Man, Economy, and State, by Rothbard, Chapter 11—Money and Its Purchasing Power
Section * Next
AND ITS PURCHASING POWER
has entered into almost all our discussion so far. In chapter 3 we saw
how the economy evolved from barter to indirect exchange. We saw the
patterns of indirect exchange and the types of allocations of income
and expenditure that are made in a monetary economy. In chapter 4 we
discussed money prices and their formation, analyzed the marginal
utility of money, and demonstrated how monetary theory can be subsumed
under utility theory by means of the money regression theorem. In
chapter 6 we saw how monetary calculation in markets is essential to a
complex, developed economy, and we analyzed the structure of
post-income and pre-income demands for and supplies of money on the
time market. And from chapter 2 on, all our discussion has dealt with a
The time has come to draw the threads of our analysis of the market
together by completing our study of money and of the effects of changes
in monetary relations on the economic system. In this chapter we shall
continue to conduct the analysis within the framework of the
2. The Money Relation: The
Demand for and the Supply of Money
Money is a commodity that serves as a general medium of exchange; its
exchanges therefore permeate the economic system. Like all commodities,
it has a market demand and a market supply, although its
special situation lends it many unique features. We saw in chapter 4
that its “price” has no unique expression on the
market. Other commodities are all expressible in terms of units of
money and therefore have uniquely identifiable prices. The money
commodity, however, can be expressed only by an array of all the other
commodities, i.e., all the goods and services that money can buy on the
market. This array has no uniquely expressible unit, and, as we shall
see, changes in the array cannot be measured. Yet the concept of the
“price” or the “value” of
money, or the “purchasing power of the monetary
unit,” is no less real and important for all that. It simply
must be borne in mind that, as we saw in chapter 4, there is no single
“price level” or measurable unit by which the
value-array of money can be expressed. This exchange-value of
money also takes on peculiar importance because, unlike other
commodities, the prime purpose of the money commodity is to be
exchanged, now or in the future, for directly consumable or productive
The total demand for money on the market consists
of two parts: the exchange demand for money (by
sellers of all other goods that wish to purchase money) and the reservation
demand for money (the demand for money to hold by those who
already hold it). Because money is a commodity that permeates the
market and is continually being supplied and demanded by
everyone, and because the proportion which the existing stock of money
bears to new production is high, it will be convenient to analyze the
supply of and the demand for money in terms of the total
demand-stock analysis set forth in chapter 2.
In contrast to other commodities, everyone on the market has both an
exchange demand and a reservation demand for money. The exchange demand
is his pre-income demand (see chapter 6, above). As
a seller of labor, land, capital goods, or consumers’ goods,
he must supply these goods and demand money in exchange to obtain a
money income. Aside from speculative considerations, the seller of
ready-made goods will tend, as we have seen, to have a perfectly
inelastic (vertical) supply curve, since he has no reservation uses for
the good. But the supply curve of a good for money is equivalent to a
(partial) demand curve for money in terms of the good to be supplied.
Therefore, the (exchange) demand curves for money in terms of land,
capital goods, and consumers’ goods will tend to be
For labor services, the situation is more complicated. Labor, as we
have seen, does have a reserved use—satisfying leisure. We
have seen that the general supply curve of a labor factor can be either
“backward-sloping,” depending upon the
individuals’ marginal utility of money and marginal
disutility of leisure forgone. In determining
labor’s demand curve for money, however, we can be far more
certain. To understand why, let us take a hypothetical example of a
supply curve of a labor factor (in general use). At a wage rate of five
gold grains an hour, 40 hours per week of labor service will be sold.
Now suppose that the wage rate is raised to eight gold grains
an hour. Some people might work a greater number of hours because they
have a greater monetary inducement to sacrifice leisure for labor. They
might work 50 hours per week. Others may decide that the increased
income permits them to sacrifice some money and take some of the
increased earnings in greater leisure. They might work 30 hours. The
first would represent a “forward-sloping,” the
latter a “backward-sloping,” supply curve of labor
in this price range. But both would have one thing in common. Let us
multiply hours by wage rate in each case, to arrive at the
total money income of the laborers in the various situations. In the
original case, a laborer earned 40 times 5 or 200 gold grains per week.
