Page 146 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 8: Money

Notes

Case Study Price Discoordination and Entrepreneurship

n an effort to illustrate the problems of an excess demand for money, some have
likened the problem to an oversupply of fiduciary media. The problem of an
Ioversupply of money in the loanable funds market is that it leads to a reduction in the
rate of interest without a corresponding increase in real savings. This leads to changes in
the prices between goods of different orders, which send profit signals to entrepreneurs.
The structure of production becomes more capital intensive, but without the necessary
increase in the quantity of capital goods. This is the quintessential Austrian example of
discoordination.
In a sense, an excess demand for money is the opposite problem. There is too little money
circulating in the economy, leading to a general glut. Austrian monetary disequilibrium
theorists have tried to frame it within the same context of discoordination. An increase in
the demand for money leads to a withdrawal of that amount of money from circulation,
forcing a downward adjustment of prices.
But there is an important difference between the two. In the first case, the oversupply of
fiduciary media is largely exogenous to the individual money holders. In other words, the
increase in the supply of money is a result of central policy (either by part of the central
bank or of government). Theoretically, an oversupply of fiduciary media could also be
caused by a bank in a completely free industry but it would still be artificial in the sense
that it does not reflect any particular preference of the consumer. Instead, it represents a
miscalculation by part of the central banker, bureaucrat, or bank manager. In fact, this is
the reason behind the intertemporal discoordination — the changing profit signals do not
reflect an underlying change in the “real” economy.
This is not the issue when regarding an excess demand for money. Here, consumers are
purposefully holding on to money, preferring to increase their cash balances instead of
making immediate purchases. The decision to hold money represents a preference. Thus,
the decision to reduce effective demand also represents a preference. The fall in prices
which may result from an increase in the demand for money all represent changes in
preferences. Entrepreneurs will have to foresee or respond to these changes just like they
do to any other. That some businessmen may miscalculate changes in preference is one
thing, but there can be no accusation of price-induced discoordination.
The comparison between an insufficient supply of money and an oversupply of fiduciary
media would only be valid if the reduction in the money supply was the product of central
policy, or a credit contraction by part of the banking system which did not reflect a change
in consumer preferences. But, in monetary disequilibrium theory this is not the case.
None of this, however, says anything about the consequences of deflation on industrial
productivity. Will a rise in demand for money lead falling profit margins, in turn causing
bankruptcies and a general period of economic decline?
Whether or not an industry survives a change in demands depends on the accuracy of
entrepreneurial foresight. If an entrepreneur expects a fall in demand for the relevant
product, then investment into the production of that product will fall. A fall in investment
for this product will lead to a fall in demand for the capital goods necessary to produce it,
and of all the capital goods which make up the production processes of this particular
industry. This will cause a decline in the prices of the relevant capital goods, meaning that

Contd...

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