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Getting the Quantity Theory of Money Straight

Here’s another letter to Binghamton University student “Karl Marx”:

Mr. “Marx”:

You reply to my e-mail of August 20th by asserting that “the data which plainly shows war time price controls prevented inflation overrides” what you call my “desperate attempt to salvage free market fundamentalism by making up reasons why the data is unreliable. The historical record shows Meg Jacobs and Isabella Weber are still correct that WWII price controls were a total success.”

Perhaps you didn’t notice that one of the links in my previous letter in which I noted that price controls reduce the quality of goods and services is to a piece by NPR – a media organization that is hardly guilty of running interference for “free-market fundamentalism.”

More to the point, data never speak for themselves. They must always be carefully interpreted in light of the theoretical propositions that they are used to test. The theoretical proposition at issue here says that increases in the money supply relative to the demand to hold money reduce money’s purchasing power. Without price controls in place, this reduced purchasing power is manifested overwhelmingly in the form of higher nominal prices. But when government prohibits nominal prices from rising, it is no surprise that officially recorded prices do not rise. The historical record nevertheless reveals the predicted fall in purchasing power. This fall in purchasing power is manifested – and is detected by competent economists and historians – as declines in the quality or quantities of what buyers get for any given sum of money. The theoretical proposition that Jacobs and Weber claim to be invalid is, in fact, found to be vindicated.

In summary: The fact that inflation-induced deteriorations of product quality when price controls are in place don’t show up in time-series data on nominal prices is irrelevant. The more general argument is that increases in the money supply reduce money’s purchasing power. If that which a given sum of money purchases today is worse or less than it was yesterday, then purchasing power has been reduced and, therefore, price controls cannot be said to have succeeded at protecting against the ravages of inflation.

I leave you with another observation, this one from 2012, offered by the great economic historian Robert Higgs:

Economists are trained in theory, statistics, modeling, and other skills. Historians are trained in the careful scrutiny and interpretation of historical sources. Neither economists nor historians, unfortunately, are trained to use common sense in their work. Postwar proponents of the reimposition of price controls have often pointed to the success of such controls during the war. Yet, despite thousands of employees and an army of volunteer monitors associated with the Office of Price Administration and despite the U.S. Attorney General’s prosecutory zeal in hauling alleged violators into court, the government’s price-control efforts during World War II failed to stem the tide of rising prices set in motion by the huge contemporary increases in the money stock.

Price controls, at most, only create a population of liars. True prices continue to do what the existing economic conditions cause them to do. No one can control the amount of precipitation by passing a law against reporting more than a stipulated amount of rain and snow.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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