The man with a backward-sloping supply curve will earn 30 times 8 or
240 gold grains a week. The one with a forward-sloping supply
curve will earn 50 times 8 or 400 gold grains per week. In both cases, the
man earns more money at the higher wage rate.
This will always be true. In the first case, it is obvious, for the
higher wage rate induces the man to sell more labor. But it is true in
the latter case as well. For the higher money income permits a
man to gratify his desires for more leisure as well, precisely
because he is getting an increased money
income. Therefore, a man’s
backward-sloping supply curve will never be
“backward” enough to make him earn less
money at higher wage rates.
Thus, a man will always earn more money at a higher wage rate, less
money at a lower. But what is earning money but
another name for buying money? And that is
precisely what is done. People buy money by selling
goods and services that they possess or can create. We are now
attempting to arrive at the demand schedule for money in relation to
various alternative purchasing powers or
“exchange-values” of money. A lower exchange-value
of money is equivalent to higher goods-prices in terms of money.
Conversely, a higher exchange-value of money is equivalent to lower
prices of goods. In the labor market, a higher exchange-value
of money is translated into lower wage rates, and a lower
exchange-value of money into higher wage rates.
Hence, on the labor market, our law may be translated into the
following terms: The higher the exchange-value of money, the
lower the quantity of money demanded; the lower the
exchange-value of money, the higher the quantity of money
demanded (i.e., the lower the wage rate, the less
money earned; the higher the wage rate, the more money earned).
Therefore, on the labor market, the demand-for-money schedule is not
vertical, but falling, when the exchange-value of money
increases, as in the case of any demand curve.
Adding the vertical demand curves for money in the other exchange
markets to the falling demand curve in the labor market, we
arrive at a falling exchange-demand curve for money.
More important, because more volatile, in the total demand for money on
the market is the reservation demand to hold money.
This is everyone’s post-income demand.
After everyone has acquired his income, he must decide, as we
have seen, between the allocation of his money assets in three
directions: consumption spending, investment spending, and addition to
his cash balance (“net hoarding”). Furthermore, he
has the additional choice of subtraction from his cash balance
(“net dishoarding”). How much he decides to retain
in his cash balance is uniquely determined by the marginal utility of
money in his cash balance on his value scale. Until now we have
discussed at length the sources of the utilities and demands for
consumers’ goods and for producers’ goods. We have
now to look at the remaining good: money in the cash balance,
its utility and demand.
Before discussing the sources of the demand for a cash balance,
however, we may determine the shape of the reservation (or
“cash balance”) demand curve for money. Let us
suppose that a man’s marginal utilities are such that he
wishes to have 10 ounces of money held in his cash balance over a
certain period. Suppose now that the exchange-value of money, i.e., the
purchasing power of a monetary unit, increases, other things
being equal. This means that his 10 gold ounces accomplish more work
than they did before the change in the PPM (purchasing power of the
monetary unit). As a consequence, he will tend to remove part of the 10
ounces from his cash balance and spend it on goods, the prices of which
have now fallen. Therefore, the higher the PPM (the
exchange-value of money), the lower the quantity of money demanded in
the cash balance. Conversely, a lower PPM will mean that the
previous cash balance is worth less in real terms than it was before,
while the higher prices of goods discourage their purchase. As a
result, the lower the PPM, the higher the quantity of money demanded in
the cash balance.
As a result, the reservation demand curve for money in the
cash balance falls as the exchange-value of money increases.
