Hi everyone, I would very much appreciate feedback to this reflection on economic indicator.
Besides the division of labor as conceived by Adam Smith, another factor that greatly contributes to human welfare or economic progress, according to Menger, is knowledge. This view is held also Mises, Hayek, Rothbard, Reismann and other “Austrians”. What is not so obvious is how an economy “grows” or “shrinks” or how a nation’s wealth is “created”.
As I understand it, this cannot be separated from money. Its role as catalyst, which has always been implied in the process, is acknowledged.
Now, Austrians view that theoretically any amount of money in a country will serve the function well. Moreover, the tendency of movement of prices in a “healthy” unhampered economy is such that it tends to go down, meaning that the purchasing power of money tends to increase--that is, assuming there is no increase in the money supply; hence no inflation.
Are we thus correct in concluding that the purchasing power of money actually does reflect the economic progress or retrogress itself so much so that it could be used as a realiable, overall, real economic indicator although it cannot specify in what sectors progress was made? (I’m thinking gold price is being used as its benchmark.)
Yes, but only as an average measure of economic gain per human being. Assuming no inflation, of course, including no gold inflation.
Three things are the variables here, the economic gain, the number of participants and the inflation of money stock. If for example, the number of participants should start to increase at a higher rate, this may move the prices up, even though there is a positive economic gain.
Thorgold:Three things are the variables here, the economic gain, the number of participants and the inflation of money stock. If for example, the number of participants should start to increase at a higher rate, this may move the prices up, even though there is a positive economic gain.
I don't think that's correct. If the population increases, nominal prices will move down (assuming a constant money supply and no increase in productivity). Real prices will remain constant and the purchasing power of money is unaffected.
The reason is that with a constant money supply, nominal wages must decrease if population increases (there's less money to go around), but if productivity remains constant, nominal prices must fall in line with wages.
Of course if productivity does increase while the population increases, then nominal prices will fall even faster and the purchasing power of money will increase.
An interesting question to ask is, does an increasing population require a corresponding increase in the money supply to prevent distortions to the structure of production?
To leonida:
"... does an increasing population require a corresponding increase in the money supply to prevent distortions to the structure of production?"
I suppose the answer is already implied in my post above, the reason being that we can always "divide" U$1 to a family of any number of members. Actually, my question has been based precisely on this consideration. (The word "distortion", btw, carries a negative connotation.)
My tentative conclusion is therefore: an increase of purchasing power does show something about an increase in productivity, but this has yet to consider population change, which has strong influence on the relationship.
To Thorgold: I wonder what you mean by gold inflation. Can there be such a thing?
My point was this: A population change, by itself, would have little effect on the purchasing power of money in the long run. However, a poulation change might affect the structure of production.
Consider that a sudden increase in the money supply artificially lowers interest rates which induces malinvestment and overconsumption. The boom is then followed by a bust. The same thing could occur if the money supply remained constant and the population suddenly decresed.
Conversely, cetaris perabis a sudden decrease in money supply induces underinvestment in the higher order stages and underconsumption, leading to depression followed by a recovery boom. My feeling is that a similar thing could occur if, cetaris perabis, there was a sudden increase in population.
I am really thankful for all helpful feedback and clarification; also for the institute for making this forum possible.
Btw, I just read Chapter 4 on "Production, Income, and Economic Growth" in Milton Saphiro's Foundations of Market Price System. Though it neither refutes nor confirms my surmise, somehow I could conclude how very inadequate it is to measure growth (i.e. well-being) via changes in ppm.
I also realized that discussions on this matter usually omit this crucial element of money, at least in most textbooks I have read so far.
leonidia:If the population increases, nominal prices will move down (assuming a constant money supply and no increase in productivity). Real prices will remain constant and the purchasing power of money is unaffected.The reason is that with a constant money supply, nominal wages must decrease if population increases (there's less money to go around), but if productivity remains constant, nominal prices must fall in line with wages.
If the population increases, nominal prices will move down (assuming a constant money supply and no increase in productivity). Real prices will remain constant and the purchasing power of money is unaffected.
