Handbook on Contemporary Austrian Economics

Money is non-neutral 117
or less the same as they were before." A common explanation for money
illusion stems from the costs of obtaining information. If nominal prices
change slowly and by relatively small amounts, what incentives exist for
people to collect information about the inflation adjusted prices Similarly,
people often fail to collect information about the source of price changes.
Whether supply or demand changed because of a real or nominal change
involves costs that people often view as relatively high. In most costs, not
knowing the real price of a good has very little impact on behavior.
An alternative Austrian explanation exists but has been little explored.
Hayek's The Sensory Order (1952) argues that people's perceptions evolve
in response to repeated interaction with the external environment. If
people operate within an environment of nominal prices (as they do), they
will think in nominal terms. It should not be surprising that they confuse
real and nominal variables as their minds have evolved to operate within
the nominal world. Future research may examine the relationship between
Hayek's psychological writings and their relationship to the monetary
economy.
8.3.4 Sticky prices and long-term contracts
For money to have neutral effects, wages and prices must adjust to
changing demand and supply conditions. If prices respond to changes in
the monetary contraction or expansion, money is neutral. Yet, in many
markets, prices do not adjust immediately to new conditions. They remain
the same after the monetary authority has adopted a course of action that
either reduces or increases the money supply. A number of reasons have
been posited to explain the lag in changing prices after a change in the
money supply.
Long-term contracting limits the neutrality of money in the short run.
Hayek (1935, p. 131) wrote that "the existence of a generally used medium
of exchange will always lead to the existence of long-term contracts in
terms of this medium of exchange, which will have been concluded in the
expectation of a certain future price level." Individuals guess as to what
future prices will be. Sometimes they correctly guess future prices and
sometimes they do not. They negotiate contracts in order to minimize
uncertainty about the future. When they guess wrong about the future,
money has a non-neutral effect. For example, wage contracts are denominated
in nominal terms. If actual inflation exceeds expected inflation, then
the real wage falls. If the workers realized their real wages have fallen, they
may respond by reducing productivity.
New Keynesian models formalized and extended the sources of price
stickiness. Menu costs offered a simple, example. When price changes
are small, it may be too costly to print up new menus. The benefits from