Lam hit the nail on the head. I said that if we hold T and V constant, a change in M will necessitate a change in P. At which point nirgrahamUK pointed out “not so! if we change T or V an increase in M needn’t lead to a change in P!” At which point he made an important point, I didn’t specify which direction M changed in.
Justin (and by extension DD5), this isn’t really something the free bankers aren’t aware. Horwitz has written at great length about the dangers and social ills caused by inflation, perhaps more than any other modern Austrian economist (possible exception would be Huerta de Soto). One of the key points listed by Horwitz is that inflation changes the relative prices of goods. Likewise, Garrison points out that the high level of aggregation favoured by monetarists obscures some of the key points concerning the macroeconomy.
As concerns Justin’s initial post, the fact that it does obscure what you, correctly, consider to be crucial facts merely means that it isn’t sufficient to analyse the macroeconomy. I agree that if one is going to talk about the price level changing one should note that the money first enters the economy in the market for capital goods, raising their prices and causing all of the effects discussed by Hayek and subsequent Austrians in his analysis of the business cycle. But this doesn’t change the fact that once the money has filtered through the economy a change in M really does result in a change in P. I understand that the identity only establishes relationships and not necessarily cause and effect.
I suppose I like the identity because it does help with ones thinking and it does make writing about macroeconomics somewhat easier. Instead of writing “changes in the demand for money should be accomodated by changes in the money supply so that the price level doesn’t have to bear the burden of adjustment, but the interest rate does” when describing the monetary equilibrium position I can merely write “MV should be kept stable so that P doesn’t have to bear the burden”.
As regards DD5’s point, I can’t agree. The fact of the matter is that if you consider the holding of banknotes to be a form of saving then when people desire to hold more cash the firm practising FRB will find it profitable to extend more loans. Now, the crux of this matter is not that I’m working at too high a level of aggregation to see the relative price effects because I would have no problem supplemented my analysis in terms of the identity with verbal reasoning to same effect. The crux of the matter (amongst others) is whether or not the holding of bank notes constitutes a form of saving.
This is both a crude strawman and an instance of shifting the goalposts. Not once have I claimed that the identity is a “superior tool”. I’ve said that it has helped in my understanding of various macroeconomic questions in spite of its flaws. I never said everybody should use it, just that I have and it has helped my thinking.
Once again, your shifting the goalposts. Your original point was that I simply wasn’t correct, now you’re saying that the terms I used are incorrect/ ambiguous. I might even agree with the latter charge (although, if you like you can rewrite the identity as M/MoneyDemand = PQ your criticism loses its force) but your former completely missed my use of the term ceteris paribus.
To be honest, I don’t understand your original point. Almost every economist out there, Austrian or otherwise, would agree than an increase in the supply of money would lead to an increase in the level of prices if the other factors are held equal.
MV = PT, in which P represents average prices and T the total physical volume of trade.
In short, the equation merely equates the sums spent to the total of prices paid, assuming an equality between the values of the prices paid and the goods bought. This is contrary to the subjective or marginal theory of value, wherein all voluntary exchanges are exchanges of unequal values. In using totals and averages, the equation of exchange also implies the fallacies inherent in the concepts of “price level” and the “neutrality of money” (q.v.).
Although designed as an explanation of the purchasing power of money, the equation of exchange is an holistic concept which fails to explain either how the purchasing power of money arises or how changes in it occur. The purchasing power of money is actually determined by the reactions of individuals to their ever changing individual situations and not by any mathematical formula.
in short. austrians dismiss(get by without) MV=PT because it lacks the explanatory power required for doing worthwhile economic study.
What I feel is a much neglected paper by Salerno gives a good Austrian Pedagogical Alternative to this equation.
Link
Salerno offers what could be the basis of a whole economic renaissance right there. He only analyzes MDe in terms of Market Equilibrium prices (i.e the clearing price of products) but if similar analysis under the model of this equation could be taken to the theories of market process, co-ordination and disequilibrium (i.e prices before they clear) I think more insight can be gained than just using MV=PT which does not provide a suitable framework for differentiating between MDe and MDr