The natural quantity of money

Ricardo’s views on the working of a monetary system and his prescriptions for the conduct of monetary affairs can be summarised as follows: a) the monetary authorities are accountable only for those changes in money prices which can be imputed to a monetary disturbance; b) a desirable monetary regime is one in which such an occurrence is least likely to occur; c) targeting the quantity of money, in order to prevent a monetary disturbance, is both undesirable and ineffectual. In this paper I try to show how Ricardo derived these propositions from his monetary and value theory and what is the role played by the concept of the “natural” level of the quantity of money. Ricardo firmly believed that it was possible to distinguish variations in money prices having a monetary origin from those originating in real causes. Changes in money prices that have a monetary cause could and (should) be prevented, while those due to a change in the conditions of production of commodities could (and should) not be avoided. Ricardo’s belief that it was possible to separate “monetary” from “real” causes of variations in money prices rests on two presuppositions: (i) there is a market mechanism which ensures that the value of money, once the price of the standard is fixed in terms of the currency at home and abroad, remains constant; (2) there is an actual commodity which is “invariable” in value. The mechanism, which ensures that the level of the quantity of money is self-adjusting –and therefore that the value of money is kept constant- relies on individuals’ responses to profitability conditions for arbitraging in gold in the domestic and in the foreign markets. While the mechanism which ensures that the quantity of money adjusts to its “natural” level, rests on two conditions: a) the currency is freely convertible into the standard at a fixed price (and at a small cost) at home; b) the standard can be freely exported and imported into the country. The profitability conditions for shipping gold which can bring about the stability of the purchasing power of the currency in terms of gold at home and abroad are then derived. It is then argued that since there is no solution to the problem of finding a standard of money which is “invariable” in absolute value, which would make it possible to distinguish between variations in money prices due to a change in the value of commodities or in the standard, there can be no ground for Ricardo’s belief in the possibilities of distinguishing between “monetary” and “real” causes of rising money prices. However, the level of the quantity of money, at which its value is constant need not be calculated either by relating the cost of production of gold to the cost of production of commodities, nor is it determined as the equilibrium condition given by the equality of supply and demand of money. On the contrary, if the “natural” level of money is interpreted as an equilibrium level, (as in most Gold Standard models) then a gratuitous inference is drawn from Ricardo’s monetary theory: the attainment of the purchasing power parity of gold in terms of commodities. The “natural” level associates the quantity of money not to an equilibrium quantity of gold and a constant relative value of gold in terms of commodities, but to the equality of the purchasing power of gold relative to the currency at home and abroad. This means that relative value of gold in terms of commodities may differ across countries. Furthermore the enforcement of the law of one (international) price is required only for gold, not for all tradable commodities as is implied by the purchasing power parity condition which can be found in most Gold Standard models. By comparison, Ricardo’s theory appears more reasonable as a description of the working of actual markets , and perhaps more in accordance with facts.