# Why does money matter?

In a recent post I argued that money matters for real variables like the unemployment rate.  But it’s surprisingly hard to explain why, requiring a roundabout analysis.  First we’ll need to explain why money matters for nominal variables like inflation and NGDP.  Only then will we be able to return to the even more difficult problem—the business cycle.

This post will cover a few basics that experienced readers will wish to skip.  The key concept with be the “value of money,” which can be defined as:

Value of money = 1/(price level)

This definition actually comes out of basic microeconomics.  In upper level micro classes we move away from simple supply and demand curves, and start talking about “relative prices,” or “real prices.”  Thus if the CPI rises 10% per year, then goods going up 8% are seeing their price fall in relative terms and those experiencing 12% price increases see their relative price increase.  The relative price is the actual price relative to the price of all other goods in the economy.  Now let’s do the same with money.  What’s the nominal price of money?  The answer is one.  What’s the real price?  It’s the purchasing power of money, how many goods you can buy with each dollar, which is simply 1/price level.  Thus if the price level doubles then the purchasing power of money, i.e. its value, falls in half.

The field of monetary economics exists for one reason, and one reason only—money is the medium of account, the good we use to measure all other values.  Most textbooks oversimplify this concept, combining two ideas into “unit of account.”  Currency notes are the medium of account, the thing used to measure value.  Abstract accounting units like the US dollar, the Canadian dollar, and the euro are examples of a unit of account.

Because money is the good in terms of which all other goods are priced, changes in the value of money are associated with changes in the price level, and in other nominal variables as well.  Note that this is not a “theory,” it’s a definition.  Theory will come in later, when we ask whether government policymakers can control the price level via “monetary policy.”

Irving Fisher liked to use the metaphor of money as a measuring stick (of value.)  First we’ll do an example with the price level, then the same example with measuring sticks:

Year      Income    Price level  Real Income

1978     \$20,000        1.0           \$20,000

2013    \$120,000       3.0          \$40,000

So prices have tripled over the past 35 years.  The person’s income rose by 6-fold.  How much better off are they?  They can now buy twice as many goods and services.  Technically this is derived as follows: real income = \$120,000*(1.0)/(3.0).  Now let’s do the same example with the height of the child:

Year      Height    Real height

1978      1 yard         1 yard

2013      6 feet          2 yards

The child grew 6-fold in nominal terms, but is only twice as tall in real terms.  Everyone would scoff if a proud father claimed his son was now 6 times taller, and yet someone who claims to be making 6 times as much money in 2013 as in 1978 is making the exact same mistake.  They are implicitly assuming that 1978 dollars are the same thing as 2013 dollars.  But each dollar today only has 1/3 the value of a 1978 dollar.  We would say they suffer from “money illusion.”

Suppose something other than cash had been used as money.  If apples were money, then a huge apple harvest that lowered the value of apples would cause lots of “inflation.”  In fact every time the relative price of apples falls sharply we do have lots of “apple inflation.”  And when the relative value of silver soars we have lots of “silver deflation.”  Why do we only care about money inflation, not the other types of inflation and deflation?  That’s a surprisingly hard question to answer.  In textbooks it’s covered in two different sections:

1.  The welfare costs of inflation.

2.  The welfare costs of business cycles.

In theory measuring sticks should not matter very much.  Whether you measure things using foot long rulers or yardsticks doesn’t affect their actual size.  But imagine a kingdom where for some strange reason people made contracts to supply 100 “units of wheat” 12 months in the future, where units were left unspecified.  Or they agreed to work for the next year at a wage of 2 units of wheat per hour.  Also assume the king could change the units from kilos to pounds to ounces whenever he wished.  Now a change in units certainly would affect the public.  And that’s the primary reason why monetary inflation is important and apple inflation matters very little (except for apple farmers and consumers.)  Our measuring stick of value (money) is itself always changing in value, and this causes all sorts of problems.

An economist once said; “money is a veil [hiding the real economy], but when the veil flutters, real output sputters.”

Next we need to explain why the value of money changes over time.  Another couple posts.

PS.  A NASA satellite once crashed because some parts had been measured in inches rather than centimeters, and were mismatched.

PPS.  Some journalists define the value of money in terms of its ability to buy other monies.  This is an odd definition, but the math is the same.  The dollar price of euros is 1/(euro price of dollars).  Even weirder are those who define the value of money in terms of a very scarce but heavy yellow metal.  Later we’ll see that there is one arbitrary definition of the value of money that might be even more useful than the standard definition:  The share of nominal GDP that can be bought with each dollar.

