Mises Defining Inflation the Monetary Equilibrium Way (in 1951)

Steven Horwitz

On this blog and on various discussion fora over at Mises.org and this summer at FEE, the battle has raged over how Austrians might define inflation, with folks like me and our "monetary equilibrium" view of inflation as a supply of money greater than the demand to hold it on one hand and the Rothbardians with their "any increase in the money supply not backed by an increase in gold" view on the other.  Often part of this battle are claims about what Mises had to say, especially by the Rothbardians who want to claim Mises exclusively as their own.

One of the commonly heard positions, on both sides, is that Mises adopted the monetary equilibrium perspective in his earlier writings, such as The Theory of Money and Credit, but by the time Human Action rolled around, he was more clearly of the Rothbardian view.

I had the chance this morning to skim through a FEE volume that collected lectures Mises gave at the Foundation in the summer of 1951.  Note that date:  it is AFTER the publication of Human Action.  In the lecture on "Money and Inflation," Mises defined inflation the following way:

Inflation is an increase in the quantity of money without a corresponding increase in the demand for money, i.e., for cash holdings.

This is exactly the same definition of inflation that Mises gives in TTOMAC (p. 272, 1980 Liberty Press edition).  The 1951 lectures are available from FEE as The Free Market and its Enemies (2004) or online here.  Check page 44.  [UPDATE:  to be clear, this means that Mises would agree that an increase in the quantity of money that brings the supply up to match the demand for cash balances is NOT inflationary.]

So it would seem as though our buddy Lu was pretty consistent throughout his career in adopting the definition of inflation that the MET crowd does, and not the Rothbardian one.  That doesn't by itself make Mises right (though I believe he was), but it does mean that those who accept the Rothbard definition can't say the ME definition is somehow "un-Misesian" or "un-Austrian," which they do incessantly on the web.

Finally, for those folks on the Mises Institute discussion boards who think the concept of "the demand for money" is also somehow nonsensical from an Austrian perspective, perhaps you want to think again because Mises had no problem with it.  In fact it was Mises who really developed the cash balance approach to the demand for money that is now largely accepted in the discipline.  Discussions of monetary theory and banking theory and practice in the Austrian blogosphere would be greatly enhanced if people talked about what Mises actually said rather than what they'd like him to have believed, not mention actually knowing how banks work.

Comments

[Bill Woolsey]

Steve:

Isn't it generally accepted that Mises would count an increase in the quantity of money fully backed by gold as inflation? I thought it was Rothard that simplified things to that inflation equals an undesirable incease in the quantity of money (that is, any create not implied by 100% gold reserve banking.)

As for Mises, some of his quotes seem to be of the ceteris paribus sort. Implicit is, "given the demand to hold money," an increase in the quantity of money has this or that impact.

One final note, Lesvic provided a quote from Mises on a different thread where Mises said that an increase in the quantity of money during a recession would create malinvestments unless entrepreneurs assume that it will cease at the end of the recession. Isn't that exactly the scenario that is being pursued when the quantity of money is expanded to prevent a secondary depression? Also, was Mises suggesting some kind of liquidity trap? If the monetary expansion is going to cease at the end of the recession, it will have no impact? Or was he taking what I think is the correct view which is that no sensible entrepreneur is going to take low, depression level interest rates to be signals of long term interest rates, and so will not make investments based upon that, but nominal expenditures will expand (or perhaps not decrease at all.)

[Lee Kelly]

I think it may be helpful to talk about the price of money.

The price of money rises when 1) its supply decreases relative to other goods, and 2) its demand increases relative to other goods.

The first case is due to an economic growth, and *is not* associated with a decline in the rate of spending. But the second case is due to a change in individuals' valuation of money, and *is* associated with a decline in the rate of spending.

When demand for money increases, its asking price rises; for example, while it used to cost a hamburger to buy $5, it may now cost a hamburger and fries.

I think it is important to remind people that an increase in the price of buying $5 does not imply that it costs more, since due to economic growth it may now cost the same to produce a hamburger and fries as it used to cost to produce a hamburger. The increase in the price of money is due to the *relative* increase in its scarcity. (This is the "good" kind of deflation.)

With rare exception (e.g. collectors), people hold money with a desire to spend it later (i.e. they save). An increase in money demand with no increase in productivity will increase the price of money *and* reduce the rate of spending. In this case the an increase in the price of $5 really does mean an increase in its cost, and in some circumstances it can lead to the "bad" kind of deflation.

