Interest and Prices

CHAPTER 4

THE SO-CALLED COST OF PRODUCTION THEORY OF MONEY

No theorist can to-day lend his support to the traditional conception that money possesses in itself an independent, and more or less invariable, intrinsic value, against which the exchange values of real commodities are, as it were, compared or measured; though echoes of this doctrine are sometimes observed even in modern monetary literature. The πάντα ρεί of the modern theory of value must have put a definite end to this manner of approach. The value of an object is merely the importance that we ascribe to its possession for the purpose of gratifying our wants. This importance varies according to the extent of the range of those wants which, beginning with the most urgent, have already secured their gratification.

It is generally admitted that money provides no exception to this universal rule. But whether or not in this connection it can be regarded “exactly like any other commodity” is quite a different question.

The answer has already been provided. Money as such, i.e. so long as it fulfils the functions of money, is of significance in the economic world only as an intermediary. It is its purchasing power over commodities that determines its utility and marginal utility, and it is not determined by them.

But even though there is nothing to determine or set limits to the exchange value of our commodity (M), as we have called it, in the market in which it plays the part purely and simply of a medium of exchange, there is no reason why its exchange value should not be determined, more or less completely, through the influence of other markets in which it appears as a commodity proper. (These markets may be materially distinct from the first or may in fact be more or less closely bound up with it, the distinction then being a purely conceptual one. But that does not concern us here.)

This would in fact be the case where the commodity that is used as money is one of the ordinary articles of consumption of the country or perhaps one of its principal staple commodities—for instance, in early times hunting tribes used skins, tobacco was used in Virginia.

An example of the same kind is provided by copper, which in fairly recent times still provided the main part of the coinage in certain countries, e.g. during large portions of the seventeenth and eighteenth centuries in Sweden (and also in Russia). But it proved quite unsuitable for this purpose because of the violent fluctuations in its value.

Even though it may be quite common for people to accept this “money commodity” in payment for goods and services, having no other object in view than again to pass it on in exchange for other goods and services at the prices that are then current, yet there always remains the possibility of employing it as an article of actual consumption or of trade and speculation. This possibility will be realised as soon as a shift, no matter how small, of the general level of prices causes the exchange value of the money commodity to move above or below the position that is called for by the conditions of production and sale; or, on the other hand, as soon as a change occurs in these factors, so that they no longer remain in equilibrium with the ruling prices, i.e. with the purchasing power of the money commodity over other commodities.

But the case is a different one where the employment of the money commodity as an article of use, and particularly its actual consumption (in gilding, silver-plating, etc.), have come to occupy a position altogether secondary to its employment as a medium of exchange, and where, in addition, the yearly production results only in a relatively slow increase in monetary stocks. Such is the case with the precious-metal standard of to-day, and with the instruments of exchange that are based upon it. Not one man in a thousand would ever ask himself, on completing a piece of business, whether it would pay him better to convert into jewellery the gold coins that he receives rather than to continue to employ them as money; scarcely one in several hundred would actually carry out such a course even though commodity prices were rising very considerably and the exchange value of the money commodity were suffering a corresponding reduction.

A cheapening, however, of the precious metal in terms of commodities will at least set up a tendency for its production to decrease and for its consumption to increase, or rather for its consumption by actual use to increase (for it must not be forgotten that a portion of the consumption of the precious metal goes into what may be regarded as a kind of treasure-store, and a portion also, closely related to it, into what is principally a display of wealth, and that these portions are subject to their own peculiar laws and may sometimes follow an opposite course to consumption by actual use). But it is a matter of experience that any direct reaction on prices of the conditions of production and consumption is scarcely noticeable. This may be because movements of prices are not appreciably affected, up to a certain point, by the conditions of production and consumption, or it may be because their effects are temporarily obscured or neutralised by other factors. At the present stage of development of the monetary system, the output of the precious metal—or let us simply say the newly extracted gold—passes, for the most part, not into circulation but into the stocks of cash of monetary institutions; and gold for industrial uses is mainly taken either out of these stocks or directly out of imported stocks of uncoined metal. In neither case can it be supposed that there is any direct effect on prices.

It was W. N. Senior, an Englishman, who played a preeminent part in developing the theory that the exchange value of gold must be determined by its cost of production (or, more generally, by its cost of extraction). Though several of Senior’s assertions suffered at the hands of later critics, his treatment, which shows great powers of penetration, has not entirely failed to be of permanent value to learning. Even Senior has to admit that this line of causation is in practice exceedingly slow in operation. He mentions himself1 that, at the time when he wrote (1828), the Mexican mines, which then supplied by far the greatest part of the metal (silver) needed for the world’s coinage, had as a result of political unrest “been almost totally unproductive for the past fifteen years, so much so indeed, that silver has been sent to Mexico from Europe, and yet neither the general value of silver, nor its specific value in gold, has suffered any perceptible alteration”.