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47 Responses to “Why does money matter?”

1. Martin
18. March 2013 at 14:23

Very nice re-cap Scott! Your writing makes it look so deceptively simple.

2. Jim Crow
18. March 2013 at 14:34

I am really looking forward to your book.

3. Sina Motamedi
18. March 2013 at 14:47

Great thought experiment with the imaginary kingdom. Really drives the point.

4. Petar
18. March 2013 at 15:02

Thnx mr. Sumner. Keep them coming!

5. Neal
18. March 2013 at 15:38

Google indicates that the quote about veils originates from Jack Gurley, mocking Milton Friedman. It’s cited in the third paragraph here: http://www.newyorkfed.org/research/quarterly_review/1993v18/v18n1article8.pdf

6. Doug M
18. March 2013 at 15:41

Regarding the Mars orbiter that crashed,

http://www.wired.com/thisdayintech/2010/11/1110mars-climate-observer-report/

Darn metric system.

7. Don Geddis
18. March 2013 at 15:53

Love these layman’s summaries, with clear, easy-to-understand examples. Child’s height in yards and feet is brilliant. King changing units of wheat is excellent too. Can’t wait for subsequent entries in the series.

8. Doug M
18. March 2013 at 15:55

The value 1/the value of a basket of commodities is an ancient measure of the value of money.

That basket could be a basket of currencies, 42 gallons of viscus fluid, or a fixed mass of shiny metal… all have their uses and their flaws…

I can find you a group of economists (most that I know are in Berkeley Calfornia) who would say that the value of money should be derived from an hour of work.

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18. March 2013 at 16:08

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10. Geoff
18. March 2013 at 16:34

I think this post is a great encapsulation of some important monetary concepts.

Minor quibbles:

1. Money can only be understood in a framework of exchanges. A commodity that serves as a medium of account, must be derived from that commodity being a medium of exchange. Therefore it is more accurate, I think, to say that money is primarily and fundamentally a medium of exchange, and that it just so happens that because it is a medium of exchange, it is also a medium of account. The monetary values of goods tabulated for money as a medium of account, are generated by money being exchanged against those goods. No exchanges, no medium of account.

2. Contrary to Fisher, money is not a “measurement of value”. The idea that money is a “yardstick”, or a “measurement” of value, derives from the (classical) erroneous belief that value is an objective attribute of a good itself, along with the erroneous belief that goods are only traded if their values were equal. So it seemed that if people determined whether the objective attribute of one thing was equal to the same objective attribute of another thing by way of measurement, why not do the same thing with economic goods? It was therefore assumed that money provides a valid “measure” of this (alleged) inherent value in goods. Modern subjective value theory supplanted this false conception of value, by recognizing that value is subjective, i.e., it is grounded in individual preference scales that rank goods ordinally. Utility economics was born. Yet economists just couldn’t shake the old habit, because only cardinality could allow for mathematical and “scientific” manipulation and analysis. Thus Fisher tried to conceive of utility as a cardinal concept, and by extension, treating money as a “measurement” of value. However, the law of marginal utility does not posit any unit of value, since the value of two units of a given stock is necessarily greater than, but less than double, the value of a single unit.

11. ssumner
18. March 2013 at 17:35

Everyone, Thanks for the support.

Neal, Thanks for that info.

Geoff, I see the medium of account as the key, and medium of exchange as less important.

2. It certainly is a measure of prices, or market values. Perhaps “value” is a word with multiple meanings.

12. Geoff
18. March 2013 at 18:11

Dr. Sumner:

Geoff, I see the medium of account as the key, and medium of exchange as less important.

I know. I suppose it depends on what argument you’re intending to make, and which of the two is more important for that purpose.

For me I tend to put logical hierarchies as most important, so if we realize medium of account derives from medium of exchange, then whatever argument we intend to make using money as a medium of account, I think it’s still important to realize that the arguments depend on money being a medium of exchange, even if the medium of account is more important for a particular argument.

It certainly is a measure of prices, or market values. Perhaps “value” is a word with multiple meanings.