This falling demand curve, added to the falling exchange-demand curve
for money, yields the market’s total demand curve
for money—also falling in the familiar fashion for
There is a third demand curve for the money commodity that deserves
mention. This is the demand for nonmonetary uses of
the monetary metal. This will be relatively unimportant in the advanced
monetary economy, but it will exist nevertheless. In the case of gold,
this will mean either uses in consumption, as for ornaments, or
productive uses, as for industrial purposes. At any rate, this demand
curve also falls as the PPM increases. As the
“price” of money (PPM) increases, more goods can be
obtained through expenditure of a unit of money; as a result,
the opportunity-cost in using gold for nonmonetary purposes increases,
and less is demanded for that purpose. Conversely, as the PPM falls,
there is more incentive to use gold for its direct use. This demand
curve is added to the total demand curve for money, to obtain the total
demand curve for the money commodity.
At any one time there is a given total stock of the
money commodity. This stock will, at any time, be owned
by someone. It is therefore dangerously misleading to adopt
the custom of American economists since Irving
Fisher’s day of treating money as somehow
“circulating,” or worse still, as divided into
“circulating money” and “idle
This concept conjures up
the image of the former as moving somewhere at all times, while the
latter sits idly in “hoards.” This is a grave
error. There is, actually, no such thing as
“circulation,” and there is no mysterious arena
where money “moves.” At any one time all the money
is owned by someone, i.e., rests in someone’s cash balance.
Whatever the stock of money, therefore, people’s actions must
bring it into accord with the total demand for money to hold, i.e., the
total demand for money that we have just discussed. For even
pre-income money acquired in exchange must be held at least
momentarily in one’s cash balance before being transferred to
someone else’s balance. All total demand is
therefore to hold, and this is in accord with our analysis of total
demand in chapter 2.
Total stock must therefore be brought into agreement, on the market,
with the total quantity of money demanded. The diagram of this
situation is shown in Figure 74.
On the vertical axis is the PPM, increasing upward. On the horizontal
axis is the quantity of money, increasing rightwards. De
is the aggregate exchange-demand curve for money, falling and
is the reservation or cash-balance demand for money. Dt
is the total demand for money to hold (the demand for nonmonetary gold
being omitted for purposes of convenience). Somewhere intersecting the Dt
curve is the SS vertical line—the total
stock of money in the community—given at quantity 0S.
The intersection of the latter two curves determines the
equilibrium point, A, for the
exchange-value of money in the community. The exchange-value,
or PPM, will be set at 0B.
Suppose now that the PPM is slightly higher than 0B.
The demand for money at that point will be less than the stock. People
will become unwilling to hold money at that exchange-value and will be
anxious to sell it for other goods. These sales will raise the prices
of goods and lower the PPM, until the equilibrium point is reached. On
the other hand, suppose that the PPM is lower than 0B.
In that case, more people will demand money, in exchange or in
reservation, than there is money stock available. The consequent excess
of demand over supply will raise the PPM again to 0B.
Changes in the Money Relation
The purchasing power of money is therefore determined by two factors:
the total demand schedule for money to hold and the stock of money in
existence. It is easy to see on a diagram what happens when either of
these determining elements changes. Thus, suppose that the schedule of
total demand increases (shifts to the right). Then (see Figure 75) the
total-demand-for-money curve has shifted from DtDt
to Dt'Dt'. At the
previous equilibrium PPM point, A, the demand for money now exceeds the
stock available by AE. The bids push the PPM upwards until it reaches
the equilibrium point C. The converse will be true for a shift
of the total demand curve leftward—a decline in the
total demand schedule. Then, the PPM will fall accordingly.
The effect of a change in the total stock, the demand curve remaining
constant, is shown in Figure 76. Total quantity of stock increases from
0S to 0S'.
At the new stock level there is an excess of stock, AF,
over the total demand for money. Money will be sold at a lower PPM to
induce people to hold it, and the PPM will fall until it reaches a new
equilibrium point G. Conversely, if the stock of
money is decreased, there will be an excess of demand for
money at the existing PPM, and the PPM will rise until the new
equilibrium point is reached.
