear, the shifting of and movements along the curves are reversed if we take the employer's point of view. The movement down the employer's demand for labor corresponds to an apparent shift in the supply of labor (Friedman, 1976, p. 223).

10. The exposition of monetary dynamics as seen by Hayek draws largely from his early writings (Hayek, 1967 and 1975b). Even the more advanced of these two books was intended only as an outline (1967, p. vii). Hayek's monetary dynamics is based upon a theory first set out by Mises (1953, pp. 339-66), which integrated the capital theory of Böhm-Bawerk with a theory of interest-rate movements adapted from Wicksell (1936).

11. The kernel of truth in the idea of rational expectations is clearly recognized by Mises as early as 1953 as is demonstrated by the following passage on inflationary finance: "Here the famous dictum of Lincoln holds true: You can't fool all of the people all of the time. Eventually the masses come to understand the schemes of their rulers. Then the cleverly concocted plans of inflation collapse.... [I]nflationism is not a monetary policy that can be considered as an alternative to a sound money policy. It is at best a temporary makeshift. The main problem of an inflationary policy is how to stop it before the masses have seen through their rulers' artifices. It is a display of considerable naivete to recommend openly a monetary system that can work only if its essential features are ignored by the public" (Mises, 1953, p. 419). For a comparison of Hayek's approach to the issue of expectations with that of New Classicism, see Garrison (1986).

12. For a treatment of Austrian capital theory that emphasizes these features, see Lachmann (1956).

13. Jevons (1970, pp. 229-36) had earlier employed a triangular construction for similar purposes. Attempting to characterize the economy's capital structure in terms of the dimensions of a triangle is what qualifies Prices and Production as an outline. In Hayek's more formal—and more formidable—Pure Theory of Capital (1941), many of the heuristic assumptions of his earlier efforts were relaxed. This volume was to serve as the basis for a more comprehensive treatment of monetary theory (Hayek, 1941, p. v-vi), but no follow-on volume was ever written.

14. At the time of Hayek's London lectures, which were to become Prices and Production, this formulation was largely unintelligible to his British audience. Hicks (1967, p. 204) was later to note that "Prices and Production was in English, but it was not English economics." While the neo-Austrian Hicks pointed to difficulties in Hayek's communication of the message, Joan Robinson, who had difficulties with the message itself, dubbed the Hayekian episode a "pitiful state of confusion" and categorized it as a crisis in economic theory (Robinson, 1972, p. 2).

15. See Hayek, 1967, p. 54). In his earlier writing (1975b, pp. 143-48) Hayek criticized L. A. Hahn and Ludwig von Mises for beginning their stories with "arbitrary interferences on the part of banks." Hayek regarded an exogenous credit expansion as a "specially striking case," and as a sufficient condition but not a necessary one for the occurrence of alternating boom and crisis. He did note (p. 150) that "it is possible to assume, with Professor Mises, that the Central Banks, under the pressure of an inflationist ideology, are always trying to expand credit and thus provide the impetus for a new upward swing of the Trade Cycle; and this assumption may be correct in many cases."

16. This aspect of the market process reflects the insights of Wicksell (1936, pp. 102-21): a economic boom grows out of the divergence between the loan rate of interest and the natural rate. But as an anonymous referee has noted, Hayek differed from Wicksell on the question of what causes the divergence of the two rates. Wicksell believed that the natural rate increases first due to technological advance and that the loan rate adjusts but with a lag.

17. This aspect of Hayek's theory is the central focus of his 1937 article, "Investment that raises the demand for capital." (See Hayek, 1975c, pp. 73-82.)

18. Early on, Hayek was acutely aware that his own monetary theory of the trade cycle was distinctive in that it did not hinge on changes in the general level of prices: "We are in no way concerned to explain the effect of the monetary factor on trade fluctuations through changes in the value of money and variations in the price level..." Instead, his explanations hinged upon "changes [monetary in origin] which are bound to disturb the equilibrium inter-relationships existing in the natural economy, whether the disturbance shows itself in a change in the so-called 'general value of money' or not" (1975b. pp. 103-4).

