Recently, Neoclassical (aka Strangeloop) was shocked to find out that Austrians don’t believe in the neutrality of money and do not adhere to the mechanistic interpretation of the quantity theory of money. I could tell by his reaction (complete shock) that he was unfamiliar with Austrian monetary theory (when Austrian’s say that money is non neutral, they are not saying that prices do not adjust in the long run). The theoretical differences between Austrian and mainstream monetary theory are highly technical but essentially revolve around the transmission mechanism, i.e., how monetary injections affect the structure of relative prices and how they influence economic variables (the mainstream employs the helicopter theoretical construct where cash balances are increased by a proportional amount to what individual’s already posses, for every single economic actor. The Austrians, on the other hand, focus on where the money is first introduced and how it is spent. Additionally there are significant differences when it comes to capital).
I found this passage from Roger Garrison that explains the Austrian position perfectly (especially to those that are only familiar with mainstream monetary theory):
I was surprised to hear that Austrians believe money is non-neutral in the long run. I suspected that a “bust” (structural re-adjustment and correction) implied that.
If, because the boom didn’t happen in the first place, the bust didn’t have to happen, wouldn’t people be better off in the long term? And isn’t that enough to establish that money is “non-neutral” in the long term?
If by “long run” you mean general equilibrium or the evenly rotating economy, then the question doesn’t even make sense, because money does not exist in such conditions. The demand for cash balances is due to uncertainty, which is absent in such conditions. In the evenly rotating economy what used to be money, if it exists at all, becomes a mere token: a numeraire.
Esuric, thank you for your attempt at clarification.
To be sure I have the gist of it, do Austrians claim money is non-neutral in the long-run because the distortions have such a long-lasting effect? Furthermore, do you believe “busts” correct the distortions?
The problems are (a) how do we define “the long run” (Japan has two lost decades) and (b) velocity is neither constant nor stable, which means that the market of interest continuously fluctuates around the natural rate, and this is true even in a free banking environment (in other words, we never truly achieve inter-temporal equilibrium). Thus, money continuously exerts an active influence on relative prices and therefore the allocation of resources, including the original factors of production (land and labor) and capital.
The bust attempts to correct the distortions, so yes. But this process is anything but smooth (during recessions market interest rates will temporarily exceed the natural rate of interest causing “secondary phenomena”), and the fact remains that money is only neutral (exerts no active influence on the structure of relative prices) if there is inter-temporal equilibrium (market rate of interest = the natural rate), which is an impossible condition in complex monetary economies.
In other words, if we assume a stochastic process towards a general equilibrium , where there is inter-temporal equilibrium, then we can say that money is neutral in the long run, but this process is entirely illusory. In fact, Austrian’s would argue that the concept of general equilibrium itself is entirely disconnected from reality (see Grayson’s response above). Simply put, Austrian’s, unlike the mainstream, believe that there is only perpetual disequilibrium (continuous change and continuous malinvestments).
And finally, the Monetarist story is merely one type of Austrian business cycle (where money is uniformly distributed to all economic actors) but which abstracts from extremely relative phenomena (assumes stable consumer preferences and ignores the structure of capital), and the Keyensian story merely explains the effects of “secondary phenomena.” The Austrian theory of cycles is extremely broad (most general and adaptable explanation).
I feel like I had correctly understood you to begin with (although I think we differed on what the “long-run” meant–I consider it post-bust, which never takes too radically long), but I’ll let your expertise be the judge on that! Plus, I appreciate the added elaboration.
I’m not sure mainstream economists actually believe market equilibrium exists, but that the world is near enough for equilibrium models to be meaningful.
I just want to make sure that you understand what I’m saying, in addition to the argument put forth by Garrison (which you clearly understand). Money is theoretically neutral in the long run if we assume a set of conditions that are not only unrealistic but are in fact impossible.
If you had to recommend one book (or article) that explains monetary theory in way that would be most agreeable to a “neoclassical” mind, what would it be?
The non-neutrality of money can easily be explained by pointing out that inflation transfers wealth from producers to non-producers, (producers must create a good and sell it for money, thus making someone else better off, in order to increase their supply of money, while inflationists can simply create money without making anyone else better off) and thus changes the economic structure of society permanently. For this reason, fractional reserve banking must ultimately cause the destruction of capitalism.
This is a tough question. I want to say Hayek’s Monetary Theory and the Trade Cycle (which I have a short study guide for, in case you’re interested) because it’s relatively short and hits on most of the major issues, but Hayek uses esoteric terminology (such as “money receipts” for nominal income). Roger Garrison’s papers are absolutely awesome, and he’s able to articulate Austrian theory to non Austrian economists (something most Austrian’s have a hard time doing), but I haven’t yet read his Time and Money.
Wicksell’s Interest and Prices is basically irrelevant at this point.
[quote=“[F. A. Hayek]
(http://mises.org/books/hayekcollection.pdf)”][M]oney bears a completely neutral relationship to the price of goods, and tends neither to raise nor to lower it. . . . Not a money which is stable in value but a neutral money must therefore form the starting point for the theoretical analysis of monetary influences on production, and the first object of monetary theory should be to clear up the conditions under which money might be considered to be neutral in this sense.
[/quote]