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The (quantity) theory of money and credit

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The Theory of Money and Credit (1912) is rightly regarded as a seminal book in the development of the Austrian school approach to monetary theory. We argue that Mises’ understanding of the equation of exchange differs from both of the conventional textbook versions, and warrants recognition as being a distinct contribution. After supporting this claim we discuss it in light of expectations, monetary regimes, and the microfoundations of the quantity theory.

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  1. This article will deliberately focus on this text, and although where necessary we will draw upon wider literature, our intention is not to provide a broad and exhaustive history of the quantity theory (for this see Humphrey 1974; Blaug et al. 1995). Rather, we intend to focus on Mises’ status as a quantity theorist as found in The Theory of Money and Credit. We are reliant on translations from the original German, and will provide citations for the 1981 Liberty Fund edition.

  2. Indeed it could be argued that the crudest form of the quantity theory renders the two concept as synonymous, and thus seeks to attribute any changes in the general price level to changes in the money supply.

  3. Although it’s interesting to note that Laidler cites Mises (and indeed FA Hayek) as being the intellectual forebears of New Classical economists such as Lucas, Barro, Sargant and Wallace in contrast to the “monetarists” that rest on more Keynesian foundations (Laidler 1982, p.ix).

  4. The publisher was Jonathan Cape Ltd (London), and another important edition was published by Yale University Press in 1953.

  5. As Percy Greaves said, “only a few Americans were familiar with its contents before the passage of the Federal Reserve Act in December, 1913. If his great contribution had then been known, understood and accepted, there would have been no post World War I inflations and no 1929 depression. The whole history of our century would have been vastly different and living standards the world over would have been much higher than the world has ever known” (Mises 1978 p.xxiv)

  6. Of course more than these versions of the quantity theory exist – Humphrey (1984) shows how Fisher and Pigou’s algebraic equations “had already been largely or fully anticipated by at least 19 writers located in five countries over a time span of at least 140 years”. Horwitz (2006) makes the point that the cash balance approach adopted by Leland Yeager “dates back to at least Mises”.

  7. See Shaw et al. 1997, p.78.

  8. See Mises (1912, p.162–167, p.174–175, p.188–189; 1928, p.91; 1949 p.404–405) for a critique of the mechanical version of the quantity theory.

  9. Indeed the speculative demand for money almost glosses over money’s unique role as a “loose joint” and views it as an asset class like any other.

  10. For an Austrian approach that does attempt to split up various facets of the demand for money, see Salerno (2006).

  11. Interestingly, in 1923 and writing in German, Mises used the English phrase “standard of deferred payment” without offering a comment (see Mises 1978, p.5). He argued that if a monetary unit deteriorates in value then it cannot be used as standard of deferred payment, which appears to conflate two of these “secondary” functions. However this ties in with his view that “it is simplest to regard this as part of its function as medium of exchange” (Mises 1912, p.47).

  12. Indeed the rise of Bitcoin as a virtual currency that can be untraceable (when used in exchange) lends evidence to the importance of anonymity in a near-money.

  13. In that article Pigou doesn’t claim that Fisher’s equation is wrong, per se, indeed “Professor Irving Fisher has accomplished great things. But less experienced craftsmen need, I think, a better – a more completely fool-proof tool” (Pigou 1917, p.65).

  14. However, whereas the Cambridge approach treats k as a function of income, we would suggest that the demand for money is the fraction of total assets one wishes to hold as cash.

  15. Although Q and Y are two of the equivalent techniques for the calculation of GDP, in reality the concepts are quite different. Nalewaik (2010) shows that estimates of GDI differ from GDP in important ways.

  16. George Selgin makes the point that during a boom total nominal spending (PT) can be expected to rise by more than measured nominal income (PY), and therefore especially during a boom Y is not a good approximation of T. See “Intermediate spending booms”, October 1st 2012. [] Accessed May 7, 13.

  17. Note that this is in the context of the transaction demand for money

  18. For a proposal to target NGDP see Gustavson and Randazzo (2010) and Sumner (2011)

  19. This is perhaps a relic from the mistaken classical attempts to distinguish between fixed and circulating capital, and the debate over whether capital approximates income.