Fortunately, the market order is well equipped to deal with the "bad" kind of deflation, because as savings increase the money supply can increase and "stabilise" the rate of spending. This allows the relative price adjustments need to recover from malinvestment, but it does not require the paiful process or risks of a steep deflation.

Unfortunately, central banks and governments prevent this from occurring.

[Lord Buzungulus, Bringer of the Purple Light]

Maybe if Steve had read more than the first 66 pages of MES he'd know that Rothbardians do have a sensible theory of monetary demand. Much easier, I guess, to harp about their ethical theories that he happens to disagree with.

[GilesStratton]

Thanks for the clarification of Mises' monetary views! Scholars (and laymen) associated with the MI are all too wont to try and forget the "deviant" lines of Austrian thought.

[Lee Kelly]

When the price of money rises due to gains in productivity, the cost of money remains constant. For example, the price of buying $30k may be two cars whereas it used to be one car; however, if productivity has doubled, then it costs the same to produce two cars as it used to produce one. The cost remains constant due to gains in productivity even though the price has increased.

When the price of money rises due to an increase in its demand, the cost of money rises. For example, the price of buying $30k may be two cars whereas it used to be one car; however, if productivity has remained constant, then it costs twice as much to produce two cars as it does one. The cost increases due to there being no gains in productivity and the price increases, too.

(Of course, it wouldn't cost twice as much to build two cars rather than one, but it is a harmless simplifying assumption).

In any case, it seems to me this distinction about increases in prices, costs, or both is important when distinguishing the two kinds of deflation which ME proponents keep talking about.

[Pedro]

I may very well be wrong and I'm no economist, but it seems to me that this discussion is actually a different form of the discussion "free banking" vs "no fractional reserve".

Consider the following definition: "Inflation occurs when the supply of money grows more than it would in a free market".

But what is a free market for money? Rothbardians think no fractional reserve would exist in a free market. So, for them, any paper that is used as money but is not backed by gold increases the money supply in a way that wouldn't occur in a free market. The definition above is, therefore, compatible with their definition.

For those who advocate free-banking, saying inflation is when the supply of money grows more than it would in a free market is the same as saying that inflation is when the supply of money is greater than the demand for money (because in a free market supply and demand would have a tendency to be equal). So, from the point of view of a free-banking advocate, the above definition is compatible with the MET definition.

I think all would agree with the above definition. The problem is, in the case of money, there are different views as to what constitutes a free market.

If there are any mistakes in what I said, please point it out.

[Steve Horwitz]

Lord B:

Of course *Rothbard* has one. He did, after all, understand economics. You'll note that my comment about the demand for money was aimed at "folks on Mises Institute discussion boards" not Murray, or Salerno et. al.. I didn't even say "Rothbardians." I was VERY specific about the group to whom I was referring. Perhaps your purple light is interfering with your eyesight and reading comprehension skills.

(And be forewarned: if you get personal about your hosts or our guests again, I'll have no hesitation about giving you the boot.)

[Don Lloyd]

Steve,

"[UPDATE: to be clear, this means that Mises would agree that an increase in the quantity of money that brings the supply up to match the demand for cash balances is NOT inflationary.]"

The problem with this is that the word 'match' is problematical because of a unit divergence. The quantity of money is denominated by the number of little pieces of green paper, while the demand for cash balances is a demand for purchasing power.

Let's say that your entire demand for cash balances is to buy food, coffee, etc. at street vendors and snack trucks at unpredictable times and in unpredictable quantities. In this case there is no alternative to cash money. If the prices for food or coffee rise or are expected to rise, you must increase your demand for cash balances to maintain your purchasing power. To the extent that the quantity of money is increased to try to match the demand for cash balances, it must fail and will just drive the prices higher still.

In general, there is an additional demand for cash balances that is the result of the unavailability of worthwhile investment alternatives or goods which might be purchased in advance of need or for speculative purposes. This additional demand for cash balances responds to actual and potential price inflation in the opposite of the direction that the demand for cash balances for unpredictable purchases takes.

Regards, Don

[Lord Buzungulus, Bringer of the Purple Light]

Oh come off it, Steve. You were clearly contrasting the beliefs of those who adhere to Rothbards monetary thought with the ME theorists. Clever wording about (unnamed) discussants at the mises blog doesn't change the gist of your post.