I'm pretty sure this is incorrect. Given a constant money supply, nominal and real prices change in direct proportion (that is to say, there is no need for this distinction). Population changes per se will not affect the overall price level at all, other things being equal. Nominal wages per person will decrease if population increases, but the total amount of wages paid will remain constant. Nominal prices will likewise be unchanged, because effective demand (the money supply) is unchanged - it is only divided among more individuals.
Population changes could certainly affect the relative prices of various goods - but not the overall price level. Population changes likewise may affect productivity, which would affect the overall price level, but you have explicitly assumed this to remain constant; and in any case, changes in productivity are exactly what it has been proposed that the PPM be used to measure.
That being said, I think there is another problem with using the PPM as an economic indicator. The PPM is really just the inverse of a price index. All the same problems (impossibilities, really) with defining and calculating a price index are equally applicable to calculating the PPM.
EDIT - I saw my mistake as soon as I posted this. I got the nominal/real concept wrong, and I also forgot to consider that more total goods will be produced. Same total wages + more goods = lower nominal prices, but an hour of labor purchases the same quantity of goods as before (real prices are unchanged). leonidia was exactly correct - my apologies.
kaxahdan: Besides the division of labor as conceived by Adam Smith, another factor that greatly contributes to human welfare or economic progress, according to Menger, is knowledge. This view is held also Mises, Hayek, Rothbard, Reismann and other “Austrians”. What is not so obvious is how an economy “grows” or “shrinks” or how a nation’s wealth is “created”. As I understand it, this cannot be separated from money. Its role as catalyst, which has always been implied in the process, is acknowledged. Now, Austrians view that theoretically any amount of money in a country will serve the function well. Moreover, the tendency of movement of prices in a “healthy” unhampered economy is such that it tends to go down, meaning that the purchasing power of money tends to increase--that is, assuming there is no increase in the money supply; hence no inflation.
So money could be seen as a catalyst for the exchange between parties within an economy. The purchasing power of money should indeed grow over time, while an economy is becoming more productive.
You would have to define, what you mean with "knowledge". Is knowledge to you just awareness of facts (information). Is it the ability to process information for useful means. And would you distinguish between knowledge that can deliver utilities to others (technology) from knowledge of having only a private function?
Functioning social relations (values, manners, good business practices) are also important for a sustainable economy.
TGibson11, thanks.
Torsten, what you said about the role of money reminds me of some first chapters of Rothbard's What Has Government Done With Our Money. I can't agree more.
By knowledge I meant just as Menger said in his Principles, "Nothing is more certain than that the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge." In pp 73-74 he elaborated his points.
In Shapiro's book chapter that I quoted in my earlier comment, this knowledge is also acknowledged. He also adds other, no less important, factors a.o. the social/political institutions or organizations.
tgibson11:The PPM is really just the inverse of a price index. All the same problems (impossibilities, really) with defining and calculating a price index are equally applicable to calculating the PPM.
The PPM is really just the inverse of a price index. All the same problems (impossibilities, really) with defining and calculating a price index are equally applicable to calculating the PPM.
Just wanted to share this: according to Mises' The Theory of Money and Credit (pp. 139-44 and 187-200) , ppm is more than just the inverse of the index, and it is neither possible nor permissible to lump the "prices" of money against all commodities. The price level concept is a fallacy. It fails to capture changes in the structure of demands of any given society, relative prices and relative incomes in production--in short, the composition of the array constituting the ppm itself.
Don't forget that in a society where the money supply remains level and the population rises, the velocity of exchange will inevitably rise also due to the increased demand for goods to service the increased population, creating a tendancy for the price level to remain stable even though the tendancy for the value of each monetary unit may rise. Both pressures exist simultaneously, causing the price level to remain stable to some extent. This should not effect the structure of production as the demand should not alter in proportions of goods demanded. As soon as new currency is introduced however, the structure of production will probably change.
Donald Lingerfelt:Don't forget that in a society where the money supply remains level and the population rises, the velocity of exchange will inevitably rise also due to the increased demand for goods to service the increased population, creating a tendancy for the price level to remain stable even though the tendancy for the value of each monetary unit may rise.
