forthcoming in History of Political Economy
vol. 36, no. 2 (summer) 2004
in the Mises-Hayek Theory of
the Business Cycle
Roger W. Garrison
forced saving, though seeming antonyms, are actually cognates that describe
different phases of the business cycle, as variously understood by the
Austrian economists. Recognizing the sense in which the two terms are conformable
helps to resolve terminological and substantive differences within the
Austrian school and to show why the term "forced saving" has been such
an obstacle to understanding-both within and beyond that school. Accounting
for overconsumption (as well as overinvestment) allows for some reconciliation
between Austrian and mainstream views, while at the same time enhancing
the internal logic of the Austrian theory. As an important aside, unperceived-or
only dimly perceived-shortcomings in F. A. Hayek's theorizing may help
explain why Hayek was largely ineffective in responding to his critics
and why he failed to produce a timely and effective critique of Keynes's
The business cycle theory developed during
the interwar period by Ludwig von Mises and Friedrich A. Hayek is a theory
of the unsustainable boom. Responding to cheap-credit policies of the central
bank, the economy can find itself on a growth path that is inconsistent
with the underlying economic realities. (1)
Internal tensions in the market forces that guide consumption and investment
decisions eventually precipitate a bust.
This understanding of the market process that takes the economy through
boom and bust has come piecemeal and in a leapfrog progression in the writings
of Mises and Hayek. Mises first gave the theory its Austrian identity in
his Theory of Money and Credit ( 1953, pp. 357-366). Clearly,
the theory emerges as a combination of the interest-rate dynamics introduced
by Swedish economist Knut Wicksell ( 1962) and the Austrian capital
theory outlined by Carl Menger ( 1981) and developed by Eugen von
Böhm-Bawerk ( 1959). The divergence of the market rate of interest
from the natural rate causes a misallocation of resources among the temporally
sequenced stages of production. The "internal tensions," which become most
pronounced at the upper turning point of the cycle, manifest themselves
in Mises's original account as "counter-movements" in the prices of consumption
goods relative to the prices of production goods. These relative prices
fall during the boom but eventually rise, provoking corresponding counter-movements
of resources and marking the economy's transition from boom to bust.
In the mid 1920s, Hayek applied Mises' theory to the policy-driven boom
in the United States. But having been persuaded by Gottfried Haberler that
Mises's initial casting of the theory was too sketchy to serve this purpose,
Hayek (1984, pp. 27-28) added a footnote of more than five-hundred words
to set out his own version of Mises' theory. (2)
The counter-movements in Hayek's account take the form of movements in
the demand for raw materials in the early stages of production. When the
rate of interest is artificially low, this demand is strengthened, but
because of ultimate resource constraints and pressing demands elsewhere,
it must eventually decline.
A key analytical stepping stone in the development of the Austrian theory
came with Hayek's 1931 lectures at the London School of Economics and his
introduction of a graphical device for depicting the effects of a change
in the rate of interest on the intertemporal allocation of resources. The
Hayekian triangle depicted in Figure 1 keeps track of the relationship
between (1) the economy's consumable output and (2) the time dimension
of the production process from which that output emerges. This relationship
is not fixed by technological considerations but rather can vary with changes
in intertemporal preferences. Variation can also be induced—though not
to the benefit of the economy's long-run macroeconomic health—by the central
In its simplest application, the two legs of this right triangle measure
consumption and the corresponding production time (reckoned in the number
of stages of production) for an economy that has achieved an intertemporal
equilibrium. A primitive instance of this intertemporal equilibrium and
of potential changes in it can be illustrated by a Robinson Crusoe who
for some time is content to sustain himself by catching fish with the aid
of little or no fishing equipment. A greater output of fish is possible
but only if Crusoe is willing to take time away from fishing in order to
fashion a net and possibly a boat. Consumable output would have to fall
while the production process is being enhanced. Once the new, more capital
intensive (and more time-consuming) process is completed, however, the
level of output would rise above its initial level. The new intertemporal
equilibrium can be depicted by a Hayekian triangle with a longer consumption
leg, representing more fish, and a longer production-time leg, representing
the increase in the time spent maintaining the new production process.
The Hayekian triangle is intended to apply generally to the macroeconomy,
a setting in which the decisions to forgo current consumables in order
to be able to enjoy greater levels of consumption later and the decisions
to alter the production process are made by different groups of individuals.
The saving decisions of the first group affect the investment decisions
of the second group through movements in the interest rate. A decision
on the part of income earners to save more depresses the rate of interest.
And with a lower interest rate, investment rises. This much follows straightforwardly
from the pre-Keynesian loanable-funds theory, a theory relied upon in much
of Mises's and Hayek's theorizing. Unique to the Austrian theory is the
accompanying change in the intertemporal pattern of investments. A saving-induced
lowering of the interest rate favors investments in the relatively early
stages of production. Further, incentives to shift resources from late-stage
activities to early-stage activities is reinforced by a pronounced derived-demand
effect operating in the late stages: Reduced demand for current consumables,
that is, for output of the final stage of production, translates into reduced
demands for resources used in stages in close temporal proximity to the
During the capital restructuring, the macroeconomy is depicted by a Hayekian
triangle whose consumption leg is shortened and whose production-time leg
is lengthened. The ultimate effect of the increased investment—and, importantly,
the altered pattern of investment activities—is to shift consumable output
forward in time. It is through just such adjustments in the face of reduced
current consumption demand and a lower interest rate that the market economy,
according to the Austrians, is able to bring investment decisions in line
with the changed intertemporal preferences. Accordingly, policy actions
by the central bank can distort the adjustment process, "forcing" behavior
that is at odds with intertemporal preferences.
Forced Saving or Overconsumption?
The boom-bust cycle, in the Austrian view, is
an instance in which the interest rate is lowered by a centrally directed
credit expansion rather than by a change in intertemporal preferences.
In Wicksellian terms, the market rate is pushed below the natural rate.
The policy-induced lowering of the interest rate causes the economy to
react in important respects
as if the additional investment funds
had been made available by voluntary saving. Hence, the corresponding increase
in investment in the early stages of production gets labeled with the opposing
term "forced saving": Resources are allocated (at least in the initial
phases of the boom) in accordance with greater saving even though the saving
implied by such an allocation is not at all voluntary—and even though saving
in the more literal sense of abstaining from consumption has not increased
at all. The term "forced saving" used in this way signals a conflict between
consumers and producers and hints strongly that there will be trouble ahead.
But the very fact that it is intertemporal markets that are thrown into
disequilibrium means that time must elapse before the market process that
allocates resources intertemporally turns conflict into crisis. Hayek's
and Production ( 1967), which is the print version of his 1931
LSE lectures, details the sequence of boom and bust with the aid of this
particular notion of forced saving.
