The Austrian School's Contribution to Monetary Theory

The Austrian contribution to monetary theory is two-fold: First, it emphasizes the role of money in the pricing process and incorporates money--or, more precisely, changes in the stream of money payments--into the determination of relative prices. Second, it analyzes the effects of such money-induced relative price changes on the time structure of production, that is, the capital structure. . . .

Monetary changes are not neutral--they do not affect all prices uniformly so as to change their nominal height but leave relative price relationships unaltered. In reality money does not enter the economy by way of a simple uniform change in all money balances, as many textbook writers like to assume. Rather, newly created money always enters the economy at a specific point and is spent on certain specific goods before gradually working through the system.

Thus some prices and expenditures are altered first, and other prices and expenditures, later. As long as the original monetary change is maintained, this monetary "pull" on price interrelationships will persist. . . .

Resource allocation will not be left unchanged as a result of these relative price changes. At the point at which the new money enters the economy, prices will rise relative to prices elsewhere. The pattern of outputs will be altered correspondingly. Monetary expansion also prevents some prices from falling that otherwise might. Thus some businesses make profits that otherwise would have losses, and workers are employed in jobs they otherwise would leave. Another result of the monetary expansion is that more new and different kinds of businesses are started. Firms are also led to embark on new and/or different lines of production. In short, the pattern of expenditures, resource allocation, and above all relative prices is changed by monetary expansion.

--Gerald P. O'Driscoll Jr. and Sudha R. Shenoy, "Inflation, Recession, and Stagflation," in The Foundations of Modern Austrian Economics, ed. Edwin G. Dolan (Kansas City: Sheed and Ward, 1976), 194-195.