Monetary-disequilibrium theory

Monetary disequilibrium theory is a product of the monetarist school and is mainly represented in the works of Leland Yeager and Austrian macroeconomics.

The basic concepts of monetary equilibrium and disequilibrium were, however, defined in terms of an individual's demand for cash balance by Mises (1912) in his Theory of Money and Credit.

[2] Leland Yeager's (1968) understanding of the monetary disequilibrium theory begins with fundamental properties of money.

The differences between individuals' actual and desired holdings of money are the proximal causes of them affecting the level of spending in the macroeconomy.

The theory also addresses the effects of monetary policy on real sectors of the economy, that is, on the quantity and composition of output.

Monetary-disequilibrium theory states that output, not (or not only) prices and wages, fluctuate with a change in the money supply.

[4] Monetary-disequilibrium is a short-run phenomenon as it contains within itself the process by which a new equilibrium is established i.e. through changes in the price level.

If the demand for real balances changes, either the nominal money supply or price level can adjust to monetary equilibrium in the long run as seen from the figure.

Finally, the third condition of monetary-equilibrium concerns equilibrium in the commodity market defined as stable price level.

The whole approach begins with the work of Knut Wicksell in the development of the concepts of natural and market rates of interest.

Wicksell's work had a clear Austrian connection as he relied on Eugen Ritter von Böhm-Bawerk's theory of capital in developing the concepts.

According to Ludwig von Mises, monetary equilibrium happens first at the individual level.

Mostly modern Austrian economists emphasize the effects of inflation more than the harm caused by rapid deflation.

However, it does not guarantee that ex-post will match it especially if entrepreneurs are prevented from finding the price that will bring equilibrium in the market.

In loanable funds market equilibrium ex-ante plans of savers and investors match precisely.

Banks will create more loanable funds than people's real willingness to save as determined by their time preferences.

This view was a part of the belief in laissez-faire that government intervention is not required to prevent general shortages.

Now, if the preferences of the income earners shift towards the future resulting in a fall in C and increase in S as shown in equation 2.

In the simple classical model increase in savings cause a fall in the interest rates thereby inducing additional investment expenditure.