I agree that depending on the meaning of the word “value”, we will arrive at specific outcomes concerning whether or not money is a “measurement.” Since not all meanings can be correct or equally useful, I think we should go further than stopping at “it depends on the meaning of value.” Either objective or subjective value is right. One must be wrong. So long as the subjective theory of value is accepted, the question of “measurement” cannot arise. Measurement of values requires objective values.

Subjective value theory treats value as the importance attributed to marginal commodity units by a human subject who desires to consume or otherwise dispose of commodities to the best use. Here, every economic transaction presupposes a comparison of values. However the necessity for such a comparison, and the possibility of it, is due to the circumstance that the person concerned has to choose between several commodities. The ordinal ranking comes from that fact. No measurement is possible here.

Even if \$5.00 exchanges for a hamburger, this doesn’t mean the value of the hamburger is “measured” by \$5.00. Subjective value theory holds that the hamburger seller ranks the \$5.00 as higher than the hamburger, while the \$5.00 seller ranks the hamburger higher than the \$5.00. Neither individual’s ranking is objective. Each individual’s valuation of the hamburger and the \$5.00 are equally valid. Saying that \$5.00 is the “measurement” of the value of the hamburger would, by extension, have to be accompanied by the notion that the hamburger is the “measure” of the value of the \$5.00. But measurement requires an objective, absolute of reference. Trades don’t have that. They have offsetting valuations. Sellers of goods rank the money sums (prices) higher than goods, and sellers of money rank goods higher than the money sums (prices).

13. J
18. March 2013 at 18:30

Geoff:

If we assume (yes, this is a large assumption) that goods can be bought in continuous amounts and traded freely, and that the derivative of utility with respect to consumption of a good is continuous, then I will continue to buy hamburger at \$5 per unit until the value of a unit does not exceed \$5, but exactly equals \$5.

14. Ted
18. March 2013 at 19:00

Should the height in the table that says 6 feet really read 6 yards? I think it’s a typo.

15. John
18. March 2013 at 19:40

“Why do we only care about money inflation, not the other types of inflation and deflation? That’s a surprisingly hard question to answer.”

That’s actually pretty easy to answer. Increased supplies of consumer or capital goods that drive down the price of that good (other things equal) are beneficial to society as a whole. Increasing or decreasing the supply of money has no direct benefit or harm (the benefits/harms come from indirect effects on business cycles). Any amount of money within reason will perform all the services money provides. There’s no reason to prefer an economy with 1 trillion units of currency over one with 10 trillion. On the other hand, I’d definitely prefer to live in a society that produced ten billion pounds of wheat compared to one billion pounds other things equal.

16. John
18. March 2013 at 20:04

Geoff,

I think you’re about to encounter the feeling of beating your head into a wall trying to make these seemingly self-evident points “Austrian” (I think they’re just good economics) points that Chicago School guys don’t care about. You two are speaking a different language and thinking of the same things in different ways like the proverbial blind man and the elephant.

I’ve gotten the same frustration trying to make points about how the manner in which money enters the system has effects on the real economy. “Macro” guys that think in terms of large aggregates don’t care about those arguments. It doesn’t fit into the theoretical framework.

By the way, this isn’t intended as a dig at Dr, Sumner or the Chicago School approach at all. I enjoy this blog very much both when I agree (non-monetary stuff) and when I disagree (macro/money).

17. John
18. March 2013 at 20:45

The veil of money idea means that all exchanges in the economy can trace back to exchanges of first-order consumer goods (end use items). This is a fun idea to play around with in day to day life. For instance, the pay of autoworker comes from his contribution to the production of cars. Therefore when he goes out and buys groceries, he is trading cars (or at least the theoretical portion that he produced) against food. Services like legal and medical advice count as first-order consumer goods I believe. It gets more complicated and interesting to try and follow this line of reasoning for something like credit default swap deals or niche options trading.

What makes this interesting is that money just allows for a far greater network of exchanges to occur; allowing wide ranging specialization and division of labor. However, no matter how complicated a modern money-based economy gets, you can always trace every exchange back to end use consumer goods.

18. TravisV
18. March 2013 at 21:40

I have to say, I’m very frustrated with Paul Krugman.

He’s said that he would love to see either a 4% inflation target or NGDP targeting. And yet he continues to say things like “fiscal stimulus [is]…..about doing something in a liquidity trap, when monetary policy can’t cure mass unemployment.”

http://krugman.blogs.nytimes.com/2013/03/14/night-of-the-living-alesina-continued

Mr. Krugman, what is your position? Can monetary policy cure mass unemployment or can’t it?

