On not understanding the quantity theory of money

So, bloke writes a book about the Weimar inflation. Gets something quite right:

Germany’s inflationary experience took a characteristic course. Price rises led to strikes and wage demands from the huge public sector. As the purchasing power of the mark plummeted, people would rid themselves of money as fast as possible, seeking safer goods or currencies for survival. Mounting velocity of circulation effectively increased the money in use, stoking the fires of inflation ever higher.

Yep, the V in MV=PQ rose.

Blizzards of broken paper promises are history. Only a short time ago Ben Bernanke of the US Fed was able to order trillions of dollars of new money at the touch of a button. Extraordinarily, although Havenstein regularly sent the mark/dollar rate to new unplumbed depths, latter-day QE, though hardly less alarming, has so far failed seriously to breach those dams of public trust in money that keep inflation at bay.

Has the nature of money changed?

Errm, no. We’re trying to compensate for the fact that the V in MV=PQ has fallen.


6 thoughts on “On not understanding the quantity theory of money”

  1. The quantity theory of money, and in particular that equation, are poor explanations for the value of money and its effect on prices. Surprised so many people are so impressed with it. Mises got it all right a hundred years ago by explaining money in the same denand/supply/marginal utility terms as everything else. And people like Rothbard have torn that equation to pieces.

  2. Good point, Tim. Hyperinflation would be better termed “hypervelocity”.

    Interestingly, we saw hyperinflation in action in Greece during the run-up to the bank closures. Everyone was dumping (Greek) Euros as fast as they could – exchanging them for non-Greek Euros or Swiss francs, buying high-ticket items, paying off loans and even paying taxes (seriously). Had the Bank of Greece been able to print Euros freely, the hyperinflation would have been obvious. As it wasn’t, the country simply ran out of money.

  3. Common non-sense
    Comment on ‘On not understanding the quantity theory of money’

    The current economic situation is a clear refutation of both commonplace employment and quantity theory. When things get tough everyone can see that economists have no idea how the economy works.

    The quantity theory falls into the class of flat-earth theories, which are immediately convincing to common sense. The first thing an economist has to realize, though, is that common sense is not the best guide in economic matters. This is known since J. S. Mill:

    “People fancied they saw the sun rise and set, the stars revolve in circles round the pole. We now know that they saw no such thing; what they really saw was a set of appearances, equally reconcileable with the theory they held and with a totally different one. It seems strange that such an instance as this, … , should not have opened the eyes of the bigots of common sense, and inspired them with a more modest distrust of the competency of mere ignorance to judge the conclusions of cultivated thought.” (Mill, 2006, p. 783)

    The MV=PQ equation provides one of the silliest of the numerous common sense explanations. The correct equation for the determination of the price level is given by

    Note well: the quantity of money does not appear as independent variable in this equation. For the rectification of the commonplace quantity theory see (2011a; 2011b).

    There is not much use in discussing defunct theories any further. In particular, it should be evident after 100 years that from all scientifically incompetent economists the worst are assembled in Mises’s Austrian school.

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2011a). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL http://ssrn.com/abstract=1895268
    Kakarot-Handtke, E. (2011b). Reconstructing the Quantity Theory (II). SSRN Working Paper Series, 1903663: 1–20. URL http://ssrn.com/abstract=1903663
    Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation,
    volume 8 of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund.

  4. Peter Shaw (@PCSoblahdeehell)

    Illustrating once again: “Lessons may be learned from history: but beware comparisons without very careful qualifications – “mutandis” too little “mutatis”.

    And beware any columnist who starts: “My [old] study .. has found a new audience … etc etc” [with following subtext: I am finally being recognized] .Seriously, I find it a bit vulgar that the first four paragraphs are infused with advertisement of AF’s own book, and its merited place in history.

    There’s a nice German saying: “Eigenlob stinkt”. The first word would translate as “self-praise”.

    This puts a rather large cart of self before the Weimar horse – with a further, tendentious hobbyhorse lashed to its tail, re: purportedly foolish (recent) monetary policies.

  5. ICYMI Peter Shaw

    First rule of economic discourse: “Remember: occasionally, it may be an interesting question to ask why a man says what he says; but whatever the answer, it does not tell us anything about whether what he says is true or false.” (Schumpeter, 1994)

    The quantity theory is pseudo-scientific junk — but your comment is pseudo-psychological junk. As Feynman said: the farce that is economics.

  6. I’ve never understood the fuss about MV=PQ save that it satisfies economists’ physics envy. More particularly no one has been able to satisfy me that all four variables are fully defined and independently measurable, so allowing testing of the equation.

    On the other hand, it’s good to seed the resurrection of Justice Cocklecarrot.

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