19. Hayek uses the term "Ricardo Effect" (1948a) to refer to the quantity adjustments in markets for capital goods brought about by this upturn in interest rates. Also, see O'Driscoll (1977, pp. 92-134).

20. Richard Wagner (1979, pp. 182-85) demonstrates that the applicability of Austrian business-cycle theory is independent of any unemployed labor that may be associated with the downturn and that to estimate the social costs of a monetary disturbance by the unemployment caused by it is to underestimate those costs.

21. As Hayek (1967, p. 33) clearly recognized, this same distinction separated his own theorizing (1967) from the contemporaneous theorizing of Dennis Robertson (1949).

22. The claim that capital is more radically heterogeneous than labor is not based simply on a difference in degree. Different man-hours of labor are not perfectly substitutable for one another. But our attempt to construct an analogous claim for capital is revealing: Different ________ of capital are not perfectly substitutable for one another. The difficulty of even filling in the blank is a clear sign of dimensional, or radical, heterogeneity. We must resort either to some universal non-unit, such as "hunks," or to some value measure, such as "dollar's worth," which leads to an inescapable conflation of the price of capital and its corresponding quantity. Further, differences between different man-hours of labor are conventionally attributed to differences in human capital. Theories about labor that hinge on such differences are faced with the same thorny problems that are inherent in theories about capital. It is largely because of these well-recognized problems that most monetary theorists have preferred to think in terms of homogeneous, perfectly substitutable, man-hours.

23. Hayek recognized that some capital goods are substitutes for one another. We emphasize the notion of capital complementarity to contrast Hayek with most other theorists, who, explicitly or implicitly, take all capital goods to be substitutes.

24. For an alternative treatment of the relationship between labor-based and capital-based theories, see O'Driscoll and Rizzo, 1985, pp. 160-87.

25. These critics would not take Hayek to be the most viable alternative to Friedman. They would opt instead for theories of monetary disequilibrium in the style of Warburton (1966) and Clower (1969). Their preference is based upon a perceived asymmetry between price adjustments associated with a falling price level and price adjustments associated with a monetary injection. "Deflation has to work through a sequence of millions of piecemeal price and wage decisions; the alternative of nominal monetary expansion puts no such demands on the economy's coordinating mechanism" (Birch, Rabin, and Yeager, p. 213). But the asymmetry is non-existent unless the question-begging assumption of "helicopter money" is employed. Actual deflations and actual monetary expansions "[have] to work through a sequence of millions of piecemeal price and wage decisions."

26. For an instrumentalist defense of Friedman's economics, see Boland (1979).

27. Musgrave (1981) uses the modifiers "negligibility," "domain," and "heuristic" to define three categories of assumptions that underlie various theoretical constructions. Generically, a domain assumption identifies the domain, or scope, of direct applicability; a heuristic assumption is a deliberate fiction used to facilitate the logical development of a theory. Musgrave uses these distinctions to evaluate Friedman's treatment of methodological issues (1953) in which assumptions are categorized as "realistic" or "unrealistic."

28. For a treatment of Hayek's analysis in terms of the Phillips curve, see O'Driscoll (1977, pp. 115-18). It should be noted that O'Driscoll uses Phillips' original construction, which has wage inflation on the vertical axis; the analysis is applicable whether or not there is price inflation as well.

29. It may be misleading to claim that Hayek generalized his theory only in recent years. The case involving the expansion of credit to producers provided a focus for Prices and Production where Hayek "concentrated on the successive changes in the real structure of production, which constitute [cyclical] fluctuations." In his earlier work where he was concerned with "the monetary causes which start the cyclical fluctuations," his arguments were much more general in nature. (See, for instance 1975b, pp. 91, 146-47, and passim; the quoted passages are from the preface, p. 17.) Modern Hayekians may even judge that Hayek generalized a little too much: "The initial change [eliciting a cyclical fluctuation] need have no specific character at all, it may be any one among a thousand different factors which may at any time increase the profitability of any group of enterprises" (1975b, pp. 182-83).

