Reflections on the Pure Theory of Money of Mr. J. M. Keynes

Friedrich August von Hayek, August 1931 and February 1932

Hayek’s two-part review article examines the foundations of Keynes’s Treatise on Money, especially its treatment of profits, saving, investment, and the credit cycle. He welcomes its attention to saving and investment but argues that monetary analysis requires an adequate account of capital and production through time. The first installment scrutinizes Keynes’s definitions and fundamental equations; the continuation extends the criticism to interest, hoarding, and cyclical adjustment.

For profits in his view are considered as a “purely monetary phenomenon” in the narrowest sense of that expression.

Hayek challenges this treatment by distinguishing aggregate monetary results from changes within production. Profits in industries nearer consumption may coexist with losses in earlier stages, and their aggregate balance can conceal contractions in employment and investment. Changes in existing capital values likewise cannot be explained simply by comparing current receipts and expenditure. Because production takes time, current sales need not correspond to current production costs.

This objection informs Hayek’s criticism of investment aggregates. Additions to physical capital, the value of those additions, and changes in total capital value are distinct magnitudes. Treating investment as a single total obscures reallocations between stages of production. Nor can replacement be sharply separated from new investment: both depend on relative prices and expected profitability. The important choice concerns how far into the future production is directed, not merely how output is divided between consumption goods and investment goods.

But these two functions cannot be absolutely separated even in theory, because the essential function of the entrepreneurs, that of assuming risks, necessarily implies the ownership of capital.

Hayek’s objection to separating entrepreneurial and capital-owning functions reinforces his demand for an integrated account of production. Capital maintenance is itself an economic problem, not a fixed background against which monetary profits can be calculated. His appeals to Böhm-Bawerk and Wicksell concern the explanatory foundations of the Treatise.

All this would do no harm if his analysis of this complicating moment were based on a clear and definite theory of capital and saving developed elsewhere, either by himself or by others.

The equations, in Hayek’s reading, do not remedy this missing foundation. Current income cannot automatically be equated with the historical cost of current output during economic change. Measurement at base-date costs also has difficulty capturing altered production methods. His discussion of “efficiency earnings” questions the relation between contractual factor payments and average output costs. More broadly, he distinguishes equilibrium between saving and investment from price-level stability: productivity changes can alter prices without monetary disequilibrium.

The continuation asks how bank interest affects investment when it departs from the equilibrium rate. Hayek emphasizes changes in available investment funds rather than capitalization as an independent causal mechanism. Fixed capital depends on complementary circulating capital, so an interest-rate change affects different capital goods and production stages unevenly.

Saving must be understood through the resources it releases. Funds used to cover entrepreneurs’ losses may preserve existing capital without permitting additional investment. Hayek argues that credit expansion designed to create corresponding new investment would then exceed genuine saving. Lengthening production requires resources sufficient to sustain consumption until the more distant output becomes available.

His assessment is not uniformly negative. He values Keynes’s account of hoarding through bank deposits and securities expectations, recognizing that inactive income need not increase banks’ lending capacity. He nevertheless questions assumptions about buying in response to falling security prices and banks’ control over inactive balances. He also disputes the evidential force of the Gibson paradox for Keynes’s particular theory.

The concluding argument locates depression in the production structure established during the boom. Credit-induced investment may lengthen production without the voluntary saving necessary to sustain it. Renewed consumption demand then increases costs and renders some projects unprofitable. Deflation can aggravate contraction, but Hayek treats it as potentially secondary to this real maladjustment. The article insists that monetary disturbances must be traced through relative prices, heterogeneous capital, and production time. Its warning against renewed credit expansion follows from the possibility that sustaining expenditure may postpone the required reallocation of resources.