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9.4.1 A detour through monetarism

Some macroeconomists would answer the critical question in the affirmative,

taking the market’s allocation of resources to the production of consumption

goods and the production of investment goods, the latter financed by saving,

to be on a par with the market’s allocation of resources to the production of

fruits and the production of vegetables. In other words, within the overall

output aggregate, the allocation issue – whether among narrowly defined

goods (peaches and potatoes) or among broad-based sub-aggregates (consumption

and investment) – is largely the province of microeconomics.

Macroeconomics, in this view, should focus on the overall output aggregate

itself as it relates to other macroeconomic variables, such as the general

price level and the money supply. These macroeconomic variables, symbolized

as Q, P and M, come together in the familiar equation of exchange:

MV = PQ (9.1)

This equation, of course, was ground zero for the monetarist counter-revolution

against the Keynesianism of the 1950s (see Chapter 4). The velocity of

money, V, is defined by the equation itself, and before the early 1980s its

empirically demonstrated near-constancy in different countries and in different

time periods established a strong relationship between the money supply

and some index of output prices. What is commonly known as the quantity

theory of money is more descriptively called the quantity-of-money theory of

the price level.

The monetarists argued that the long-run consequence of a change in the

money supply is an equiproportional change in the general level of prices – a

consequence tempered only by ongoing secular changes in real output and in

the velocity of money. Allowances were made for short-run variations in real

output. That is, overall output Q may rise and then fall while P is adjusting to

an increased M. However, the monetarists paid little attention to the relative

movements of the major sub-aggregates (consumption and investment) during

the adjustment process and no attention at all to the sub-aggregates

(stages of production) that make up aggregate investment. Whether dealing

with long-run secular growth or with short-run money-induced movements in

real output, the focus was on the summary output variable Q. Whatever

change is occurring within the output aggregate – as might be tracked by the

Austrians in terms of the Hayekian triangle – was taken to be irrelevant to the

greater issues of macroeconomics.