In Mises's subsequent exposition in Human Action (1966), forced
saving takes on a substantially different meaning. Mises articulates a
theory of boom and bust that is largely compatible with Hayek's formulation
but not obviously so. The essential problem of the credit-induced boom
is repeatedly summarized by Mises (1966, pp. 432, 470, 563, 564, 565, 467,
569, and 575) with variations of the phrase "malinvestment and overconsumption."
The aspect of the problem identified by the first term of this phrase is
recognized and emphasized by Hayek. The misallocation of resources—too
many resources committed to the early stages of production—is the malinvestment.
But what about the "overconsumption"? Can a macroeconomy experience forced
saving and overconsumption at the same time or, at least, during the same
boom? On the surface it would seem that the two terms are virtual antonyms.
(3) A sorting out of their various meanings and applications
to the different phases of the boom-bust sequence, however, can almost
fully resolve the seeming contradiction and in the process produce a more
thorough understanding of the Mises-Hayek theory of the business cycle.
The notion that the boom is characterized by overconsumption also follows
straightforwardly from the loanable-funds theory. The market for loanable
funds—or, more inclusively, for investable resources—is equilibrated by
movements in the interest rate, broadly conceived. An increase in saving
would be depicted by a rightward shift in the supply of loanable funds.
The market would take the economy down along the demand for loanable funds
to a new equilibrium at which the interest rate is lower and both saving
and investment are greater.
While creating similar incentives for the business community, a credit
expansion in the absence of an increase in saving would have ultimate consequences
that are fundamentally different. With this policy-induced change in market
conditions, the apparent rightward shift of the supply curve represents
an increase in credit in the absence of an increase in saving.
Saving is simply augmented by credit creation. Nonetheless, the
rate of interest would fall and the business community would be enticed,
at least initially and to some extent, to undertake greater investments
and would tend to allocate the credit-financed resources to the early stages
of production. But since saving, as still represented by the unaugmented
supply curve, has not changed, the lower rate of interest means that the
amount saved actually decreases.
Only in the extreme and unlikely case of a perfectly inelastic supply of
loanable funds would there be no decrease in saving. With an upward sloping
supply, credit expansion causes the volume of saving to decrease—which
is to say, it causes consumption to increase. This increase in consumption
associated with a policy-induced decrease in the rate of interest is justifiably
labeled by Mises as "overconsumption." Workers and other factor owners
receiving increased incomes as a result of credit expansion will be induced
to consume more than is implied by their pre-expansion intertemporal choices.
There is an easy—though only partial—reconciliation between Mises's and
Hayek's contrasting formulations. It comes from our recognition that Hayek's
"forced saving," rather than being the antonym of "overconsumption," is
actually a synonym for "malinvestment." With unduly favorable credit conditions,
the business community is investing
as if saving has increased when
in fact saving has decreased. There is no contradiction here between Mises
and Hayek but rather a contradiction recognized by both in the market forces
associated with a credit-driven boom. It is this contradiction, if fact,
that lies at the root of the boom's unsustainability. A fuller resolution
of the differences between Mises and Hayek requires a closer look at "forced
saving" and "overconsumption" as used by each.
Forced Saving: A Problem or a (Partial) Solution?
In his 1932 "Note on the Development of 'Forced
Saving,'" Hayek ( 1975, pp. 183-197) traced this concept from Jeremy
Bentham and Henry Thornton through J. S. Mill, Leon Walras, Knut Wicksell,
and, though without so saying, to himself. According to Fritz Machlup (1963,
p. 217), Joseph Schumpeter once considered the term "an extremely happy
expression" [?!], but later saw it as a "misleading phrase" which "it is
better to avoid." Machlup himself identified some thirty-four different
meanings of forced saving. John Maynard Keynes found a use for the concept
Treatise on Money (1930, vol. 1, p. 171), but in his General
Theory ( 1964, p. 79-81) he found the term virtually meaningless.
There is no need to recount these many meanings and contrasting assessments
here. Our concerns are relatively narrow ones, focusing largely on Hayek's
use of the term (despite his own dissatisfaction with it) and on Mises
Sometime between Hayek's survey of the term's use and Machlup's probing
of economic semantics, the economics profession learned the importance
of maintaining the distinction between "saving" and "investment." The words
stand for two different activities such that saving and investment, in
conditions of disequilibrium, can be of different magnitudes. This is a
lesson that was learned or relearned while grappling with Keynes's General
Theory, a book in which saving and investment are but two perspectives
on the same magnitude and in which difficulties arise when saving is not
equal to investment.
The problem with Hayek's "forced saving," then, is that it presents itself
syntactically as a kind of saving while referring contextually to a pattern
of investment. Hayek himself was certainly alive to this point even as
early as his Monetary Theory and the Trade Cycle. In a chapter titled
"Unsettled Problems in Trade Cycle Theory," Hayek ( 1975, p. 220)
referred to the term as a "rather unfortunate expression." He preferred
the phrase "artificially induced capital accumulation." In his subsequent
"Note on the Development," Hayek ( 1975, p. 197) mentions Keynes's
avoidance of the term in his Treatise on Money: "Keynes ... rejects
this terminology [forced saving] and prefers to speak simply of investment
being in excess of saving; and there is much to be said in favor of this."
But despite Hayek's and others' dissatisfaction with using the term to
refer to a pattern of investment rather than a kind of saving, forced saving
(both the term and the concept) has come to be considered the sine qua
non of Austrian business cycle theory and particularly of Hayek's rendition
of that theory.
In his most mature discussion of the boom-bust sequence, Mises (1966, esp.
pp. 548-565 and pp. 571-78) makes use of the term "forced saving" a dozen
or more times, but he associates with it a meaning quite different from
the one intended by Hayek. Ironically, the meaning adopted by Mises is
similar to that assumed by Piero Sraffa (1932), Hayek's harshest critic.
Credit expansion redistributes wealth away from workers, who tend to have
low saving preferences, and toward entrepreneurs and capitalists, who tend
to have high saving preferences. With wealth redistributed in this way,
the total amount of saving may be greater than before and the corresponding
natural rate of interest may be lower than before. Mises refers
to this extra increment of saving as "forced saving" without explicitly
recognizing that his use of the term is fundamentally different from Hayek's.
