Monetary stability in all three areas spurs productivity and investment because it gives individuals and businesses the confidence that the prices of goods, services, labor, and capital will remain relatively constant and predictable over time. Monetary instability, by contrast, undermines this assurance and makes people wary of investing. For consumers, monetary instability undercuts their ability to distinguish what they find marginally preferable in the marketplace from what they find marginally inferior. This makes it harder for consumers to align their available resources with meeting their needs and pursuing their wants over extended periods of time.

If this is true, then we need monetary policies that prevent monetary stability from being undermined, especially by disturbances emanating from the money supply itself. The primary and long-term goal of monetary policy should thus be to keep the supply of money as “neutral” as possible. Certainly, as observed by the Nobel Prize-winning economist Friedrich von Hayek, perfect monetary stability could only be maintained if the flow of money remained constant, all prices were perfectly flexible, and the future movement of prices was very predictable. The second and third of these conditions, he stated, are unlikely to be fulfilled. Hence, when we speak of “neutral” money, we’re really talking about minimizing unnecessary friction and volatility in order to maintain some predictable constancy in exchange rates, interest rates, and a currency’s average purchasing power over time.

Undermining Money

In more recent decades, governments and central banks have tried to use monetary policy to achieve goals besides monetary stability. In such schemas, money becomes one of several statistically traceable macro-aggregates that government institutions use to try to direct the economy in order to realize goals such as full employment.

Eventually, such policies contributed to the growth of inflationary pressures in many countries, until central banks such as the Federal Reserve used interest rates to break inflation in the late 1970s and early 1980s. Although it was necessary, this step contributed to higher unemployment for several years. Even so, few governments have given up viewing monetary policy as a means of addressing economic problems in ways that help them avoid making economically necessary—but electorally costly—decisions.

Governments on the left and right have seen monetary policy as a macroeconomic tool for boosting short-to-medium term employment, at the expense of devaluing people’s savings and their money’s purchasing power, among other things. This is despite knowing that reducing unemployment over the long term depends much more on microeconomic factors such as ensuring labor market flexibility and exorcising cronyism as far as possible from the economy.

The most recent instance of using monetary policy to avoid making politically hard decisions is called “quantitative easing.” In simple terms, this involves keeping distressed economies ticking by increasing the money supply via the central bank’s buying of bonds and other financial assets from private banks and other financial institutions. The goal is to encourage private lending, which in turn increases the money supply, thereby stimulating the economy—but also avoiding or putting off the painful process of allowing fiscally unsustainable businesses to be liquidated.

Like all addictive stimulants, quantitative easing provides short-term stimulation at the price of some undesirable long-term effects. In market economies, for example, people need to be able to distinguish between viable and nonviable companies so that they can invest in the former and avoid the losses associated with the latter’s probable failure. Quantitative easing, however, helps to keep unsustainable businesses afloat. This distorts the information that people need to make prudent investment choices. That helps to undermine opportunity cost in the economy and facilitates serious misallocations of financial capital. And this means less economic growth over the long term.

Much more could be said about the ways in which our contemporary economic challenges are being facilitated by questionable monetary policy. How all this will end is an open question. But if we are going to fix these problems, we need to recall what are money’s core functions and purposes, and what are not. That is the path to good money—and a sounder economy.

This article first appeared in The Public Discourse on Feb. 8, 2017.