Good Money, Part I: The New World includes seven of Hayek's articles from the 1920s that were written largely in reaction to the work of Irving Fisher and W. C. Mitchell. Hayek encountered Fisher's work on the quantity theory of money and Mitchell's studies on business cycles during a U.S. visit in 1923-24. These articles attack the idea that price stabilization was consistent with the stabilization of foreign exchange and foreshadow Hayek's general critique that the whole of an economy is not simply the sum of its parts.
Good Money, Part II: The Standard offers five more of Hayek's articles that advance his ideas about money. In these essays, Hayek investigates the consequences of the "predicament of composition." This principle works on the premise that the entire society cannot simultaneously increase liquidity by selling property or services for cash. This analysis led Hayek to make what was perhaps his most controversial proposal: that governments should be denied a monopoly on the coining of money.
Taken together, these volumes present a comprehensive chronicle of Hayek's writings on monetary policy and offer readers an invaluable reference to some of his most profound thoughts about money.
"Each new addition to The Collected Works of F. A. Hayek, the University of Chicago's painstaking series of reissues and collections, is a gem."— Liberty on Volume IX of The Collected Works of F. A. Hayek
"Intellectually [Hayek] towers like a giant oak in a forest of saplings."—Chicago Tribune
"One of the great thinkers of our age who . . . revolutionized the world's intellectual and political life."—Former President George Herbert Walker Bush
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A SURVEY OF RECENT AMERICAN WRITING: STABILIZATION PROBLEMS IN GOLD EXCHANGE STANDARD COUNTRIES
It may seem surprising to Europeans, who envy the United States for the solidity of its gold currency, that the imperfection of the existing monetary organization is felt more strongly there at present than in any other country. Yet it is a fact that the best American economists are devoting themselves primarily to the task of circumventing the dangers with which these flaws confront the country. In most European countries, where gold currencies have collapsed, the problems created by monetary instability could be attributed to deviations from the gold standard. In the United States, however, where, in contrast to most other countries, gold currency has remained intact, the intrinsic weaknesses of the gold exchange system have manifested themselves most clearly. The relative stability of the gold currencies in the prewar period, which rested on the free movement of gold and on the competition of central banks for gold, has now vanished. As long as the gold standard is maintained in its present form, the United States will continue to be faced with a steady influx of gold, which threatens to overwhelm them with enormous price increases. This could easily lead to the opposite reaction, once European economies have recovered sufficiently to reverse the flow of gold in their direction. Only halfhearted and purely provisional measures have been mounted against this threat. In the face of present conditions, a decisive change must soon be introduced. It is in any case highly unlikely that the relative stability of the prewar period will ever again be attained. American economists are therefore actively pursuing more or less radical plans to reform the obsolete gold exchange system.
The true center of this attack and criticism is not the specific form of the gold exchange system but the organization of the monetary system as such. Therein seems to lie the seed for serious economic disruptions and business crises, as long as it is kept in its present guise. Reform must concentrate on this target if human production is to stabilize and the abundance of goods is to be increased to its maximum. According to Foster and Catchings, the shortfall of production below its maximum because of fluctuations caused losses to the United States in excess of the combined income of all millionaires between 1877 and 1922, perhaps even in excess of the combined income of the 250,000 wealthiest people (to wit, persons with annual incomes in excess of $10,000). For many years these periodic disruptions of the economy and the period of depression that followed in their wake were accepted as unavoidable. Once their causes came to be understood, the search for a remedy was set in motion. As Wesley Clair Mitchell, probably the most prominent economist in this field, has stated:
For since the money economy is a complex of human institutions, it is subject to amendment. What we have to do is to find out just how the rules of our own making thwart our wishes and to change them in detail or change them drastically as the case may require. Not that this task is easy. On the contrary, the work of analysis is difficult intellectually and the work of devising remedies and putting them into effect is harder still. But one has slender confidence in the vitality of the race and in the power of scientific method if he thinks a task of this technical sort is beyond man's power.
Even without fully sharing Mitchell's optimistic views, one must give full credit to the great practical and theoretical advances in understanding and controlling business fluctuations that have taken place since the publication in 1913 of Mitchell's basic work on Business Cycles, which ushered in a new stage in this sphere of research. The impetus given this branch of research by the severe postwar crisis of 1920–21 has been so great that today many American economists devote themselves primarily to its problems. A significant factor in its expansion was its close connection with practical business concerns, which in turn awakened businessmen's interest in related scholarly research. The theoretical studies on the business cycle fuelled the search for practical applications of the knowledge that had been gained and led to the establishment of commercial economic forecasting services, whose function it is to help businessmen with their business planning. These services are already in wide use. Banks and large business concerns have also set up their own economic and statistical divisions to supplement by their own research data that is available for the public at large. With generous funding at their disposal, a number of independent economic research institutes have been founded and are doing excellent work, among them the National Bureau of Economic Research in New York, the Pollak Foundation for Economic Research in Newton, Mass., the Institute of Economics in Washington, D.C., and the Harvard Committee on Economic Research, which are already very productive.
