Money is generally referred to as the medium of exchange. Thus far most economists agree. Kind of.

According to the Wikipedia article on money, which summarizes the common view, the functions of money are generally listed as “a medium of exchange; a unit of account; a store of value; and, occasionally in the past, a standard of deferred payment.” This makes it a little more open what “is” a money, but to be a medium of exchange certainly is a core attribute or function. And, one can argue, if it is the generally accepted medium of exchange then it also functions as a unit of account, a store of value, and a standard for deferred (as contrasted by immediate) payment. The latter easily follow from the former, so let’s not add complexity where none is needed.

Even the simple definition as a generally accepted medium of exchange can be confusing. The reason is that the term “medium” says nothing about the character or nature of money. One has to be careful, therefore, when speaking about money with other economists, and make sure that there is a shared understanding. Usually, if you’re an Austrian, there is not. The reason is that we, as Austrian economists, tend to think of money “in the narrower sense” while non-Austrians think of money “in the broader sense” (primarily fiat money or money substitutes). (See Mises’s masterful Theory of Money and Credit for definitions and an expanded discussion.)

As Joseph T. Salerno points out in his great Money: Sound and Unsound, money is to non-Austrians a “measure of value” or a “veil” rather than an actual market institution:

those who treat money as a measure of value tend to conceptually isolate it from real-world market processes, attributing the origination of money and of its purchasing power to some vague extra-market “convention.” Thus, for example, Friedman declares, “the existence of a common and widely accepted medium of exchange rests on a convention” and “the value of money rests on a fiction.” Following classical monetary theorists like John Stuart Mill, Friedman argues that money is a “veil,” which is neutral to and does not influence the underlying “‘real’ forces that determine the wealth of a nation.” The only time that money impinges on the real economy, according to Friedman, is when it “gets out of order” and the “fiction” supporting money’s common acceptance and market value threatens to completely dissolve. For Friedman and the monetarists, disorderly money is characterized by an unstable price level.


Money is “neutral” and something that is easily tampered with, and it “works” as long as it does not get out of order. The difference between different non-Austrian theories of money can, though quite simplified, be summarized as their differences as to how much a central bank (or other economic planning agency of government) can and should tamper with money. To Friedman and the monetarists, the role of the central bank is limited to having money supply keep up with economic growth. To a Keynesian like Krugman, the money supply should be radically increased to cause a spending frenzy and wipe out government debt. And so on.

Now, it is not necessary for an Austrian to be firm “gold bug” to deviate from the mainstreamers. Neither is it necessary to discuss policy and the evils thereof. One can, on the mainstreamers’ own terms, argue that they are very wrong. The reason is that the Austrian theory of money, as developed by Mises based on insights from Menger and Wieser, follows in the tradition of the Currency School. Mainstreamers do not.

While this may seem like a minor point of no interest except for those interested in the history of economic thought, it makes a lot of difference. The Currency School realized a fundamental point, though they didn’t follow the logic all the way through (as shown in e.g. the 1844 Peel’s Act), which is well in line with Austrian thinking of the market as a dynamic and interrelated (indeed, interdependent) process of change and discovery: money is not neutral.

So even if money exists and is accepted as ink-stained rectangular pieces of paper of no “inherent” value or as bits and bytes on a computer hard drive, money affects and is affected by actions in the market. It is simply not possible to “inject” more money in the economy without forcing reallocations of productive assets and, consequently, a different production structure and therefore output. Even if it were possible for “Helicopter Ben” to turn himself into a “Helicopter Harry Potter” and magically double everybody’s money assets, their behaviors would change and prices would not immediately adjust – and not even to the same degree.

This is why we talk about Cantillon effects, the phenomenon that new money hits the economy in “waves” of adjustments that eventually leads to reallocation of value from those who are last to get their hands on the new money to those who are first.

So even if we grant Friedman and others – for the benefit of argument (we wouldn’t want to go further down that path!) – their argument, it is still impossible to carry out. (And why would we need a stable price level, anyway? Shouldn’t prices go down as innovations make production more effective and efficient?)

Add to this, then, that money as a “veil” – impossible as it is – is assumed to be a great tool for central planners in government who wish to endlessly borrow money to buy votes while never picking up the tab.

It is necessary to realize that money is indeed a medium of exchange and that this makes it valued for its own sake (which is another way in which mainstream theories are disproved), and that it therefore cannot be and never is neutral. The reason, I speculate, that mainstreamers are so eager to use monetary policy to “solve” problems is that they refuse to think of money as a market institution where money is never neutral. Because if they do, then they have to also accept the disastrous effect of meddling with it. And then their case falls.

It is a simple argument to claim we would be better off with a free-market gold standard without any manipulation by banks or government. But there is no reason to make this argument, which to many seems a bit crazy. It is sufficient – at least at present – to point out that money is never neutral and that therefore the mainstream theories, whether they are monetarist or Keynesian, fall flat. They can possibly get around these problems to save their theory, but not to save their preferred and recommended policies.