Study Guide to the Theory of Money and Credit
11. The Problem of Measuring the Objective Exchange Value of Money and Variations in It
Chapter Outline
1. The History of the Problem
Some of the greatest minds in economics have devoted themselves to the development of indexes that would provide an objective measurement of the change in the purchasing power of money. However, such statistical techniques have never lived up to their promises, as even their own creators often admitted.
2. The Nature of the Problem
Just as we can express the price of any commodity by reference to how many units of money it takes to purchase one unit of the commodity, the opposite approach can yield the “price” of a unit of money in terms of the commodity. However, this technique yields as many “prices” of money as there are commodities. What economists desire is a method for combining all of this information into a single measurement of “the” purchasing power of money. Then, a second task is to ask of any particular commodity’s price change, how much can be attributed to forces arising from the side of money (in contrast to a change in the relative scarcity of the good which would also make its price rise).
3. Methods of Calculating Index Numbers
Nearly all attempts at measuring the objective exchange value of money have relied on the assumption that if a large enough collection of goods are included in the “basket” to be measured, then changes in the relative scarcities of the goods themselves will largely cancel out. Thus the average or net change in the prices of all the goods (as quoted in money) will demonstrate whether the purchasing power of money has risen or fallen. Unfortunately, in practice it is only possible to carry out such calculations by making ad hoc assumptions about the relative importance of various factors. In the end, the economic theorist does not gain much from studying the various statistics of price movements that he could not obtain from deductive reasoning about the nature of exchange and money.
4. Wieser’s Refinement of the Methods of Calculating Index Numbers
Wieser devised the most careful and satisfactory approach to measuring the objective exchange value of money, with a technique involving the contrast between nominal and real income. However, even Wieser’s approach had several fatal flaws. For example, over large stretches of time, the types of income people could earn become incommensurable, robbing Wieser’s technique of its desired precision.
5. The Practical Utility of Index Numbers
The criticisms leveled against various techniques for calculating index numbers refer to the problems of economic theory. In practical use for government policy, these techniques provide a rough guide to changes in the purchasing power of money.
Technical Notes
• On page 189 Mises writes, “Invariability in respect of the property to be measured ... is a sine qua non of all measurement.” For example, if a person is using a meter stick to measure length, then he must be assuming that the meter stick’s length is itself invariable. Yet when economists try to measure changes in the objective exchange value of money (i.e., in the purchasing power of money), they run into the problem that there are no such invariable benchmarks. If the exchange ratio between money and any other commodity changes, it is not clear whether the change originates from the side of money or the commodity.
• Some numerical examples may clarify Mises’s observations on index numbers (pp. 188–90). If the price of oil increases from $90 to $100, while the price of a television falls from $100 to $90, it is possible that these changes have nothing to do with the purchasing power of money, and merely reflect a shift in demand away from televisions and into oil. On the other hand, if all prices (quoted in money) in the community increased exactly by 10 percent in one year, then it would be clear that the purchasing power of money had fallen and was the driver of the price increases. But in the real world, things are never so clear-cut. Typically some prices rise while others fall, and the price movements are not in the same percentages across commodities. There is no nonarbitrary way to determine how much of a given good’s change in price is due to changes in its relative value (with respect to other commodities) versus a change in the purchasing power of money.
Study Questions
1. Explain: “Only by letting fall morsels of statistics is it possible for the economic theorist to maintain his prestige in the face of questions of this sort.” (p. 188)
2. Explain: “He who cares to go to the trouble of demonstrating the uselessness of index numbers for monetary theory and the concrete tasks of monetary policy will be able to select a good proportion of his weapons from the writings of the very men who invented them.” (p. 188)
3. Why are index numbers not very important for the “extension of the theory of the nature and value of money”? (pp. 189–90)
4. Even if we grant for the sake of argument that a loaf of bread possesses a constant utility in the objective sense of food value, why is this approach unhelpful when it comes to the use of index numbers in monetary theory? (p. 193)
5. Does Mises think that index numbers are completely useless? (p. 194 )