The effect of the quantity of money on its exchange-value is thus
simply set forth in our analysis and diagrams.
The absurdity of classifying monetary theories into mutually exclusive
divisions (such as “supply and demand theory,”
“quantity theory,” “cash balance
theory,” “commodity theory,”
“income and expenditure theory”) should now be
For all these elements are
found in this analysis. Money is a commodity; its
supply or quantity is important in determining its
exchange-value; demand for money for the cash balance is also
important for this purpose; and the analysis can be applied to income
and expenditure situations.
Utility of the Stock of Money
In the case of consumers’ goods, we do not go behind their
subjective utilities on people’s value scales to investigate
why they were preferred; economics must stop once the ranking has been
made. In the case of money, however, we are confronted with a different
problem. For the utility of money (setting aside the nonmonetary use of
the money commodity) depends solely on its prospective use as the
general medium of exchange. Hence the subjective utility of money is
dependent on the objective exchange-value of money, and we must pursue
our analysis of the demand for money further than would otherwise be
The diagrams above in
which we connected the demand for money and its PPM are therefore
particularly appropriate. For other goods, demand in the market is a
means of routing commodities into the hands of their
consumers. For money, on the other hand, the
“price” of money is precisely the variable on which
the demand schedule depends and to which almost the whole of the demand
for money is keyed. To put it in another way: without a price, or an
objective exchange-value, any other good would be
snapped up as a welcome free gift; but money, without a price, would
not be used at all, since its entire use consists in its command of
other goods on the market. The sole use of money is to be exchanged for
goods, and if it had no price and therefore no exchange-value, it could
not be exchanged and would no longer be used.
We are now on the threshold of a great economic law, a truth that can
hardly be overemphasized, considering the harm its neglect has caused
throughout history. An increase in the supply of a producers’
good increases, ceteris paribus, the supply of a
consumers’ good. An increase in the supply of a
consumers’ good (when there has been no decrease in the
supply of another good) is demonstrably a clear social benefit;
for someone’s “real income” has increased
and no one’s has decreased.
Money, on the contrary, is solely useful for exchange purposes. Money,
per se, cannot be consumed and cannot be used directly as a
producers’ good in the productive process. Money per
se is therefore unproductive; it is dead stock and produces
nothing. Land or capital is always in the form of some specific good,
some specific productive instrument. Money always remains in
someone’s cash balance.
Goods are useful and scarce, and any increment in goods is a social
benefit. But money is useful not directly, but only in exchanges. And
we have just seen that as the stock of money in society changes, the
objective exchange-value of money changes inversely (though not
necessarily proportionally) until the money relation is again in
equilibrium. When there is less money, the exchange-value of the
monetary unit rises; when there is more money, the exchange-value of
the monetary unit falls. We conclude that there is no such
thing as “too little” or “too
much” money, that, whatever the social money stock,
the benefits of money are always utilized to the maximum extent.
An increase in the supply of money confers no social benefit whatever;
it simply benefits some at the expense of others, as will be detailed
further below. Similarly, a decrease in the money stock involves no
social loss. For money is used only for its purchasing power in
exchange, and an increase in the money stock simply dilutes the
purchasing power of each monetary unit. Conversely, a fall in the money
stock increases the purchasing power of each unit.
David Hume’s famous example provides a highly
oversimplified view of the effect of changes in the stock of
money, but in the present context it is a valid illustration of the
absurdity of the belief that an increased money supply can confer a
social benefit or relieve any economic scarcity. Consider the magical
situation where every man awakens one morning to find that his monetary
assets have doubled. Has the wealth, or the real income, of society
doubled? Certainly not. In fact, the real income—the
actual goods and services supplied—remains unchanged. What
has changed is simply the monetary unit, which has been diluted, and
the purchasing power of the monetary unit will fall enough (i.e.,
prices of goods will rise) to bring the new money relation into
One of the most important economic laws, therefore, is: Every
supply of money is always utilized to its maximum extent, and hence no
social utility can be conferred by increasing the supply of money.