We shall begin with a work that has been the object of lively discussion not only within the narrower circle of specialists but among a wider audience as well and that has served as the basis of a proposed bill that has been seriously considered by the competent committee of the House of Representatives: Irving Fisher's Stabilizing the Dollar. The basic features of Fisher's plan, which are developed in this book, have been popularized by his earlier work, The Purchasing Power of Money, where it was outlined in the appendix. Meanwhile Fisher has offered improved versions in a number of articles, which in turn have led to an extensive discussion of his ideas in the United States and have contributed to shoring up many of Fisher's weak points. The present volume contains a plan to implement the proposed bill worked out in full technical detail and may therefore be considered Fisher's final version, since the proposed bill incorporates verbatim the text presented in the book.
This book, like all Fisher's other works, is composed with admirable pedagogic skill and has a very clear structure. The arguments in favour of stabilizing the purchasing power of money are marshalled so convincingly and the proposed remedy seems so compelling in Fisher's presentation that one sincerely regrets not being fully convinced of its flawless operation. Fisher's basic idea is well known: to counter movements in the value of money by changes in the gold content of the monetary unit. As he states in the introductory words to his legislative proposal, the dollar should cease to be a constant quantity of gold with a variable purchasing power and become a variable quantity of gold with a nearly constant purchasing power. On the basis of an officially ascertained index number, a change in the weight of the gold unit should be decreed at regular, perhaps monthly, intervals, thereby reestablishing its purchasing power. If the index number were to increase by about 1 per cent during such an interval, the gold content of the unit would increase by 1 per cent and the converse. To avoid having to keep minting new coins to put into circulation, gold is to be replaced completely with notes, which can at any time be converted to the corresponding quantity of gold. To eliminate the possibility of speculation, conversion of gold into notes and of notes into gold would not be done at exactly the same exchange rate. In the latter case, the amount of gold would be slightly less, perhaps 1 per cent less, so that the span between these two relations would set an upper limit to the change in gold parity at any given time. Longer-term speculation would be minimized by the magnitude of the risk and by the failure to earn interest, at least with respect to speculation on a rising value of gold. The problem of keeping adequate reserves for the circulating notes with changes in the conversion ratio could be handled, to mention just one of Fisher's proposed alternatives, by the government's depositing a certain amount of notes with the banks and when the weight of the dollar rises, withdrawing and destroying an equivalent amount, so that the total remaining notes are still covered by gold when the new conversion rate takes effect. Conversely, when the gold content of the dollar is decreased, new notes will be put into circulation by deposits with the banks, until the full value of available reserves is reached. The change of the money in circulation immediately effected thereby would considerably increase the effectiveness of the intervention.
We cannot engage here in the lengthy theoretical disquisition that would be needed to deal critically with this seductive proposal. The feasibility or desirability of such a change in the modern monetary system hinges on the most complex and still unresolved questions of monetary theory. Suffice it to state here that Fisher's presentation fails to deal with the question whether an artificial stabilization of this sort is compatible with the role played by money. This omission is all the more mystifying because Fisher insists that his proposal not only eliminates all monetary causes of price level fluctuations but goes so far as to emphasize that the mechanism he envisages would be effective, whether or not price fluctuations were triggered by irregularities in gold production or by problems on the commodity side. That is why it is difficult to imagine how his plan would work when a change in the production costs of a commodity requires a price change to reestablish equilibrium. Both the accumulation of large stocks of goods at the end of a period of speculation, which calls for a liquidation, and a sudden general shortage of goods arising from an extremely poor harvest worldwide exemplify situations where the only feasible rapid adjustment is an abrupt price change. Might not the attempt to maintain the price level artificially, under these circumstances, merely postpone the unavoidable balancing of supply and demand, so that with each change in the gold content of the dollar new price movements would be required, and the system would have to be abandoned in the end? And in truth, would perfect stability in the purchasing power of money really be an ideal state of affairs? Should the aim not be, instead, to have the share of the social product assigned to each entity of the money in circulation vary in line with the expansion or contraction of the social product? Are average wholesale prices really an adequate expression of the value of money, whose stabilization is to be desired? Would such a change in the gold content of the primary money have a sufficient influence on the credit instruments based upon it in order to be effective? Fisher's book hardly clarifies any of these questions. Although we cannot pursue them any further here, we feel that our ignorance about money is too great to give unqualified approval to Fisher's plan. Fisher's proposal will certainly give a strong impetus to the discussion of these problems, and the book, which contains not only the proposal but a very valuable compilation of material, is in any case a most significant contribution to economic knowledge.
