Handbook on Contemporary Austrian Economics

Money is non-neutral 113
I. Money acts only as a veil. The introduction of money does not
affect resource allocation and the economy acts as if it were a barter
economy.
2. Monetary equilibrium holds at all times; that is, no excess demand for
or supply of money exists.
3. Changes in the money supply only affect the aggregate price level as
described in the quantity theory of money.
4. Changes in the rate of inflation do not affect real variables. This is the
super-neutrality proposition.
Hayek (1935, p. 130) discussed the proposition that money serves only
as a veil and does not affect real variables. He wrote that the concept of
neutral money "refers to the set of conditions under which it be conceivable
that the events of 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 'real' factors" (italics original). Money only
serves as a veil. The introduction of money into the economic system does
not change relative prices. Real factors solely determine prices. Money
only provides a scalar to facilitate exchange by reducing transaction costs
but does not influence production or consumption decisions. This definition
of neutral money was a policy ideal unlikely to be attained in the
modern world.
The Austrian tradition has addressed the impact of monetary disequilibrium
much more thoroughly. Hayek's writings emphasize the effects
of changes in the money market on aggregate outcomes. Monetary equilibrium
occurs when there is no excess supply of or demand for money.
Individuals hold their optimum quantity of money based on their subjective
expectations and information they have. When the monetary authority
introduces new money into the economic system, individuals alter their
demand for money. Prices change as the new recipients use their money to
purchase goods and services. The rise in prices that results from the new
money forces others to change the amount of money they hold for consumption.
Individuals alter their behavior to adjust to the new monetary
situation. Similarly, when changes in productivity take place, the demand
for money changes and monetary disequilibrium occurs. For example,
an increase in productivity reduces prices and individuals demand less
money. As they adjust the quantity of money they hold, prices change and
resources are reallocated.
The third definition of neutral money follows from the quantity theory
of money. In the equation of exchange (MV = PQ where M is the money
supply, Vis the velocity of money, P is the general price level, and Q is the
quantity of output), money has a neutral affect when V and Q are held