10 replies to this topic

[Murphy]

In what sense did Mises’ monetary theory integrate micro- and macroeconomics?

[Rune]

Contemporary economists were of the opinion that money had to be treated as a phenomenon separated from the real economy because they wrongly believed that an increase in the quantity of money had a neutral effect on the real economy; that it only would affect “the general price level”. This led to a focus on the aggregate effects of money (macro level) and ignorance of its relevance for individual action and interaction (micro level).

Although this may be a bit on the side of this question, I can mention that Mises demonstrated that the increase in money does not have a neutral effect on the real economy. Some individuals or groups have to be the first receivers of new money. While they buy goods at yesterday’s prices, the increased demand for the goods (based on newly created money) tends to increase the price of the goods. Others, who receive the new money later or not at all, have to pay the increased price. The result is redistribution of wealth and a reshuffling of the structure of production.

Mises was able to integrate micro- and macroeconomics by demonstrating that the principle of marginal utility applied to the value of money.

[Murphy]

Right. Mises used the marginal utility approach that all other economists used for barter, in order to explain valuation of money units. In this articleI elaborate.

[Joanne]

Murphy, on Sep 4 2005, 02:52 PM, said:

In what sense did Mises’ monetary theory integrate micro- and macroeconomics?

Since money circulates through the entire economy, consumers will respond to any attempts to change or tamper with the value of money. vMises stipulated that when the money supply is increased, that overall wealth is not increased and purchasing power for individual consumers is lessened. Consumers will change their perceptions of their purchasing power relative to their incomes and act accordingly.

vMises also realized that changes in the money supply do not confer immediate dilution to all participants in the economy. "Newly created" money in the economy was doled out to banks first, long before the information about dilution became impounded into the price signals of consumers. Likewise, the perception of undervalued or overvalued money, and the subsequent changes in interest rates sent errant signals to producers, and from here vMises built his theory of the business cycle. (Along with Wicksell's theory of interest rates.)

[Murphy]

Joanne, on Nov 20 2006, 08:02 AM, said:

Since money circulates through the entire economy, consumers will respond to any attempts to change or tamper with the value of money. vMises stipulated that when the money supply is increased, that overall wealth is not increased and purchasing power for individual consumers is lessened. Consumers will change their perceptions of their purchasing power relative to their incomes and act accordingly.

vMises also realized that changes in the money supply do not confer immediate dilution to all participants in the economy. "Newly created" money in the economy was doled out to banks first, long before the information about dilution became impounded into the price signals of consumers. Likewise, the perception of undervalued or overvalued money, and the subsequent changes in interest rates sent errant signals to producers, and from here vMises built his theory of the business cycle. (Along with Wicksell's theory of interest rates.)

These points are all true but I'm not sure you're hitting the essential point for this thread. As Rune explained pretty well, before Mises there were two hermetically sealed strands of economics. On the one hand economists used subjective marginal utility theory to explain the equilibrium relative prices between various goods. These considerations could imply, for example, that TV sets should have a price 5x the price of a DVD. But then in order to come up with actual dollar amounts for the price tags, ecoomists relied on a completely different approach involving aggregate quantities of money and measures of "velocity of circulation."

So what Mises did was come up with a theory explaining the formation of actual money prices (not just ratios of money prices between any pair of goods) that was subjecitvist and marginal.

[Joanne]

Murphy, on Dec 13 2006, 11:37 PM, said:

These points are all true but I'm not sure you're hitting the essential point for this thread. As Rune explained pretty well, before Mises there were two hermetically sealed strands of economics. On the one hand economists used subjective marginal utility theory to explain the equilibrium relative prices between various goods. These considerations could imply, for example, that TV sets should have a price 5x the price of a DVD. But then in order to come up with actual dollar amounts for the price tags, ecoomists relied on a completely different approach involving aggregate quantities of money and measures of "velocity of circulation."