30. Drawing from Hicks (1946, p. 222), Leijonhufvud (1968, p. 222) contends that the Austrian construction cannot be generalized in this way: "the result reached for the point-input point-output case ... 'does not generalize in the sort of way in which it might have been expected to generalize.'" But the obstacles that make generalizing difficult are not to be attributed to the Austrian formulation but to the very nature of capital and hence of capital theory. (See footnote 20 above.) If measured in terms of the "period of production," the time element in the production process depends upon the "quantity" of capital employed at each point in time; the quantity of capital must be measured in value terms, which in turn depend upon the rate of interest. Thus, the "lengthening" of the period of production brought about by a fall in the rate of interest may involve a "lengthening" that follows from the very definition of the period of production plus a "lengthening" that results from a market process set into motion by the fall in the rate of interest. Hayek (1941, pp. 76-77, 140-45, 191-92 and passim) was aware of the hoary problems of this sort well before the so-called "reswitching" debate of the 1960s. The fact that the Austrian formulation is capable of making some important distinctions, such as between the two senses of "lengthening," should be seen as a credit to that theory and not as grounds for condemning it.

31. For modern treatments of Hayek that rely heavily on Kaldor's critique, see Blaug (1978, pp. 571-74) and Ackley (1978, p. 632). Ackley refers to the Austrian view as a fantasy and is particularly vitriolic in his treatment of it. 'In what must be one of the most devastating critiques in the history of economics, Nicholas Kaldor showed the absurdity of what he called Hayek's "concertina effect"—the cyclical "lengthening" and "shortening" of the production process. Remnants of this idea may still be circulating in the byways of economics, but the writer has not encountered them for several decades.'

32. Wainhouse (1984), whose comparison of Friedman and Hayek is compatible with the one offered in the present paper, employs "Granger causality tests" in an attempt to establish the empirical relevance of Hayek's story.

33. In recent years Friedman has been attributing high interest rates, not to an inflation premium, but to the volatility of money growth (Brimelow, 1982, p. 5-6). And his argument sounds more Hayekian than Friedmanian: In 1980 the Federal Reserve began a relatively rapid monetary expansion. Businessmen assumed the cheap credit was going to last for a considerable period, but when it didn't, "you had the business community left with all sorts of commitments based on a wrong diagnosis, a wrong prediction. And you had a great deal of distress borrowing that was highly insensitive to interest rates."

34. This policy prescription observes the stricture of separating policy implications from judgments of political feasibility. There is no evidence that Hayek has changed his mind about the implications of his theory, but in recent years he has tempered his recommendations. Prefacing an argument for a stable price level (1975a, pp. 26), Hayek "confess[ed] that 40 years ago I argued differently. I have since altered my opinion—not about the theoretical explanation of the events but about the practical possibility of removing the obstacles to the functioning of the system by allowing deflation to proceed...." And looking to future monetary systems, Hayek (1984, pp. 325-26) notes that "Sixty years ago I began my work on monetary theory by questioning the belief, then universally accepted, that the purchasing power of money should be kept stable. I then suggested that it was more desirable for the purchasing power of money over consumer goods to increase over time. But I have since become convinced that a money of stable value is really the best we can hope for."

35. When Friedman (1969a, pp. 255-56) explicitly considers the question of why the lag should be so long, he gives a Hayekian-triangle answer rather than a Phillips-curve answer. The process of monetary expansion effects the demand for "equities, houses, durable producer goods, durable consumer goods, and so on.... The effects can be described as operating on 'interest rates,' if a more cosmopolitan interpretation of 'interest rates' is adopted than the usual one which refers to a small range of marketable securities." This same process later generates "reactions [which] undo the initial effects on interest rates."

36. The positive slope is attributed in one piece of analysis (1976, p. 233) to "slow adjustments of anticipations to experience, long-term contracts, government interventions into specific markets, and other elements of 'friction' or 'rigidity'...."; and in the other piece of analysis (1977, p. 460) to "the interdependence of experience and political developments."