Some writers have inferred from this law that any factors devoted to
gold mining are being used unproductively, because an increased supply
of money does not confer a social benefit. They deduce from this that
the government should restrict the amount of gold mining. These critics
fail to realize, however, that gold, the money-commodity,
is used not only as money but also for nonmonetary purposes, either in
consumption or in production. Hence, an increase in the supply of gold,
although conferring no monetary benefit, does
confer a social benefit by increasing the supply of gold for direct use.
The Demand for Money
Money in the ERE and in the Market
It is true, as we have said, that the only use for money is in
exchange. From this, however, it must not be inferred, as some writers
have done, that this exchange must be immediate.
Indeed, the reason that a reservation demand for money exists and cash
balances are kept is that the individual is keeping his money in
reserve for future exchanges. That is the function
of a cash balance—to wait for a propitious time to
make an exchange.
Suppose the ERE has been established. In such a world of certainty,
there would be no risk of loss in investment and no need to keep cash
balances on hand in case an emergency for consumer spending should
arise. Everyone would therefore allocate his money stock
fully, to the purchase of either present goods or future goods, in
accordance with his time preferences. No one would keep his money idle
in a cash balance. Knowing that he will want to spend a certain amount
of money on consumption in six months’ time, a man
will lend his money out for that period to be returned at precisely the
time it is to be spent. But if no one is willing to keep a cash balance
longer than instantaneously, there will be no money held and no use for
a money stock. Money, in short, would either be useless or very nearly
so in the world of certainty.
the real world of uncertainty, as contrasted to the ERE, even
“idle” money kept in a cash balance performs a use
for its owner. Indeed, if it did not perform such a use, it would not
be kept in his cash balance. Its uses are based precisely on the fact
that the individual is not certain on what he will spend his money or
of the precise time that he will spend it in the future.
Economists have attempted mechanically to reduce the demand for money
to various sources.
There is no such
mechanical determination, however. Each individual decides for
himself by his own standards his whole demand for cash balances, and we
can only trace various influences which different catallactic events
may have had on demand.
One of the most obvious influences on the demand for money is expectation
of future changes in the exchange-value of money. Thus,
suppose that, at a certain point in the future, the PPM of money is
expected to drop rapidly. How the demand-for-money schedule now reacts
depends on the number of people who hold this expectation and the
strength with which they hold it. It also depends on the distance in
the future at which the change is expected to take place. The further
away in time any economic event, the more its impact will be discounted
in the present by the interest rate. Whatever the degree of impact,
however, an expected future fall in the PPM will tend to
lower the PPM now. For an expected fall in the PPM means that
present units of money are worth more than they will be in the future,
in which case there will be a fall in the demand-for-money schedule as
people tend to spend more money now than at the future date. A general
expectation of an imminent fall in the PPM will lower the demand
schedule for money now and thus tend to bring about the fall at the
Conversely, an expectation of a rise in the PPM in the near future will
tend to raise the demand-for-money schedule as people decide to
“hoard” (add money to their cash balance) in
expectation of a future rise in the exchange-value of a unit
of their money. The result will be a present rise
in the PPM.
An expected fall in the PPM in the future will therefore lower the PPM
now, and an expected rise will lead to a rise now. The speculative
demand for money functions in the same manner as the speculative demand
for any good. An anticipation of a future point speeds the adjustment
of the economy toward that future point. Just as the speculative demand
for a good speeded adjustment to an equilibrium position, so the
anticipation of a change in the PPM speeds the market adjustment toward
that position. Just as in the case of any good, furthermore, errors in
this speculative anticipation are
“self-correcting.” Many writers believe that in the
case of money there is no such self-correction.
They assert that while there may be a “real” or
underlying demand for goods, money is not consumed and
therefore has no such underlying demand. The PPM and the demand for
money, they declare, can be explained only as a perpetual and rather
meaningless cat-and-mouse race in which everyone is simply
trying to anticipate everyone else’s anticipations.
