Sourced from The Mises Circle Blog. Page 39 Prices and Production.

 

Introduction:

 

The Hayekian Triangle is a visual representation of the stages of production. Many professional Austrian economists refer to it as a pedological device for explaining the Austrian Business Cycle Theory (Block & Barnett, 2006, P.2) [1]. Above all, it is something of an outlier in the Austrian School of Economics. Due to the methodological rejection of the Neo-Classical approach, graphs and equations are rarely ever used. Despite this methodological consideration, the Haykeian Triangle is viewed by many as being imperative in understanding “boom-bust” business cycles. Even though some prominent Austrian economists such as Walter Block have expressed their grievances with this depiction of ABCT.

 

The triangle was first introduced by Nobel Laureate F.A. Hayek in his 1931 book Prices and Production (revised in 1935). Presenting the variable of time on the Y-axis and output of consumer goods on the X-axis.  Forming a right triangle. Per Hayek’s own explanation:

…. means of production is expressed by the horizontal projection of the hypotenuse, while the vertical dimension, measured in arbitrary periods from the top to the bottom, expresses the progress of time,  so that the inclination of the line representing the amount of original means of production used means that these original means of production are expended continuously during the whole process of production. The bottom of the triangle represents the value of the current output of consumers’ goods. The area of the triangle thus shows the totality of the successive stages through which the several units of original means of production pass before they become ripe for consumption.  (Hayek, 1931, P.39-40) [2]

 

The triangle diagrams the relationship between time and productive output. It measures this relationship from the harvesting and producing higher-order goods (those in earlier stages of production. All the way to the final phases of production such as packaging. Hayek’s diagram also details the amount of capital deployed into production per a specific stage. Per his observations, all variables unencumbered by manipulation, more money is spent in the earlier stages of production (Hayek, 1931, P.53) [3]. The amount tends to decrease in the later stages. Much of the variance in resource allocation throughout the stages of production mirrors consumer demand.

 

Understanding consumption patterns is key to production. As acting individuals, we can either save, invest, or spend money.  The entrepreneur who is managing the production of consumer goods will cater it patterns of buying behavior (Hayek. 1931. P.50) [4]. If consumers are saving more and spending less demand will go down. Consequentially, savings are not necessarily detrimental. Despite the Keynesian consensus that drop-in aggregate demand will bring the economy to grinding stop. Commonly known as the Paradox of Thrift. When consumers start saving they become more future ordinated as Dr. Roger Garrison would put it. They put off present consumption today for future consumption. This can include investment. Investment differentiates itself from consumer consumption by aiding production potential. An increase in investment now can help producers acquire capital to expand production capacity later (Hayek, 1931, P.60, 88) [5].

 

One fact that cannot be overstated is how the loanable funds market parallels production. When demand is low prices are low and vice versa. It is important to remember that all sectors of the economy are interconnected. Under normal conditions, interest rate fluctuations, supply-and-demand drives the rate. Much how consumer prices do the same. If consumer demand is low prices will reflect demand. The same goes for acquiring a loan. When consumer demand is low production hits a lull. However, consequentially the going interest rates will be low as well. Making it an ideal time to get a loan to upgrade old and worn-out equipment. As more business people acquire loans the interest rate will naturally increase. It is no more different than any other segment of the economy. Just a different product.

 

Because consumers are not ravenous demand new products, more money is spent on starting production. Hence, the greater expenditures in the earlier stages. There isn’t any immediate need to have completed products. Once consumer demand starts to increase more business owners will be acquiring loans to increase production. Driving the interest rate upward. Then as the interest rate increases, fewer entrepreneurs will be taking out loans. This will impact demand on the loanable funds market. Once the price for consumer goods increases there will be a decline in demand for products and services.  Bringing us right back to where we started. Lower interest rates, prices, and product demand. This cycle is cylindrical and self-regulating. Per popular consensus of Austrian economists will result in economic growth.

 

The problem becomes that often policymakers seek to interfere with this process. This circles back to the Paradox of Thrift. When consumer confidence is down, lowering interest rates operate as a form of stimulus. Whether they are lowered to out of genuine concern for the economy or callous political opportunism is irrelevant. It is still an erroneous course of action. Artificially decreasing the interest rate will lead to malinvestment (Hayek, 1931, P.58) [6]. Entrepreneurs borrow money for projects that would not be profitable to undertake with higher interest rates (Hayek, 1931, P. 86) [7]. They will invest more money into the earlier stages of production when consumer demands reflect more emphasis on the later stages. Also, they will be bold enough to undertake entrepreneurial ventures that require long production times.

 

The mechanism by which institutions such as the Federal Reserve lowers interest rates is important to note. They engage in credit creation by injecting more currency into the money supply. In other words, they get the printing presses up and running. Trading purchasing power for liquidity. This will result in higher prices for consumers. This is known as inflation. Prices will continue to rise until the institution manipulating the interest rate finds the rate of inflation to be exorbitant. Subsequently decides to lower the interest rate (Hayek, 1931, P. 90) [8].  Alternately, the rate of inflation becomes so hight that people stop using U.S. fiat currency altogether (Murph, 2015, P.253) [9]. That is an extreme example, reserved for the most extreme cases of hyperinflation.  Unfortunately, the bubble has burst and the fall out is just beginning.  All the ventures started under the low-interest rates are now insolvent and cannot be completed (Hayek, 1931, P. 92).  Unless the borrower is able to complete the project at a loss. Resulting in mark failures and economic depressions.  Assumably worsening economic conditions than if the interest rate had remained unmanipulated.

 

In part II: we will examine the innovations made to the Haykeian Triangle by Dr. Roger Garrison. He attempted to revise the triangle, making it easier to be applied in a Neo-Classical context.

 

 

 

 

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