19. Saturos
19. March 2013 at 00:29

“In fact every time the relative price of apples falls sharply we do have lots of “apple inflation.””

Funny, since so many people think the exact opposite.

“That’s a surprisingly hard question to answer.”

I dunno, maybe because money is what makes our transactions possible…?

Also, you need to comment on this: http://marginalrevolution.com/marginalrevolution/2013/03/how-will-the-price-specie-flow-mechanism-operate-in-cyprus.html

20. Saturos
19. March 2013 at 00:38

And Evan Soltas weighs in on Cyprus and Europe: http://www.bloomberg.com/news/2013-03-18/the-lesson-from-cyprus.html

21. Saturos
19. March 2013 at 00:39

TravisV, he’ll say it can: you’ll want to to ask him if he thinks it’s reliable.

22. J.V. Dubois
19. March 2013 at 02:26

Scott: Geoff, I see the medium of account as the key, and medium of exchange as less important.

This answer begs a question “Medium of exchange is less important” … for what exactly? For definition of “money”. For explaining business cycles? For definition of something named “price level” (1/”value of money”)

You may say that “medium of account” is more important to you, but I think that your definition of medium of account implicitly contains existence of medium of exchange. As Geoff says above, the value of money is set in the moment of exchange. If you trade something, you may have a hierarchy of values. You may wish to trade bag of salt with somebody for a pouch of gold, or two pouches of silver, or three bags of wheat etc. You may value these things for utility they directly offer you when you consume them, or by utility of them being exchanged for something else. And I would say that this is the key concept – money is something you value because it can be exchanged for something else.

If I would measure moneyness, this would be the key property I would focus on. Did you exchange your work for green papers because you like them and maybe you plan consume them by using them as wallpaper in your living room, or because you believe that that you can exchange them for something else.

Try to imagine a semi-barter system where people trade in multiple currency items. How will you define something like “price level”? You come to the market with bag of salt and look for something useful to trade it for. There are no set “prices”, no price tags. People may use vague price ranges – like there are three categories of goods – small, medium and large and each category has a “medium of account” – something that expresses the approximate value of typical good in that category (like basked of eggs for small thing, a pig for medium thing and a horse for large things). But actual “price” is always agreed upon in each individual trade. If you know that there were 20 transactions conducted in each category, Would you say that at that given day there was 20 egg/pig/horses volume of trades conducted that day? Or if you know that people use pouches of salt to go as a currency item – and exchange them – would you say that it would be more correct to measure the total volume of trades using actual data of how much pouches of salt changed ownership that day?

23. J
19. March 2013 at 06:03

Dr. Sumner,

The Fed is buying \$85 billion of assets per month until unemployment falls below a certain threshold or inflation rises above a certain threshold. Since this \$85 billion is fixed (or assuming it’s fixed), is fiscal policy not accommodated at all? Monetary stimulus will be the same no matter what happens in fiscal policy, so fiscal stimulus should boost AD and fiscal austerity should shrink AD, right?

24. Il Gattopardo
19. March 2013 at 06:42

Geoff,

To accountants, the unit of account is important.

To economists, the medium of exchange (=means of payment) is important.

To macroeconomists, the store of value is important.

25. Grim23
19. March 2013 at 07:18

Some people even say that the value of money is the return you get from lending money to the treasury.

26. JSeydl
19. March 2013 at 07:30

“The child grew 6-fold in nominal terms, but is only twice as tall in real terms.”

Then you need the child’s height to be 6 yards in 2013, not 6 feet.

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19. March 2013 at 07:40

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28. Errorr
19. March 2013 at 07:44

Are not all the other “definitions” of the value of money just derived from ” The share of nominal GDP that can be bought with each dollar.”

29. Suvy
19. March 2013 at 09:28

One thing to add here: what about assets. Assets claims of a future yield that trade at a discounted present value. On top of that, asset prices change in fundamentally different ways than the prices of goods and services do. When you define the value of money as 1/price level, what part do asset prices play?

I think another important part about capital assets is that their formation depends on the current price level that can be realized in the market today combined with the costs of production. So shifts in the price level(assuming you mean goods and services) would create shifts in the formation of capital assets that shift the way the goods and services are produced and create future shifts in the price level. Therefore, a huge part of those future shifts may be discounted in the current value of the capital assets in money terms and that should also play a role in the way that money is used.

