In Hayek's 1933 essay, he writes:
In complete contrast to those economic changes conditioned by "real" forces, influencing simultaneously total supply and total demand, changes in the volume of money have, so to speak, a one-sided influence that elicits no reciprocal adjustment in the economic activity of different indiduals. By deflecting a single factor, without simultaneously eliciting corresponding changes in other parts of the system, it dissolves its "closedness," makes a breach in the rigid reaction mechanism of the system (which rests on the ultimate identity of supply and demand) and opens a way for tendencies leading away from the equilibrium position.
This text is the core reasoning for the necessity of a monetary theory of a trade cycle. In a barter economy, there would not be the possibility for a tendency away from an equilibrium. I feel like I understand that money dissolves the "closedness" of a system, but I don't understand exactly how, meaning, I could not explain to another person how the introduction of money effects the general direction of pricing.
Could someone please explain, in a mechanistic sense, how it is that the general introduction of money permits prices to tend towards non-equilibrium positions?
The Anarch is to the Anarchist what the Monarch is to the Monarchist.
One of the most important and best written sections in Human Action was the section upon the non-neutrality of money. New money appears in the economy, but it only appears to certain individuals. This means that they have more money to spend and demand for certain goods shifts to the right, so more is produced and prices rise. With this said, however, real ratios of supply and demand have not changed. Production potential has not increased, nor have the individuals who have a greater amount of money received a lasting form of an increase in income.
The money moves around, increasing demand in general, as monetary incomes have now increased. This entire period, between when new money is introduced and prices have adjusted is a period of disequilibrium, even in the ERE. Because the spending on outputs is larger than the spending previously was on inputs, profit margins will increase, and as I hope you know a situation in which there are profits, (let's forget about monopoly for now) is not an equilibrium position.
To use Neo-Classical terms the introduction of new money in the economy shifts AD to the right, without increasing real AS, meaning that it hits the vertical part of the AS curve, so Q will be identical, but P will increase. Eventually competitive forces take place, the productive capacity of the economy isn't enough to satisfy the new demand for goods, so the bidding process will drive up prices to meet the new level of demand, productive factors in the hands of the industries with the highest profit margins, until profit margins disappear and a new equilibrium is reached. Because everyone (presumably) has more money they will all spend more money than they would have at the old level of the money supply, prices on the whole will increase.
What I said was all a little redundant, but I hope it answers your question.
I'm sorry but I don't think it does. Actually I think you may have done too much. What Hayek is talking about doesn't have anything to do per se with 'new money' (I take it you mean a Misesian definition of inflation?), but a fundamental difference in the tendency of price movements between a barter economy and a money economy.
I think it's something like this: in a barter economy, when you make a trade, you are doing two things you would be doing in a money economy: selling your product and buying the product you want. Because in a money economy, you don't make both transactions at once, but complete this 'barter transaction' (good for a good) over a non-instantaneous period of time this somehow allows prices to move in a direction which is not necessarily equilibrium. I don't quite understand what it is about the non-instantaneousness of the money transaction as opposed to the instantaneousness of the barter transaction which allows prices to move as aforementioned.
EDIT: On second thought I think you did answer my question. :P
I thought I had work to do, and then it turned out I didn't. :D
But yeah, Hayek is talking about inflation. He directly mentions changes in the "volume" of money
Also, the basic idea of the quantity theory of money should be undeniable so I agree that printing money can be called inflation, but with this said I find the stubbornness of Austrians to say that this and only this is inflation is foolish. Overall increases in the price structure can be considered inflation, even if, as Rothbard rightly said, it can be practically impossible to really calculate any sort of "price level"