But the train of thought may have been carried too far. At any rate Jevons assumes that the decrease in the production of silver between 1810 and 1830 helped to bring about the fall in prices which, as he computed for England from Tooke’s tables of prices, began in 1818.2

This view is supported by the experience of more recent times. That the conditions of production of the precious metals have an effect on the purchasing power of money cannot logically be denied. Indeed it is a priori evident that if this influence continues to operate in the same direction over a very long period of time, it must eventually transcend all other factors in importance: one has only to think of the probable consequences of the discovery of inexhaustibly rich mines of precious ores, or on the other hand of the complete exhaustion of all deposits of gold or silver. But it is never possible to detect any precise parallelism from year to year, or even from decade to decade, between the level of commodity prices and the ease or difficulty with which gold is being produced. All attempts to discover such a relation have hitherto proved a failure.

Some authors, for instance W. Roscher, attempt to uphold the Cost of Production Theory of Money on the basis that “the value in exchange of the precious metals is determined by the cost of producing them from the poorest mines which must be worked in order to supply the aggregate want of them”.3

It is rather the Quantity Theory of Money which is involved in such an argument. For the marginal cost of production is primarily an effect, rather than a cause, in relation to the exchange value of money. The exchange values of the precious metals might conceivably be subject to considerable fluctuations in either direction, on account, for instance, of changes in the demand for money, while the natural conditions that govern their production remained completely unaltered.

Now it is precisely changes in prices and fluctuations in the value of money over relatively short periods—ten, fifteen, or twenty years—which have the most serious consequences for trade. The more gradual changes—secular they may be called—in the value of money are of far less importance in this connection, even though they mount up considerably in the course of centuries. To some extent their interest is purely historical. The Cost of Production Theory may appear sufficiently logical, and it may indeed appear self-evident, but it is just when enlightenment is most urgently needed that this theory leaves us sadly in the lurch. The treatment of money (or rather of the substance of which money consists) as a commodity, and the theory of the value of money that is based on this treatment, lead to almost entirely negative conclusions as soon as we have to deal with these questions of real practical importance which arise in modern monetary systems. We must therefore look for other means of elucidation.

Here is to be found our answer to the question, which though frequently discussed is essentially rather an idle one, whether money is a “commodity”. In Roscher’s opinion, “the wrong definitions of money may be divided into two classes: those which convey the idea that it is more than the most current of all commodities, and those which imply that it is less”.4

In sharp antithesis to this conception we have R. Hildebrand’s assertion that, so far from being a commodity like any other commodity, money is “the very opposite of a commodity”.5

In spite of these contradictions it may safely be stated that there is really no essential difference of opinion. In origin and substance, money—I mean concrete money, specie, which is the only kind of money that we are at present discussing—is undoubtedly a commodity. But so long as it circulates from hand to hand, it obviously cannot play the part of a commodity. On the other hand, as soon as it assumes the role of a commodity its rôle as money is at an end, or has not yet begun. How far its use as money, or how far its use as a commodity, is the predominant determinant of the exchange value of the money commodity, and consequently of the level of commodity prices, really depends, as we have already seen, upon purely quantitative relations. It is just because the metal used in coinage is employed so little for industrial purposes, and because, above all, its real consumption proceeds at so small a rate, that the value of money, at any rate over short periods of time, is not dependent on these factors, but is governed by quite different laws, which we still have to discuss.

In passing, there is a point to be noticed. The growth in the use of money, and the increase in monetary stocks, tends more and more to reduce the significance of the commodity characteristics of money. On the other hand, the development of the monetary system results in a displacement of specie by credit instruments and so-called money substitutes, and there exists, therefore, an important tendency towards a strengthening of the commodity aspect of money and of its influence on prices.

It is sometimes said to be feasible to base a monetary system upon gold and yet to dispense entirely, or almost entirely, with the employment of gold both in circulation and in the banks’ reserves. This would be done by extending the use of cheques, by the issue of notes of which the cover is of a purely banking nature, and so on. This view, which is held by some of the most prominent writers on monetary questions, must be regarded as Utopian. In such a system the value of money would be directly exposed to the effects of every fortuitous incident on the side of the production of the precious metal and every caprice on the side of its consumption. It would undergo the same violent fluctuations as do the values of most other commodities.

