Handbook on Contemporary Austrian Economics

112 <strong>Handbook</strong> on contemporary Austrian economics
Wicksell does not use the term but other writers cited by Hayek do
(Patinkin and Steiger, 1989). Hayek criticized Wicksell's usage and used
the term neutral to explain how a change in the interest rate induced by
monetary policy affects relative prices between consumption and investment
goods. Money had a neutral impact when it did not change relative
prices. It served as a goal of monetary policy.
The concept of neutral money predates Hayek's discussion by many
decades. David Hume ([1742] 1987), in his essays 'Of Money' and 'Of
Interest' contain early statements of the non-neutral aspects of money as
does Richard Cantillon's ([1755] 1931) Essay on the Nature ofCommerce. l
They discussed both the short-run and long-run effects of changes.
Monetarists and New Classicists have claimed Hume as a predecessor but
they have ignored the relative price changes that arise from changes in the
money supply that drive parts of his analysis (Mayer, 1980; Lucas, 1996).
Keynes emphasized the non-neutrality of money in his Tract on Monetary
Reform (1923). His famous remark that "In the long run we are all dead"2
referred to irrelevance of the long-run monetary neutrality proposition
discussed by proponents of the quantity theory of money. Like the
Austrians, Keynes stressed the non-neutrality of money.
This chapter briefly restates the logic of claims of monetary neutrality.
It then examines the sources on non-neutrality both mentioned by
Hayek and later writers both within and outside of the Austrian tradition.
Then it turns to the ques'tion of why non-neutral money matters
for Austrian economics. In particular, it places non-neutral money
within the Austrian theory of the business cycle. Finally, it considers
the New Classical challenge; in particular, the claims made by rational
expectations-based macroeconomics and offers reasons to expect further
development of its implications for understanding fluctuations in GDP
that take place.
8.2 What is neutral money
The neoclassical definition of neutral money emphasizes the long-run
relationship between changes in the money supply and the aggregate
price level. Money has neutral properties when an increase or decrease
in its supply only affects the price level and does not affect real variables.
Formally, neutral money refers to a demand function that is homogeneous
of degree zero in money prices and in the initial quantity of financial assets.
But the neoclassical definition is only one of several possible definitions of
neutral money. There are at least four different propositions that describe
neutral money (Visser, 2002, p. 527). All the propositions have one thing
in common: changes in the money supply do not affect real variables. The
four propositions are: