A Non-Austrian Vindication of Hayek’s Monetary Policy

Hayek has always been considered somewhat of a maverick within the Austrian School. His views on several economic and philosophical issues depart from those of others in the Austrian tradition, particularly those in the Rothbardian lineage. A good example is Hayek’s support for a government-provided safety net in the form of “a minimum income for everyone, or a sort of floor below which nobody need fall even when he is unable to provide for himself.”

Monetary theory is another area of disagreement between Hayek and other Austrians. Hayek favored a monetary system of competing private fiat currencies, which he discussed in detail in his famous book The Denationalization of Money. Such a system doesn’t require a central bank, at least in its current monopolistic form (Hayek didn’t rule out the possibility that, after abolishing central banks, some private financial institutions would take over the “classic functions of central banks, such as that of acting as lender of last resort or of holder of ultimate reserve”).

Rothbard (and Huerta de Soto, too) was also in favor of abolishing central banks and replacing them with a free-market monetary arrangement, but of a different kind: a 100-percent-reserve system with gold acting as reserve currency. Under this system, commercial banks would issue their own bills and deposits fully backed by gold.

Hayek’s views on monetary policy were also heterodox, at least if we compare them to the position represented by Rothbard or Huerta de Soto. As mentioned above, Hayek argued for a very peculiar free-banking system based on private fiat currencies competing with each other. However, given that central banks exist and aren’t likely to be abolished in the medium term, what should the aim of central banks be according to the author of The Road to Serfdom and how does it differ from that of the Austrian orthodoxy?

Hayek believed that the ultimate goal of central banks should be to stabilize nominal spending (i.e., nominal GDP). This policy goal implies offsetting changes in the velocity of money by increasing or decreasing the money supply. For instance, in the aftermath of 2008 crisis, this would have involved undertaking an expansionary monetary policy to prevent nominal GDP from falling below trend. In other words, Hayek would have called for monetary expansion to fight a deflationary spiral resulting from the financial crisis and subsequent recession.

This sounds at odds with the Rothbardian view that central banks should stand still and do nothing during and after an aggregate demand shock (if “doing nothing” is possible for a central bank, which, as George Selgin convincingly argues in this article, it isn’t). Put differently, central banks should refrain from conducting expansionary monetary policies  even when there is an increase in the demand for real money balances (i.e., a decrease in the velocity of money).

Given his heterodox position on these and other issues, it is not surprising that at least a part of the intellectual heirs to Hayek’s monetary policy views don’t belong to the Austrian tradition. I’m referring to market monetarists. Market monetarism is school of thought that advocates the adoption by central banks of a nominal GDP level target that replaces the current inflation-targeting framework.

Market monetarism is based Milton Friedman’s classic monetarist views, although with two basic differences. First, market monetarists believe that nominal GDP is a better indicator of the stance of monetary policy than monetary aggregates. Second, they argue for the creation of a futures market in nominal GDP contracts to hit this monetary-policy target.

Even though there are some differences between Hayek’s proposal (which is closer to Selgin’s productivity norm) and market monetarism, they both share the idea that central banks should aim at stabilizing nominal spending, letting the price level fluctuate throughout the business cycle.

As shown, Hayek’s monetary policy prescriptions are pretty much in line with those of market monetarists, a school far from the Austrian tradition. In this respect, his views are far from the Rothbardian strain of the Austrian School of Economics.

Hayek’s ideas should thus be vindicated not just by Austrians, but also by other schools of thought that have been directly or indirectly influenced by one of the most important economists and political theorists of the twentieth century.