[Steve Horwitz]

I actually chose my words very carefully and precisely. If you'd like a link to said discussions on the Mises discussion groups (not the blogs - once again, your reading skills seem to be clouded by your purple light), I'll happily provide them.

[Steve Horwitz]

And way to change the subject while you're at it Lord B. I take it then you agree that it's problematic when those who adopt the Rothbardian understanding of inflation cite Mises as a source for their definition thereof?

[Lord Buzungulus, Bringer of the Purple Light]

How am I changing the subject, Steve? Given your track record on the matter, I'm certainly not going to take your comments on Mises here as the final word. And yes, I would like to see the links to the discussion group you're referring to.

[Steve Horwitz]

For starters: http://mises.org/Community/forums/t/10305.aspx?PageIndex=9 then find the thread on velocity from a few days earlier.

And what "comments on Mises?" Check the link on the web. It's Mises's own words, not mine. Was Mises lying? Was Bettina Bien Greaves? Was FEE? Mises held a MET definition of inflation in 1912 and in 1951. Whatever the merits of Rothbard's definition, it ain't the same one as Mises held.

[knapp]

Perhaps both sides are right if we distinguish between Mises-the Monetary Theorist and Mises-the Austrian Institutionalist critic of fiat money.

If money is a real good (following Menger-Rothbard) then money demand is just an indirect way of expressing a goods-for-goods transaction.

But if money is fiat, then Mises MET quotes hold true.

[Lord Buzungulus, Bringer of the Purple Light]

Yeah Steve, that discussion board is SO different from the blog, you're really tripping me up there. The point is not that Mises or whomever is lying, but that without seeing the entire context in which these quotes are taken, I'm taking your claims with a grain of salt.

[Steve Horwitz]

Fair enough Lord B.. Happy reading and make sure you turn off the purple light so you can see things nice and clear.

[Steve Horwitz]

Knapp:

Fiat money means money by state decree. I'm not sure how that's relevant, unless you are confusing "fiat" with "fiduciary." You can have money that isn't a commodity (which is what I think you mean by "real good") but is also not "fiat money." For example, free bank notes.

Mises's MET quote holds for any kind of money. He doesn't qualify it. In fact, in TTOMAC, he explicitly INCLUDES fiduciary media in his definition.

[Lord Buzungulus, Bringer of the Purple Light]

BTW, this set of lectures by Mises can be downloaded at the Institute web site (I don't have the link available).

[Barkley Rosser]

I do not have a dog that barks in this debate. However, I will note that once a commodity becomes viewed as "money," its equilbrium price rises above what that price would be if it were "just another commodity." That is because of the demand by those to hold it or use it as money, say all those gold bars still sitting central bank basements despite the official removal of the link. A commodity can only serve as money as long as its "value" remains above its value for use as a straight commodity.

I have a curious example of this to tell. My wife and I were in Moscow in August 1992 to attend the International Economic Association conference there. This was in the midst of the early transition hyperinflation phase. Kopecks were (and still) are one hundredth of a ruble, like pannies to the dollar, and were made out of copper. By August 1992, the hyperinflation had devalued kopecks so much that they had been mostly gathered up by arbitrageurs (reputedly mostly Koreans) and melted down for their metal content. However, public telephones had not yet been replaced, and the old price to make a phone call on the street was two kopecks, with no change being given.

So, this led to an absurd situation. My wife needed to make a pay phone call on the street. She had no kopecks. She ended up having to pay somebody three rubles to get two kopecks to make the phone call. This would be like paying somebody three dollars to get two pennies.

[Jake McCloskey]

Steve,

As someone involved in that debate, I'd like to get your thoughts on another line of discussion that occurred in that thread. It seems to me that even if we switched to a system that eliminated checking accounts as we know them and implemented instead a warehouse/CD system, the supply of money would remain the same. If people began trading CDs for goods, as they reasonably would given the restriction on the payment system, then it would not be fundamentally different from the FRB system.

Further, if we also eliminated CDs and loans were made entirely out of bank capital, these loans themselves would begin trading for goods as well (in an ideal world of course; it isn't liable to be very efficient). The institutional arrangement shouldn't have a strict bearing on the market supply of money. This is not to deny it doesn't have an important effect overall; it just doesn't have the effect the Rothbardians assume.

What do you think?

[YAM-YAM]

what is really meant by monetary equilibrium?

[cash for gold]

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