Too Much Money and Too Little Money

Too Much Money and Too Little Money

One of the most prevalent and widely discussed explanations of business cycles involves the flow of money and credit. One of the outstanding exponents of this general idea is Professor Irving Fisher, but this school of thought includes many well-known economists. Moreover, its effect upon the monetary policies of both England and America during the depression of the 1930s has been profound. It is Fisher's belief that depressions are caused by fluctuating price levels. Since production in modern society is constantly increasing, if the volume of money remains fixed prices will fall and a crisis will ensue. One must bear in mind that money as here discussed means not only cash but credit as well, and the rapidity with which money and credit circulate must also be considered. In the midst of the recent depression Professor Fisher advocated an increase in the volume of money in circulation in order to re-establish 1926 price levels. This prac­tical suggestion was indeed followed by the Democratic govern­ment then in office.

Contrary to the theory of Professor Fisher, who contends that too little money is the real cause of depressions, Professor Alvin H. Hansen of Minnesota believes that too much money is re­sponsible. He describes the situation this way: Purchasing power consists of the cash in circulation and the volume of bank credit available. Restrictions placed upon the extension of credit pre­vent its unlimited expansion but credit varies greatly. If in a period of rising prices banks extend credit, they increase the pur­chasing power without increasing the amount of goods available. This process accelerates the rise in prices, and the purchasing power of consumers generally is actually reduced since bank credit is usually issued to entrepreneurs to facilitate business transactions. The rising price levels encourage new production in the anticipation of profit; this is but a transitory period, since the inability of banks to extend more credit and the recall of bank loans reduces purchasing power and turns the price level down­ward. As a consequence business activity is reduced to a mini­mum. The downward movement comes to a close when the ac­cumulation of bank reserves leads to a lowering of discount rates to a point where use of credit is profitable. Exchange and new issues of securities are again in evidence, credit is extended, and the upswing of the cycle is on.

In England the monetary explanation of business cycles has been sponsored by R. H. Hawtrey (1879- ) of the British Treasury. His understanding of the causes of the fluctuations in business has been colored by the ideas of Fisher and Hansen. On the one hand he believes that the rise and fall in business ac­tivity is due to variations in consumer's expenditure out of in­come. Changes in consumer's outlay, however, are due principally to the quantity of money. If the quantity of money is diminished, demand slackens and the goods produced move slowly, resulting in heavy supplies, curtailed production, unemployment, and de­creasing wages. If the reverse be true, and the supply of money increases, demand increases, prices rise, stocks are depleted, pro­duction, wages, and prices increase.

So far this statement is in accord with the general quantity theory of money. Hawtrey's peculiar contribution lies in his emphasis upon bank Credit as the motivating power behind changes in the quantity of money. In precipitating such changes it is the discount rate which he feels exerts the greatest influence. A reduction in the discount rate causes merchants to borrow in order to increase their stocks. They give larger orders to producers. Increased production means larger incomes and consequently increased demand for goods generally, and depletion of stocks. The cumulative expansion of productive activity is pushed forward by a continuous increase in credit. Rising prices and the velocity of circulation add to the upward pressure upon business activity.

When credit can no longer be extended, the turning point in the cycle has been reached and the downswing is set in motion. The end of credit expansion is controlled largely by law, that is, by the acceptance of some standard of currency such as gold, and an established reserve ratio of cash to credit. The marks of the downward motion are those noted previously, namely the specific difference given to the importance of credit contraction in bringing about lower prices, smaller orders, higher inventories, and lower production. Implicit throughout Hawtrey's discussion is the fact that both the upswing and the downswing are cumu­lative; that is, each part of the cycle influences and builds upon itself. Therefore once set in motion the various phases of the cycle generate their own power of movement.