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• Foreword
• On the Manipulation of Money and Credit Three Treatises On Trade-cycle Theory
• Stabilization of the Monetary Unit— From the Viewpoint of Theory
• Introduction *
• I: The Outcome of Inflation
• II: The Emancipation of Monetary Value From the Influence of Government
• III: The Return to Gold
• IV: The Money Relation
• V: Comments On the “balance of Payments” Doctrine
• VI: The Inflationist Argument
• VII: The New Monetary System
• VIII: The Ideological Meaning of Reform
• Appendix: Balance of Payments and Foreign Exchange Rates *
• Monetary Stabilization and Cyclical Policy
• Preface *
• Part I: Stabilization of the Purchasing Power of the Monetary Unit
• I: The Problem
• II: The Gold Standard
• III: The “manipulation” of the Gold Standard
• IV: “measuring” Changes In the Purchasing Power of the Monetary Unit
• V: Fisher’s Stabilization Plan
• VI: Goods-induced and Cash-induced Changes In the Purchasing Power of the Monetary Unit
• VII: The Goal of Monetary Policy
• Part II: Cyclical Policy to Eliminate Economic Fluctuations
• I: Stabilization of the Purchasing Power of the Monetary Unit and Elimination of the Trade Cycle
• II: Circulation Credit Theory
• III: The Reappearance of Cycles
• IV: The Crisis Policy of the Currency School
• V: Modern Cyclical Policy
• VI: Control of the Money Market
• VII: Business Forecasting For Cyclical Policy and the Businessman
• VIII: The Aims and Method of Cyclical Policy
• The Causes of the Economic Crisis an Address
• I: The Nature and Role of the Market
• II: Cyclical Changes In Business Conditions
• III: The Present Crisis
• A.: Unemployment
• B.: Price Declines and Price Supports
• C.: Tax Policy
• D.: Gold Production
• IV: Is There a Way Out?
• The Current Status of Business Cycle Research and Its Prospects For the Immediate Future
• 1.: The Acceptance of the Circulation Credit Theory of Business Cycles *
• 2.: The Popularity of Low Interest Rates
• 3.: The Popularity of Labor Union Policy
• 4.: The Effect of Lower Than Unhampered Market Interest Rates
• 5.: The Questionable Fear of Declining Prices
• The Trade Cycle and Credit Expansion: the Economic Consequences of Cheap Money
• 1.: Introductory Remarks *
• 2.: The Unpopularity of Interest
• 3.: The Two Classes of Credit
• 4.: The Function of Prices, Wage Rates and Interest Rates
• 5.: The Effects of Politically Lowered Interest Rates
• 6.: The Inevitable Ending

V

Fisher’s Stabilization Plan

1.

Political Problem

The superiority of the gold standard consists in the fact that the value of gold develops independent of political actions. It is clear that its value is not “stable.” There is not, and never can be, any such thing as stability of value. If, under a “manipulated” monetary standard, it was government’s task to influence the value of money, the question of how this influence was to be exercised would soon become the main issue among political and economic interests. Government would be asked to influence the purchasing power of money so that certain politically powerful groups would be favored by its intervention, at the expense of the rest of the population. Intense political battles would rage over the direction and scope of the edicts affecting monetary policy. At times, steps would be taken in one direction, and at other times in other directions—in response to the momentary balance of political power. The steady, progressive development of the economy would continually experience disturbances from the side of money. The result of the manipulation would be to provide us with a monetary system which would certainly not be any more stable than the gold standard.

If the decision were made to alter the purchasing power of money so that the index number always remained unchanged, the situation would not be any different. We have seen that there are many possible ways, not just one single way, to determine the index number. No single one of these methods can be considered the only correct one. Moreover, each leads to a different conclusion. Each political party would advocate the index method which promised results consistent with its political aims at the time. Since it is not scientifically possible to find one of the many methods objectively right and to reject all others as false, no judge could decide impartially among groups disputing the correct method of calculation.

