Monday, August 25, 2014

Monetary Myths

Patrick Barron of the Mises Institute -- the leading think tank promoting Austrian economics -- wrote a very helpful and informative article the other day in which he describes, and debunks, six myths about money and monetary policy.  Here's the first in his list:
Myth 1: Increased money leads to economic prosperity.
This Keynesian myth postulates that increasing aggregate demand through increasing the money supply will lead to more spending, higher employment, increased production, and a higher overall standard of living.

The reality is that an increase in money (when injected into credit markets via bank lending of newly-created reserves) leads to malinvestment. The time structure of production is thrown into disequilibrium by encouraging investment in projects more remotely removed in time from final consumption. There are insufficient resources in the economy for the profitable completion of all projects, since individual time preference is unchanged, meaning that there is no increase in savings. When prices rise, due to this unchanged time preference, these projects will be liquidated, revealing the loss of capital. Production will be lower than otherwise. Unemployment will increase while workers adjust to economic reality.