This morning Justin Merill alerted me, via Facebook, to a recent episode of The Tom Woods Show titled “Against Market Monetarism and NGDP Targeting.” The episode consists of an interview with Austrian monetary economist Joe Salerno, in which Salerno takes issue with Market Monetarists and, especially, with those current or former Austrians, including Larry White and me, who share Market Monetarists’ view that a well-functioning monetary system should avoid fluctuations in aggregate spending.

In the course of the interview Salerno, egged on by Woods, * suggests that when ostensible free banking proponents like Larry White and me treat stability of spending (MV) as a desirable monetary policy outcome, we implicitly endorse a centrally-planned money supply. Evidently it doesn’t occur to him that we like free banking precisely because we consider it, when combined either with a metallic standard or a frozen (or otherwise absolutely limited) stock of fiat (or "synthetic commodity") base money, an excellent device for achieving a stable level of total spending, and far superior in that respect to discretionary central banking. But you can hardly blame him for the oversight: after all, Larry and I have only pointed out this connection in just about every one of our writings on free banking, including my Theory of Free Banking, the first part of which is almost entirely devoted to showing how a free banking system tends automatically to stabilize spending.

It gets worse. When Salerno challenges what he refers to as “Larry White’s program” for having M change so as to offset opposite changes in V, Episode 361 of the Tom Woods Show graduates from scurrilous to spurious. “As people who believe in Austrian business cycle theory will tell you,” Salerno declares, “any creation of money by the Fed always goes through credit markets. That pushes interest rates down below their natural level. And that brings about the series of events that we know as the Austrian business cycle theory. So we think that is not a good policy; it’s a dangerous policy.”

The only problem with this argument is that at least one person who most certainly believed in Austrian business cycle theory would not have agreed with it. No biggie, right? Well, it wouldn't be, were it not for the fact that the person in question happens to have been ... Friedrich Hayek, the Austrian business cycle theory's most important elaborator and exponent.

Though before he put the finishing touches on his famous theory Hayek shared Salerno’s preference for a constant money stock, he changed his mind in the course of writing his best-known works on the subject. Hayek’s mature understanding made its debut in the first English edition of Prices and Production (1931, p. 297), where Hayek observes that “[a]ny change in the velocity of circulation would have to be compensated by a reciprocal change in the amount of money in circulation if money is to remain neutral toward prices.” Somewhat later, in his essay on “Saving” (1933), Hayek observed that “Unless the banks create additional credits for investment purposes to the same extent that the holders of deposits have ceased to use them for current expenditure, the effect of such saving is essentially the same as that of hoarding and has all the undesirable deflationary consequences attaching to the latter.” Apart from minor modifications, this remained Hayek's theoretical position throughout the remainder of the 1930s and for some time beyond.

So, if Larry White doesn’t know his Austrian business cycle theory quite as well as Joe Salerno does, he shouldn’t feel too bad about it: after all, he’s in pretty good company.

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*Apologies to Tom for my inaccurate first impression.

Addendum 1(3-21-2015): As some readers have misunderstood me on the point, let me make clear that I do not mean to suggest that Hayek himself favored discretionary central banking as a means for implementing his ideal! His position resembled White's in that he favored a rule-based system founded on gold convertibility while viewing central banks as the main cause of the then-existing system's failure to approximate his ideal. In fact Hayek resisted calling for monetary expansion in the 30s despite the collapse in spending that had occurred--though he came to regret having done so. The fact remains that Salerno's characterization of the Austrian business cycle theory is inconsistent with Hayek's own understanding.

Concerning Salerno's suggestion that it is wrong for White and others to endorse or rationalize expansionary central bank action even as a "second best" alternative, see my previous post on the matter, the gist of which is that it's meaningless to suggest that a central bank, assuming one exists, "do nothing." Consequently it's impossible to avoid implicitly endorsing a second-best alternative that could be construed as offering "advice" to a central planner. That is what Joe Salerno effectively does in arguing for a constant-M ideal. It is also, in effect, what Hayek did, to his ultimate regret, when he opposed Bank of England expansion in the early 1930s. My point isn't to condemn the implied advice in either case, but simply to point out that saying that a central bank should "do nothing" can also be construed--unfairly--as endorsing a particular monetary central plan.

Addendum 2(3-21-2015): Bill Woolsey weighs in on Salerno's notion of monetary neutrality.