But it would be quite possible to maintain a stable value of money without the use of reserves of a precious metal. Only it would be necessary for the metal to cease to serve as a standard of value. To these questions also we shall be returning later.

Among the attempts that have been made to attribute to the cost of production of money the dominating influence on its value in exchange, that of Karl Marx deserves special notice. Marx fits the value of money in with his general conception of the origin of all value, and regards it as determined by the amount of labour which is necessary for its production. But this process is not instantaneous. If the measure of value itself falls in value, “this fact is first evidenced by a change in the prices of those commodities that are directly bartered for the precious metals at the sources of their production”; it is only gradually that “one commodity infects another through their common value-relation, . . . , until finally the values of all commodities are estimated in terms of the new value of the metal that constitutes money. This process”, he continues, “is accompanied6 by the continued increase in the quantity of the precious metals, an increase caused by their streaming in to replace the articles directly bartered for them at their sources of production”.7 Marx refuses to admit that the quantity of money may possibly exert an influence on prices. Such an opinion would, he says, be based on the “hypothesis that commodities are without a price, and money without a value, when they first enter into circulation, and that, once in the circulation, an aliquot part of the medley of commodities is exchanged for an aliquot part of the heap of precious metals”.8

If the medium of exchange becomes greater in quantity than “the circulation can absorb”, its velocity of circulation is retarded or a portion “falls out of circulation” altogether. “All that is necessary in order to abstract a given number of sovereigns from the circulation is to throw the same number of one-pound notes into it, a trick well known to all bankers.” 9

This gives rise, of course, to the same objections as does Marx’s general theory of value. It is only on the margin of production that the value of a commodity is equal to its cost of production in the narrowest sense, that is to say, to the cost of labour (true interest being left out of account). It is on this margin, if it exists at all, that the value of a commodity is just sufficient to cover the cost of labour, and nothing is left over for the rent of land. But this margin is not fixed in position. If an improvement is effected in the general conditions under which the commodity—in this case gold—is produced, or if its exchange value rises, capital and labour flow in and the margin is pushed back; in the reverse case the margin moves forward. There is, therefore, as was emphasised above, no logical reason why a change in the conditions of production of gold (a rise or fall in the average cost of production) should not at first, and perhaps for a fairly long period of time, be consistent with a temporarily constant exchange value of gold.

But in the actual locality where the gold is produced it is very probable that increased output will result at first in a certain lowering of the value of money; this is fully confirmed by the fabulous rise in prices which took place in California and Australia upon the discovery of gold. But such a tempestuous wave of upward-moving prices is very soon dissipated in the neighbourhood of its origin.10 There is usually only a very small direct effect on the general level of world prices, and it is so often obscured by other factors that it is impossible to regard it as the most important, much less the sole, source of the price changes which occur in practice.

It is no easier, in my opinion, to justify Marx’s second conception, which is not peculiar to him but is to be found in the works of very many other writers on monetary questions. The money which has “fallen out of circulation” must have fallen into some other use. But so long as conditions remain unaltered it is not possible that there should arise some new need which the money could serve to satisfy. It is, therefore, hard to see how the money which is released in this, way can fail to bring about an upward movement of prices. But this matter is best discussed in connection with a more detailed analysis of the theory to which the next chapter is devoted.

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11 Three Lectures on the Value of Money (London, 1840), p. 73 (printed for private circulation; the lectures were delivered in Oxford in 1829) [a reprint was published in 1931].

12 Investigations in Currency and Finance, p. 132 [second edition, p. 124].

13 Roscher, Principles of Political Economy, book ii., chap, iii., section cxxii. [Lalor’s translation, vol. i., p. 365].

14 Ibid., section cxvi., note [p. 342; Lalor’s translation has had to be slightly modified].

15 Theorie des Geldes, p. 10. This rather obscure statement depends on a point of view which is not, in my opinion, consistently adhered to in the later portions of Hildebrand’s work.

16 The italics are mine.

17 Capital (English translation by S. Moore and E. Aveling), 1887, vol. i., p. 93.

18 Ibid., p. 99.

19 Ibid., pp. 95, 96.

20 Cf. Tooke and Newmarch, History of Prices, vol. vi., Appendix xxxii., p. 854: “In the palmy days of 1848 and ‘49” (in California) “all were purchasers at any price; ... a Dollar was paid for a pill, and the same sum for an egg; a hundred dollars for a pair of Boots”, etc. “But in ‘51, bales of valuable Goods were sometimes not worth their storage”, etc.