In addition, however, there is still one more very important consideration. The early proponents of the Quantity Theory believed that changes in the purchasing power of the monetary unit caused by a change in the quantity of money were exactly inversely proportional to one another. According to this Theory, a doubling of the quantity of money would cut the monetary unit’s purchasing power in half. It is to the credit of the more recently developed monetary theory that this version of the Quantity Theory has been proved untenable. An increase in the quantity of money must, to be sure, lead ceteris paribus to a decline in the purchasing power of the monetary unit. Still the extent of this decrease in no way corresponds to the extent of the increase in the quantity of money. No fixed quantitative relationship can be established between the changes in the quantity of money and those of the unit’s purchasing power.1 Hence, every manipulation of the monetary standard will lead to serious difficulties. Political controversies would arise not only over the “need” for a measure, but also over the degree of inflation or restriction, even after agreement had been reached on the purpose the measure was supposed to serve.

All this is sufficient to explain why proposals for establishing a manipulated standard have not been popular. It also explains—even if one disregards the way finance ministers have abused their authority—why credit money (commonly known as “paper money”) is considered “bad” money. Credit money is considered “bad money” precisely because it may be manipulated.

2.

Multiple Commodity Standard

Proposals that a multiple commodity standard replace, or supplement, monetary standards based on the precious metals—in their role as standards of deferred payments—are by no means intended to create a manipulated money. They are not intended to change the precious metals standard itself nor its effect on value. They seek merely to provide a way to free all transactions involving future monetary payments from the effect of changes in the value of the monetary unit. It is easy to understand why these proposals were not put into practice. Relying as they do on the shaky foundation of index number calculations, which cannot be scientifically established, they would not have produced a stable standard of value for deferred payments. They would only have created a different standard with different changes in value from those under the gold metallic standard.

To some extent Fisher’s proposals parallel the early ideas of advocates of a multiple commodity standard. These forerunners also tried to eliminate only the influence of the social effects of changes in monetary value on the content of future monetary obligations. Like most Anglo-American students of this problem, as well as earlier advocates of a multiple commodity standard, Fisher took little notice of the fact that changes in the value of money have other social effects also.

Fisher, too, based his proposals entirely on index numbers. What seems to recommend his scheme, as compared with proposals for introducing a “multiple standard,” is the fact that he does not use index numbers directly to determine changes in purchasing power over a long period of time. Rather he uses them primarily to understand changes taking place from month to month only. Many objections raised against the use of the index method for analyzing longer periods of time will perhaps appear less justified when considering only shorter periods. But there is no need to discuss this question here, for Fisher did not confine the application of his plan to short periods only. Also, even if adjustments are always made from month to month only, they were to be carried forward, on and on, until eventually calculations were being made, with the help of the index number, which extended over long periods of time. Because of the imperfection of the index number, these calculations would necessarily lead in time to errors of very considerable proportions.

3.

Price Premium

Fisher’s most important contribution to monetary theory is the emphasis he gave to the previously little noted effect of changes in the value of money on the formation of the interest rate.2 Insofar as movements in the purchasing power of money can be foreseen, they find expression in the gross interest rate—not only as to the direction they will take but also as to their approximate magnitude. That portion of the gross interest rate which is demanded, and granted, in view of anticipated changes in purchasing power is known as the purchasing-power-change premium or price-change premium. In place of these clumsy expressions we shall use a shorter term—“price premium.” Without any further explanation, this terminology leads to an understanding of the fact that, given an anticipation of general price increases, the price premium is “positive,” thus raising the gross rate of interest. On the other hand, with an anticipation of general price decreases, the price premium becomes “negative” and so reduces the gross interest rate.

