The Effect of Changes In Money

The Effect of Changes in Money on Relative Prices

Utilizing an insight first attributed to Richard Cantillon (see Chapter 4), Mises fo­cused his monetary analysis on the effects of changes in the stock of money on eco­nomic activity. Once again, he rejected the macroeconomic approach in favor of methodological individualism. In response to the quantity theory advanced by John Locke, Cantillon had argued that the result of an increase in the stock of money will not be uniform across the economy, but rather will cause prices to rise at uneven rates in different sectors, thereby changing relative prices in the process. Mises combined the marginal-utility theory of money with this "Cantillon effect" to elucidate the im­pact of changes in the supply of money.

In modern societies, when governments or central banks increase the supply of money, they do not do so in a way that affects everyone equally. Instead, new money is created by the government or by banks to be spent on specific goods and services. The demand for these specific goods rises, thereby raising their prices first. (The el­ements of this in a Misesian economy should now be clear: as money holdings in­crease, the marginal utility of money declines so that certain goods are revalued ahead of money on subjective preference scales, pushing the prices of these goods upward.) Gradually the new money ripples through the economy, raising demand and prices as it goes. Income and wealth are thereby redistributed to those who receive the new money early in the process, at the expense of those who receive the new money later, or those who live on fixed incomes and receive none of the new money.

Recognizing these relative price effects and the ensuing wealth redistribution they entail, Mises took a very strong stand against inflationary expansion of the money supply. Indeed, he argued that because the exchange services of money are not increased by a higher stock of money, inflation will always be a zero-sum game, benefiting some at the expense of others.

The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding of a definite amount of purchasing power. As the operation of the market tends to determine the fi nal state of money' s purchasing power at a height at which the sup­ply of and the demand for money coincide, there can never be an excess or a deficiency of money. Each individual and all individuals together always enjoy fully the advantages which they can de­rive from indirect exchange and the use of money, no matter whether the total quantity of money is great or small. Changes in money's purchasing power generate changes in the disposition of wealth among the various members of society. From the point of view of people eager to be en­riched by such changes, the supply of money may be called insufficient or excessive, and the ap­petite for such gains may result in policies designed to bring about cash-induced alterations in pur­chasing power. However, the services which money renders can be neither improved nor impaired by changing the supply of money.... The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do (Human Action, p. 418). It is clear from the above passage that Mises' economic analysis made him wary of the potential abuse present in every concentration of economic power. Monetary ex­pansion is a method by which the government, its controlled banking system, and favored political groups are able to partially expropriate the wealth of other groups in society. Having witnessed firsthand the German hyperinflation after World War I, Mises remained skeptical of any government's willingness to show monetary re­straint over long periods of time. It is for this reason, and not because he attributed any mystical qualities to gold, that Mises championed a gold standard as the best form of money.