2. Money and Wealth
• Money is different from other goods and
services.
• Imagine that wasn’t any money. We are living
in a barter economy. If I want something that I
haven’t produced, I have to trade to get it.
• What I own has two kinds of value: its direct
use to me and how much other people want
it.
3. More Money?
• Money in a free market is a commodity, like
gold and silver.
• It has some direct use as a commodity. E.g.,
gold is used for jewelry.
• Almost all of the value of money is its
exchange value. If you have money, how much
of other goods can you get for it?
4. Still More Money
• How much is a unit of money worth? This
depends on its purchasing power, i.e., what
you can buy with it.
• Is it true that the more units of money you
have, e.g. more dollars, the better off you are?
• Not necessarily. It depends how much each
dollar is worth.
5. The Value Of Money
• What determines the value of a dollar?
• Just like other goods, the value depends on
demand and supply.
• The supply consists of the number of
monetary units.
• The demand depends on how much people
want to hold money
6. Value of Money Continued
• Suppose that people don’t want to increase
their holding of money. If the number of
money units goes up, the purchasing power of
money will decrease.
• Each dollar will buy less.
7. Optimal Amount of Money
• Any amount of money is sufficient to perform
the services of money in the free market.
• With a given stock of money, people can
satisfy whatever demand they have to hold
money. Purchasing power will adjust to
changes in demand.
• It is not true that as the economy grows, more
units of money have to be issued.
8. More Optimal
• One way to express this point is that any
amount of money is optimal.
• This statement can be misunderstood.
• The correct reading is the one we have already
discussed: any amount of money is sufficient.
• The incorrect reading is: If x is the amount of
money at time t, then any change in x is sub-
optimal, so long as demand to hold money
stays the same.
9. Inflation
• People very often don’t realize that an
increase in the supply of money doesn’t make
everybody better off.
• Many economic cranks think that making
money or credit more readily available will
result in prosperity.
• Hazlitt mentions the Social Credit movement
as an example.
10. Effects of Inflation
• You might think from what we have said so far
than increasing the supply of money wouldn’t
have any effect, so long as the demand to hold
money hasn’t changed.
• Suppose all prices, wages, etc., instantly
doubled. What would change?
• The Austrians define inflation as an increase in
the money supply, rather than the price rise
that often accompanies this rise.
11. Effects Continued
• In most cases, inflation does have effects.
• When the state increases the supply of
money, the money usually doesn’t get to
everybody at the same time.
• Suppose the state increases purchases of
armaments and finances this by printing
money. Then, the armaments makers have the
money to spend.
12. Spreading Money
• When they spend their money, this will drive
up the prices of what they spend it on.
• The makers of these products will have new
money to spend. This will in turn drive up the
prices of other goods.
• Price increases will gradually spread through
the economy.
13. Cantillon Effects
• In the initial stages of the spread of money,
people will have extra money but most prices
haven’t risen yet.
• People in the initial stages thus benefit from
the increase.
• Those in the later stages find that prices rise
before they get more money. They lose out.
14. More Cantillon
• The way in which an increase in the money
supply spreads through the economy is called
Cantillon effects. These were named after the
18th century economist Richard Cantillon.
• The relation between an increase in the
money supply and price rises has to be traced
in detail.
15. Quantity of Money
• There isn’t a mechanical relation between an
increase in the quantity of money and an
increase in prices.
• E.g., it isn’t the case that doubling the supply
of money automatically doubles the money
supply.
16. Bank Credit Expansion
• One kind of inflation is important for the
business cycle. This is an expansion of bank
credit.
• The expansion of bank credit lowers the rate
of interest on loans.
17. Rate of Interest
• In the Austrian view, the rate of interest is not
primarily determined by the demand and
supply of money.
• Rather, interest depends on time preference.
• This is the rate at which people prefer present
satisfactions to equivalent future satisfactions.
18. Interest and Production
• In the economy, some resources are devoted
to making consumption goods, i.e., goods that
people directly use.
• Other resources are devoted to making
production goods. These are goods used to
produce other goods.
• We also have goods that are used to produce
goods that are used to produce these
production goods, etc.
19. Interest and Production Continued
• In other words, we have different stages of
production. A stage depends on how many steps
it takes to get to consumer goods.
• What determines how resources are distributed
among the stages of production and also how
many stages there are?
• The answer is the rate of time preference.
Because people prefer goods in the present to
goods in the future, the structure of production
will be limited in extent.
20. Back To Bank Credit
• We can now return to the expansion of bank
credit.
• When the bank expands credit, this will lower
the money rate of interest.
• Entrepreneurs will be able to invest in higher
stages of production than before. Before the
credit expansion, investing in these stages
wouldn’t have been profitable.
21. Collapse
• Now the big problem comes up.
• The rate of interest is fundamentally
determined by the rate of time preference,
not by the supply and demand of loanable
funds.
• After the credit expansion stops, the rate of
interest will go up again.
22. More Collapse
• The businesses that expanded will no longer
be able to get money to continue their
activity.
• These businesses will then collapse. Resources
need to be shifted to lower stages of
production, to correspond with the rate of
time preference.
• This collapse and resource transfer is the
depression.