by Sebastian Müller

For a long time, Austrian macro had a unique selling point in what might be called the ‘money matters’ view: referring to the notion that changes in the money supply by their very nature can never be said to be neutral. Yeager (1997) and Horwitz (2000) describe the Austrian stance as a “fluttering veil”. On the one hand, it incorporates the belief that prosperity cannot be generated through an expansion of the money supply in the long-run (long-run neutrality of money). On the other hand, changes in the money supply have real effects (short-run non-neutrality).

This proposition can be traced back to the works of classical economists such as Hume (1970), Mill (1909), Cairnes (1873), and Cantillon (1755).[i] In his essay on economic theory, Cantillon (1755) points out that an expansion of the money supply necessarily entails distributional effects as first receivers of the newly created money benefit compared to those ones further down the line.

“Changes in the money relation, i.e., in the relation of the demand for and the supply of money, affect the exchange ratio between money on the one hand and the vendible commodities on the other hand. These changes do not affect at the same time and to the same extent the prices of the various commodities and services. They consequently affect the wealth of the various members of society in different ways.” (Mises 2007)

Influenced by the classical economists, this thought was taken up by Ludwig von Mises and F.A. Hayek who extended early approaches by developing the Austrian theory of the business cycle (ABCT). Considering interest rates as the most relevant prices in the economy, they realized that changes in the money supply through credit policies are of importance for an understanding of boom-and-bust cycles. Following the ABCT, changes in the money stock (or interest rates) alter the structure of production and initiate structural distortions (and thus distributional effects) in the medium- to long-term perspective. Hayek’s triangle will come to mind here. Newer Austrian research uses, for example, the concept of ‘financial duration’ to investigate distributional effects at the cross-sectional level (here, here and here).

Up to recently, few Non-Austrian economists considered distributional effects of monetary policy worth studying. Some economists upheld the money neutrality view. The stock of money or changes in the growth rate of the money supply were considered to have no influence on real outcomes (money neutrality and super-neutrality of money). Others conceived monetary policy primarily as a tool to smooth the business cycle by attenuating the harmful effects of market imperfections and sticky prices in the short run or eliminating negative effects of (unexpected) macroeconomic shocks (New Keynesian View). Little was discussed the role of monetary policy as a potential source of structural distortions, disequilibria or any long-term distributional effects.[ii]

But things were about to change.

The unexpected outbreak of the financial crisis of 2007, the subsequent interest rates cuts and the looming threat of deflation prompted central bankers to implement new monetary policy measures. Those measures were in parts directly targeted to certain markets or agents (governments, banks, and large enterprises). Moreover, Thomas Piketty’s medial success around the world evoked the interest in distributional effects and inequality. With the extended monetary policy toolkit and the new interest in distributional effects, new research projects emerged which combined monetary policy and inequality. Many economists do not fit in the dichotomy anymore. They (implicitly) object to the idea of money being neutral and investigate whether the new measures adopted by central banks are creating an uneven playing-field and causing (re)distributional effects.

For Austrians this is a reason for delight and an immense opportunity.

It is a delight because distributional effects are recognized and taken up by a large variety of economists. Many economists are challenging the traditional view of money neutrality trying to investigate and isolate potential distributional channels. The old paradigm is dwindling and science progresses. The opportunity lies in extending the Austrian analysis toward distributional effects not studied before. Up to recently, Austrians that looked beyond structural distortions when it comes to distributional effects were on the fringes. Transmission channels of monetary policy to income/wealth distribution were hardly given center stage. Many did not even move beyond Hayek’s old triangle concept. Austrian economists should embrace the opportunity to advance Austrian Economics as a progressive research program.

It’s not too late to jump on the bandwagon. The current surge of papers investigating distributional effects of monetary policy is not the result of an increased recognition or awareness of the Austrian perspective but rather of pragmatic nature. Thus, Austrian economists who engage in these issues might get a genuine opportunity to enrich the current literature and articulate their ideas beyond their circles.

In addition, the literature is still in its infancy and has not provided a clear-cut picture (an overview can be found here). On the one side, the authors suggest a positive relationship between monetary policy and inequality (see here, here and here). On the other side, it is argued that specifically crisis policies have only weak and offsetting effects and might actually lead to a reduction in inequality (here and here). So far, the general opinion seems to follow the second view regarding distributional effects to be of a small magnitude and thus, compared to other factors, negligible.

“The degree of inequality we see today is primarily the result of deep structural changes in our economy that have taken place over many years, including globalization, technological progress, demographic trends, and institutional change in the labor market and elsewhere. By comparison to the influence of these long-term factors, the effects of monetary policy on inequality are almost certainly modest and transient.” (Bernanke 2015)

As long as the economic literature is not able to provide a clear-cut picture about the issue at hands, distributional effects are likely to remain a contested topic. Ambiguous results evoke the danger that policymakers and central bankers are invited to interpret them in an arbitrary way which fits their political agenda or policy goals. This is troublesome from an Austrian perspective.

References

Bernanke, Ben. (2015). Monetary policy and inequality. Ben Bernanke’s Blog at Brookings.

Cantillon, Richard (2010). An Essay on Economic Theory: An English Translation of Richard Cantillon’s Essai sur la nature du commerce en général. Auburn: Ludwig von Mises Institute.

Cairnes, John E. (1873). Essays in Political Economy. London: Macmillan and Company, pp. 1-65.

Horwitz, Steven (2000). Microfoundations and macroeconomics. London: Routledge.

Hume, David (1970). On Money. In Writings on Economics, Eugene Rotwein, ed. Madison: University of Wisconsin Press, pp. 33–46.

Mill, John Stuart (1909). Principles of Political Economy, Sir William Ashley, ed. (1909), bk. 3, chap. 8.

Mises, Ludwig von (2007). Human Action. Indianapolis: Liberty Fund.

Yeager, Leland B. (1997). The fluttering veil. Essays on Monetary Disequilibrium. Indianapolis: Liberty Fund.

[i] Although classical economists are believed to hold some kind of money neutrality view in the long run (that the stock of money does not affect real economic outcomes in the long run), they seem to have already been aware of potential distributional effects resulting from changes of the money stock.

[ii] One notable exception is the work of Borio and White (here and here) who warn against the harmful effects of too loose monetary conditions and the build-up of (financial) imbalances.