The theory of money and credit is a landmark treatise.
It remains today a must-read for anyone
wishing to get acquainted with the Austrian monetary theory.
Its contributions are deep and numerous,
but I would consider only one of them here,
namely the foundation of monetary theory,
and von Mises breaks new grounds in this field
through a systematic application of the Mangerian Subjectivist Framework to the Study of Monetary Phenomena.
The aim of my paper and lecture is to show that in spite of the importance and continuing relevance
of the approach and monetary theories of von Mises, they are today completely unknown
or almost completely unknown to standard neoclassical economists.
In order to make this point, I will use a very little number, but of significant texts.
First, the elementary level textbook by Gregory Mankiw, Economic Principles.
Then a very advanced monetary textbook full of mathematical equations by Carl Walsh,
Monetary Theory and Policy, published by the MIT Press.
And I will also use selected entries in the new Palgrave Dictionary of Economics, so the reference text today in Economic Thought.
Since time is quite short, I will only review the major topics. First, the determination of the purchasing power of money.
Second, the demand for money. And third, the neutrality of money.
So explaining the purchasing power of money, the PPM, this obviously is the core of monetary theory.
And even though it may come as a surprise, Gregory Mankiw in his textbook expounds a subjectivist theory of the purchasing power of money
that's quite similar to the theory developed by von Mises in The Theory of Money and Credit.
There are, however, important differences that I will underline a little later.
So here is the figure that represents the illustration
that's offered by Gregory Mankiw in his textbook.
We have a demand for money that's decreasing
with the purchasing power of money.
A supply of money that is the total quantity of money.
And Gregory Mankiw defines the demand for money
as a demand for cash balances.
And he shows that the purchasing power of money
tends to converge towards its equilibrium level
at the intersection of the two curves.
He then quite easily showed that
when the quantity of money increases,
the purchasing power of money decreases.
This presentation by Mankiw is in fact identical
to the one offered by Rothbard in Man Economy and State.
It's very unlikely that Mankiew ever read Rothbard's treatise, and yet the striking similarity between their respective theories seems to indicate that Rothbard, and maybe ultimately von Mises, may have had an indirect influence upon Mankiew.
Now let's turn to von Mises. His concept of the demand for money as a demand for cash balances and his theory of the adjustment process following an increase in the quantity of money are similar to those used by Mankiw, but there are significant differences between the two representations.
So this is the way Murray Rothbard also explains the determination of the purchasing power of money.
Now, von Mises. First point, subjectivism.
Von Mises offers a purely subjectivist account of the determination of the purchasing power of money.
There is no price level in his presentation.
No purchasing power of money that could be calculated or represented as a single number.
And von Mises never makes a rezoning based on the aggregate functions of demand for money or supply of money.
He always starts with the individual subjective scales of preferences and the decisions by each individual to change or to preserve his own monetary relation.
When the demons or the supplies of many people are affected in the same direction, their accumulative actions, based on their subjective evaluations, will lead to a change in the purchasing power of money.
Second point of difference, the diffusion process of money.
Since the theory developed by von Mises is based upon the individual decisions and actions,
it cannot be separated from the diffusion process of the new money through the economic
system.
And indeed when he analyses the effects of an increase in the quantity of money, von Mises
immediately takes into account the fact that the new monetary units enter into the economic
economic system through the cash balances of specific individuals.
And Man Q, on the other hand, totally neglects the question of who gets the new money first
and how these additional monetary units propagate through the economic system.
He just moves the aggregate curves of supply or demand and shows the changes in the purchasing
power of money.
The main problem with this kind of aggregate rezoning that it conceals the redistribution
effect that occurs during the diffusion process of the new money.
And indeed, Mankiw never even once evokes this redistribution effect in his textbook.
Third point, a bit more theoretical.
According to Mankiw, it's only in the long run that the purchasing power of money adjusts
to balance the money demand and supply.
In the short run, the purchasing power of money, according to him, cannot play any equilibrating
role because, I quote, many prices are slow to adjust to changes in the money supply,
unquote, and therefore the price level is, I quote, stuck at some level in the short
run.
The money demand and supply then are balanced in the short run by changes in the interest
Interest Rate, as explained by the Canadian Theory of Liquidity Preference.
So Mankiw puts forward two entirely different adjustment processes of the money demand and
supply through the interest rate in the short run and through the purchasing power of money
in the long run.
And from the Misesian perspective, this standard framework is highly questionable.
