von Mises on "The Quantity Theory of Money"

[Practice Good Theory Blog]

von Mises on the Quantity Theory of Money:

Reading von Mises a while ago, I was surprised to see him speak against the Quantity theory of Money, but what he said made a lot of sense. A recent Facebook comment sent me back looking for the source, and I decided to blog a few choice quotes, because others may find it interesting.

My summary of von Mises's position is as follows:

• The supply of money is an important factor in its value. This is the element of truth in the Quantity Theory
• However demand for money is the other factor. The quantity theory gives short shrift to demand for money. (One must look to individual decision-making processes and their objective context to understand the demand for money. One cannot start with the aggregate demand for money.)
• Even if supply were the only factor, it is wrong to assume the value of money will change in direct proportion to the change in supply
• It is also wrong to assume that an increase in supply of money changes all prices generally and similarly
• A good theory of the value of money will also consider money-substitutes. The availability of and confidence in money substitutes can impact the demand for money
• The quantity theory may appear right in a context where new supply is constantly being created and most other factors around demand are not varying much. However, in panics, the demand for money can increase drastically and say the velocity has changed explains nothing

Source: The Theory of Money and Credit - by Ludwig von Mises (that online text "corresponds to the 1953 Yale University Press Edition, New Haven.").

 

Below are some selected quotes from a single section. For anyone interested in Economics, I strongly suggest you read all of section 6 in chapter 8, to get the entire flavor.

 

Introducing the facts behind Demand and Supply "curves":

 

 

"When the determinants of the exchange ratios between economic goods were first inquired into, attention was early devoted to two factors whose importance for the pricing process was not to be denied. It was impossible to overlook the well-known connection between variations in the available quantity of goods and variations in prices, and the proposition was soon formulated that a good would rise in price if the available quantity of it diminished. ... ...

 

Thus, a mechanical theory of price determination was arrived at—the doctrine of supply and demand, which until very recently held such a prominent position in our science. Of all explanations of prices it is the oldest.

 

"

 

Introducing the Quantity Theory:

 

 

"It was an obvious step to take this theory, that had been constructed to explain the reciprocal exchange ratios of commodities, and apply it to fluctuations in the relative values of commodities and money also."

 

 

On the element of truth in theory:

 

 

"... one fundamental idea contained in the quantity theory, the idea that a connection exists between variations in the value of money on the one hand and variations in the relations between the demand for money and the supply of it on the other hand, ... ... constitutes that core of truth in the theory which even the modern investigator can and must recognize as useful. Although the historian of economic theory may find this formulation inexact and produce quotations to refute it, ... ... Beyond this proposition, the quantity theory can provide us with nothing.

"

 

Against the idea that changes in the value of money are proportionate to the changes in the quantity of money:

 

 

"It was not difficult to prove that the supposition that changes in the value of money must be proportionate to changes in the quantity of money, so that for example a doubling of the quantity of money would lead to a doubling of prices also, was not in accordance with facts and could not be theoretically established in any way whatever. It was still simpler to show the untenability of the naive version of the theory which regarded the total quantity of money and the total stock of money as equivalent."

 

 

... ...

 

 

 

"There is no justification whatever for the widespread belief that variations in the quantity of money must lead to inversely proportionate variations in the objective exchange value of money, so that, for example, a doubling of the quantity of money must lead to a halving of the purchasing power of money."

 

 

Objecting that we do not get demand for money by starting with the aggregate:

 

 

"For a long time it was believed that the demand for money was a quantity determined by objective factors and independently of subjective considerations. It was thought that the demand for money in an economic community was determined, on the one hand by the total quantity of commodities that had to be paid for during a given period, and on the other hand by the velocity of circulation of the money. There is an error in the very starting point of this way of regarding the matter, which was first successfully attacked by Menger.

 

 

 

... If we start with a formula that attempts to explain the demand for money from the point of view of the community instead of from that of the individual, we shall fail to discover the connection between the stock of money and the subjective valuations of individuals—the foundation of all economic activity."

 

Sometimes demand for money can increase:

 

"... ... cases do occur in which the demand for money in the narrower sense increases suddenly and to an unusually large degree, so that the prices of commodities drop suddenly. Such cases occur when the public loses faith in an issuer of fiduciary media at a time of crisis, and the fiduciary media cease to be capable of circulation. Many examples of this sort are known to history (one of them is provided by the experiences of the United States in the late autumn of 1907), and it is possible that similar cases may occur in the future. "

 

Blog cross-posted with permission. See link at top of post for original.

Edited July 12, 2016 by softwareNerd

[Weissaul]

Hi there, first thread.

 

It accepted by pretty much all economists that the quantity theory of money holds true in the long term. The dispute is whether it works out well in the short term and how long the short term is.

 

One problem the theory had for a long time was that prices were (and still are) sticky. For example it would take time to re-calibrate a gas pump to new prices years ago (so gas station owners didn't always want to put the effort in to raise the price to adjust for inflation immediately) but now with computers it's a simple matter of typing a few keys and voila your prices are adjusted.

 

My question is, since it is easier than ever for a store owner to track prices (via electronic means) and thus adjust nominal values to react to inflation, is the quantity theory of money becoming truer in the short term?

[softwareNerd]

Welcome to the forum.

 

Except for really high inflation, where prices are changing week to week, I doubt the mechanics of re-stickering is a major reason for price-stickiness. Take the gas-station example: with the thin margins that gas-stations have, I expect owners would take the time to change prices (upward so not to lose margin, downward so not to lose revenue) unless they had to do it multiple times a day. It is a bigger cost for a business that is forced by law to sticker each and every item. However, this type of cost would remain even if it is easy to change the cost within the computer system.

 

As for the quantity theory being accepted by pretty much all economists: it depends what one means by "the quantity theory". First, there's the abstract idea that a large increase in the supply of something (including money) will cause its market value to fall (prices to rise, in the case of money). Then, there is the more concrete idea that a doubling of the money-supply will cause a doubling of prices. This second -- the "linear quantity theory of money" is weak, and might be false.

 

Here are some quotes from von Mises, who was very critical of the quantity theory of money.

 

In addition, during turning points, when the Fed is pumping money into the system the 'ceteris paribus" assumption breaks down. It is not simply supply of money that increases. The demand for money changes too.

Edited March 8, 2013 by softwareNerd