There is, however, a “real” or
underlying demand for money. Money may not be physically consumed, but
it is used, and therefore it has utility in a cash balance.
Such utility amounts to more than speculation on a rise in the PPM.
This is demonstrated by the fact that people do
hold cash even when they anticipate a fall in the PPM. Such holdings
may be reduced, but they still exist, and as we have seen, this must be
so in an uncertain world. In fact, without willingness to hold cash,
there could be no monetary-exchange economy whatever.
The speculative demand therefore anticipates the underlying
nonspeculative demands, whatever their source or inspiration. Suppose,
then, that there is a general anticipation of a rise in the PPM (a fall
in prices) not reflected in underlying supply and demand. It is true
that, at first, this general anticipation raises, ceteris
paribus, the demand for money and the PPM. But this situation
does not last. For now that a pseudo “equilibrium”
has been reached, the speculative anticipators, who did not
“really” have an increased demand for money, sell
their money (buy goods) to reap their gains. But this means that the
underlying demand comes to the fore, and this is less than the money
stock at that PPM. The pressure of spending then lowers the PPM again
to the true equilibrium point. This may be diagramed as in Figure 77.
Money stock is 0S; the true or underlying money
demand is DD, with true equilibrium point at A.
Now suppose that the people on the market erroneously anticipate that
true demand will be such in the near future that the PPM will be raised
to 0E. The total demand curve for money then shifts
the new total demand curve including the speculative demand. The PPM
does shift to 0E as predicted. But now the
speculators move to cash in their gain, since their true demand for
money really reflects DD rather than DsDs.
At the new price 0E, there is in fact an excess of
money stock over quantity demanded, amounting to CF.
Sellers rush to sell their stock of money and buy goods, and the PPM
falls again to equilibrium. Hence, in the field of money as well as in
that of specific goods, speculative anticipations are
self-correcting, not “self-fulfilling.” They speed
the market process of adjustment.
Secular Influences on the Demand for Money
Long-run influences on the demand for money in a progressing economy
will tend to be manifold, and in both directions. On the one hand, an
advancing economy provides ever more occasions for new exchanges as
more and more commodities are offered on the market and as the number
of stages of production increases. These greater opportunities tend
greatly to increase the demand-for-money schedule. If an economy
deteriorates, fewer opportunities for exchange exist, and the demand
for money from this source will fall.
The major long-run factor counteracting this tendency and tending
toward a fall in the demand for money is the growth
of the clearing system.
Clearing is a device by
which money is economized and performs the function of a medium of
exchange without being physically present in the
A simplified form of clearing may occur between two people. For
example, A may buy a watch from B for three gold ounces; at the same
time, B buys a pair of shoes from A for one gold ounce. Instead of two
transfers of money being made, and a total of four gold ounces changing
hands, they decide to perform a clearing operation. A pays B two ounces
of money, and they exchange the watch and the shoes. Thus, when a
clearing is made, and only the net amount of money
is actually transferred, all parties can engage in the same
transactions at the same prices, but using far less cash. Their demand
for cash tends to fall.
There is obviously little scope for clearing, however, as long as all
transactions are cash transactions. For then people
have to exchange one another’s goods at the same
time. But the scope for clearing is vastly increased when credit
transactions come into play. These credits may be quite short-term.
Thus, suppose that A and B deal with each other quite frequently during
a year or a month. Suppose they agree not to pay each other immediately
in cash, but to give each other credit until the end of each month.
Then B may buy shoes from A on one day, and A may buy a watch from B on
another. At the end of the period, the debts are canceled and cleared,
and the net debtor pays one lump sum to the net creditor.