Is it true, as Mankiw claims, that the purchasing power of money is stuck at some level in the
short run?
No, it's not true.
Many prices are free to move and will move in the short run if the quantity of money
increases.
Admittedly, quite a lot of prices are contractually fixed in the short run, so if an unanticipated
increase in the quantity of money occurs, the PPM will not change as quickly as it would
if all prices were flexible or if the change had been anticipated.
In this sense, it can be said that the initial movement of the purchasing power of money
Money is slow, but the purchase in power of money will nevertheless immediately begin
to fall.
It is not fixed and exogenous in the short run as the Canadian theory claims.
And in The Theory of Money and Credit, the decrease in the value of money that follows
a growth in the money supply is both a short run and a long run phenomenon.
Last but not least, von Mises clearly explains in The Theory of Money and Credit that money
Many prices have a historical component, this is well known.
He credits Von Wieser for this discovery.
So the purchasing power of money of the current period depends on the purchasing power of
the previous period, which depends in turn on the purchasing power of the still earlier
period and so on and so forth.
Now this historical component of the purchasing power of money is not taken into account in
in the figures nor, of course, in the theory of Manq, where the purchasing power of money
is implicitly the current one.
But this time lag needs to be explicitly acknowledged in the theory and the graphical representations.
And for all the reasons I've given and maybe other reasons, von Mises would certainly have
I have considered that the figure used by Mankiw is a very poor representation of the theory of the purchasing power of money that eludes some of the most important questions raised by monetary theory.
There is no doubt that von Mises' subjectivist theory of the purchasing power of money is vastly superior to the textbook version offered one century later by Gregory Mankiw.
One of the main contributions of von Mises in The Theory of Money and Credit is his trenchant criticism of the classical equation of exchange.
This equation, however, is still used today in every standard textbook.
and what is more, it's most often the only formulation of the quantitative theory of money that is offered to students.
And the way Gregory Mankiw addresses this issue is revealing.
There are two versions of his textbook.
There is an elementary and introductory level version
And there is a more advanced intermediate level version, so the subjectivist account and the figure that I have shown above are presented in his elementary level textbook, but this quasi-Misesian account completely disappears in the intermediate level textbook in which only the equation of exchange is explained and the demand for money is defined as the ratio
from the quantity of money to the level of prices.
All the subjectivist elements have been removed.
So we get the feeling that the quasi-Misesian theory
is for beginners, it's too simple.
But when things get serious,
let's move to the mathematical equation.
But the opposite is true, of course.
The Misesian theory is much more sophisticated
than the equation of exchange.
and von Mises develops a general theoretical framework
in which the deductions from the equation of exchange
appear as simplistic theories at best.
And some essential theoretical elements
are impossible to express with this equation,
the subjectivist foundation of the purchasing power of money,
the historical component in the determination
of this purchasing power and the diffusion process
of the money through the economic system.
Now let's move to the demand for money.
Why do people demand money?
More precisely, why do they choose to hold a stock of money?
The answer given by von Mises in The Theory of Money and Credit
is not entirely satisfactory.
In that, it lacks consistency.
I have no time here to go into the details,
but let's just say that in human action,
von Mises resolves the contradiction
that affects the theory of money and credit
and conclusively adopts the idea
that the demand for money is a demand for cash balances
that's fundamentally explained by the existence
of a radical uncertainty of the future.
This idea is already present in The Theory of Money and Credit
and explicitly told by von Mises,
but there are other ideas
with which it is not entirely consistent.
Now, how is the individual demand for money understood
in current textbooks?
Here I refer to the very advanced textbook by Carl Walsh
that I have quoted above
and the main standard model is the M.I.U. model, Money in the Utility Function.
In this model, the demand for money is directly integrated into the utility function of the representative household.
So, here it goes.
Usually, the utility function of the representative household only depends on the consumption goods, Ct, at moment t,
but now in this model, you see that the stock of money here expressed in real terms, Mt, is added, integrated into the utility function.
Why does money bring in utility in this model?
As Carl Walsh openly and repeatedly concedes, the model does not answer this question.
Does not answer this question, and I give you one of the quotations where Carl Walsh recognizes the problems.
So in the MIU model, there's a clearly defined reason for individuals to hold money.
It provides utility, but it has been put, in fact, in the utility function.
However, this essentially solves the problem of generating a positive demand for money by assumption.
And I underline here, it doesn't address the reasons that money,
particularly money in the form of unbacked pieces of paper, might yield utility.
