Money is not another commodity
Where the Austrians and other proponents of 'real' economics get it wrong
In his book "Living Economics", die-hard Austrian Peter Boettke all but declares war on Keynesian thought he singles out as "bad economics" - while betraying the very fundamental misunderstanding about monetary economics so typical for Austrians (and, indeed, other proponents of the ‘underlying’, real economy).
In his view, Keynes violated the self-evident truths provided by classical economist J.B. Say that "the slightest excess supply beyond the demand is sufficient to produce a considerable alteration in price." Only that in a fiat money economy, it sometimes doesn't.
The system of relative real prices at the core of Austrian worship gets derailed once a non-commodity money is introduced. As Keynes roughly put it: ‘Since money is not grown on trees, thus allowing for the divertion of labour into money growing, any excess demand for money necessarily entails unemployment.’
In modern economies, money is simply created and destroyed by governments (more precisely: central banks) and commercial banks, as the term ‘fiat money’ aptly expresses.
Part and parcel for the analysis of spending and saving in an economy, then, is the notion of ‘liquidity preference’ (see for example this excellent paper by Jörg Bibow): All other things equal, people sometimes prefer to hold more money than usual to provide for a safety cushion: They might fear to lose their job, or rising prices, or higher taxes etc.
It's people’s relative level of optimism for the future (Keynes's 'animal spirits') or, put another way, their relative tolerance for the inevitable uncertainty they're facing that determines their spending or saving and thus their demand for money.
I.e., households' demand for money is at least in part exogenous to the economic calculus and down to the effects of real uncertainty (rather than calculated risk): People's liabilities are denominated in money, so money it is they need to fulfil their obligations.
In a fiat money system, the nominal interest rate thus follows from people's liquidity preference = demand for money, not the other way round.
It's no use to lower interest rates on the part of central banks when people are looking for safety (since there's no demand for loans when households and firms are anxious). And that, of course, is exactly what happened in the years after the Great Financial Crisis: Interest rates would get to zero or even below, yet they still failed to instigate borrowing and spending (see my pre-print on interest-rate theory for further elaboration on this point).
Hence, far from inadvertently violating the mechanism of relative prices as alleged by Boettke and other Austrians, Keynes showed why its very operating at the centre of an economy creates macroeconomics pitfalls once money is different from just another commodity. And this is also where 'money is a veil'-advocates, insisting on the indirect premise of a commodity money (known as 'loanable funds' theory), get it wrong.
It's true that in terms of fiscal policy, Keynesian thought is readily more exploitable by political interests than, e.g., Austrian economics. However to present this unrelated fact as another original sin of Keynes's amounts to straw-man thumping.
In the end, it isn't so much Keynes and his Post-Keynesian disciples ignoring basic economic intuition as claimed exclusively by Boettke & his ilk, but rather those treating fiat money as a mere veil, stubbornly employing real analysis to a nominal world. Keynes had a much better understanding of the effects of people's level of economic confidence than many other economists; in this, he was much more akin to modern behavioural economics than the 'bastard' Neo-Keynesian economics à la Samuelson and Hicks he is so often reduced to.