This forced saving can support an extra increment of investment. But could
considerations of wealth redistribution cause saving to be as great as
it would have been had the economic expansion been initiated by a change
in saving preferences rather than credit creation? Sraffa (1932, pp. 47-48)
seems to think it would; at least, he charges Hayek with failing to prove
that it wouldn't. Mises (1966, p. 549) argues in summary terms that it
So, unlike Hayek's forced saving, the term in Mises's argument (as in Sraffa's)
actually refers to a particular instance of saving rather than to a pattern
of investment that is at odds with saving preferences. Mises differs from
Sraffa, however, on the issue of the magnitude of such saving in comparison
to the saving actually needed to see the policy-induced investments through
to completion. Mises points out that it isn't necessarily true that such
saving will be a positive amount, let alone a sufficient amount. The effect
on total saving of a redistribution of wealth depends upon the particular
pattern of the redistribution relative to the particular saving preferences
of those who lost or gained wealth in the process.
Further, the overconsumption, which Mises takes to be a characteristic
of the boom, virtually guarantees that the net change in saving, if positive
at all, is far short of sufficient. According to the summary statement
offered by Mises (1966, pp. 575f), "it is very questionable whether forced
saving can achieve more than to counterbalance a part of the capital consumption
generated during the boom." Hayek ( 1975, p. 226) was aware early
on that the term was sometimes understood as a (partial) solution to the
problem (a source of saving) rather than as the problem itself (an unsustainable
pattern of investment): "[I]t is probably more proper to regard forced
saving as the cause of economic crises than to expect it to restore a balanced
structure of production" [emphasis original].
Overconsumption and then Forced Saving
In a few instances, Mises uses "forced saving"
in a way that is wholly unrelated to the redistribution of wealth that
may accompany a credit-driven boom. In these instances, the term refers
to an increase in saving near the end of the boom. Consumer goods have
been in high demand during the boom but are now increasingly in short supply
because so many resources have been committed to production processes that
are yet to yield any consumable output. The prices of consumer goods are
bid up, which according to Mises (1966, p. 556), "brings about the tendency
toward forced saving." Reinforcing this tendency is the movement in the
rate of interest during this same phase of the cycle (p. 558). Entrepreneurs
who are trying to secure additional—but increasingly scarce—resources to
see their projects through to completion are bidding up interest rates,
a circumstance that provides an incentive for would-be consumers to save
Used in this way, the concept of forced saving is wholly conformable with
the concept of overconsumption. The two terms taken together suggest a
pattern of consumption and saving that characterize the boom-bust cycle.
As the boom begins, consumption demand is high relative to the pre-expansion
level. Incomes earned by workers and other factors in the early stages
of production are being spent on consumer goods. To the extent that this
high consumption demand is met with increased allocations to the late stages
of production, then resources are being doubly misallocated. Considerations
of derived demand and of time discount are sending resources in opposite
The Hayekian triangle is being pulled at both ends against the middle.
Production activities in the middle stages, which have been effectively
raided because of high demands in both the early and late stages, eventually
reach maturity—but with yields of consumer goods that are deficient with
respect to both the boom phase and the pre-expansion economy. It is at
this point that consumption falls, as it must, and saving increases. Framing
the concept of forced saving in this way is not suggested by Hayek (who,
as we will see, denied overconsumption) but is implicit in Mises. Interestingly,
the notion of the production process being pulled at both ends against
the middle is clearly set out by Richard Strigl as understood by Fritz
Machlup (5). According to Strigl (
[A] prerequisite of any
production using roundabout methods is, of course, the corresponding supply
of consumer goods which can serve to support the originary factors of production.
Here [in the case of credit expansion] we are confronted on the one hand
with an expanded provision of consumer goods, and on the other, with an
lengthening of the roundabout production methods. Both of these movements
work together in such a way that the expansion in provisions occurs at
the expense of the supply of capital.... [T]he consumption of capital only
makes an expanded supply possible temporarily, but as a result of this
consumption of capital, a continuous provision will not be possible to
the same extent. At the same time, lengthening the roundabout methods of
production requires that a perpetual supply from the previous stock of
capital lasts in order to be able to bridge the time span until the end
of the lengthened roundabout production process. In a simple formula: Expanding
the production of consumer goods by consuming capital will further increase
the difficulties which must result from lengthening the roundabout methods
In a 1933 lecture at Columbia University (see footnote 5), Machlup recast
Strigl's formulation with an explicit reference to the stages of production
that make up the Hayekian triangle:
The additional credit causes
an increased demand on the market for consumer goods without a substantial
delay. The output of consumer goods is elastic, indeed, and simultaneous
expansion of production in the construction goods industry and in the consumption
goods industry takes place. We see at the same time symptoms of a lengthened
and of a shortened production period, a swelling at both ends of the production
structure at the expense of some middle parts of the stage system.
The subsequent maturing of those middle stages is coincident with—and virtually
synonymous with—forced saving. But neither Strigl nor Sraffa nor anyone
else claims that this increase in saving could be sufficient to
accommodate the increased demands by the business community. Funds—and
resources—needed to complete the projects initiated during the boom are
simply not available. This is the essence of the internal conflict in the
market process set in motion by credit expansion. Just as overconsumption
eventually begets forced saving, malinvestment eventually begets liquidation.
Using the two pairs of terms in this way maintains the distinction between
saving and investment while emphasizing the essential nature and temporal
charactistics of the boom-bust cycle.
Overconsumption, then, is not a denial of forced saving in the Hayekian
sense but rather a compounding of the problem identified with that term.
That is, the market conditions during the boom are even more untenable—less
sustainable—than if saving were merely involuntary or than if saving had
simply not increased. The problem created by forced saving (read: malinvestment)
is compounded by a simultaneous decrease in saving (read: overconsumption).
Mises ( 1953, p. 362) was aware of this compounding of effects even
in his earliest exposition, when he tended to think in terms of the classical
economists' subsistence fund:
A time must necessarily
come when the means of subsistence available for consumption are all used
up although the capital goods employed in production have not yet been
transformed into consumption goods. This time must come all the more
quickly inasmuch as the fall in the rate of interest weakens the motive
for saving and slows up the rate of capital accumulation (emphasis added).
Almost inexplicably, Hayek himself never gives play to the overconsumption
that accompanies credit expansion or even acknowledges the possibility
of it. (6) In connection with his discussion
of Arthur Spiethoff's analysis, (7) Hayek
( 1975, p. 172) refers to the scarcity of circulating capital that
characterizes the end of the boom as "relative over-consumption." The "relative"
appended here suggests that consumption is excessive only in comparison
with the level consistent with the actual completion of the investment
projects initiated during the boom. This term does not allow for consumption
in excess of its pre-expansion level.
