Prices and Production

APPENDIX TO LECTURE 4

The term “neutral money,” as mentioned in Lecture I, was apparently first used by Wicksell, but more or less incidentally, and without the intention to introduce it as a technical term. It was only comparatively recently that it came to be more widely used, apparently first in Holland, probably owing to the influence of Mr. J.G. Koopmans, who has for years been investigating this problem. The first results of Mr. Koopmans’ studies have, however, appeared only recently, since the present book was first published.81 But Mr. Koopmans has carried his investigations considerably further than was possible in the present essay, and to anyone who is interested in that problem I can only warmly recommend Mr. Koopmans’s study, with which I find myself in general agreement.

A short but earlier discussion of the problem is to be found in a German work by Mr. W.G. Behrens.82 Mr. Behrens also points out correctly that this is only a new name for the problem which had been discussed by Carl Menger and Professor Mises under the (in my opinion rather unfortunate) name of the invariability of the “innere objektive Tauschwert” of money, or shortly of the “innere Geldwert.” And it may also be added that it was essentially for the same purpose that L. Walras and the later economists of the Lausanne School used the concept of a “numéraire” as distinguished from that of “monnaie.”

It is not intended here to go further into the extremely difficult theoretical problems which this concept raises. There is, however, one respect in which recent discussions devoted to it have shown a certain ambiguity of the concept, which it seems desirable to clear up. It is frequently assumed that the concept of neutrality provides a maxim which is immediately applicable to the practical problems of monetary policy.

But this need by no means be the case, and the concept was certainly not primarily intended for that purpose. It was destined in the first instance to provide an instrument for theoretical analysis, and to help us to isolate the active influences, which money exercised on the course of economic life. It refers to the set of conditions, under which it would be conceivable that events in a monetary economy would take place, and particularly under which, in such an economy, relative prices would be formed, as if they were influenced only by the “real” factors which are taken into account in equilibrium economics. In this sense the term points, of course, only to a problem, and does not represent a solution. It is evident that such a solution would be of great importance for the questions of monetary policy. But it is not impossible that it represents only one ideal, which in practice competes with other important aims of monetary policy.

The necessary starting point for any attempt to answer the theoretical problem seems to me to be the recognition of the fact that the identity of demand and supply, which must necessarily exist in the case of barter, ceases to exist as soon as money becomes the intermediary of the exchange transactions. The problem then becomes one of isolating the one-sided effects of money—to repeat an expression which on an earlier occasion I had unconsciously borrowed from Wieser83—which will appear when, after the division of the barter transaction into two separate transactions, one of these takes place without the other complementary transaction. In this sense demand without corresponding supply, and supply without a corresponding demand, evidently seem to occur in the first instance when money is spent out of hoards (i.e., when cash balances are reduced), when money received is not immediately spent, when additional money comes on the market, or when money is destroyed. So this formulation of the problem leads immediately to the solution of a constant money stream, with the exceptions sketched in the last lecture. The argument has, however, been developed systematically only by Mr. J.G. Koopmans in the essay mentioned above.

In order to preserve, in the case of a money economy, the tendencies toward a stage of equilibrium which are described by general economic theory, it would be necessary to secure the existence of all the conditions, which the theory of neutral money has to establish. It is however very probable that this is practically impossible. It will be necessary to take into account the fact that the existence of a generally used medium of exchange will always lead to the existence of long-term contracts in terms of this medium of exchange, which will have been concluded in the expectation of a certain future price level. It may further be necessary to take into account the fact that many other prices possess a considerable degree of rigidity and will be particularly difficult to reduce. All these “frictions” which obstruct the smooth adaptation of the price system to changed conditions, which would be necessary if the money supply were to be kept neutral, are of course of the greatest importance for all practical problems of monetary policy. And it may be necessary to seek for a compromise between two aims which can be realized only alternatively: the greatest possible realization of the forces working toward a state of equilibrium, and the avoidance of excessive frictional resistances. But it is important to realize fully that in this case the elimination of the active influences of money has ceased to be the only, or even a fully realizable, purpose of monetary policy; and it could only cause confusion to describe this practical aim of monetary policy by the same name, which is used to designate the theoretically conceivable situation, in which one of the two competing aims was fully obtained.

The true relationship between the theoretical concept of neutral money, and the practical ideal of monetary policy is, therefore, that the former provides one criterion for judging the latter; the degree to which a concrete system approaches the condition of neutrality is one and perhaps the most important, but not the only criterion by which one has to judge the appropriateness of a given course of policy. It is quite conceivable that a distortion of relative prices and a misdirection of production by monetary influences could only be avoided if, first, the total money stream remained constant, and second, all prices were completely flexible, and, third, all long term contracts were based on a correct anticipation of future price movements. This would mean that, if the second and third conditions are not given, the ideal could not be realized by any kind of monetary policy.