Numéraire
Volume the Twenty-first · of the table of twenty-six
The Aggregates · Group V · № 21 · Lv

The Level

money's value over time

The level is the third of the aggregates, and it concerns the worth of the very thing in which the other two are counted. Growth is the long rise of real output and the cycle its fluctuation around the trend; but output and wages, debts and savings, are all measured in money, and money itself has a value that changes over time. The level is that value — what a unit of money will buy, and why it rises or falls across the years. Its inverse is the price level, so the value of money is the story of inflation and deflation: of money losing worth as prices climb, or gaining it as prices fall. The volume begins with the oldest answer, the quantity theory, that the value of money tracks its abundance, so that sustained inflation is at bottom too much money chasing too few goods. It then traces the temptations and catastrophes that a power so great invites: the false hope that a little inflation might buy lasting employment, which the natural rate dispels; the catastrophe of hyperinflation, where the value of money flees toward zero in a self-feeding panic; and the structural temptation that biases even a well-meaning authority toward inflation. Beneath all of it lies a startling truth about modern money, which is backed by nothing physical at all: that its value rests on belief, sustained by the credibility of the institution that governs it. And so the volume arrives at the question the author set it — who should hold the strange and awesome power to move the value of every price at once.

in print · № XXI · 12 of 12 plates
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The argument of the volume

Begin with the value of money itself, for it is the thing the whole volume is about. What a unit of money is worth is simply what it will buy, the inverse of the price level; so the value of money over time is the story of the price level, of inflation and deflation. The oldest and most fundamental account is the quantity theory, stated with unmatched clarity by David Hume: the price level is governed by the quantity of money relative to the quantity of goods, so that doubling the money, with goods unchanged, doubles all prices and leaves real wealth exactly where it stood. Money, in this view, is a veil over the real economy — its quantity sets the level at which prices are quoted but not, in the long run, how much is produced or who owns what in real terms. From this follows the central fact about inflation: that a sustained rise in every price at once is not the work of grasping merchants or powerful unions, which can only raise one price against others, but requires money growing faster than goods. Sustained inflation is, at bottom, a monetary phenomenon. Yet in the short run the veil lifts, for new money reaches some hands before others, quickening activity and shifting real wealth toward those who receive it first — the source of money's power over real things, and of its danger.

If the value of money can be moved, the temptation arises to move it for gain, and the volume turns to the temptations and catastrophes that follow. Edmund Phelps dispelled the most seductive hope, that a little inflation might purchase lasting employment: the Phillips curve seemed to offer such a trade, but inflation lowers unemployment only by fooling workers with wages worth less than they expected, and once the inflation is anticipated the effect vanishes, leaving only the rising prices, as the stagflation of the 1970s confirmed. Phillip Cagan studied the opposite extreme, hyperinflation, where a government printing money to pay its bills sets off a flight from the currency: as prices erupt, people spend money the instant they get it, its velocity soars, and prices rise faster still, in a self-feeding spiral that devours the inflation tax's own base and ends only when the printing credibly stops. And Finn Kydland and Edward Prescott found the temptation built into the power itself: a central bank free to inflate will be expected to inflate, and so will be forced to deliver an inflation it gains nothing from — the inflation bias of discretion — unless it surrenders the freedom to choose, binding itself to a rule or to independence so that its promise of stable money can be believed.

Beneath the temptations lies the deepest truth, which the flagship draws out. Modern money is backed by nothing — no gold, no metal, only a paper claim on nothing at all — and yet it holds its value, because everyone believes it will and trusts that others will take it in exchange. Its worth is a social fact, a shared confidence, and what people expect it to be worth tomorrow is what it is worth today. Thomas Sargent showed the principle at its sharpest: the great inflations end not gradually but at a stroke, the moment the public believes the regime behind the money has truly changed, for money's value is ruled by expectations of those who control it, not by the quantity of money alone. The central bank's deepest task is therefore to be the anchor of that confidence, which is why the power to set the value of money is given to an institution insulated and committed enough to be believed — the paradox of an unaccountable power at the heart of a democracy, held there because it must be insulated to be trusted. So the volume answers the question it set itself, who should hold the power to change the value of every price at once: an anchor, a credibly committed and independent institution, bound by a clear mandate and placed beyond the reach of the temptations that would unmoor it. One motion of the aggregate then remains — not the worth of the measure but the division of what it counts, between those who labor and those who own, which is the share.