Also, what about liquidity preference? One of the biggest reasons to hold cash is so that if something happens, you can jump in on an opportunity. Cash, unlike many other assets, is liquid–which provides value in and of itself. This would usually show up in the rate of interest, but it won’t show up in the value of money and may not even show up in the price level.

Isn’t it silly to just say that the value of money is always 1/price level, especially when considering the role of capital and financial assets?

30. ssumner
19. March 2013 at 11:41

Ted, No typo, I meant 6 feet.

John. It’s much more complicated than that. There are short run non-neutralities.

Saturos, Even if money is the medium of exchange, it’s not at all obvious why changes in the value of money have real effects. A currency reform is a huge change in the value of money, yet it has almost no real effects.

It’s not good news when the euro drops because of problems in the eurozone–file that under “never reason from a price change.”

JV, It’s hard to imagine a medium of exchange not also being a medium of account, but it could occur in theory. If it did I’d focus on the medium of account. The MOA determines NGDP, etc. Under barter there is no such thing as the price level or NGDP.

J, The Fed’s recent moves were partly in response to the expected fiscal cliff in late 2012. Policy changes occur at each meeting as communication is by far the most important policy, far more important than how much they buy each month.

JSeydl. No, the nominal increase is the increase in the “number,” which rose from 1 to 6. With nominal changes the units can vary.

Errorr, I’m not sure what you mean by ‘derived.’ They are simply different definitions, it’s not clear to me how one is derived from another.

Suvy, As I said, the value of money can be defined in many different ways, including assets prices. The question is which definition is the most useful, for the problem at hand.

31. mbk
19. March 2013 at 21:38

Scott, this and your more recent post are great, great work. You’re in top form here. I presume, this is working yourself up to the book.

” It certainly is a measure of prices, or market values. Perhaps “value” is a word with multiple meanings.”

A biz prof friend of mine always explains it that way to his students. There are three ways of looking at something in the economy: cost, price, and value.

32. J.V. Dubois
20. March 2013 at 03:08

Scott: Yes I am well aware of your “zimbabwean dollar” example of MoA differing from MoE. There were some great posts written in that discussion but I would rather not dwell on it here.

If I may put it in a different way, I think that by you focusing solely on MoA aspect of money you jump too quickly into a system of higher complexity. There you focus on things like price level, NGDP etc. They are easy to visualize and it is a place where you and some other economists are feeling at home.

But then you completely miss some crucial questions like ones Nick Rowe asks from time to time. Like if it can be considered a recession not only if it is hard to exchange newly produced goods for money, but also if it is hard to exchange old goods for money. See, no NGDP can be defined here (as with barter) but the welfare costs of missed trade opportunities due to insufficient money can be quite severe.

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20. March 2013 at 06:00

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34. Travis Allison
20. March 2013 at 06:16

I love these monetary posts. One question, Scott.

How would you mathematically define the price level?

35. J.V. Dubois
20. March 2013 at 08:09

Scott: This is also actually pretty interesting. So you claim that during the gold (silver) standard, gold (silver) was medium of account. By your definition therefore gold was money

Now I am really curious, because this would mean that if for instance velocity of circulation of paper currency under gold standard changes permanently – then this means (under assumption that Central Bank will offset this by selling/buying their gold reserves for currency) just a change in supply/demand for gold. The two things (change in velocity of paper currency and change in demand for gold) are not only equivalent, they are the same thing.

If one follows this logic, then if central bank pegs the currency to CPI basket then CPI basket and not dollar (Euro, Pound …) is money. So we can safely stop talking about people hoarding/disgorging cash, it is for all purposes of monetary economics exactly the same thing as change in supply/demand of items in CPI basket in the economy. It has to be, money is MoA by definition – remember? Now this is an excellent news , as it is one less thing to worry about and as a side effect iIt enables macroeconomists to build models of economy without money.