• 1See, for instance, his preface to the German edition of his Vorlesungen, II.: Geld und Kredit, 1922.
• 2Ibid., p. 198.
• 3Lectures, II.: On Money and Credit, 3rd Swedish ed., p. 197.
• 4See the following papers in the Ekonomisk Tidskrift: (i) Davidson, “On the Concept of the Value of Money”, 1906; (ii) Wicksell, “The Stabilisation of the Value of Money, a Means of Preventing Crises”, 1908; (iii) Davidson, “On the Stabilisation of the Value of Money”, 1909; (iv) Wicksell, “Money Rate of Interest and Commodity Prices”, 1909. Cf. also Brinley Thomas, “The Monetary Doctrines of Professor Davidson”, Economic Journal, March 1935.
• 5In Wicksell’s opinion the money rate should be raised to ensure equilibrium on the capital market and prevent a rise of the price level; see Wicksell’s answer.
• 6Loc. cit., 1908, p. 211.
• 7Loc. cit., 1909, p. 64.
• 8Loc. cit., pp. 65, 66.
• 9Only recently has a change in this respect come about as a result of Lindahl’s The Means of Monetary Policy (in Swedish), 1930, and of Myrdal’s “Der Gleichgewichtsbegriff als Instrument der geldtheoretischen Analyse”, Beiträge zur Geldtheorie, edited by F. A. v. Hayek, 1933, (published in Swedish in the Ekonomisk Tidskrift, volume of 1931 but printed in 1932).
• 10Statsökonomisk Tidskrift, Oslo, 1917.
• 11Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
• 12Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
• 13Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
• 14As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
• 15As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
• 16As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
• 17In his rejoinder Wicksell admitted that this case required more attention than he had so far given to it. Davidson’s reasoning depended, however, on “the tacit assumption that the supply of real capital has been increased in the same proportion as productivity. Davidson is obviously of the opinion that money wages remain unaltered; thus if commodity prices have fallen, real wages would have been subject to an increase, but how can they be raised without an increased supply of real capital?” Making reference to Böhm-Bawerk’s theory of capital, Wicksell asserted that this is impossible, and continued: “If the quantity of real capital is increased the real rate of interest will fall even if prices remain unaltered and thus money wages rise. . . . Naturally, however, my assumption is that ‘other things remain equal’; i.e. that real capital and real wages are not subject to any change. . . . An increase in productivity when the supply of real capital is unaltered must necessarily mean a rise in the real rate of interest, and equilibrium on the market can never exist unless the money rate is made to coincide with the latter, i.e. unless it is in this case raised.” Although it was possible that prices might temporarily fall, a tendency for a cumulative rise in prices would set in unless the money rate was raised.
• 18In his rejoinder Wicksell admitted that this case required more attention than he had so far given to it. Davidson’s reasoning depended, however, on “the tacit assumption that the supply of real capital has been increased in the same proportion as productivity. Davidson is obviously of the opinion that money wages remain unaltered; thus if commodity prices have fallen, real wages would have been subject to an increase, but how can they be raised without an increased supply of real capital?” Making reference to Böhm-Bawerk’s theory of capital, Wicksell asserted that this is impossible, and continued: “If the quantity of real capital is increased the real rate of interest will fall even if prices remain unaltered and thus money wages rise. . . . Naturally, however, my assumption is that ‘other things remain equal’; i.e. that real capital and real wages are not subject to any change. . . . An increase in productivity when the supply of real capital is unaltered must necessarily mean a rise in the real rate of interest, and equilibrium on the market can never exist unless the money rate is made to coincide with the latter, i.e. unless it is in this case raised.” Although it was possible that prices might temporarily fall, a tendency for a cumulative rise in prices would set in unless the money rate was raised.
• 19The chief reason why Wicksell changed his views so little was undoubtedly that the criticism which his theory met did not go down to fundamentals. During his last years Wicksell was again questioning the whole structure of monetary theory; this was not, however, due to the criticism which he had received but to his own doubts about the reliability of the explanation of war-time inflation which he, like all other Swedish economists, had presented and defended.
• 20Wicksell’s opinion of the character of the business cycle is perhaps most clearly presented in his paper “The Riddle of Crises”. Here he pointed out that there are two entirely different methods of explaining the comparatively regular ups and downs of business. One is to assume that some extraneous forces work intermittently and so cause oscillations. The other makes use of the hypothesis that the present economic system will, by its very nature, react in an oscillatory manner to any irregular forces which tend to make it move. It might be imagined to be like a rocking-horse. Wicksell undoubtedly inclined towards the latter view, while maintaining that intelligent credit policy—at least under most conditions—could prevent the rocking tendency from growing violent.