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Economics in One Lesson
demand: if people want the goods, they assume, and have the money
to pay for them, the goods will almost automatically be produced.
On the other hand is the group—and it has included some eminent
economists—that holds a rigid mechanical theory of the effect of the
supply of money on commodity prices. All the money in a nation, as
these theorists picture the matter, will be offered against all the goods.
Therefore the value of the total quantity of money multiplied by its
“velocity of circulation” must always be equal to the value of the total
quantity of goods bought. Therefore, further (assuming no change in
“velocity of circulation”), the value of the monetary unit must vary
exactly and inversely with the amount put into circulation. Double the
quantity of money and bank credit and you exactly double the “price
level;” triple it and you exactly triple the price level. Multiply the quan-
tity of money
n
times, in short, and you must multiply the prices of
goods
n
times.
There is not space here to explain all the fallacies in this plausible
picture.
1
Instead we shall try to see just why and how an increase in
the quantity of money raises prices.
An increased quantity of money comes into existence in a specific
way. Let us say that it comes into existence because the government
makes larger expenditures than it can or wishes to meet out of the
proceeds of taxes (or from the sale of bonds paid for by the people
out of real savings). Suppose, for example, that the government prints
money to pay war contractors. Then the first effect of these expendi-
tures will be to raise the prices of supplies used in war and to put addi-
tional money into the hands of the war contractors and their employ-
ees. (As, in our chapter on price-fixing, we deferred for the sake of
simplicity some complications introduced by an inflation, so, in now
considering inflation, we may pass over the complications introduced
by an attempt at government price-fixing. When these are considered
it will be found that they do not change the essential analysis. They
1
The reader interested in an analysis of them should consult Benjamin M. Anderson,
The
Value of Money
(New York: Macmillan, 1917; New York: Richard R. Smith, 1936); or Lud-
wig von Mises,
The Theory of Money and Credit
(New Haven, Conn.: Yale University Press,
1953).
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The Mirage of Inflation
149
lead merely to a sort of backed-up inflation that reduces or conceals
some of the earlier consequences at the expense of aggravating the
later ones.)
The war contractors and their employees, then, will have higher
money incomes. They will spend them for the particular goods and
services they want. The sellers of these goods and services will be able
to raise their prices because of this increased demand. Those who
have the increased money income will be willing to pay these higher
prices rather than do without the goods; for they will have more
money, and a dollar will have a smaller subjective value in the eyes of
each of them.
Let us call the war contractors and their employees group A, and
those from whom they directly buy their added goods and services
group B. Group B, as a result of higher sales and prices, will now in
turn buy more goods and services from a still further group, C. Group
C in turn will be able to raise its prices and will have more income to
spend on group D, and so on, until the rise in prices and money
incomes has covered virtually the whole nation. When the process has
been completed, nearly everybody will have a higher income measured
in terms of money. But (assuming that production of goods and serv-
ices has not increased)
prices
of goods and services will have increased
correspondingly; and the nation will be no richer than before.
This does not mean, however, that everyone’s relative or absolute
wealth and income will remain the same as before. On the contrary,
the process of inflation is certain to affect the fortunes of one group
differently from those of another. The first groups to receive the addi-
tional money will benefit most. The money incomes of group A, for
example, will have increased before prices have increased, so that they
will be able to buy almost a proportionate increase in goods. The
money incomes of group B will advance later, when prices have
already increased somewhat; but group B will also be better off in
terms of goods. Meanwhile, however, the groups that have still had no
advance whatever in their money incomes will find themselves com-
pelled to pay higher prices for the things they buy, which means that
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