36. Mark Sentesy
20. March 2013 at 11:37

This is a definition that articulates standard economic concepts very clearly. Good work! However, it is false, and unethical to boot. Money does not measure all other values. It is the unit of account when by ‘account’ we mean economic exchange, and not ‘reason’.
One way to point this out is to observe that money only has a positive value. There is no negative monetary unit. If money was the unit of all value, a person who makes money by selling children into sex slavery is doing something of positive value because he makes money. Similarly, a man who goes into debt to enjoy sex slavery is a positive contributor to the economy because he generates economic activity and promotes exchange.
It is true that these actions have real value, because they are evil. These men have failed, morally and socially, but no market has failed. The value of their actions is measurable, but it is not measurable by money. Therefore, money is not the unit by which we measure all other values.
In fact, as the examples clearly show, it is indifferent to ethical value. This does not make it superior, it makes money unethical. Anything that promotes or encourages people not to think ethically is unethical. Therefore, to propose that we reduce value to money is unethical.

37. Becky Hargrove
20. March 2013 at 13:03

J.V. Dubois, Mark Sentesy,
It is all fine and well to point out that value lies beyond money. But for all intents and purposes, the economic activity that people recognize as valid in the 21st century is mostly tied to money. Even if you were to point to the barter nature of a time bank, the fact remains that one can expect to hear in such quarters “The best people to trade time with are the ones who are already really busy.” And those people are really busy because money is such a big component of their lives! So the underlying valuation is still money in spite of other appearances.

Lest anyone question that assumption on my part, I would be thrilled if someone here can point out skills barter time banks that are actually being set up to tend to greater societal needs in given communities. People would be horrified, for instance, if they realized there are only a handful of beds available for people in many places in the U.S. who need a transition with skilled services before returning home from extensive surgery. Who on the left or the right politically is dealing with vital “beyond money” important issues such as this?

38. ssumner
20. March 2013 at 19:25

Thanks mbk.

JV, But as I said before, I don’t think a lack of money causes the drop in sales–I think it is a lack of MOA (relative to demand)

Travis, I’d rather not try. Maybe the deflator is the lesser of evils.

JV, I answered something similar more recently. I’ve done posts talking about the “end of macro.” But I see that occurring with NGDPLT, not PLT.

39. Claron
21. March 2013 at 04:18

The NASA satellite you mentioned was probably the Mars Climate Orbiter. It burned up in the Martian atmosphere due to a calculation done with non-SI units of lbs seconds-instead of newton-seconds. The satellite itself was not flawed.
http://en.wikipedia.org/wiki/Mars_Climate_Orbiter

40. Mark Sentesy
21. March 2013 at 13:56

Becky Hargrove, I agree completely that people in fact take money to be the unit of value. What I am pointing out is that this is unethical.

The system of monetary exchange is unethical because it is indifferent to ethical value, that is, because money, like any tool, becomes the principle and medium of relationships, together with the fact that it is indifferent to its being used for good or evil.

Let no-one be deluded into thinking that making money is inherently good, or inherently good for society.

The only point of disagreement I have with your observation is that ethical value is not “beyond” money in the sense that money might become ethically invisible or seem like it has no effect on ethical relationships. It is totally obvious that money can corrupt people. It is also totally obvious that treating people as monetary assets and liabilities is a violation of their dignity. But I think you agree with this already.

41. ssumner
23. March 2013 at 07:29

Thanks Claron.

42. Geoff
23. March 2013 at 08:57

J:

“If we assume (yes, this is a large assumption) that goods can be bought in continuous amounts and traded freely, and that the derivative of utility with respect to consumption of a good is continuous, then I will continue to buy hamburger at \$5 per unit until the value of a unit does not exceed \$5, but exactly equals \$5.”

OK, now what about the real world, where “discreteness” rather than “continuity” exists? Can’t do derivatives then…

John:

I don’t consider this a game or match or competition between “Austrian” and “Chicago” schools. I think it’s just economics, and within economics, right and wrong answers, superlatives and omissions, rhetoric and rationalism, etc.

J.V. Dubois:

Il Gattopardo:

Unit of account presupposes medium of exchange. Storage of value presupposes medium of exchange as well. What accountants versus economists versus macro-economists (I chuckled (because there is a ring of truth to it) at your separating of macro-economists from economists, by the way) focus on has no bearing of what the actual, activity based hierarchy exists in the market, regarding these concepts.

43. J.V. Dubois
25. March 2013 at 02:35

Scott: I understand what you are saying and actually for all practical purposes (currently) it seems that focusing on MoA function of money is sufficient – if one wants to promote policies like NGDPLT etc.

But on the other hand I feel that it is wrong on some intuitive level. Discarding MoE property may be sufficient for some things, but I thing that we lose something important by it. It is more of a “philosophical” discussion that may have impact on some different topic in different time maybe.

