Handbook on Contemporary Austrian Economics

114 <strong>Handbook</strong> on contemporary Austrian economics
constant. Under these assumptions, changes in M only affect P. This is
the fundamental truth of the quantity theory. As Milton Friedman stated:
"inflation is always and everywhere and a monetary phenomenon" (1963).
Hayek (1935, p. 4) dismissed the quantity theory as relatively useless
because: "For none of these magnitudes as such ever exerts an influence
on the decisions of individuals; yet it is on the assumption of a knowledge
of the decisions of individuals that the main propositions of nonmonetary
economics theory are based." In other words, the neutrality of
money in the quantity theory refers to long-run properties of a monetary
economy. But, again, as Keynes so memorably wrote, "In the long run
we are all dead." In the real world, the neutrality proposition holds only
after decades have passed and the ups and downs of the business cycle
have occurred. It does not address the issues that arise as the economy
shifts from one equilibrium to another. The process of how prices change
remains unexplained or is assumed away. Milton Friedman (1969), in a
well-known analogy, depicted the money supply process as the monetary
authority dumping money from a helicopter to all the citizenry equally.
In the modern economy, helicopters do not have a role in money supply
process. The new money is not distributed equally. As a result, money has
non-neutral effects.
The fourth neutrality proposition addresses the super-neutrality of
money. An increase in the money supply may not affect real variables and
leave relative prices the same, but changes in the growth rate of money
supply may affect the real economy. In other words, changes in rate of
inflation can have effects on the real economy, especially the rate of economic
growth and the distribution of income. Inflation has distributional
effects. For example, the wealthy often have the means to adjust their
portfolio to assets less affected by inflation than the poor. As a result,
the harmful effects of inflation are disproportion ally borne by the poor.
Similarly, changes in the variance in inflation can affect economic growth
by increasing uncertainty in an economy. As investors become less able
to predict future inflation rates because it lacks stability, they choose to
invest their resources elsewhere. As investment falls, so does the rate of
economic growth. Traditional Austrian approaches have said little about
the likelihood of super-neutral money although it does not present an
analytical problem.
To sum up, neutral money has several definitions. Conventional
macroeconomic wisdom contends that the effect of money in the long run
is neutral. Changes in the quantity of money do not affect real economic
variables. Nearly all empirical evidence has supported the claims that
money has neutral effects in the long run. It would seem that the Austrian
approach to monetary economics has little, if any, empirical support.