The argument remains open. What follows is an attempt to fix its exact edges.

The twelve plates of this volume

  1. i The Quantityin print Hume; the price level tracks the quantity of money, so money is a veil over real wealth and inflation is, at bottom, too much money. Read the plate →
  2. ii The Neutralin print the neutrality of money; whether money can move real things or, in the long run, only the prices at which they are quoted. Read the plate →
  3. iii The Tradeoffin print Phelps; the Phillips curve and the natural rate — inflation buys lower unemployment only by surprise, and never for long. Read the plate →
  4. iv The Flightin print Cagan; hyperinflation, where the value of money flees toward zero in a self-feeding panic as people rush to be rid of it. Read the plate →
  5. v The Temptationin print Kydland and Prescott; the inflation bias of discretion, and why the power to inflate must be bound to a rule to be trusted. Read the plate →
  6. vi The Erosionin print the costs of inflation; the silent tax on cash and savings, and the arbitrary redistribution between debtor and creditor. Read the plate →
  7. vii The Descentin print deflation; the silent trap of falling prices, the rising real burden of debt, and the floor beneath which interest cannot fall. Read the plate →
  8. viii The Anchorin print the capstone: money is backed by nothing but belief, so its value rests on the credibility of the regime, and the power to set it must be insulated to be trusted. Read the plate →
  9. ix The Speciein print the gold standard; the metallic anchor that once gave money a worth beyond any government's word, and why the anchor was cut. Read the plate →
  10. x The Targetin print Svensson; the inflation forecast as an intermediate target, and the public discipline of a conditional promise. Read the plate →
  11. xi The Transmissionin print monetary transmission; the levers, the interest rate and the open-market operation, by which a central bank actually moves the value of money. Read the plate →
  12. xii The Mandatein print central bank independence; the uneasy bargain by which a democracy places the power over money beyond the reach of its own voters. Read the plate →

In closing

This volume took up the third of the aggregates, the level — the value of money itself across time, the changing worth of the very unit in which growth and the cycle, wages and debts and savings, are all reckoned. Its subject was inflation and deflation, the rise and fall of money's worth; and the question the author set it was the deepest one a theory of money's value can pose: who should hold the power to move the value of every price at once.

The volume traced that value from its foundation to its frontier. David Hume gave the quantity theory, that the price level tracks the quantity of money relative to goods, so that money is a veil over real wealth and sustained inflation is at bottom too much money chasing too few goods. Edmund Phelps dispelled the hope that inflation might buy lasting employment, showing the Phillips tradeoff to work only by surprise and to vanish once anticipated, leaving only the rising prices. Phillip Cagan anatomized hyperinflation, the value of money fleeing toward zero in a self-feeding panic as a government printing to pay its bills sets off a flight from its own currency. And Finn Kydland and Edward Prescott exposed the temptation built into the power itself — the inflation bias of a bank free to inflate — and the remedy of binding it to a rule, so that its promise of stable money might be believed.

Beneath the mechanisms the volume found the deepest truth of the modern money. Thomas Sargent showed that money, backed by nothing physical, holds its value only by belief, and that the great inflations end the instant the public believes the regime behind the money has truly changed — so that money's worth is ruled by expectations of those who control it, not by its quantity alone. The central bank's deepest task is to be the anchor of that confidence, and the power to set the value of money is therefore given to an institution insulated and committed enough to be believed, an unaccountable power placed at the heart of a democracy precisely so that it can resist the temptations the accountable could not. The level is growth's quieter companion: where growth is the trend of real output and the cycle its fluctuation, the level is the worth of the money that counts them both. One motion of the aggregate yet remains. The level governs the worth of the measure; but how is the thing measured, the national product, divided between those who labor and those who own? That is the share.

Modern money is backed by nothing, and holds its value only because all believe it will; its worth rests, in the end, on the credibility of the institution that governs it. That institution can move, by a single lever, the value of every wage and debt and savings account at once — a power vast and, by design, insulated from the vote. So the question the level leaves open is the one the volume was set to ask: who should hold the power to change the value of every price at once?