[After submitting this to a discussion group as my synopsis of the difference between those two schools of thought on monetary theory and policy, I decided to tweak it a little and post it here. If nothing else, it might clarify my stance on a few key issues for newer visitors to this blog.]
Keynesians 1, Austrians 0
The fundamental debate about monetary policy boils down to fiat money vs commodity money — and the question, "Which of those is a better system for ensuring a stable value of money?"
Before we can answer that, we need to agree on the definition of "stable money." In many minds, it means "money that does not suffer unanticipated inflation higher than 2-3%." In my opinion, that is only half of the proper definition; it should also include "money that also does not suffer deflation of any level." In short: Stable money is money that does not inflate or deflate.
Now, if you agree with my proposed definition, the flaw I see in the Austrian side of the monetary argument becomes easier to detect. As an experiment, try this: search any of their essays or texts on the subject, and count the number of occurrences of the word "inflation"; then count the number of occurrences of the word "deflation." I predict the ratio will be at least 100:1, if not 100:0 (infinite). Deflation is at best an afterthought in that ideology, even though it can produce worse consequences than inflation -- such as a downward-spiraling implosion of the real economy, which in the past has tended to end in the violent overthrow of governments.
An even harder-to-detect flaw in the commodity-money dogma (besides the "deflation? who cares?" attitude) is its shaky track record of actually preventing inflation itself, in spite of how plausible the theory sounds. As with any type of money, commodity money (eg, gold or silver) is inflationary whenever an increase in its supply outstrips the economy's ability to increase its production of real goods and services. The California gold rush produced inflation (arguably with excellent results for the real economy); on the other hand, Spain's obsession with bringing in silver from the new world caused a domestic inflation that removed Spain from the industrial revolution. In both cases, sudden increases in the supply of commodity money were inflationary — the same thing that happens to fiat money when its supply increases too quickly.
Moreover, some in the Austrian school define "inflation" differently from the way most people think of it these days. The (archaic, in my opinion,) definition is "any increase in the money supply." Contrast that with the way most people define inflation: "any increase in the general price level." To achieve stable prices, the money supply must increase roughly at the same rate as the supply of real goods and services. But to achieve the Austrians' version of "no inflation" the money supply must not increase -- which means prices and wages must fall as the real economy grows -- IF it grows *in spite* of the stagnant pool of money available to the economic participants. I have yet to see an essay proposing a politically-viable way of convincing the general public that falling nominal wages are no problem at all, because falling nominal wages are in fact constant or rising real wages in a real economy that's growing. And, as Lincoln said, "With public sentiment, nothing can fail; without it, nothing can succeed."
The Keynesians, in my judgment, have the upper hand in monetary theory: the proper goal is to prevent BOTH inflation AND deflation in the general price level. Deflation is partially-disguised as rising unemployment, but it is deflation nonetheless. (Reason it's disguised: When prices fall, businesses must reduce costs in order to survive. But hourly wage rates tend to be more rigid than prices; therefore, to reduce the cost of wages and salaries, businesses must reduce labor hours instead of labor $/hr. One full-time employee equals 2000 hrs/yr; you know the rest.) The Keynesians and neo-Keynesians seem to be the only ones genuinely concerned about preventing a deflationary spiral in unusual times like the ones we have been experiencing; the opposing viewpoint isn't much more than "Deflation? So what, who cares?" — and amounts to a hands-off policy of letting unemployment rise to whatever level we supposedly deserve because of prior excesses. I think that is an unacceptable mistake of ignoring money that's unstable in the downward direction.
Unanticipated inflation gives debtors an unfair advantage. Unanticipated deflation gives creditors an unfair advantage — that is, up until the debtors default, at which time everybody loses because of an accelerating downward spiral to oblivion. A "stable value of money" means preventing both inflation and deflation. The Keynesians have articulated both sides; the Austrian school has been vocal about inflation, but inexplicably silent about deflation. Makes me wonder if the Austrians could only see monetary theory from the creditors' viewpoint. In any case, on monetary theory, you can count me with the Keynesians, until something better comes along.
Keynesians 1, Austrians 1
That said, I must qualify my objections to the Austrian school of thought: My objections are strictly limited to their 19th century thinking regarding monetary theory and money mechanics. I am an enthusiastic advocate of Hayekian ideas regarding the growth and vitality of the real economy in a free society. The Hayekian model for the real economy (as oppposed to the monetary side) is market- and rule-of-law driven, analogous to the biological model of natural selection and adaptation. By contrast, the central planning, government-knows-best model is analogous to Intelligent Design in biology. I most definitely do not subscribe to Intelligent Design in biology, nor do I subscribe to it in economics; the evidence in both cases is overwhelmingly in favor of the evolution model employing selection and adaptation. Hayek's brilliant essay, The Use of Knowledge in Society, explains why the market-driven model of selection and adaptation creates growing prosperity, and why Intelligent Design (a.k.a. central planning) fails.
So, I keep the money side of the economy well separated from the real goods and services side in my thinking. Money flows the opposite direction from real goods and services. Stable money is one of government's responsibilities, according to Adam Smith and most subsequent thinkers (...the other responsibilities being defense, justice, education, and infrastructure). After providing those, the government is NOT responsible for the real goods and services side of the economy. [That's why I support the Fed's monetary initiatives, but oppose the GM bailout and life-support programs. Stable money is the government's responsibility; automobile manufacturing is not.]
In short: It's all tied up: Keynesians 1, Austrians 1.
That's my interpretation, anyway, after a couple decades of research into the subject. And it's the reason I think Reaganomics is far from "dead," in spite of the wishful thinking on the left these days. Reaganomics is growth economics; what we've had to switch to is stop-the-bleeding economics. It's not an either-or choice, as I explained in more detail in this article a few months ago.
That's it. Happy Independence day, and have a safe and fun weekend.
