[I wrote this post several days ago, as an afterthought in what JP Koning calls "The great monetary injection debate of 2012". Then I sat on it. Not just because it's a bit ad hominem/gotcha!. I'm not sure it's quite right. Anyway, with that caveat, I'm just throwing it out there, to see what readers might make of it, if anything.]
Hayek assumed that newly-printed money is injected via the credit market, where it pushes down the market rate of interest relative to the natural rate of interest, and this causes people's plans and expectations to be mutually inconsistent, and this causes an unsustainable change in the time-structure of production.
But Hayek's assumption is obviously usually wrong.
Newly-printed money can be injected anywhere in the economy. It might be spent on bonds. But it might instead be spent on tanks. Or it might be spent on increased transfers, or tax cuts, which is just another name for helicopter money. And when we look at the numbers, we see that changes in annual government spending and tax revenue are bigger than changes in the amounts of money the central bank prints each year. We can ask what would happen if we printed more money and held government spending and taxes constant. But this isn't what usually happens.
If Austrian economists are right to insist that it really really matters where the new money is injected into the economy, then Hayek was making a very special assumption, one that is nearly always empirically false, and false in a way that matters a lot, and so Hayek's analysis is mostly irrelevant.
I'm going to defend Hayek against the Austrians.
Suppose the government gives me $1 billion in newly-printed notes. The helicopter only flies over my house. (That is equivalent to the central bank buying $1 billion in government bonds, plus the government selling $1 billion in government bonds to give me a transfer payment of $1 billion. I would say we can analyse those two operations).
I'm richer. We can expect to see an impact on the markets for old sports cars and new canoes. It would probably be different if you got the $1 billion instead of me.
But what do I do immediately with that $1 billion in freshly-printed notes? I go to the bank, and deposit them, or most of them, in my account. I lend the bank $1 billion. That $1 billion in base money enters the credit market just as surely as if the central bank had lent my bank an extra $1 billion.
Even if I didn't do that, and instead paid cash for $1 billion worth of old sports cars, the sellers of those cars don't want to hold the cash either. They deposit it in their banks. They lend $1 billion to their banks. Again, that $1 billion in base money enters the credit market just as surely as if the central bank had lent an extra $1 billion to their banks or bought $1 billion worth of bonds.
We don't want to hold an extra $1 billion in base money. So we lend it. Or most of it. Or try to lend it, by pushing down interest rates. It enters the credit market.
OK Hayek, over to you. What happens next?
Here's my old sketch of what happens next.
By the way, is this an ad hominem argument?