  20. It’s important to point out that these propositions aren’t universally endorsed, and we’re not endorsing them now.

  21. This usually rests on an assumption that V is determine by habit and assumed constant in the short run.

  22. We are using “monetary equilibrium” here to refer to the notion that the balance between the demand for and supply of money determine its value. Mises refers to this as the “money relation”, for example “the core of the doctrine consists in the proposition that the supply of money and the demand for it both effect its value” (Mises 1912, p.152), or “The insight that the exchange ratio between money on the one hand and the vendible commodities and services on the other is determined, in the same way as the mutual exchange ration between the various vendible goods, by demand and supply was the essence of the quantity theory of money. This theory is essentially an application of the general theory of supply and demand to the special instance of money” (Mises 1949, p.405).

  23. Note that Mises deals effectively with one type of counter suggestion. For example, in July 2005 the Romanian government attempted to simplify their currency, which still showed the effects of past hyperinflation. The government replaced the leu (ROL) with the leu (RON), where 1 RON = 10,000 ROL. According to Mises this wouldn’t constitute a uniform change in the money supply and price level, but merely a change in the actual currency (Mises 1912, p.167).

  24. Note that he goes on to suggest that there’s a tendency towards equilibrium rather than viewing it as an attainable state, saying “—if, indeed, such a condition as equilibrium may be said ever to be established” (Fisher 1911).

  25. It is interesting that economists tend to focus on inflation when providing these examples. As Mises says, “to simplify and to shorten our analysis let us look at the case of inflation only” (1938), however there’s no reason to believe that different laws apply to deflation. Also, we are not aware of Mises going beyond the claim that this leads to a redistribution of wealth and specifically argue that this process makes society as a whole poorer, see Horwitz (2003), who does.

  26. Again, this risks caricaturing the classical school see Cairnes (1854).

  27. Or, to put it another way, when pushed we suspect that many economists would favour T over Y in principle, but the availability of GDP figures biases analysis in that direction.

  28. Also, to Quasi-Monetarists the PY equation is most important because it’s reductions in nominal income that affects debts, an important aspect of the debt-deflation story (Fisher 1933).

  29. Notice how this ties into the “real balance effect” attributed to Patinkin (1955).

  30. Note that if it is supposed that the demand for money increases, then that assumption also supposes - ceteris paribus - that the demand for goods, services and assets falls.

  31. Since accounting is done in nominal terms, if the price level is changing (especially if it’s changing in an unexpected way) then the real value of profits will change too. Businesses that use nominal profits to guide future plans will be fooled. This is what we mean by “account falsification” - the profit signal must be extracted from the noise of inflation and deflation.

  32. See Selgin (1988), Horwitz (1994, p.229), White (1999 p. 67), Horwitz (2000, p.91) and White (2008) for a more detailed account of how monetary equilibrium theory ties into the quantity theory in terms of the stabilization of MV.

  33. In another example of Mises being somewhat neglected, Friedman (1975) uses Abraham Lincoln’s dictum that “you can fool all of the people some of the time, you can fool some of the people all of the time, but you can’t fool all of the people all of the time”, as being a key insight behind the rational expectations revolution. However as Garrison (1998) points out Mises had previously utilised the same quote to explain how expectations adjust. (Note that although this appears in The Theory of Money and Credit, it is in the epilogue to the 1953 edition.)

  34. Notice the explanation here isn’t the same as a traditional one that would have interest rates rise because of expectations of future inflation.

  35. It’s important to stress that Mises isn’t contradicting himself. When a central bank performs an injection several things happen. The purchase of bonds transfers reserves to commercial banks who can use those reserves to issue more loans. Those loans are deposited which increases the money stock. The increase in the supply of loans reduces the market interest rate.

  36. He says something similar in Mises (1912, p.230–231)

  37. We are grateful to Nicolas Cachanosky for pointing out to us that the concept of velocity is important in terms of free banking, since it’s related to turnover and the level of deposits at issuer banks.


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Correspondence to Anthony J. Evans.

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Versions of this paper have been presented as “The (Quantity) Theory of Money and Credit: Monetarism and von Mises” City University Economics Department Seminar, (November 2012) and “The (Quantity) Theory of Money and Credit”, Association of Private Enterprise Education (APEE), Maui (March 2013), and we thank participants for useful feedback. We also acknowledge helpful comments from Nicolas Cachanosky and Kevin Dowd. The usual disclaimer applies.

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Evans, A.J., Thorpe, R. The (quantity) theory of money and credit. Rev Austrian Econ 26, 463–481 (2013).

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