Macroeconomic stability/Austrian school

Conventional economics has it that if you accelrate inflation by a lax monetary policy this will distort the relative price changes. Consequently it favours some form of monetary policy that keeps a stable price level or at least a fairly constant low inflation rate.

However the Austrian school claims that this might cause troble as well.
They use the US in the 20s as an example.
Could someone explain the economic rationale behind this?
I know that some Austrians favour freebanking, but given that we have governemnt monopoly in issuing legal tender, what sort of steering wheel do they favour?

I don’t recall hearing that. There is discussion on whether money injected into the economy goes to some rather than others, but as far as I am aware it is out of control inflation that is the real concern. A little inflation isn’t so bad, IIRC some even say that it is good, but when it gets out of hand it creates a lot of problems by creating uncertainty and undermining wealth.
I’ve never heard of Austrians advocating a loose monetary policy, but I’m sure one will be along soon to give us the scoop.

I’ve never heard of Austrians advocating a loose monetary policy, but I’m sure one will be along soon to give us the scoop.

Me neither, but if I undertsand them correctly, they advocate a monetary policy which in a situation like that in the 20s would produce deflation.

IANAEconomist, but I do read a bit about the Austrian school.

It is the nature of government or central banks to inflate currencies–creating surpluses of money–when they have the power to do so. This is mostly accomplished now by increasing bank lending (artificially lowering interest rates). When a borrower takes out a loan at a bank, most of that money is created out of thin air, or thin paper to be more accurate.

Surpluses of money mislead investors into thinking that there is more wealth available at large than there really is, making things appear great for a while, but ultimately leading to unprofitable (and hence wealth-destroying) uses of capital. Even when inflation rates are low, this mechanism occurs and has to be corrected eventually. This is what happened in the 1920’s in the U.S. The Federal Reserve had just been created the previous decade, and it was creating more money than there was gold to back it up. Inflation was distorting the U.S. economy. The seeming wealth of the 20’s was thus partly illusory, and the unwise speculation that resulted eventually led to such a destruction of wealth that no amount of tinkering with the money supply could fix things.

Given the current state of fiat currency as legal tender, it is probably not possible to come up with a solution satisfactory to the Austrian school. The only “steering wheel” they would approve of would be the invididual banks themselves, operating without government support and using money that is backed by gold, determining interest rates based on their available capital and affordable risk.

I hope this answers the question. I am certainly willing to be corrected by Austrian-schoolers if I have something wrong here.

mr. moonlight essentially got it right, except that the most important point regarding monetary policy is to get it out of the hands of the government.
Some proponents of the Austrian school would be happy with a commodity backed money, which in this day and age would probably be a basket of goods and services. Others insist that money should be privatized and different currencies should compete with each other just like every other product. Keysians have faith that the government will know the right thing to do regarding monetary policy AND have the discipline to do it. The fact is, neither is likely. The temptation to keep interest rates low in the interests of political expediency is too great. Artificially low interest rates interfere with the free markets clearing mechanisms and would tend to create a glut of money. Gluts put producers out of business (in this case, lenders) and pave the way for higher prices.

That’s why Fed govenors have fourteen year terms, and cannot be reappointed after a full term. When people talk of putting monetary policy in the hands of Congress I cringe.

Jeez, are there people actually campaigning for that?

I haven’t heard of anybody talking about it lately; but, I do seem to recall it coming up now and again. I don’t recall any mainstream politicians putting it in their platforms.