Once credit enters the picture, the clearing system can be
extended to as many individuals as find it convenient. The
more people engage in clearing operations (often in places called
“clearinghouses”) the more cancellations
there will be, and the more money will be economized. At the end of the
week, for example, there may be five people engaged in clearing, and A
may owe B ten ounces, B owe C ten ounces, C owe D, etc., and finally E
may owe A ten ounces. In such a case, 50 ounces’ worth of
debt transactions and potential cash transactions are settled
without a single ounce of cash being used.
Clearing, then, is a process of reciprocal cancellations of money
debts. It permits a huge quantity of monetary exchanges without actual
possession and transfer of money, thereby greatly reducing the demand
for money. Clearing, however, cannot be all-encompassing, for
there must be some physical money which could be
used to settle the transaction, and there must be physical money to
settle when there is no 100-percent cancellation (which rarely occurs).
Demand for Money Unlimited?
A popular fallacy rejects the concept of “demand for
money” because it is allegedly always unlimited. This idea
misconceives the very nature of demand and confuses money with wealth
or income. It is based on the notion that “people want as
much money as they can get.” In the first place, this is true
for all goods. People would like to have far more
goods than they can procure now. But demand on the
market does not refer to all possible entries on people’s
value scales; it refers to effective demand, to
desires made effective by being “demanded,” i.e.,
by the fact that something else is “supplied” for
it. Or else it is reservation demand, which takes the form of
holding back the good from being sold. Clearly, effective demand for
money is not and cannot be unlimited; it is limited by the appraised
value of the goods a person can sell in exchange and by the
amount of that money which the individual wants to spend on goods
rather than keep in his cash balance.
Furthermore, it is, of course, not “money” per
se that he wants and demands, but money for its purchasing
power, or “real” money, money in some way expressed
in terms of what it will purchase. (This purchasing power of money, as
we shall see below, cannot be measured.) More money
does him no good if its purchasing power for goods is
The PPM and the Rate of Interest
We have been discussing money, and shall continue to do so in the
current section, by comparing equilibrium positions, and not yet by
tracing step by step how the change from one position to
another comes about. We shall soon see that in the case of the price of
money, as contrasted with all other prices, the very path toward
equilibrium necessarily introduces changes that will change the
equilibrium point. This will have important theoretical
consequences. We may still talk, however, as if money is
“neutral,” i.e., does not lead to such changes,
because this assumption is perfectly competent to deal with
the problems analyzed so far. This is true, in essence,
because we are able to use a general concept of the
“purchasing power of money” without trying to
define it concretely in terms of specific arrays of goods. Since the
concept of the PPM is relevant and important even though its specific
content changes and cannot be measured, we are justified in assuming
that money is neutral as long as we do not need a more precise concept
of the PPM.
We have seen how changes in the money relation change the PPM. In the
determination of the interest rate, we must now modify our earlier
discussion in chapter 6 to take account of allocating
one’s money stock by adding to or subtracting from
one’s cash balance. A man may allocate his money to
consumption, investment, or addition to his cash balance. His
time preferences govern the proportion which an
individual devotes to present and to future goods, i.e., to consumption
and to investment. Now suppose a man’s
demand-for-money schedule increases, and he therefore decides to
allocate a proportion of his money income to increasing his cash
balance. There is no reason to suppose that this increase
affects the consumption/investment proportion at all. It
could, but if so, it would mean a change in his time
preference schedule as well as in his demand for
If the demand for money increases, there is no reason why a
change in the demand for money should affect the interest rate one iota.
There is no necessity at all for an increase in the demand for
money to raise the interest rate, or a decline to lower it—no
more than the opposite. In fact, there is no causal connection
between the two; one is determined by the valuations for money, and the
other by valuations for time preference.
Let us return to the section in chapter 6 on Time Preference and the
Individual’s Money Stock. Did we not see there that an
increase in an individual’s money stock lowers
the effective time-preference rate along the time-preference schedule,
and conversely that a decrease raises the time-preference rate? Why
does this not apply here? Simply because we were dealing with each
individual’s money stock and assuming that the
“real” exchange-value of each unit of money
remained the same. His time-preference schedule relates to
“real” monetary units, not simply to money itself.
