Thursday, November 13, 2014

The Quantity Theory in the Cambridge Marshallian Tradition in the Late 1800s

In what follows I give a brief overview of Alfred Marshall’s development of the quantity theory in the late 1800s on the basis of the discussion in Laidler (1991).

In Classical Political Economy, the long-run value of gold money was thought to be determined by the cost of production of gold (Laidler 1991: 51). It was only in the short-run that the quantity theory was used to explain the value of money and hence the price level (Laidler 1991: 51).

Curiously, the quantity theory of money was deployed by bimetallists and opponents of the gold standard in the 1873 to 1896 period (Laidler 1991: 50). This use of the quantity theory by bimetallists actually caused the quantity theory to be brought into some disrepute in this period, and advocates of the gold standard and sound money started to look on it with some suspicion (Laidler 1991: 52).

Alfred Marshall actually sketched an early version of the Cambridge Cash Balance Equation in an unpublished paper of 1871 called “Money” (Marshall 1975 [1871]), and later in his paper “Remedies for Fluctuations in General Prices” (Marshall 1887), and in his testimony before the British “Royal Commission on the Value of Gold and Silver” (1888–1889) and the Indian Currency Committee (1899) (Laidler 1991: 53). Hence before the early 20th century Marshall’s teachings on the quantity theory were mainly oral (Laidler 1991: 53). Marshall did, however, publish his views late in life in his book Money, Credit and Commerce (1923).

We can set out the published sources of the early Marshallian quantity theory tradition, as follows (in chronological order):
Marshall, Alfred. 1975 [1871]. “Money,” in J. K. Whitaker (ed.), The Early Economic Writings of Alfred Marshall, 1867–1890. Macmillan for the Royal Economic Society, London.

Marshall, A. 1887. “Remedies for Fluctuations in General Prices,” Contemporary Review 51: 357–375.

Final Report of the Royal Commission Appointed to Inquire into the Recent Changes in the Relative Values of the Precious Metals; With Minutes of Evidence and Appendixes. Eyre and Spottiswoode, London, 1888.

Keynes, J. M. 1911. Review of The Purchasing Power of Money: Its Determination and Relation to Credit, Interest, and Crisis by Irving Fisher, Economic Journal 21.83: 393–398.

Pigou, Arthur Cecil. 1912. Wealth and Welfare. Macmillan, London.

Pigou, A. C. 1917. “The Value of Money,” The Quarterly Journal of Economics 32.1: 38–65.

Marshall, A. 1923. Money, Credit and Commerce. Macmillan, London.
Marshall’s 1871 paper “Money” was a basic statement of his teaching right down to 1906 (Laidler 1991: 56).

Marshall inherited the quantity theory from Classical economics, and in particular from John Stuart Mill’s writings (Laidler 1991: 54). But Marshall introduced the stock demand for money into consideration as a determinant of money’s value, and downgraded the importance of commodity money’s cost of production as a factor determining its value (Laidler 1991: 54–55).

In explaining the price level, a greater emphasis was put on variations in the demand for currency by the Marshallians (Laidler 1991: 56).

Marshall also understood the limitations of the ceteris paribus assumption in the quantity theory and thought that factors other than money supply changes were probably more influential in causing price level changes:
[sc. Question:] 9629. To pass now to the question which has been raised of the dependence of prices upon the quantity
of the currency, what observations have you to make? …

[sc. Marshall’s answer:] I accept the common doctrine that prices generally rise, other things being equal, in proportion to the volume of the metals which are used as currency. I think that changes in the other things which are taken as equal are very often, perhaps generally, more important than the changes in the volumes of the precious metals.A question was asked by the Commission some time ago as to the dependence of prices upon the amount of the precious metal which was used as the standard of value. I object to make any such distinction. I believe that the shillings and half-crowns in circulation have just the same effect upon prices as they would have if they were legal tender; I believe that four half-crowns affect prices exactly in the same way as a half sovereign does. But putting that aside, I think that we have not the statistics, and that we shall not, in this generation, be able to get the statistics which would enable us to trace any statistical connexion between the amount of the precious metals, or, as I would prefer to say, between the amount of currency and the average level of prices; because, supposing that the volume of the currency remains the same, the height of average prices may yet vary in consequence of several causes. The first of these is a change in the volume of things on sale, and with regard to that no doubt we have fairly good statistics. The second is an increase or diminution in the average number of times each of these things changes hands during the year, and with regard to that we have no statistics whatever; indeed, there has never been any attempt to obtain statistics on the subject. The third cause is the average number of times that each coin or each element of the currency changes hands during the year; on that subject also there are no statistics. The last cause is the proportion which purchases otherwise than by currency bear to purchases by means of currency; on that subject I think we have no statistics which are in the least trustworthy, although, of course, a great many people have given guesses of more or less value. It seems to me that it is an insufficient account to say that average prices depend on the amount of the currency combined with the amount of credit. For without any change in the amount of the currency the average level of prices might be altered, not only by a change in the proportion of credit to other means of purchasing, but also by any other change in the methods of business, as for instance the growth of intermediaries.”
Alfred Marshall’s testimony, Minutes of Evidence taken before the Royal Commission on Gold and Silver. Forty-third Day, 19th December 1887 in Final Report of the Royal Commission Appointed to Inquire into the Recent Changes in the Relative Values of the Precious Metals; With Minutes of Evidence and Appendixes. Eyre and Spottiswoode, London, 1888. p. 2.
Laidler notes that Marshall and the Cambridge Marshallians eventually de-emphasised and abandoned the velocity of circulation concept as an important concept in the quantity theory (Laidler 1991: 59). Instead, the important concept was the money people choose to hold as a stock (Laidler 1991: 59), or the cash balance which would become the variable k in the Cambridge Cash Balance Equation.

BIBLIOGRAPHY
Final Report of the Royal Commission Appointed to Inquire into the Recent Changes in the Relative Values of the Precious Metals; With Minutes of Evidence and Appendixes. Eyre and Spottiswoode, London, 1888.
https://archive.org/details/cu31924030184745

Keynes, J. M. 1911. Review of The Purchasing Power of Money: Its Determination and Relation to Credit, Interest, and Crisis by Irving Fisher, Economic Journal 21.83: 393–398.

Laidler, David E. W. 1991. The Golden Age of the Quantity Theory: The Development of Neoclassical Monetary Economics 1870–1914. Harvester Wheatsheaf, New York and London.

Marshall, A. 1887. “Remedies for Fluctuations in General Prices,” Contemporary Review 51: 357–375.

Marshall, A. 1923. Money, Credit and Commerce. Macmillan, London.

Marshall, Alfred. 1975. The Early Economic Writings of Alfred Marshall, 1867–1890 (ed. by J. K. Whitaker). Macmillan for the Royal Economic Society, London.

Marshall, Alfred. 1975 [1871]. “Money,” in J. K. Whitaker (ed.), The Early Economic Writings of Alfred Marshall, 1867–1890. Macmillan for the Royal Economic Society, London.

Pigou, Arthur Cecil. 1912. Wealth and Welfare. Macmillan, London.

Pigou, Arthur Cecil. 1917. “The Value of Money,” The Quarterly Journal of Economics 32.1: 38–65.

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