The individual businessman is not generally aware of the fact that monetary value is affected by changes from the side of money. Even if he were, the difficulties which hamper the formation of a halfway reliable judgment, as to the direction and extent of anticipated changes, are tremendous, if, not outright insurmountable. Consequently, monetary units used in credit transactions are generally regarded rather naively as being “stable” in value. So, with agreement as to conditions under which credit will be applied for and granted, a price premium is not generally considered in the calculation. This is practically always true, even for long-term credit. If opinion is shaken as to the “stability of value” of a certain kind of money, this money is not used at all in long-term credit transactions. Thus, in all nations using credit money, whose purchasing power fluctuated violently, long-term credit obligations were drawn up in gold, whose value was held to be “stable.”

However, because of obstinacy and pro-government bias, this course of action was not employed in Germany, nor in other countries during the recent inflation. Instead, the idea was conceived of making loans in terms of rye and potash. If there had been no hope at all of a later compensating revaluation of these loans, their price on the exchange in German marks, Austrian crowns and similarly inflated currencies would have been so high that a positive price premium corresponding to the magnitude of the anticipated further depreciation of these currencies would have been reflected in the actual interest payment.

The situation is different with respect to short-term credit transactions. Every businessman estimates the price changes anticipated in the immediate future and guides himself accordingly in making sales and purchases. If he expects an increase in prices, he will make purchases and postpone sales. To secure the means for carrying out this plan, he will be ready to offer higher interest than otherwise. If he expects a drop in prices, then he will seek to sell and to refrain from purchasing. He will then be prepared to lend out, at a cheaper rate, the money made available as a result. Thus, the expectation of price increases leads to a positive price premium, that of price declines to a negative price premium.

To the extent that this process correctly anticipates the price movements that actually result, with respect to short-term credit, it cannot very well be maintained that the content of contractual obligations is transformed by the change in the purchasing power of money in a way which was neither foreseen nor contemplated by the parties concerned. Nor can it be maintained that, as a result, shifts take place in the wealth and income relationship between creditor and debtor. Consequently, it is unnecessary, so far as short-term credit is concerned, to look for a more perfect standard of deferred payments.

Thus we are in a position to see that Fisher’s proposal actually offers no more than was offered by any previous plan for a multiple standard. In regard to the role of money as a standard of deferred payments, the verdict must be that, for long-term contracts, Fisher’s scheme is inadequate. For short-term commitments, it is both inadequate and superfluous.

4.

Changes in Wealth and Income

However, the social consequences of changes in the value of money are not limited to altering the content of future monetary obligations. In addition to these social effects, which are generally the only ones dealt with in Anglo-American literature, there are still others. Changes in money prices never reach all commodities at the same time, and they do not affect the prices of the various goods to the same extent. Shifts in relationships between the demand for, and the quantity of, money for cash holdings generated by changes in the value of money from the money side do not appear simultaneously and uniformly throughout the entire economy. They must necessarily appear on the market at some definite point, affecting only one group in the economy at first, influencing only their judgments of value in the beginning and, as a result, only the prices of commodities these particular persons are demanding. Only gradually does the change in the purchasing power of the monetary unit make its way throughout the entire economy.

For example, if the quantity of money increases, the additional new quantity of money must necessarily flow first of all into the hands of certain definite individuals—gold producers, for example, or, in the case of paper money inflation, the coffers of the government. It changes only their incomes and fortunes at first and, consequently, only their value judgments. Not all goods go up in price in the beginning, but only those goods which are demanded by these first beneficiaries of the inflation. Only later are prices of the remaining goods raised, as the increased quantity of money progresses step by step throughout the land and eventually reaches every participant in the economy.3 But even then, when finally the upheaval of prices due to the new quantity of money has ended, the prices of all goods and services will not have increased to the same extent. Precisely because the price increases have not affected all commodities at one time, shifts in the relationships in wealth and income are effected which affect the supply and demand of individual goods and services differently. Thus, these shifts must lead to a new orientation of the market and of market prices.