For Hayek ( 1975, p. 218-19), overconsumption seems to be ruled out
by the very concept of forced saving: "This phenomenon, we are to understand,
consists of an increase in capital creation at the cost of consumption,
through the granting of additional credit, without voluntary action
on the part of individuals who forgo consumption, and without their deriving
any immediate benefit." (Hayek offered this statement as the "usual presentation,"
objecting to it only because it supposedly works through a change in the
overall value of money rather than through a change in relative prices.)
In Prices and Production, Hayek ( 1967, p. 88) denied even
the possibility of overconsumption in the sense later emphasized by Mises.
His discussion of the situation created a by cheap-credit investment boom
is to the point: "[A]s thing are, for some time, society as a whole will
have to put up with an involuntary reduction of consumption."
(8) Hayek does allow for an increase in consumer demand and for
this increase having significant price effects, but he allows for no positive
quantity effects in the early phases of the boom. It is as if the supply
of consumption goods were in fact perfectly inelastic. He even allows for
the increase in incomes of workers and other factor owners and for the
resulting increases in consumption demands to drive the price of consumer
goods still higher. Hayek ( 1967, p. 89) insists, however, that during
the boom, "these decisions [i.e., increased consumption demand] will not
change the amount of consumers' goods immediately available."
If we were to lay stress on the word "immediately," we could take Hayek
to be making the simple and obvious point that these goods do not and cannot
simply pop into existence; all production activities take time; resources
have to be reallocated. Hayek's own emphasis, however, makes clear that
his meaning is something different. For him, the eventual increased
consumption characterizes the end of the boom. Using italics, he
makes the "fundamental point" that the increase in consumer demand means
"a new and reversed change of proportion between the demand for consumers'
goods and the demand for producers' goods in favour of the former."
In summary terms we can say that Hayek sees the boom-bust cycle as forced
saving, which is
eventually countered by intensified consumption
demand; Mises sees the boom as malinvestment, which is immediately compounded
by overconsumption. We now understand that Hayek's forced saving and Mises's
malinvestment are the same thing. But how do we understand the contrast
of views about the corresponding pattern of consumption?
At this point there seems to be no room for reconciling the two views.
We must ask instead: Which is more consistent with our understanding of
the market forces set in motion by credit expansion? Several considerations
suggest that Mises's view is the more consistent and the more plausible
of the two.
First, for Hayek's view to be correct, there must be an accounting of the
time lag between the increased allocation of resources toward the early
stages and the subsequent reallocation in the direction of late stages.
Why wouldn't workers and other factor owners in the early stages spend
their higher incomes on consumer goods almost immediately? And why wouldn't
entrepreneurs respond to the increased demand so that there would be not
only a price effect but also a quantity effect? These are the questions
posed by John Hicks (1967) in his critique of Hayek's version of the theory.
Hicks could find no basis for such a lag and thus concluded that the counter-movement
of resources would set in almost immediately. The Hayekian business cycle
would end just about as soon as it began. (9)
Comparing Hayek with Mises (or Hayek and Strigl), we see that there is
an alternative answer: While there is no lag between earning money (in
the early stages) and spending it (on consumables), there is scope for
both malinvestment and overconsumption to take place at once. Thinking
strictly in terms of the Hayekian triangle, we can envision a pattern of
reallocation in which both early and late stages get increased allocations
at the expense of middle stages. This understanding of the market process
set into motion by credit expansion helps dramatize the notion that malinvestment
and overconsumption are compounding problems. And even beyond this two-way
distortion of the intertemporal pattern of resource allocation, there is
scope for temporary, i.e., unsustainable, increases in production all around.
Both capital and labor can be employed more intensely than is possible
on a sustainable basis. Routine maintenance of machinery can be postponed,
and the machinery can be kept running more hours per day or more days per
week than usual. A greater proportion of the population can be drawn into
the labor force, some workers can work overtime, and others can postpone
retirement. These considerations allow for the production of both investment
goods and consumption goods to increase simultaneously but, of course,
not on a sustainable basis.
Second, Hayek may have allowed the "rather unfortunate expression," forced
saving, to mislead him into the belief that income earners, like it or
not, were actually saving. What else could he mean when he wrote, as quoted
above, that "for some time, society as a whole will have to put up with
an involuntary reduction of consumption"? To the extent that such reductions
actually occurred, the resources would in fact be available to continue
the credit-driven investment activities, and the subsequent crisis would
be less severe. The problem is precisely that people do not forgo
current consumption. The telling point, as recognized by Mises, is that
the incentives they actually face are pushing in exactly the opposite direction.
Third, even a casual understanding of economic conditions created by credit
expansion warns against arguing that people are somehow forced to save
while the economy becomes more capital intensive. The Roaring '20s, (and,
later, the Bullish '80s and the Dot.com '90s) were years of high consumption.
And the high consumption—the overconsumption—is driven by the same set
of incentives that drives the malinvestment. Further, we should recognize
that it's the "good times" (read: high consumption) associated with artificial
booms that make credit expansions so attractive to elected officials and
policymakers. Policies that actually did force people to reduce consumption
would not likely be included in any incumbent candidate's re-election strategy.
All of these reasons for questioning Hayek's view of the pattern of consumption
during the boom-bust cycle are also reasons for accepting Mises's view:
Credit expansion gives rise to malinvestment (a.k.a. "forced saving") and,
at the same time, overconsumption. On the eve of the bust, market conditions
change such that income earners actually do curtail consumption and save
instead. This forgoing of consumption, which more-than-offsets the earlier
overconsumption, is a necessary part of the market process that takes the
economy back to a sustainable growth path. (10)
The case can be made for reserving the term forced saving to refer to this
eventual eve-of-the-bust curtailment of consumption. The discussion and
graphics (11) in the following section
make just such a use of the term. The analytical coherence of the story
that can be told with the aid of forced saving so conceived (together with
the overconsumption that precedes it) lends credence to our treatment of
these and related terms in the Mises-Hayek theory.
Overconsumption and Forced Saving by the Numbers
A change in actual saving behavior has effects
that can be represented by changes in consumption and in investment, the
latter being facilitated by the saving. The direction of change, which
is suggested by a straightforward application of loanable-funds theory,
can be depicted with the aid of a production possibilities frontier (PPF)
showing sustainable combinations of consumption (on the vertical axis)
and investment (on the horizontal axis). (12)
An increase in saving allows for an increase in investment by curtailing
consumption; the economy moves clockwise along the PPF. A decrease
in saving allows for an increase in consumption by curtailing investment;
the economy moves counterclockwise along the PPF.
The initial effects of credit expansion can be conceived as a hybrid of
the effects of (1) an increase in saving and (2) a decrease in saving.
