Money and Markets: Essays in Honor of Leland B. Yeager
Money and Markets: Essays in Honor of Leland B. Yeager
Money and Markets: Essays in Honor of Leland B. Yeager
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174 Steven Horwitzdur<strong>in</strong>g the process <strong>of</strong> the price level equilibrat<strong>in</strong>g the supply <strong>and</strong> dem<strong>and</strong> for realbalances fits nicely with the monetary disequilibrium perspective associated with<strong>Yeager</strong> <strong>and</strong> others. For the 100 percent reserve theorists, the price adjustmentsnecessitated by <strong>in</strong>flation do not occur smoothly, <strong>in</strong>stantaneously, <strong>and</strong> costlessly.The wastes associated with the boom <strong>and</strong> bust <strong>of</strong> the Mises–Hayek cycle happenbecause the adjustment process is so imperfect.However, should the dem<strong>and</strong> for money rise, the 100 percent reserve Austrianssee no trouble with the price level simply “adjust<strong>in</strong>g” downward to equilibrate thesupply <strong>and</strong> dem<strong>and</strong> for real balances. 11 The possibility that the market process willnot produce <strong>in</strong>stantaneous <strong>and</strong> correct downward adjustments does not evenappear to have been considered. As <strong>Yeager</strong>’s work suggests, there are reasons tobelieve that prices will not fall <strong>in</strong>stantaneously <strong>and</strong> the Austrians’ very own <strong>in</strong>sightthat markets are discovery processes would suggest that once they come unstuck,they will not fall evenly <strong>and</strong> “accurately.” Moreover, one could ask what is supposedto happen if the dem<strong>and</strong> for money should fall with the money supply fixedby the supply <strong>of</strong> the money commodity. As real balances are disgorged <strong>in</strong>to thespend<strong>in</strong>g stream, why will the effects not be as pernicious as if the supply <strong>of</strong> moneywere exp<strong>and</strong>ed beyond the supply <strong>of</strong> the money commodity? Is there a lack <strong>of</strong>appropriate parallel treatment here?What is miss<strong>in</strong>g from the 100 percent reserve theory analysis is the monetarydisequilibrium theory <strong>in</strong>sight that the supply <strong>and</strong> dem<strong>and</strong> for bank liabilities areconnected with sav<strong>in</strong>gs <strong>and</strong> <strong>in</strong>vestment (Brown 1910). The dem<strong>and</strong> to hold moneybalances, at least when they are bank liabilities, is a source <strong>of</strong> loanable funds <strong>in</strong> afractional reserve bank<strong>in</strong>g system. To the extent that one allows one’s bank balanceto accumulate, one is supply<strong>in</strong>g loanable funds to the bank by not mak<strong>in</strong>g anyclaims on its reserves. This, <strong>of</strong> course, is why banks want customers. Conversely, asbanks create additional bank liabilities, they are meet<strong>in</strong>g the dem<strong>and</strong> for loanablefunds by lend<strong>in</strong>g those new liabilities <strong>in</strong>to existence. Banks <strong>in</strong>termediate betweenthose who hold bank liabilities (i.e., those keep<strong>in</strong>g funds <strong>in</strong> their accounts, whichappear on the right side <strong>of</strong> the bank’s balance sheet) <strong>and</strong> those who borrow them <strong>in</strong>order to spend them (i.e., those with loan obligations to the bank, which appear onthe left side <strong>of</strong> the balance sheet). The dem<strong>and</strong> to hold bank liabilities is a form <strong>of</strong>sav<strong>in</strong>g that provides the loanable funds for <strong>in</strong>vestment by borrowers <strong>of</strong> bank liabilities.This connection between bank liabilities <strong>and</strong> the market for loanable fundsenables further connections between monetary disquilibrium theory <strong>and</strong> moretraditional Austrian macroeconomics.Specifically, we can now br<strong>in</strong>g <strong>in</strong> the market <strong>and</strong> natural rate <strong>of</strong> <strong>in</strong>terestmechanism that has been central to the Austrian cycle theory yet largely absentfrom the monetary disequilibrium approach. Bracket<strong>in</strong>g out other ways <strong>in</strong> whichthe supply <strong>and</strong> dem<strong>and</strong> for loanable funds are activated <strong>in</strong> the market <strong>and</strong> focus<strong>in</strong>gonly on bank liabilities, we can see that when monetary equilibrium holds, themarket <strong>and</strong> natural rates <strong>of</strong> <strong>in</strong>terest are equal. S<strong>in</strong>ce Wicksell, the natural rate <strong>of</strong><strong>in</strong>terest has been understood to be the rate that directly reflects actors’ underly<strong>in</strong>gtime preferences, i.e., the degree to which they discount the future. The naturalrate is a theoretical construct <strong>and</strong> unobservable <strong>in</strong> the market. It can be thought <strong>of</strong>