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According to Nobel laureate in economics Milton
Friedman and his followers, also known as monetarists, the volatility in the rate
of the money supply is the major source of boom-bust cycles. Monetarism
maintains that in the short run, increases in the money supply rate of growth
raise the rate of growth in real output. Conversely, decreases in the money
supply rate of growth the lower the real output rate of growth. In the long
run, it is held, changes in money do not have any effect on movements in real
output, it only affects changes in the price level. In other words, according
to monetarism, money is neutral with regard to real economy in the long run
and not neutral in the short run.
The main reason for this difference, monetarists
argue, is that in the long run changes in money supply are fully anticipated
and therefore discounted. However, in the short run fluctuations in money
supply are not predictable. Monetarists however, maintain that it is in the
power of the central bank to make money is also neutral in the short run.
According to monetarists this could be achieved by setting money growth at a
particular percentage and sticking to this percentage for an indefinite
period of time. The essence of this way of thinking is that there is no
relation between a constant rate of monetary growth and the rate of growth in
real output.
This view, which is also supported by numerous
statistical analyses undertaken by monetarists, appears to be making a lot of
sense. Thus, it is maintained, that whenever money is growing at a constant
percentage, then this rate of growth becomes an expected event. This in turn
means, so it is held, that people will adjust their demand for money in such
a way that the effect from the constant money growth on real output will be
neutralized.
According to Milton Friedman and his followers, the
1930's Great Depression can be explained by the monetarists' framework of
thinking. In his writings, Friedman argues, that by allowing a sharp fall in
the money stock the Federal Reserve caused the Great Depression. Monetarism
maintains that the Great Depression could have been averted if the rate of
growth of the money supply had been stable. If the monetarists' framework is
correct then one could infer that changes in the demand for any good whose
supply is predictable could make this good neutral. In other words, this good
will not have any real effect on human beings.
Does it make any sense? For instance the main
attribute of bread is that it supplies nourishment to the human body, once
the bread is eaten. The real effect on human beings who consume bread then is
through the process of nourishing the human body. Could then adjustments in
the demand for bread in response to a predictable supply make the bread
neutral? In other words would the bread se to supply nourishment?
That bread supplies nourishment when eaten is the
fact of reality. This fact cannot be altered by changes in people's demand.
On the contrary, people are demanding bread because of its characteristic,
which is supply of nourishment when eaten. Now, if people's wishes could
alter goods characteristic then this would mean that humans demands could
alter facts of reality. Thus by means of a wish I could transform a cat into
a dog or a stone into a bread.
The service that money offers is that of the medium
of the exchange. The existence of money enables the product of one specialist
to be exchanged for the product of another specialist. Or we can say that
money offers the facility that permits the exchange of something for
something else. In other words a useful good can be exchanged for money and
the obtained money in turn can now be exchanged for some other good, hence an
exchange of something for something else.
When a counterfeit money is introduced it
masquerades as genuine money. Once accepted, the counterfeit money gives rise
to an exchange of nothing for something. For the counterfeiter did not
exchange anything for money which he printed. He then uses the printed money
to exchange it for goods and services. Consequently, once the counterfeit
money is introduced and is accepted by people as genuine money, it will
always give rise to an exchange of nothing for something. The exchange of
nothing for something means unearned consumption of real goods and services
i.e. the transfer of real wealth from wealth producers towards the
counterfeiter.
The exchange of nothing for something therefore,
generates a real effect. Exactly the same outcome is generated whenever the
banking system expands the money stock i.e. creates money out of "thin
air". Now, let us assume that the central bank has succeeded to fix the
money rate of growth at a particular percentage. Could this make money
neutral with respect to the real economy? Could this alter the fact that
money which is created out of "the blue" sets in motion an exchange
of nothing for something?
People's adjustment of the demand for money will
only have an effect on the value of money i.e. its purchasing power. This
however, cannot undo an exchange of nothing for something once money is
created out of "thin air". Further to this, regardless of whether money
is printed at a constant rate or at a variable rate, it will lower the
interest rate structure below the level dictated by the demand versus the
supply of savings. This in turn will set in motion a boom-bust cycle.
Finally, in his writings the great Austrian
economist Ludwig von Mises argued that the whole idea that money could be
neutral is ridiculous. Neutrality means that money would cease to be the
medium of the exchange. However, then it would no longer be money.
Frank Shostak
Frank Shostak
is a former professor of economics and M. F. Global's chief economist.
Also
by Frank Shostak
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