Credit expansion increases both investment and consumption without there
being any corresponding curtailment. In effect, it combines the positive
aspects of the opposing preference changes but eliminates (or, rather,
postpones) the negative aspects. Figure 2 depicts an macroeconomy in terms
of the PPF, the corresponding supply and demand for loanable funds, and
the Hayekian triangle. The solid points represent a fully employed economy
with a market-clearing rate of interest, such that saving is equal to investment.
Credit expansion is depicted by the augmented supply of loanable funds.
With Saug in play, the rate of interest falls from ieq
toward i', motivating savers to save less and investors to invest more
(as shown by the two hollow points in the loanable-funds diagram).
(13) The decreased saving translates into the PPF diagram as
increased consumption. Thus, conflicting forces in the loanable funds market
correspond to forces in the PPF diagram that are inconsistent with the
economy remaining on its frontier. Market forces are pushing the economy
neither clockwise nor counterclockwise along the PPF but rather are pushing
in a direction nearly orthogonal to the frontier. The levels of consumption
and investment consistent with the two hollow points in the loanable-funds
diagram correspond to a hollow point that lies beyond the PPF. The very
nature of this hybrid effect helps to explain why credit expansion has
such strong political appeal.
To allow for market forces that are pushing towards some point beyond the
frontier during a credit expansion is to recognize that there will actually
be some movement—some quantity adjustments—in that direction. New money
is being lent to the business community and spent on investment projects.
Closely on the
heels of this effect, workers and other factor owners are earning greater
incomes and spending them to a larger extent than before on consumption
goods. In the early phase of the expansion, it doesn't much matter that
it is the business community that gets the new money first. There is no
significant lag between the earning and the spending. It all happens, according
to John Hicks (1967, p. 208), within a "Robertsonian week." Resources are
reallocated on the basis of conflicting market signals.
The low interest rate that accompanies the boom phase of a credit expansion
directs resources to the early stages of production. But at the same time,
the increased demand for consumption goods is accompanied by an increased
(derived) demand for resources in the very late stages. Resources are pulled
in that direction, too. For a time both kinds of policy-induced misallocations
can occur, as depicted as a double distortion of the Hayekian triangle.
The misallocation of resources (both malinvestment and overconsumption)
shown in Figure 2 corresponds to the economy that has reached the hollow
diamond point along the adjustment path that extends beyond the PPF. The
Hayekian triangle shows resources being allocated away from middle stages
of production in both directions. This movement would translate into Strigl's
account of the unsustainable boom as increased consumption and increased
long-term capital creation, both made possible, in part, by the undermaintenance
of existing capital. John Cochran (2001, 19) has introduced the memorable
term “dueling production structures” to refer to this conflicted pattern
of resource allocation.
While the Hayekian triangle of Figure 2 gives us a snapshot of one point
in the adjustment path, Figure 3 allows us to track the adjustment by the
numbers. The hollow diamond point in Figure 2 translates into Figure 3
as Point 1, where the economy is experiencing both overconsumption and
Not far beyond the PPF the limits imposed by scarcity become increasingly
binding, but the low rate of interest continues to favor investment over
consumption. At this point it does matter that the investment community
gets the new money first. (14) Resources
continue to be bid into the early stages, while production processes
that were in their middle stages at the beginning of the expansion—and
from which resources were being misallocated at point 1—now begin to yield
a declining volume of consumables. Overconsumption, measured by the vertical
displacement from the initial equilibrium, reaches its maximum at point
2. At point 3 forced saving in the sense most conformable with overconsumption
sets in. (15) Projects that were in their
middle stages at the outset of the expansion are now reaching maturity.
Earlier misallocations have reduced the supply of consumables now available,
and at the same time, interest rates have risen (not shown in Figure 2)
in the face of distress borrowing by the business community. The boom is
faltering; the consumers are under duress. Overinvestment reaches its maximum
level at point 4, where the continued investment in early stages of production
can be accommodated only by drawing resources from the late and final stages
of production. (16) With forced saving
continuing at point 5, liquidation has begun. Amid bankruptcies and other,
less dramatic reorientations of businesses, resources can now be allocated
away from early stages of production and toward the late stages.
Under favorable institutional arrangements, the reallocation of resources
that follows the bust can bring business decisions back into conformity
with actual consumer preferences. In circumstances of the intertemporal
disequilibrium created during the boom, the needed liquidation will undoubtedly
take the economy inside the PPF. But in the absence of systemic perversities,
market forces will move the economy back in the direction of the initial
equilibrium. History suggests that there is clearly a danger, especially
in the face of ill-conceived policy actions by the monetary and fiscal
authorities and counterproductive measures of the
regulatory authorities, that the recovery phase will be preempted by spiraling
downward into deep depression. Points 6, 7 and 8 show the economy moving
to successively lower levels of both consumption and investment despite
its already having fallen below the PPF. This is the aspect of the downturn
that concerned Keynes in his
General Theory—which is why he couldn't
find application for the concept of forced saving in that book. Hayek (
1975, p. 176; 1975, p. 44) recognized that the downturn can feed on itself,
but he labeled this possible development a "secondary deflation" or "secondary
depression" to distinguish it from the more direct implications of an artificially
low rate of interest.
The discussion of Figure 3 adopts a labeling scheme that conforms reasonably
well with the use of terms in the literature. Figure 4 shows and labels
the possible four-way movements during the course of the boom-bust cycle.
The accompanying table indicates the nature of the actual movements at
points 1 through 5; movements at points 6 through 8 are summarily
labeled "secondary depression."
|POINTS ON PATH
Two further points of clarification are warranted. First, the direction
of movement indicated by the arrows have their most straightforward interpretation
in the context of a no-growth economy. In a growing economy, in which the
PPF is shifting outward, the arrows represent movements relative to trend.
Hence, a decrease in consumption may be only a decrease in consumption's
growth rate. Second, the real losses suffered as a result of resource misallocations
during boom-bust cycle will prevent the economy from fully recovering to
the initial equilibrium. That is, as a result of the cyclical episode,
the PPF itself will shift inward—or, allowing for ongoing growth, it will
shift outward at a slower rate.
The pattern of movement represented in Figure 3 is consistent with the
incentives and constraints associated with the business cycle as broadly
understood by the Austrian economists. Setting out the dynamics in this
way also helps to resolve terminological and substantive differences within
the Austrian school and to show why the term "forced saving" has been an
obstacle to understanding both within and outside that school.