So what Mises did was come up with a theory explaining the formation of actual money prices (not just ratios of money prices between any pair of goods) that was subjecitvist and marginal.

This question may appear tangential because it doesn't deal with Austrian Economics but its predecessors and competitors, but I'm not really sure what you mean by "aggregate quantities of money and measures of velocity of circulation." Would this approach constitute an ex-post, almost inventory-turn accounting sort of approach? You're correct, I think I am missing the essential part here and will go back and re-check.

[Murphy]

Joanne, on Dec 17 2006, 08:16 PM, said:

but I'm not really sure what you mean by "aggregate quantities of money and measures of velocity of circulation." Would this approach constitute an ex-post, almost inventory-turn accounting sort of approach?

Oh sorry about that. You're right, the pre-Misesian (and actually, still prevalent macro) way of dealing with money prices was/is to rely on accounting truisms at the economy-wide level. They rely on the so-called equation of exchange:

MV = PQ

where M = total quantity of money, V = "velocity" of circulation, P = "average" price, and Q = total output. So the left hand side is how much money is spent, while the right is how much money is received by producers.

If you can get into this frame of thinking, then V is something like, how many times on average does a given dollar bill change hands or "get spent."

[Murphy]

Doug K, on Apr 10 2007, 06:23 PM, said:

Hmmm... The key note I have in my book is that Mises provided a theory that "was consistent with the theory of individual choice." I think my intent with that statement was to say that Mises, by incorporating Money into the Marginal Utility analysis, was able to show how it could be extended to macroeconomics (beyond the individual level)

Yeah that sounds right.

Quote

But the talk of MV=PQ (which sounds a lot like PV=NRT, the ideal gas law) has me confused in the following way. Did Mises discredit MV=PQ? Doesn't MV=PQ support the Austrian position that the increase in the amount and velocity of money lead to price increases? (understanding the Mises better explained why those increases were manifest unevenly) Or did Mises' monetary theory make the use of MV=PQ obsolete (and - in the process - connect the micro and macro economic theories?)

I think I'm reading too much into the phrase "integrate micro and macroeconomics" If I say that Mises was able to integrate money into the marginal utility theory, and by extension there was no limit to which this could be extended to explain 'prices' throughout the economy, and consequently was applicable to the economy as a whole - then - I could accept that. Is that close to right?

Not sure how to answer this. If you accept the components of the law at face value, then yes MV=PQ; it's a tautology. But the point is, there's not really such a thing as the average price level, or the "velocity" of money; they're just placeholders to complete the tautology. You're right, it's like a physical law, but that's the (extreme) Austrian objection to it, that it's very misleading to think in those terms.

I don't know if it helps when I stray from economics, but here goes: Somebody could say that Schrodinger's equation gives the position of the electron, and then some "extremist" physicist could say, "There really is no such thing." And if you put in enough caveats, eventually you could call a component of the equation "the position" of the electron, and the equation would be true. But you could understand if the extremists scoffed and said that was a throwback to Newtonian thinking, and to move forward in subatomic physics people had to break free from that mentality.

What Mises did was use the entire body of microeconomic theory to explain the exchange ratio between regular goods and money. When economists wanted to explain the exchange ratio between apples and oranges, they didn't refer to some "fruit level" of prices. No they went directly from subjective preferences and quantities available, to price formation. So Mises rendered obsolete the old quantity theory.

But as you say, having said all that, it certainly is a useful way to remind people that the government printing press causes price inflation. Just like kids still learn the Bohr model of the atom.

[Murphy]

Mart Grams, on Jul 7 2008, 04:40 PM, said:

!st: Money is itself a market creation, thus it follows the subjectivist laws of supply and demand to later be used to satisfy other wants: purchase goods and services, investment or a a cash holding.

Right, and so the reason this integrated the two approaches is that other economists thought you had to do "micro" with relative barter prices, and then you do "macro" by slapping on absolute price levels to those relative exchange ratios using a completely different theoretical apparatus.