So I will give it another shot and I will try to reiterate my point in a different way. I say that only way you can establish value of something is by measuring units that were traded in an actual exchange. Imagine that you are visiting Egypt and you see a pretty necklace with some price listed in Egyptian Pounds (EGP). Then if you express interest in purchasing it, you may start negotiating and exchanging it for a different ammount of EGP in an act of exchange. It was this exchange that measured market value of that necklace at that time and location (and vice versa – it measured “value” of EGP at that time and location) – it was not a price tag on the necklace that measured it. So fact one is that you cannot measure value without act of exchange taking place. And in echange, you may have some media that are … well exchanged. And if you have something that is exchange in almost all trades (like medium of exchange AKA money|, then it enables you to measure value of things in a nice an consistent way.

So it is an act of exchange that is crucial for establishing market “value” of any item. Now I claim that you can measure it only in things that were actually traded in that exchange. For instance exactly that second where the exchange of EGP for necklace took place there could be another exchange in a different market where EGP were exchanged for US dollars. But I deem it wrong to say that the “value” of the necklace trade (be it necklace or EGP) could be measured by the exchange ratio of EGP for USD established at this different market. The reason is that there is no “ceteris paribus”, we are entering in a world of feedback and nonlinearity. If the necklace would be exchanged for USD instead of EGP, this act alone could change the USD/EGP price in this alternative universe. If everything else would be exchanged for USD then EGP would have no value.

So to sum up, I do not have to have such a strong claim like Geoff that value is not measurable. Even if we accept that market exchange – that moment from our real world where we can (like physicists) come and measure something closest to “value” – cannot be extended to our invented alternative universes where we just implant that “value” from real measurement. If you purchase a necklace for 100 EGP it does not follow that you would buy it for 14,70 USD – even if this is “fair market” exhange rate – in a same way that the fact that you bought a necklace for a market price of 100 EGP does not mean that you would also purchase some (fair market) amount of bread for the same price of 100 EGP.

44. TheMoneyIllusion » Short intro course on money
7. April 2013 at 08:49

[…] 2.  Why does money matter? […]

45. RussianBear
8. April 2013 at 13:17

1) This famous price level example has one weakness. It’s not taking into account scientific-technological revolution that we are living in. Goods offered today are much more “valuable” than those from 1973. Being able to buy a greater number of items back in 70’s isn’t equal to being richer.
Just think about cars. A regular car back then would cost around 3,000-4,000 USD. Nowadays in some developing countries you can still find a new car for a similar price. With all current regulations on exhaust emissions and safety in US and Europe I don’t think that it would be possible to produce Chevy Barracuda for the same price today as in 60’s-70’s.

2) We do care about money inflation, because it is “paper money” [and “credit”] what people get for their work. Money is an easily exchangeble universal medium of exchange.
After collapse of Soviet Union many workers at state plants and factories were receiving items produced by their factory instead of money. Later, factories facing lack of financial resources, switched to barter which was actively promoted and supported on official political level (e.g. agreement between goverments when Ukraine sent goods to Turkmenistan in exchange for gas. It lasted many years from 90’s till beginning of 00’s).
Without liquidity “money” is useless (anyone needs Soviet Rubles?). With sufficient liquidity – everything can be money (starting from Coca-Cola Caps and finishing with BitCoins).

46. The Slow Death of the American Author and The Money Illusion | Pink Iguana
8. April 2013 at 13:43

[…] 2.  Why does money matter? […]

47. Rod Everson
27. September 2015 at 07:53

Ted wrote: “Should the height in the table that says 6 feet really read 6 yards? I think it’s a typo.”

JSeydl wrote, in response to the following statement in the article: “The child grew 6-fold in nominal terms, but is only twice as tall in real terms.”:

“Then you need the child’s height to be 6 yards in 2013, not 6 feet.

Scott replied that his numbers were what he meant to say.

So, here we have a man who claims that a change from one yard in height to six feet in height is a six-times taller child, when obviously there’s no way that’s true.

But this is supposed to be somehow comparable to a change in nominal income from \$20,000 to \$120,000 which is factually true?

The analogy suffers because one is a stupid mistake that can’t be true (1 yard to 6 ft is a six-fold increase), while the other is factual, but simply doesn’t contain all the additional information that Scott feels is relevant (the change in prices that occurred during the actual six-fold increase in wages.)