Mises v. Hayek, Again
The most significant difference between Hayek's
and Mises's understanding of the issues lies in Hayek's taking an increase
in consumption to be a
reversal of the market process set in motion
by credit expansion. This aspect of Hayek's expostion readily translates
into an alternative PPF accounting of the process: The economy is forced
clockwise along the frontier. (If this is what Hayek had in mind,
his "forced saving" really is a forced reduction in consumption.) Then,
when income earners begin spending on consumer goods, the market forces
are reversed, and the economy moves counterclockwise back toward its original
intertemporal equilibrium. Continued attempts by the central bank to keep
the economy rotating clockwise along the frontier will, sooner or later,
throw it off the frontier in the direction of depression. This reckoning
is consistent with many passages in Prices and Production
There are two basic problems with depicting the effects of credit expansion
as a movement along the PPF. First, it denies without good reason that
a general overproduction is one of the effects. It treats the constraints
on the economy's overall output as if they were absolute physical constraints.
Second, it exposes the theory to the sort of criticism issued by John Hicks.
The basis for—and the duration of—the lag between the initial movements
along the frontier and the subsequent counter-movements are left
as unsolved mysteries. And in the absence of a lag, the policy-induced
boom is nipped in the bud by market forces. As it turns out, the two problems
are very much interrelated, and they have the same solution, namely, allowing
for movements beyond the PPF. That is, while there is little or
no lag between earning money in the early stages of production and spending
it on consumables, there is some scope for earning and spending beyond
the PPF, that is, for the (temporary) expansion of output beyond the sustainable
level. This understanding is more consistent with Mises' "overconsumption
and malinvestment" than with Hayek's "forced saving."
There remains, however, an inconsistency in Mises' characterization of
the boom. Mises allows for—and even emphasizes—overconsumption but does
not allow for—and even denies—overinvestment. By overconsumption, Mises
can't mean a counterclockwise rotation along the PPF. This movement would
be contradictory to his understanding of malinvestment. Nor is the term
intended to mean "relative overconsumption" in the sense suggested
by Hayek or merely a tendency towards overconsumption but one that
does not materialize as actual quantity adjustments. He must mean an actual
(but temporary) movement beyond the frontier in the direction of consumption.
Consider, for instance, that overconsumption "squanders capital and impairs
the future state of want-satisfaction" (Mises, 1966, p. 432). Also, "the
immediate consequence of credit expansion is a rise in consumption on the
part of those wage earners whose wages have risen on account of the intensified
demand for labor displayed by the expanding entrepreneurs" (p. 556). "As,
apart from forced saving [which occurs later in the process in accordance
with Figure 3], the boom itself does not result in a restriction but rather
in an increase in consumption" (p. 559). And again, "the boom affects also
the consumers' goods industries. They too invest more and expand their
production capacity" (p. 560).
If entrepreneurs in both the early stages and in the late stages are investing
more and expanding their production capacity, how can there be no overinvestment?
As already argued, some of the resources are drawn from the middle stages.
(This is the aspect of the policy-induced misallocations that, in due course,
necessitates forced saving in excess of the prior overconsumption.) But
it would be difficult—and unnecessary—to argue that all of the misallocated
resources must have such origins. There is some scope for overinvestment.
The employment of labor beyond the level that can be sustained indefinitely
allows for the expansion of productive capacity in most all stages of production.
In the absence of this overinvestment and abstracting from ongoing growth,
the Austrian theory would have output levels in middle stages actually
falling—and falling enough to accommodate expansions in both early and
late stages. But with the possibility of overinvestment taken into account,
the theory can allow for the output level in most stages to be rising—but
rising more rapidly in the early and late stages in comparison to the middle
stages. This combination of absolute and relative effects makes the theory
more plausible and squares the theory with our understanding of the PPF.
Mises (1966, p. 559), however, was insistent that malinvestment and not
overinvestment was the essential feature of the boom. He attributed
the common misperception of the matter to faulty observation.
The observer notices only
the malinvestments which are visible and fails to notice that these establishments
only because of the fact that other plants—those
required for the production of complementary factors of production and
those required for the production of consumers' goods more urgently demanded
by the public—are lacking" (emphasis added).
The italicized "only" in this passage is unwarranted.
The resources are coming only partly from later stages; they are
also coming from the increased use of labor and capital equipment beyond
the levels associated with full employment. Notice, too, that whereas this
passage seems almost to deny overconsumption, consistency would demand
that Mises issue a similar statement to the effect that the observed overconsumption
is achieved only by the withdrawal of resources from the earlier
stages of production. Mises (1966, p. 560) illustrates the essential malinvestment
with a parable in which both overinvestment and overconsumption are ruled
out by construction. During an artificial boom,
the whole entrepreneurial
class is, as it were, in a position of a master-builder whose task it is
to erect a building out of a limited [i.e., fixed] supply of building materials.
If this man overestimates the quantity of the available supply, he drafts
a plan for the execution of which the means at his disposal are not sufficient.
He oversizes the groundwork and the foundations and only discovers later
in the progress of the construction that he lacks the material needed for
the completion of the structure. It is obvious that our master-builder's
fault was not overinvestment, but an inappropriate employment of the means
at his disposal.
Mises' parable is a memorable one for its vivid illustration of a point
that is wholly ignored outside the Austrian school. But it does not demonstrate
the absence of overinvestment any more than it demonstrates the absence
of overconsumption. And since Mises had affirmed—even emphasized—the problem
of overconsumption in a less restrictive setting than is created for his
master-builder, he should have no reason to deny the problem of overinvestment.
What he should deny, of course, is that overinvestment is the whole
As understood in the context of a macroeconomy, it would seem that while
malinvestment is unique to the Austrian theory, both malinvestment and
overinvestment (along with overconsumption) are essential to it. Malinvestment
without overinvestment would allow the counter-movements to set in early,
undoing the damage before much damage is done. Overinvestment (along with
overconsumption) without malinvestment would allow the economy to experience
a temporarily high growth rate, moving first beyond and then back to the
PPF but without there being any intertemporal misallocations requiring
painful adjustments that can send the economy inside the frontier. Only
with both prefixes (mal- and over-) in play do we have (1) a problem of
intertemporal misallocation and (2) time for that problem to fester before
the internal conflict of market forces eventually turns boom into bust.
Reconciling Within and Beyond the Austrian
In describing the ill-fated growth path depicted
in Figure 3, "overconsumption" and "forced saving" are cognates. The market
forces set in motion by credit expansion cause income-earners first to
consume more than they otherwise would have and then to consume less than
they otherwise could have. This use of the terms squares fully with Mises'
use of "overconsumption" and with several instances of his use of "forced
saving." The corresponding "overinvestment," though denied by Mises, is
consistent with a full understanding of the nature of the credit-driven
Hayek's use of "forced saving," as Schumpeter suggested, is better avoided,
if only because what is called saving is actually investment. Still, his
usage is broadly in line with the meaning that corresponds with the downward
movement of the economy's adjustment path as depicted in Figure 3. Narrow
and broad understandings are captured in a summary treatment of the issues
in Garrison (2002, p. 66):
On the eve of the bust,
distress borrowing allows some producers to finish their projects and minimize
their losses. In this phase, the high interest rates bolstered by distress
borrowing cause people to curtail their consumption and to save instead.
