Macroeconomics

David Hume on the Real Effects of Money

few persons, who immediately seek to employ it to

advantage. Here are a set of manufacturers or mer-

chants, we shall suppose, who have received returns

of gold and silver for goods which they sent to Cadiz.

They are thereby enabled to employ more workmen

than formerly, who never dream of demanding high-

er wages, but are glad of employment from such

good paymasters. If workmen become scarce, the

manufacturer gives higher wages, but at first requires

an increase of labor; and this is willingly submitted

to by the artisan, who can now eat and drink better,

to compensate his additional toil and fatigue. He

carries his money to market, where he finds every-

thing at the same price as formerly, but returns with

greater quantity and of better kinds, for the use of

his family. The farmer and gardener, finding that all

their commodities are taken off, apply themselves

with alacrity to the raising more; and at the same

time can afford to take better and more cloths from

their tradesmen, whose price is the same as former-

ly, and their industry only whetted by so much new

gain. It is easy to trace the money in its progress

through the whole commonwealth; where we shall

find, that it must first quicken the diligence of every

individual, before it increases the price of labor.

It is likely that when writing these words, Hume

was well aware of the French experience

described in the preceding Case Study.

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stabilization policy using our simplified version of the model of aggregate

demand and aggregate supply. In particular, we examine how monetary policy

might respond to shocks. Monetary policy is an important component of stabi-

lization policy because, as we have seen, the money supply has a powerful

impact on aggregate demand.

Shocks to Aggregate Demand

Consider an example of a demand shock: the introduction and expanded avail-

ability of credit cards. Because credit cards are often a more convenient way to

make purchases than using cash, they reduce the quantity of money that people

choose to hold. This reduction in money demand is equivalent to an increase in

the velocity of money. When each person holds less money, the money demand

parameter k falls. This means that each dollar of money moves from hand to hand

more quickly, so velocity V (

= 1/k) rises.

If the money supply is held constant, the increase in velocity causes nomi-

nal spending to rise and the aggregate demand curve to shift outward, as in

Figure 9-13. In the short run, the increase in demand raises the output of the

economy—it causes an economic boom. At the old prices, firms now sell more

output. Therefore, they hire more workers, ask their existing workers to work

longer hours, and make greater use of their factories and equipment.

Over time, the high level of aggregate demand pulls up wages and prices. As

the price level rises, the quantity of output demanded declines, and the economy

gradually approaches the natural level of production. But during the transition to

the higher price level, the economy’s output is higher than its natural level.

C H A P T E R   9

Introduction to Economic Fluctuations

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