Abstract
The aim of this article is to examine the concept of neutral money in light of the Austrian school, particularly Hayek’s and Mises’s writings. Although mainstream economics analyzes the non-neutrality of money, it focuses on price rigidity or incomplete information as its causes. In contrast, Austrian economists examine primarily the first-round effect. Their analyses of the impact of unevenly distributed money on the structure of relative prices and production, in the spirit of Cantillon’s analysis, show that changes in the money supply are never neutral, even in the long term. Therefore, by not taking into account the Cantillon effect—which is a key component of the Austrian theory of money and the business cycle—central banks lead overly loose monetary policies. Thus, the article contributes to the debate on benefits and costs of expansionary monetary policy, including that conducted by the European Central Bank.
The article is partially based on the author’s doctoral dissertation, entitled “The Effects of Money Supply Growth from the Perspective of the Cantillon Effect.”
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Notes
- 1.
However, real business cycle theory inverts the analyzed relationship and assumes that changes in the money supply are a response to real disturbances. Hence, it believes not only in neutrality of money but also in superneutrality (Plosser 1990).
- 2.
- 3.
- 4.
On the typology of the neutrality of money, see Sieroń (2014).
- 5.
According to Hayek (2008a [1935]), there are three conditions for the neutrality of money: constant total money stream, perfectly flexible prices, and long-term contracts based on a correct anticipation of future price movements.
- 6.
The Cantillon effect is analyzed in detail in the next section.
- 7.
- 8.
Actually, the Cantillon effect is the basis of the Austrian business cycle theory. Some researchers even suggest that taking the first-round effect into account is the distinguishing feature of the Austrian school and its theory of money and the business cycle. See Horwitz (1994), Zijp and Visser (1994), or O’Driscoll and Rizzo (1996).
- 9.
Post-Keynesians also criticize the concept of neutral money, but they focus on institutional or qualitative neutrality related to the very existence of the money in the economy, not to the change in the money supply, arguing that “one cannot first analyze the economy in purely ‘real’ terms and then add on one’s monetary theory ‘afterwards’” (Cottrel 1994, p. 4).
- 10.
It means that boom-and-bust cycles cause lasting damage due to resource misallocations that cannot be easily and quickly undone. Consequently, economic growth “may return to its precrisis long-term trend, but output remains below its precrisis long-term trend” (Borio 2015).
- 11.
Actually, we should refer to the Eurosystem—which consists of the ECB and the national central banks of the member states—as the official monetary authority of the euro area, but we write about the ECB for the sake of simplicity.
- 12.
Similarly, a country can suffer from inflation and the business cycle even if the central bank conducts a relatively restrictive monetary policy. In other words, national fiat currencies cannot be isolated from global inflation and international business cycles (Hayek 2008b [1935]).
- 13.
“As the changes in purchasing power do not affect all prices and wages at the same moment and to the same extent, there is a shift of wealth and income between different social groups” (Mises 1990, p. 73).
- 14.
Claeys et al. (2015).
- 15.
Mises rejects the very notion of neutral money as contradictory. Although Hayek also believes that neutral money should not be the purpose of monetary policy, he argues that the concept of neutral money may be a useful instrument for theoretical analysis, or a benchmark for evaluating different monetary policies or regimes (Horwitz 2016). However, Hayek refers to money neutrality in this context to a “set of conditions, under which it would be conceivable that events in a monetary economy would take place, and particularly under which, in such an economy, relative prices would be formed, as if they were influenced only by the ‘real’ factors which are taken into account in equilibrium economics” (Hayek 2008a [1935], p. 302). As neutral money is impossible, Hayek opts for keeping nominal income (MV) constant (Hayek 2008a [1935]). Thus, Salerno (2016) dehomogenizes the views of Mises and Hayek on the neutrality of money. Although we agree that Mises’s critique of the concept of neutral money is more decisive than that formulated by Hayek, Salerno fails to notice that the issue of constancy of MV is something different than the concept of “dynamic neutrality”—the two Austrian economists differ on the former issue, while both reject the latter.
- 16.
- 17.
The concept of neutrality of money implying constancy of the price level originates from Wicksell (1978).
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Sieroń, A. (2018). Hayek and Mises on Neutrality of Money: Implications for Monetary Policy. In: Godart-van der Kroon, A., Vonlanthen, P. (eds) Banking and Monetary Policy from the Perspective of Austrian Economics. Springer, Cham. https://doi.org/10.1007/978-3-319-75817-6_8
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