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.
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