Money and Markets: Essays in Honor of Leland B. Yeager

170 Steven HorwitzFinally, although our focus has been on the way in which the market process willrestore equilibrium (again, ceteris paribus) through changes in the price level, wecan also point out that equilibrium can be restored through changes in the nominalquantity of money. For example, should the monetary authority mistakenly allowthe money supply to fall such that actual holdings are less than desired holdings, itcan respond with expansionary policy that reflates the nominal quantity such thatactual holdings realign with desired holdings. In the face of changes in the demandfor real money balances, the monetary authority can, in principle, respond quicklywith changes in the nominal supply in the appropriate direction that would changethe actual quantity to match the hypothesized change in demand. In the sections tofollow we will suggest why this strategy should be strongly preferred to allowing theWicksell adjustment process to play itself out.One important point of contact between Yeager’s perspective on monetarydisequilibria and Austrian economics is that it involves a process story of the sortthat Austrians generally favor. Specifically, if one looked only at the comparativestatics of the original equilibrium and the equilibrium after the Wicksell processplays out, and one focused solely on aggregates such as the price level, one might beled to conclude that there was no damage done. All that has happened is thatnominal values have been raised or lowered depending on which disequilibriumprevailed. However, as we shall see below and as the brief analysis above suggests,it is during those very disequilibrium market processes that all of the interestingthings happen, including the microeconomic discoordination that characterizesinflation and depression. Comparative statics will not suffice to elucidate the costsof deflation and inflation; only a theory that explains the underlying processes ofadjustment can do so. 5Excess demands for money and a market process theoryof depressionWhere the Yeagerian and Austrian theoretical frameworks meet is in seeing thedestructiveness of monetary disequilibria as taking place during the transition processthat moves from one point of monetary equilibrium to another. Although thecomparative statics may lead one to believe that it is “just” a matter of the pricelevel adjusting to realign the real value of actual money balances to the desired levelof real balances, the key shared insight is that the price level does not simply “just”change. The price level is in its essence a theoretical construct that reflects millionsof individual prices determined on individual markets across the economy. Whenmonetary disequilibria spill over into the spending stream, the changes in expenditureswill not affect all markets equally. 6 The result is that different prices will not beaffected equally as well. The upward or downward pressure on individual priceswill not be the same across markets. The ability of the price level to adjust to restoreequilibrium will depend upon the degree to which the various individual prices areable to adjust quickly and accurately in the face of monetary disequilibria. If pricesdo not adjust quickly to either excess supplies or demands for money, the economiccosts of those disequilibria will be revealed during the transition process.