Keynesian (So-Called) Full-Employment Policies Are Implausible Because of the Ricardo Effect

In the practical world of business, the function of investment expenditure is to provide the capital necessary to increase the supply of consumption goods in the future. However, Keynes’s General Theory provides a macroeconomic analysis where investment is treated as a component of aggregate demand that may be used to boost employment both directly and indirectly via the multiplier process. In setting aside the functional purpose of investment, to produce a short-run model of employment and national income, Keynesian macroeconomics neglects a hugely important area of economics; that is, the determinants of the changing levels and composition of production through time.

Hayek argues that the strategy of an expansionary monetary policy as the means to reach full employment is explained by Keynes’s ignorance of Austrian capital theory. The successful implementation of roundabout production methods requires a prior provision of resources that is delivered by voluntary saving. Forced saving (which accrues whenever inflated consumption goods’ prices reduce real wages) is not a viable alternative, because the Ricardo effect tells cumulatively against roundabout production methods. The relevance of monetary expansion is clear. A macroeconomic investment boom launched upon the back of monetary expansion is an inevitable failure. Keynesian (so-called) full-employment policies are implausible because of the Ricardo effect.

--G.R. Steele, The Economics of Friedrich Hayek, 2nd ed. (Houndmills, UK: Palgrave Macmillan, 2007), 148-149.