This is a problem, and in three passages, Carl Walsh recognizes the problem.
The problem that the utility of money in this model is postulated, but in no way explained.
And in this regard, this model is highly artificial.
It does not even try to deal with the initial question of why the agents choose to hold
positive quantities of money.
There is money in the economic system, we do not know why.
It brings utility, we do not know why either.
But the problem is even more serious, because in this model, the uncertainty of the future
has been ruled out by hypothesis. Consequently, holding money is in fact totally useless.
The conceptual foundations of the MIU model suffer from unsurparable difficulties that
I would like to sum up by saying that in this model, holding a stock of money is arbitrarily
is supposed to bring utility in a universe of certainty where money as such is useless.
In spite of these deep conceptual problems and because it fits in nicely within the standard
framework of general equilibrium and of Solow's Growth Theory, the MIU model has been elaborated
for more than three decades now by mainstream economists. And in the textbook by Carl Walsh,
you have equations three or four lines long with 40 variables impressive really very hard to read
but as you have seen the conceptual foundations five minutes left that's perfect the conceptual
for foundations are really very problematic so I have all the time required to review the
The last point, the neutrality of money.
The term neutrality of money, neutrality, does not appear in The Theory of Money and Credit
and it's understandable since it was first used at the end of the 1920s, a few years
after the publication of the last edition of von Mises' treatise in 1924.
But even if the term is missing, the issue is addressed in depth by von Mises.
I will not go into any detail here.
There's one thing, one point that needs to be underlined.
For von Mises, money is never neutral.
It can never be neutral.
And the standard economists perfectly
agree that money is not neutral in the short run.
Their arguments, however, are not at all the same
as those put forward by von Mises.
The first argument by standard economists,
why money is not neutral in the short run,
is that people can be confused by a change in prices.
Consumers fall prey to the money illusion
and confuse a simple increase in prices
with a greater scarcity of goods.
And the second standard argument, of course,
is that some prices are sticky.
Wages, for instance, adjust slowly
because of the labor contracts.
Some other selling prices are also sticky
because it's costly to change them
due to so-called menu costs.
So the non-neutrality of money in the short run
is explained either by mistakes and misperceptions,
errors of expectations, or by sticky prices.
All these arguments are correct and relevant,
But the demonstration by von Mises is much more general.
He showed that on account of the subjectivity
of the individual demands for money
and of the fact that money enters in the economic system
at specific points, even if people do not commit any mistake
and if prices are flexible, money will not be neutral.
So the standard arguments are interesting
and deserve consideration,
But they are subordinate, and they miss the essential reasons why money can never be neutral.
So far, and in spite of dissimilar arguments, there's a kind of agreement between von Mises
and current standard authors, but then a big problem arises.
Standard economists argue repeatedly that while money is not neutral in the short run,
Somehow it's still neutral in the long run.
Now strictly speaking, this result is highly questionable, if not outright impossible.
If the productive relations have been altered in the short run by an increase in the quantity
of money with non-proportionate changes in prices, then these changes cannot become proportionate
again in the long run.
Now, to be fair, when standard economists speak of long run neutrality, and they should not,
but when they speak of long run neutrality, they often use a weak definition of neutrality.
They mean in fact that changes in the quantity of money will not affect the long run evolution
of the real GDP, real rate of growth, nor the natural employment rate.
And in this sense, long-run neutrality does not imply a proportionate changes in all prices
since it rests upon a very simplified macroeconomic reasoning in which there is just one kind
of consumer goods.
I just have time to give you my conclusion.
It is a striking and unfortunate result of this inquiry that known of the most important
One of the most important messages originating in von Mises' Theory of Money and Credit is to be found in contemporary textbooks or reference texts.
It can even be observed that the more advanced the standard textbook, the more unsatisfying is the presentation of monetary theory from an Austrian perspective.
And this is also the case in price theory, but it's another subject.
There's much more von Mises, so to speak, in the elementary textbook by Mankiw than in the very advanced one by Walsh.
And this is unfortunate because the Misesian theories of the determination of the purchasing power of money
and of the neutrality of money are much sounder than their standard neoclassical counterparts.
Of course, they are not as impressive as standard models such as the MIU model from a mathematical point of view.
But mathematics is only a tool. It should never be given priority over theoretical relevance.
And as far as theoretical relevance is concerned, one century after its publication,
the monetary treatise of von Mises is as significant as ever and perhaps more significant than ever.
Thank you very much.