In view of the importance attributed by Fisher to index numbers for the new regulation of the monetary system, it is natural that he set out next to refine this instrument for measuring the value of money and to investigate and present the methods used in determining index numbers. It is Fisher's reiterated conviction — a conviction shared by many others — that the newly developed index for measuring price, output, employment, etc., movements offers a suitable basis for accurately determining the quantity of money the economy needs to advance steadily and to maintain price level stability. We shall therefore turn our attention next to research in index numbers, which are the underpinnings of this conviction. Before we come to Fisher's work on this subject, we must first examine an earlier and more comprehensive work than Fisher's monograph, which is limited to statistical methods for determining index numbers, in fact to one specific aspect of the question, in line with the overriding importance he attaches to their use. In "The Making and Using of Index Numbers", on the other hand, Wesley Clair Mitchell deals with the entire question, discusses its history and importance, and rightly introduces his presentation of the methods for determining index numbers with the comment that the method must be compatible with their purpose and that no single index number can be adequate for all purposes. Here he intentionally rejects Fisher's and C. M. Walsh's view that index numbers serve mainly to measure changes in the general purchasing power of money and that the object is to create a generally applicable index number. Since Mitchell, on the contrary, considers index numbers as the instrument of choice for the investigation of business cycles, he emphasizes that specific index numbers are valuable for specific purposes and believes that the problem of measuring the purchasing power of money has been too little investigated. In his view, it would impede further progress to insist on a single interpretation and therefore on a single 'best' solution to this problem. Mitchell dwells fully on the selection of data for constructing the index number, the nature of the prices and commodities to be included, demonstrating by means of the various American index numbers how the choice of data affects the path of the index curves. His personal experiences in studying the business cycle enable him to turn this section into what is probably the most valuable part of the book. He then takes up the mathematical and statistical problems connected with index numbers — weighting, averaging, periodicity of the index numbers thus obtained — with characteristic restraint and a critical mind. This part of the book will not be considered here in detail, as this topic is treated much more fully in Fisher's book, to which we shall turn next. We will also postpone Mitchell's evaluation of the 'ideal formula' evolved by Bowley-Pigou-Walsh-Fisher until we reach the corresponding part of Fisher's book. Mitchell concludes his work with a discussion of the most important wholesale commodity price index numbers published in the United States. The second part of this volume contains a very useful compilation of worldwide wholesale price indexes and a bibliography.
Mitchell's treatise on the whole question of price index numbers must be considered the best available general treatment of the subject, but for the narrower topic treated by the book we are considering here, Fisher's The Making of Index Numbers, the latter work deserves this commendation. Fisher's book concentrates almost exclusively on finding the most appropriate mathematical formula for calculating index numbers and might be better viewed as a treatise on statistical averages as applied to prices than as a complete presentation of the method for determining index numbers. This topic has never before been treated with this degree of thoroughness and completeness. Starting out with the six basic formulas for average values, five of which, the arithmetic, harmonic, and geometric means, the median, and the mode, are more or less widely used, and a sixth, the newly introduced 'aggregative' average, which is the index of the price sums, Fisher studies 134 different formulas — some familiar, some new — for determining average values and tests their reliability. He applies the formulas to the data for 36 wholesale commodities for the years 1913 to 1918 selected from statistics compiled by Mitchell for the War Industries Board on prices and quantities of 1474 commodities. Since these numbers included not only prices but annual sales of the commodities in question, Fisher had the data he needed to test all the different theoretically conceivable methods of weighting individual factors. In addition to the two most obvious methods, weighting of commodities in terms of their relationship to the total value of commodities sold either in the initial year or in the particular year, he introduces two additional combinations by combining the prices in the initial year with the quantities of the particular year and the quantities of the initial year with the prices of the final year. He thus obtains four weighting systems, which he combines with all six average values (except the aggregative average, which can be used only with the first two). He thereby obtains 28 different 'primary' formulas including the unweighted, or, as he more accurately designates them, simply weighted, formulas, which serve as the foundation for his subsequent research. When these formulas are applied to the wartime data, where fluctuations in prices and quantities are admittedly far more marked than in peacetime years, the various formulas display significantly divergent results within this five-year interval. There is a maximum discrepancy of 24 per cent between the simply weighted median value (190.92) and the harmonic mean weighted by the last-mentioned method (166.85). And this analysis was limited to series in which all numbers referred to a specified initial year; the divergence would have been even more pronounced if series determined by the chain system had been included.(Continues…)
Excerpted from "Good Money, Part I"
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Table of ContentsEditorial Foreword
1. A Survey of Recent American Writing: Stabilization Problems in Gold Exchange Standard Countries
Addendum: Exchange Rate Stabilization or Price Stabilization?
2. Monetary Policy in the United States after the Recovery from the Crisis of 1920
3. The Fate of the Gold Standard
4. The Gold Problem
5. Intertemporal Price Equilibrium and Movements in the Value of Money
6. On 'Neutral' Money
7. Price Expectations, Monetary Disturbances, and Malinvestments