Handbook on Contemporary Austrian Economics

Money is non-neutral 119
of borrowers and lenders. Now suppose that the central bank expands the
money supply, thereby increasing the supply of credit available. This is
the market rate of interest. The market interest rate declines as a result as
more credit is available. It is below the natural rate of interest. Saving falls
and investment increases at the lower interest rate. Consumption declines
and investment rises.
The Austrian approach differs from more conventional approaches, in
that it stresses the effects of the injection of credit on the capital structure.
The central bank provides the money to banks and the central government
through the purchase of bonds. If they use the new credit to make
investments in capital, prices for those goods rise. The initial recipients of
the new money have increased their purchasing power relative to those
who have not received the money. The non-neutral effects of money
occur because of the "loose joint" aspects of money. Money permeates all
markets. When new money enters an economy, people have to adjust their
money holdings.
Horwitz (2000, pp. 96-103) emphasized the monetary disequilibrium
understanding of neutral money and its relation to the capital structure.
Capital is a heterogeneous good that is characterized by complementarity
and substitutability, the path by which money enters the economy matters
(see Chapter 9). He wrote that:
If the capital structure is understood as being comprised of the various intertemporal
prices existing in the market, then money is neutral if the current
monetary policy or regime is not a cause of any systematic distortion in those
prices, leading to the potential un sustain ability of that structure. Changes
deriving from the money supply process are not providing too much or too
little investment in comparison to voluntary savings, creating the possibility of
a sustainable capital structure. In monetary disequilibrium, the mismatch of
savings and investment implies a lack of synchrony between the signals facing
entrepreneurs and the preferences of consumers, leading to the creation of a
capital structure that is unsustainable and must eventually be reversed. It is in
this sense that money is neutral in monetary equilibrium.
Money is non-neutral when expected relative price changes and resources
are reallocated to activities they would not be allocated to if new money
was not introduced.
8.5 The New Classical challenge
The emergence of the New Classical approach to monetary economics and
macroeconomics more generally has greatly reduced the importance of
money in explaining the effects of changes in its supply. Their rise to dominance
virtually eliminated any discussion of Austrian approaches to nonneutral
money. Early New Classical models assumed away the sources of