Sunday, October 6, 2013

More Thoughts on Hayek, the Monetary Theory of the Trade Cycle, and Price Level Stabilization

In looking over Monetary Theory and the Trade Cycle I also noticed a rather strange argument that Hayek makes in regard to changes in demand for money. He argues against a policy of stabilization outright. Even if we grant him this claim about policy, I find his desire to disregard the significance of changes in the value of money incongruous with his general concern about “all the changes originating in the monetary field.” Especially toward the end of his book, Hayek leaves little room for confusion of interpretation:

With the disappearance of the idea that money can only exert an active influence on economic movement when the value of money (as measured by one kind of price level) is changing, the theory that the general value of money is the sole object of explanation for monetary theory must fall to the ground. Its place must, henceforth, be taken by an analysis of all the effects of money in the course of economic development. All changes in the volume of effective monetary circulation, and only such changes, will therefore rank for consideration as changes in economic data capable of originating ‘monetary influences.’

In a different part of this book, the reason that Hayek presents for concentrating only on changes in the volume of currency should also apply to changes in the value of money. I refer to his claim that changes in the volume of currency impact relative prices:

“But general price changes are no essential feature of a monetary theory of the trade cycle; they are not only unessential, but they would be completely irrelevant if only they were completely ‘general’ – that is, if they affected all prices at the same time and in the same proportion. The point of real interest to trade cycle theory is the existence of certain deviations in individual price relations occurring because changes in the volume of money appear at certain individual points; deviations, that is, away from the position that is necessary to maintain the whole system in equilibrium. Every disturbance of the equilibrium of prices leads necessarily to shifts in the structure of production, which must therefore be regarded as consequences of monetary change, never as additional separate assumptions. The nature of the changes in the composition of the existing stock of goods, which are effected through such monetary changes, depends of course on the point at which the money is injected into the economic system.

Again he writes elsewhere:

But this future theory, unlike that of Wicksell, will have to examine not movement in the general price level but rather those deviations of particular prices from their equilibrium position that were caused by the monetary factor.

The confusion appears to arise from the concentration of economists like Fisher and Cassel on stabilization of the general price level in general. Hayek expresses two doubts about their theory that can easily be confronted. One concerns the viability of the policy implication. The other makes an implicit assumption about income elasticity. The first is captured in the first citation above. In a flash of parenthetical sarcasm, Hayek expresses doubt about price level stabilization because it depends on the use of “one kind of price level.” Price level in theory and price level in practice are not the same, and they should be treated as such. According to the equation of exchange, MV = PY. Even if we take Hayek’s statement about price stabilization at face value, this does not mean that changes in the value of money do not impact the production structure. In fact, a change in V can affect P! This leads naturally to the second problem. A change in V can and does impact relative prices. Simple micro theory can elucidate this point. A change in V that affects P does not affect all prices symmetrically. The impact on price depends on the income elasticity of each good or service. Unless the income elasticity for all goods and services all equal one, the change in V does affect relative prices, and therefore, it may alter the production structure. As I mentioned yesterday, Hayek eventually changed his views. For the sake of the history of monetary thought, however, this incite is valuable in evaluating movement in academic sentiment at the time.

No comments:

Post a Comment