The resources thus freed up constitute an explicit form of 'forced saving'—a
term used more broadly by Hayek to characterize all the boom-related commitments
of resources that are at odds with consumers' time preferences.
The view that economic booms were characterized by overinvestment was commonly
held when the Austrian theory was being developed. This view is still clearly
evident in today's mainstream macroeconomics. Monetary expansion sends
the economy up an upward-sloping short-run aggregate supply curve. Or,
alternatively, the economy moves up along a downward sloping short-run
Phillips curve. (The effects of monetary expansion could be similarly expressed
in the context of New Classicism or New Keynesianism.) In these reckonings,
overproduction relative to the output levels associated with the corresponding
long-run aggregate-supply and Phillips curves is the essence of the boom.
And owing to the underlying structure of this mainstream theorizing, namely,
the high level of aggregation adopted, there is no accounting for malinvestment
or for forced saving in any of the relevant senses without fundamentally
recasting the theory.
The opportunity for reconciliation is quite different from the Austrian
point of view. The movements of the mainstream aggregates are both plausible
and consistent with casual observation. There is little to be gained in
denying these movements and insisting that the boom is characterized exclusively
by misallocations within the output aggregate rather than misallocations
accompanied by a temporary bloating of the aggregates themselves. In fact,
as this paper has argued, a productive reconciliation lies in the direction
of incorporating just such movements of aggregate output into the Austrian
theory. With these movements (overconsumption as well as overinvestment)
taken into account, the Austrian theory encompasses mainstream theory and
observations while at the same time enhancing its own internal logic.
Böhm-Bawerk, E. ([1884, 1889,
and 1909] 1959) Capital and Interest, 3 vols., South Holland, Ill.:
Brimelow, P. (1982) "Talking Money
with Milton Friedman,"
Barron's, 25 October, 6-7.
Caldwell, B. (1995) "Introduction,"
in B. Caldwell (ed.)
Contra Keynes and Cambridge, Chicago: University
of Chicago Press, 1-48.
______ (1998) "Why Didn't Hayek
Review Keynes's General Theory?" History of Political Economy, 30(4),
Cochran, J. (2001) "Capital-Based
Macroeconomics: Recent Developments and Extensions of Austrian Business
Cycle Theory," Quarterly Journal of Austrian Economics, vol. 4,
no. .3, pp. 17-25.
Cowen, T. (1997) Risk and Business
Cycles, London: Routledge.
Ebeling, R. (2002), "Fritz machlup
and His Early Writings: A Summary and Appriciation," conference paper,
Southern Economic Association meetings, New Orleans, Louisiana, November.
Garrison, R (1995) "Linking the
Keynesian Cross and the Production Possibilities Frontier,"
of Economic Education, 26(2), 122-130.
_____(2001) Time and Money: The
Macroeconomics of Capital Structure, London: Routledge.
_____(2002) "Business Cycles: Austrian
Approach," Snowden and Vane, eds., Encyclopedia of Macroeconomics,
Edward Elgar. pp. 64-68.
_____( 1967) Prices and
Production, 2nd edn, New York: Augustus M. Kelley.
_____( 1975) Monetary Theory
and the Trade Cycle, New York: Augustus M. Kelley.
_____( 1975) Profits, Interest
and Investment, New York: Augustus M. Kelley.
_____(1975) Full Employment at
Any Price?, Occasional Paper 45, London: Institute of Economic Affairs.
_____( 1978) "Three Elucidations
of the Ricardo Effect," in F. A. Hayek, New Studies in Philosophy, Politics,
Economics and the History of Ideas, Chicago: University of Chicago
_____(1984) Money, Capital, and
Fluctuations: Early Essays, ed. by Roy McCloughry, Chicago: University
of Chicago Press.
Hicks, J. R. (1967) "The Hayek Story,"
in J. Hicks, Critical Essays in Monetary Theory, Oxford: Clarendon
_____(1985 ) "The Monetary
Policy of the United States after the Recovery from the 1920 Crisis," in
F. A. Hayek, Money, Capital, and Fluctuations: Early Essays, Chicago:
Howson, Susan (2001) "Why Didn't
Hayek Review Keynes's General Theory?-A Partial Answer," History of
Political Economy, 33(3), pp. 369-374.
Keynes, J. M. (1936) The General
Theory of Employment, Interest, and Money, New York: Harcourt, Brace,
_____(1930) A Treatise on Money.
2 vols. London: Macmillan.
Machlup, F. ( 1963) "Forced
or Induced Saving: An Exploration into its Synonyms and Homonyms," in Essays
on Economic Semantics, Englewood Cliffs, NJ: Prentice- Hall, pp. 213-240).
Menger, C. ( 1981) Principles
of Economics, New York: New York University Press.
Mises, L. ( 1953) The Theory
of Money and Credit, New Haven, Conn: Yale University Press.
_____(1966) Human Action: A Treatise
on Economics, 3rd rev. edn, Chicago: Henry Regnery.
_____(1969) Theory and History:
An Interpretation of Social and Economic Evolution, New Rochelle, New
York: Arlington House.
_____(1978) On the Manipulation
of Money and Credit, Dobbs Ferry, NY: Free Market Books.
Robinson, J. (1972) "The Second
Crisis in Economic Theory,"
American Economic Review, 62(2)
Strigl, R. ( 2000)
and Production, trans, M. Hoppe and H. Hoppe, Auburn, Alabama: Ludwig
von Mises Institute.
Sraffa, P. (1932) "Dr. Hayek on
Money and Capital," Economic Journal vol. 42, no. 165, pp. 42-53.
Wicksell, K. ( 1962) Interest
and Prices. New York: Augustus M. Kelley.
1. The earliest
expositions of the theory focused on alternative originating causes. Following
Lord Overestone (and Knut Wicksell), Mises (1978, p. 135) believed that
it was some "outside stimulus" [such as technological change] rather than
credit creation that initiated the boom; Hayek ( 1975, pp. 143-148)
believed that in a setting where bank credit is elastically supplied, most
any real change could initiate a boom. Accordingly, he concluded that the
cyclical process "must always recur under the existing credit organization,
and that it thus represents a tendency inherent in the economic system,
and is in the fullest sense of the word an endogenous theory (emphasis
original). His most comprehensive analysis (Hayek,  1967, p.