"a sudden decrease in money supply induces underinvestment in the higher order stages and underconsumption, leading to depression followed by a recovery boom. My feeling is that a similar thing could occur if, cetaris perabis, there was a sudden increase in population."
assuming constant capital investment, increasing the population would change the makeup of the economy, as others have mentioned (ie more labour-intensive jobs - gardeners raking up leaves, rather than using the leaf-blower etc.). but there is no reason why this would create the boom/bust cycle described by the austrians. there would be a lower standard of living, but this would be perfectly sustainable over the long term; there is nothing artificial about this. there is no malinvestment whatsoever, just increased poverty, in direct proportion to the number of immigrants.
leonidia: "The velocity of exchange" has nothing to do with it. It's not even a valid concept.
I disagree. Velocity is a valid reason for price inflation and one of the problems with artifically low interest rates. When consumers save less due to insufficient returns on savings, and companies reduce cash holdings for the same reason (and also the incentive to have abundant cash holdings in this environment due to the easy money on the loanable funds market is low), the velocity of exchange rises. No one is saving at this point, and consumption rises (as it must) along with business expendatures by entrapeneurs in higher order producer goods and labor. The return on investment is higher than on saving so companies invest in themselves rather than interest rates. Even cash holdings for business operations decline. The bust comes when consumers are loaned up to the hilt and consumption expendatures decline (among other things). Companies see this and attempt to increase their own cash holdings (reducing business expendature) and the velocity of money redically declines across the board. The central bank sees this and may reduce interest rates in a failing attempt to assure business men that money is still easy to obtain. This is totally consistant with the ABCT. I know that this is a very short summation of the ABCT and isolates only a couple of its aspects but those who are familiar with it can fill in the blanks. Sorry.
Donald Lingerfelt:Velocity is a valid reason for price inflation and one of the problems with artifically low interest rates.
if capital investment and money supply are fixed, and population increases, the structure of the economy will change to reflect the abundance of labour over capital. that is, it will be cheaper to employ a kitchenhand to wash pans in your restaurant, rather than install a dishwashing machine (by way of example). this has absolutely nothing to do with the abct, and is visible all over the world today, especially in countries will poor border control and subject to high refugee influx. think the third world. rise in povery only speaks to the diminution of capital in relation to labour.
further to my post of december 1 (11.03am), ceteris paribus is what you meant to write, i hope.
The velocity of exchange is the turover rate of currency. If currency moves faster through society, this in itself will cause price inflation, even though the quantity of currency remains the same. Demand increases causing prices to rise. This is the "V" in P=MV/Q and MV=D (see "Capitalism"_Reisman, pp.503:504). "V" cannot to my knowledge be discovered (I have tried) but is a priori in nature. It can be thought of as the speed which consumers want to buy rather than get caught with currency which is depreciating through price inflation. I think that this is just as much the reason for the inflationary recession as the expansion of the currency base. Reisman also wrote an excellent essay posted on Mises.org some years ago called "When Will The Bubble Burst?" Not that it matters, but my college text also discussed this concept. http://www.mises.org/story/284
Well, I have to disagree with you on the whole notion of the equation of exchange, MV=PQ. V cannot be discovered because it cannot be defined independently from the other variables in the equation. That's why I asked you to define it. Other elements in the equation are equally meaningless. Take the concept of "price level" P. There are only individual prices of specific goods, and these cannot be averaged to come up with a "price level" since they have no unit in common. (You cannot, for example, average a price of $4/gallon of milk with a price of $1000/unit of televison set because the denominators are different...and that's just two examples!) Thus the PQ side of the equation has no meaning. If it has no meaning, MV has no meaning either.
Now look at the units in the equation itself. M is the total amount of money. P is money/quantity (setting aside the problem of quantity of what?) and Q is quantity, so what is V? Money*V=Money/Qty*Qty.... V is meaningless.
Rothbard does an excellent analysis of the fallacy of the equation of exchange in MES Ch11 Sec13.