If the social stock of money changes or if the demand for money
changes, the objective exchange-value of a monetary unit (the PPM) will
change also. If the PPM falls, then more money in
the hands of an individual may not necessarily lower the
time-preference rate on his schedule, for the more money may only just
compensate him for the fall in the PPM, and his “real money
stock” may therefore be the same as before. This again
demonstrates that the money relation is neutral
to time preference and the pure rate of interest.
An increased demand for money, then, tends to lower prices all around
without changing time preference or the pure rate of interest Thus,
suppose total social income is 100, with 70 allocated to
investment and 30 to consumption. The demand for money increases, so
that people decide to hoard a total of 20. Expenditure will now be 80
instead of 100, 20 being added to cash balances. Income in the next
period will be only 80, since expenditures in one period result in the
identical income to be allocated to the next period.
If time preferences remain
the same, then the proportion of investment to consumption in the
society will remain roughly the same, i.e., 56 invested and 24
consumed. Prices and nominal money values and incomes fall all along
the line, and we are left with the same capital structure, the same real
income, the same interest rate, etc. The only things that have changed
are nominal prices, which have fallen, and the proportion of
total cash balances to money income, which has increased.
A decreased demand for money will have the reverse effect. Dishoarding
will raise expenditure, raise prices, and, ceteris
paribus, maintain the real income and capital
structure intact. The only other change is a lower
proportion of cash balances to money income.
The only necessary result, then, of a change in the demand-for-money
schedule is precisely a change in the same direction of the proportion
of total cash balances to total money income and in the real value of
cash balances. Given the stock of money, an increased scramble for cash
will simply lower money incomes until the desired increase in real cash
balances has been attained.
If the demand for money falls, the reverse movement occurs. The desire
to reduce cash balances causes an increase in money income. Total cash
remains the same, but its proportion to incomes, as well as
its real value, declines.
Cf. Edwin Cannan, “The
Application of the Theoretical Analysis of Supply and Demand to Units
of Currency” in F.A. Lutz and L.W. Mints, eds., Readings
in Monetary Theory (Philadelphia: Blakiston,
1951), pp. 3–12, and Cannan, Money (6th
ed.; London: Staples Press, 1929), pp. 10–19, 65–78.
From this point on, this
nonmonetary demand is included, for convenience, in the
“total demand for money.”
Cf. Irving Fisher, The
Purchasing Power of Money (2nd ed.; New York: Macmillan
& Co., 1913).
A typical such classification can
be found in Lester V. Chandler, An Introduction to Monetary
Theory (New York: Harper & Bros., 1940).
See Mises, Theory
of Money and Credit, p. 98. The entire volume is
indispensable for the analysis of money. Also see
Mises, Human Action, chap. xvii and chap. xx.
See chapter 12 below for a
discussion of the concept of social benefit or social utility.
J.M. Keynes’ Treatise
on Money (New York: Harcourt, Brace, 1930) is a classic
example of this type of analysis.
On the clearing system, see
Mises, Theory of Money and Credit, pp.
Since no one can receive a money income
unless someone else makes a money expenditure on
his services. (See chapter 3 above.)
Strictly, the ceteris
paribus condition will tend to be violated. An increased
demand for money tends to lower money prices and will
therefore lower money costs of gold mining. This will
stimulate gold mining production until the interest return on mining is
again the same as in other industries. Thus, the increased demand for
money will also call forth new money to meet the demand. A decreased
demand for money will raise money costs of gold mining and at least
lower the rate of new production. It will not actually decrease the
total money stock unless the new production rate falls below the
wear-and-tear rate. Cf. Jacques Rueff, “The Fallacies of Lord
Keynes’ General Theory” in Henry Hazlitt,
ed., The Critics of Keynesian Economics (Princeton,
N.J.: D. Van Nostrand, 1960), pp. 238–63.
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