Suppose we ignore the consequences of changes in the value of money on future monetary obligations. Suppose further that changes in the purchasing power of money occur simultaneously and uniformly with respect to all commodities in the entire economy. Then, it becomes obvious that changes in the value of money would produce no changes in the wealth of the individual entrepreneurs. Changes in the value of the monetary unit would then have no more significance for them than changes in weights and measures or in the calendar.

It is only because changes in the purchasing power of money never affect all commodities everywhere simultaneously that they bring with them (in addition to their influence on debt transactions) still other shifts in wealth and income. The groups which produce and sell the commodities that go up in price first are benefited by the inflation, for they realize higher profits in the beginning and yet they can still buy the commodities they need at lower prices, reflecting the previous stock of money. So during the inflation of the World War [1914–1918], the producers of war materiel and the workers in war industries, who received the output of the printing presses earlier than other groups of people, benefited from the monetary depreciation. At the same time, those whose incomes remained nominally the same suffered from the inflation, as they were forced to compete in making purchases with those receiving war inflated incomes. The situation became especially clear in the case of government employees. There was no mistaking the fact that they were losers. Salary increases came to them too late. For some time they had to pay prices, already affected by the increase in the quantity of money, with money incomes related to previous conditions.

5.

Uncompensatable Changes

In the case of foreign trade, it was just as easy to see the consequences of the fact that price changes of the various commodities did not take place simultaneously. The deterioration in the value of the monetary unit encourages exports because a part of the raw materials, semi-produced factors of production and labor needed for the manufacture of export commodities, were procured at the old lower prices. At the same time the change in purchasing power, which for the time being has affected only a part of the domestically-produced commodities, has already had an influence on the rate of exchange on the Bourse. The result is that the exporter realizes a specific monetary gain.

The changes in purchasing power arising on the money side are considered disturbing not merely because of the transformation they bring about in the content of future monetary obligations. They are also upsetting because of the uneven timing of the price changes of the various goods and services. Can Fisher’s dollar of “stable value” eliminate these price changes?

In order to answer this question, it must be restated that Fisher’s proposal does not eliminate changes in the value of the monetary unit. It attempts instead to compensate for these changes continuously—from month to month. Thus the consequences associated with the step-by-step emergence of changes in purchasing power are not eliminated. Rather they materialize during the course of the month. Then, when the correction is made at the end of the month, the course of monetary depreciation is still not ended. The adjustment calculated at that time is based on the index number of the previous month when the full extent of that month’s monetary depreciation had not then been felt because all prices had not yet been affected. However, the prices of goods for which demand was forced up first by the additional quantity of money undoubtedly reached heights that may not be maintained later.

Whether or not these two deviations in prices correspond in such a way that their effects cancel each other out will depend on the specific data in each individual case. Consequently, the monetary depreciation will continue in the following month, even if no further increase in the quantity of money were to appear in that month. It would continue to go on until the process finally ended with a general increase in commodity prices, in terms of gold, and thus with an increase in the value of the gold dollar on the basis of the index number. The social consequences of the uneven timing of price changes would, therefore, not be avoided because the unequal timing of the price changes of various commodities and services would not have been eliminated.4

So there is no need to go into more detail with respect to the technical difficulties that stand in the way of realizing Fisher’s Plan. Even if it could be put into operation successfully, it would not provide us with a monetary system that would leave the disposition of wealth and income undisturbed.

[1. ]See The Theory of Money and Credit [(Yale, 1953), pp. 139ff.; (Liberty Fund, 1981,) pp. 161ff.—Ed.].

[2. ]Fisher, Irving. The Rate of Interest. New York, 1907, pp. 77ff.

[3. ]Gossen, Hermann Heinrich. Entwicklung der Gesetze des menschlichen Verkehrs und der daraus fliessenden Regeln für menschliches Handeln (new ed.). Berlin, 1889, p. 206.

[4. ]See also my critique of Fisher’s proposal in The Theory of Money and Credit [(Yale, 1953), pp. 399ff.; (Liberty Fund, 1981), pp. 438ff.—Ed.].