Contemporary Austrian Economics and Non-neutral Money

Peter J. Boettke has brought together a collection of young economists to outline the core propositions that make Austrian Economics distinct. The book – “Handbook on Contemporary Austrian Economics” – is an easy read and is perfect for someone with little background in economics, mainstream or Austrian, to gain a quick introduction to the science.

It also has some fodder for those at a higher level wishing to explore and develop further. While reading chapter 8 by J. Robert Subrick I was quickly reminded of why it is that the Austrian focus on non-neutral money is so important. It is, after all, one of the basic points that defines the Austrian theory of the business cycle.

When money is created through a supply-side policy, particularly fiat money with no heed to the profit-loss calculus that defines the supply of any good, its entry disrupts the balance that exists in the economy. This is in part because money serves as the common denominator that defines prices and allows us to compare our choices. It is also because money is that medium of exchange that we transact in and use to settle our debts.

When money enters an economic system, it does so via a particular person or business, and later through transactions spreads to other agents. As it spreads it is spent on goods, placing upward pressure on their prices. Inflation results. This inflation benefits some at the expense of others.

Since money must spread prior to price inflation occurring, the first user of the new money units will be able to purchase goods at the old pre-inflation prices. As this new money is spent, prices continually increase. In this way the first user of the money has greater purchasing power, as his money supply has increased but prices have lagged. The last user of a new money unit has less purchasing power. His supply of money has not increased until the very end yet prices already adjust upward before he receives this increase to his money holdings.

Many mainstream economists make the claim that money is non-neutral in the sense that changing its supply stimulates output. As the first users of money have more purchasing power, they spend the extra cash and this stimulates business and production – at least until prices catch up, but this won’t happen until the future. We thus see a very basic rationale for increasing the money supply during a crisis such as today’s.

Austrian economists also refer to money’s non-neutral property, but they make a much stronger claim. The claim is that money does not alter the amount of goods being produced, but rather the structure that produces those goods. As fresh money enters the economic system it alters the array of relative prices, making some more attractive for investment than others. As a result, entrepreneurs alter their investment plans, and an economy aligned not with the real demands and savings of its individuals arises, but rather one consistent with injections of new money.

The culmination of this process occurs when entrepreneurs see that the system is not held together by anything real, but rather by monetary manipulations.

Boettke’s edited collection explains this process in depth, as well as other key points defining the Austrian approach to economic science. It even includes a brilliant chapter by the Cobden Centre’s own Anthony Evans about why methodological individualism is important, and what it really means.

You can read my full review here (PDF).

9 Comments

  • Richard says:

    £75?! Seriously? A pity otherwise I would certainly buy a copy.

    Don’t the IEA have produced this much more cheaply?

  • gulp says:

    Ditto Richard. I’ll buy £75 worth of gold and wait ten years.

  • John Phelan says:

    Try Amazon, I got one for about £20

  • When some foreign entity waves their money in the air and orders goods from Britain (as I understand Austrian economics), that DOESN’T cause inflation.

    But when government creates new money and puts it into the hands of a UK entity who waves the money in the air and orders goods, that DOES cause inflation.

    If I’ve got that right, we could solve the problem by temporarily giving French or German passports to the first recipients of new money couldn’t we?

    But seriously, the question as to whether new money is inflationary depends on whether the economy is or isn’t already at capacity. If it IS AT CAPACITY, the new money will be inflationary, as David Hume pointed out 250 years ago. Whether those order the new goods are natives or foreigners is irrelevant.

  • Craig says:

    It’s US$39.95 at Amazon.com. Looks good. Must get.

  • Craig says:

    If I’ve got that right, we could solve the problem by temporarily giving French or German passports to the first recipients of new money couldn’t we?

    You do have it right. In fact, it’s what the U.S. has done for years. We export as much of our inflation as possible. It’s still inflation, nonetheless.

    But seriously, the question as to whether new money is inflationary depends on whether the economy is or isn’t already at capacity.

    That’s a common misconception. Inflation is vulgarly defined as “prices increasing.” And if prices don’t rise [or don’t rise much,] it is said that there is no inflation. But without new money added to the system, it is quite likely that many prices would fall due to increases in productivity and competition.

    If, with the new money, those prices remain stable — there has still been inflation.

    • Craig: You say “If, with the new money, those prices remain stable — there has still been inflation.” You are using the word “inflation” to refer to a MONEY SUPPLY INCREASE. That meaning of the word appeared in dictionaries 30 or 40 years ago. It no longer does. Nowadays, the word to refers to continuously rising prices, or words to that effect.

      Moreover, what’s the point in having a word with two meanings? It just makes for confusion. And finally, where it is impossible to avoid using an ambiguous word, one should make clear in what sense one is using the word.

  • corrigan says:

    If the economy is operating ‘below full capacity’ – whatever THAT actually means – new MONEY may not drive an obvious rise in prices OF THE UNDER-UTILISED resources, but you firegt to ask what happens when they or their owners take that money straight round to the owners of goods and services which were not in surplus. presumably, unless the desire to hold this.money for its own sake has convenietly risen,too, THEIR prices will raise. Thus ‘inflation’ as traditionally understood will cause ‘inflation’ in the sense.now misused by the mainstream.

  • Rafael Hotz says:

    You can all download this book for free at my website.

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