The following points highlight the six major criticisms of Hayek’s theory of the trade cycle. Some of the criticisms are: 1. Restrictive Assumption of Full Employment 2. Unrealistic Assumption of Equilibrium 3. Undue Importance to Interest Rate Changes 4. Unreal Concept of Forced Saving and Others.
Criticism # 1. Restrictive Assumption of Full Employment:
The theory is based on the classical assumption of full employment in the economy.
This is why it asserts that expansion of producers-goods’ output can be possible only at the expense of consumer- goods’ output.
If the boom starts when there are unutilized labours or capital resources, then it can continue for quite some time without distorting production.
Criticism # 2. Unrealistic Assumption of Equilibrium:
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This theory also takes the unrealistic assumption that saving equals investment and the economy is in equilibrium initially which is disturbed by banks deciding to create extra credit. In fact, disturbances to equilibrium can come from many sources, some inside the system and others from outside.
Criticism # 3. Undue Importance to Interest Rate Changes:
Criticism has also been directed at the prominent place given to changes in the rate of interest by Hayek. In fact, the rate of interest is not so flexible as to influence the capital intensity of production. Business firms do not bother in the short period for small changes in the rate of interest. They are more influenced by changes in the expected rate of profit occurring in the phases of the trade cycle.
Criticism # 4. Unreal Concept of Forced Saving:
In Hayek’s analysis, expansion of the producers-goods sector is made possible by forced saving from the consumers when incomes get redistributed. If the group with reduced incomes is obliged to restrict consumption and the group having higher incomes voluntarily refrains from raising consumption to the same extent, there is no forced saving. Thus, the concept of forced saving used by Hayek is illusory.
Criticism # 5. Questionable Nature of Explanation of the Crash:
Hayek has argued that higher incomes in the hands of consumers would push up the profitability of consumer goods relatively to that of capital goods. This brings about a crash of the boom. This line of reasoning has been questioned by Fisher and Keynes.
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Increased profitability of the consumer-goods industries automatically means a higher rate of return over cost or what Keynes calls MEC. It stimulates investment, not discourages it.
Criticism # 6. Explains Only the Expansion Phase:
This theory explains only the expansion phase of the business cycle. It has no convincing logic for the upturn after depression. Since the theory fails to explain both the turning points of the trade cycle, it is unable to explain the periodicity of the business cycles.
In short, Hayek’s theory was faulty in so far as it tried to integrate unsuccessfully the monetary factors and the real factors for explaining the full trade cycle. But it had a strong point. This was the relative overinvestment in capital-goods production.
It has been recognized by economists like G. Cassel and Robertson that excessive investment is the principal destabilising element in the economy. It can be said that the monetary system is only a part of the response mechanism in the process of cyclical changes in economic activity and not a causative factor.