[A selection from Money, Bank Credit, and Economic Cycles by Jesús Huerta de Soto. For full explanatory notes, see the online version, page beginning page 576.]
From the standpoint of our analysis, it is clear that there are far greater similarities than possible differences between monetarists and Keynesians. Indeed Milton Friedman himself has acknowledged: “We all use the Keynesian language and apparatus. None of us any longer accept the initial Keynesian conclusions.” Peter F. Drucker, for his part, indicates that Milton Friedman is essentially and epistemologically a Keynesian:
His economics is pure macroeconomics, with the national government as the one unit, the one dynamic force, controlling the economy through the money supply. Friedman’s economics are completely demand-focused. Money and credit are the pervasive, and indeed the only, economic reality. That Friedman sees money supply as original and interest rates as derivative, is not much more than minor gloss on the Keynesian scriptures.
Furthermore even before the appearance of Keynes’s The General Theory, the principal monetarist theorists of the Chicago school were already prescribing the typical Keynesian remedies for depression and fighting for large budget deficits.
Table VII-1 [see chart in PDF format] recapitulates the differences between the Austrian perspective and the major macroeconomic schools. The table contains twelve comparisons that reveal the radical differences between the two approaches.
Table VII-1 groups monetarists and Keynesians together because their similarities far outweigh their differences. Nevertheless we must acknowledge that certain important differences do separate these schools. Indeed, though both lack a capital theory and apply the same “macro” methodology to the economy, monetarists concentrate on the long term and see a direct, immediate and effective connection between money and real events. In contrast Keynesians base their analysis on the short term and are very skeptical about a possible connection between money and real events, a link capable of somehow guaranteeing equilibrium will be reached and sustained. In comparison, the Austrian analysis presented here and the elaborate capital theory on which it rests suggest a healthy middle ground between monetarist and Keynesian extremes. In fact for Austrians, monetary assaults (credit expansion) account for the system’s endogenous tendency to move away from “equilibrium” toward an unsustainable path. In other words they explain why the capital supply structure tends to be incompatible with economic agents’ demand for consumer goods and services (and thus Say’s law temporarily fails to hold true). Nonetheless certain inexorable, microeconomic forces, driven by entrepreneurship, the desire for profit, and variations in relative prices, tend to reverse the unbalancing effects of expansionary processes and return coordination to the economy. Therefore Austrians see a certain connection — a loose joint, to use Hayek’s terminology — between monetary phenomena and real phenomena, a link which is neither absolute, as monetarists claim, nor totally non-existent, as Keynesians assert.
In short, Austrians believe money is never neutral (not in the short, medium, nor long run), and institutions that deal with it (banks in particular) must be founded on universal legal principles which prevent a “falsification” of relative prices due to strictly monetary factors. Such falsifications lead to the widespread malinvestment of resources, and inevitably, to crisis and recession. Thus Austrian theorists consider the following to be the three essential principles of macroeconomic policy, in order of importance:
1. The quantity of money must remain as constant as possible (i.e., as in a pure gold standard), and credit expansion must be particularly avoided. These objectives require a return to the traditional legal principles which govern the monetary bank-deposit contract and the establishment of a 100-percent reserve requirement in banking.
2. Every attempt should be made to insure that the relative prices of different goods, services, resources, and factors of production remain flexible. In general the greater the credit and monetary expansion, the more rigid relative prices will tend to be, the more people will fail to recognize the true cost of a lack of flexibility,and the more corrupt the habits of economic agents will become. Agents will eventually come to accept the misconceived idea that the vital adjustments can and should always take the form of an increase in the quantity of money in circulation. In any case, as we have already argued, the indirect, underlying cause of economic maladjustments lies in credit expansion, which provokes a generalized malinvestment of resources, which in turn creates unemployment. The more rigid the markets, the higher the unemployment.
3. When economic agents enter into long-term contracts negotiated in monetary units, they must be able to adequately predict changes in the purchasing power of money. This last requirement appears the easiest to satisfy, both when the purchasing power of the monetary unit declines continuously, as has occurred since World War II, and when it gradually and predictably rises, as would occur following the adoption of a policy to maintain the quantity of money in circulation constant. In fact the condition is even more likely to be met in the second case.