54), however, focused on "the case most frequently to be encountered in
practice: the case of an increase of money in the form of credits granted
2. The article
in which the note appears, "The Monetary Policy of the United States after
the Recovery from the 1920 Crisis" in Hayek (1984), is an extract from
a longer work first published in German in 1925.
3. The use here
of the adjective "forced" and the prefix "over-" reflects common usage
in the literature. The doctrinal issues could be sharpened by contrasting
"forced saving" with the analogous "forced consumption" or "overconsumption
with the analogous "oversaving."
4. Without referencing
the Austrians, Milton Friedman (Brimelow, 1982, p. 6) has explained at
least one instance of high interest rates on the eve of the bust in terms
of "distress borrowing" by the business community.
5. For the references
to both Strigl and Machlup, I am indebted to Richard Ebeling, who presented
a paper titled "Fritz Machlup and His Early Writings: A Summary and Appreciation"
at the Southern Economic Association meetings in New Orleans in November
2002. Ebeling demonstrates on the basis of a 1933 hand-written Machlup
lecture on file at the Hoover Institution that Machlup was fully aware
of the differences between Hayek and Strigl on the issue of overconsumption.
(Machlup's understanding of Strigl is based on a conference paper that
predated Strigl's book.) Ebeling also notes the match between Strigl's
accounting of the credit-induced distortions of the production process
in his Capital and Production (1934, pp. 130-31) and my own graphical
representation in Time and Money (Garrison, 2001, p. 69.)
6. We can imagine,
however, that in light of the trouble Hayek had in defending the idea of
forced saving [i.e., malinvestment] before his English audience in 1931
(Robinson, 1972), he would not have been eager to add that overconsumption
was occurring at the same time.
analysis gets attention in Hayek's stocktaking article, "The Present State
and Immediate Prospects of the Study of Industrial Fluctuations," originally
published in German in the 1933 Festschrift für Arthur Spiethoff
and included in translation in Hayek ( 1975, pp. 171-182).
consistency with this and similar statements, Bruce Caldwell (1995, p.
16) builds into the definition of forced saving the actual forgoing of
consumption: "[Consumers] are forced to consume less than they desire;
Hayek accordingly attached the term 'forced saving' to this phenomenon."
9. Though without
reference to Hicks' criticism, Tyler Cowen (1998, p. 97) reintroduces the
lag problem in terms of the first-, second-, and third-round recipients
of newly created funds. Once the new money has passed through the hands
of commercial banks, business borrowers, and factor owners, these factor
owners spend it in accordance with unchanged saving/consumption preferences.
Thus, the Austrian theory, according to Cowen, fails to explain how the
boom persists beyond the spending of these third-round recipients of the
10. Hayek never
recognized that the element of overconsumption was critical in responding
effectively to the criticisms offered by Sraffa and (later) by John Hicks.
Instead of allowing for overconsumption, Hayek (1978) offered his mound-of-honey
analogy to support the notion of a substantial lag between the increased
investment spending and the subsequent increase in consumption. (Pouring
money into the economy is like pouring honey into a vat: Where the honey
hits the surface, a mound forms and persists as long as the pouring continues.
Analogously, where the new money is injected into the economy, misallocations
occur and persist as long as the injections are continued.) Understandably,
Hicks found the analogy unhelpful. Taking account of overconsumption would
also have been critical in Hayek's offering a coherent view of boom and
bust that could compare favorably with the view offered by Keynes. If it
was even dimly perceived that there was a problem here with his own formulation,
the lacking of a ready solution could very plausibly be a part of the answer
to the question, asked by Bruce Caldwell (1998), "Why Didn't Hayek Review
Keynes's General Theory?" Such an answer is not included in—but
is not at odds with—the "Partial Answer" offered by Susan Howson (2001).
11. The graphical
portrayal is adapted from Garrison (2001), a book in which doctrinal issues,
such as the ones addressed here, are downplayed.
12. The PPF
of Figure 2 shows combinations of consumption and investment that are sustainable,
implying that combinations
beyond the frontier are unsustainable.
Conventional presentations of this graphical device label the area outside
the frontier "unattainable." Certainly, for points very far outside it,
this adjective is appropriate. But many of those same expositions identify
the frontier itself as entailing the "full employment" of labor and other
resources. For macroeconomic applications, then, "unattainable" should
be understood as "unsustainable." An economy with an unemployment rate
temporarily below the so-called natural rate is producing an output that
lies beyond the frontier. Similarly, an economy in which capital equipment
is being pressed beyond its normal limits is producing an output that lies
beyond the frontier. This is only to say that for the PPF to be useful,
the frontier has to depict the macroeconomically relevant limits to production
and not some physical or absolute limit.
13. Had the
expansion been financed by increased saving rather than by credit expansion,
the economy would have moved along the PPF to the small hollow point.
14. The dynamics
of a transfer expansion, during which the money goes first to consumers,
would entail a rotation in the direction of consumption. See Garrison,
2001, p. 76.
15. It may be
helpful in some applications to distinguish between forced saving relative
to the maximum overconsumption and forced saving relative to the pre-expansion
16. It should
be noted that if, at this point in the cycle, the central bank aggressively
keeps the interest rate low, the faltering demand for investment goods
may be offset by an increased demand for consumer durables, complicating
the adjustment path in ways not allowed for in Figures 2 and 3.
17. This Hayekian
understanding is incorporated in Garrison (1995), where overconsumption
plays no role in the account of boom and bust. The allowance for movements
beyond the frontier (both overconsumption and overinvestment) in Garrison
(2001) constitutes a critical difference between these two expositions,
the 2001 exposition having the greater logical integrity. Machlup, as reported
by Ebeling (2002, p. 8), offers an account of Hayek's formulation and recognizes,
in effect, that the expansion and subsequent contraction are represented
along the PPF: "Hayek holds that additional credit
will increase the demand for capital goods and that the production of production
goods will be enlarged at the expense of the production of consumer goods.
Only in a later step [will the] the inserted credit, converted into income
of the employed factors,... increase the demand for consumption goods,
rendering unprofitable the enlarged construction goods industries." Maclup
considered Strigl's formulation superior to Hayek's in this regard.
18. Though more
plausible and more consistent with Mises's emphasis on overconsumption,
this understanding suggests that Mises original account of the "counter-movements,"
which features in summary fashion the prices of consumption goods relative
to the prices of production goods, is inadequate. (I owe this observation
to Ivo Sarjanovic.)