Money Supply Revisited: A Review Article

THIRTY years have passed since anyone wrote a book exclusively-or even largely-devoted to an analysis of the supply of money. Phillip Cagan's Determinants and Efects of Changes in the Stock of Money, 1875-1960 (1965)1 would be welcome, therefore, if it did no more than intensify interest in a subject that lay dormant until recently. The book does much more, however. Cagan patiently examines the multitude of factors that influence the principal determinants of the money supply and hence the money supply itself. He then extracts from his data information about the perennial questions: Do changes in money cause the subsequent changes in output and prices? Or, is the stock of money pulled up and down by secular and cyclical changes in prices and output so that movements of money may be regarded as of little or no causal significance? These questions have been debated so heatedly that it is refreshing to find an answer that is neither polemical nor assertive. Cagan concludes that the secular movements of the price level can be reasonably interpreted as a response to prior changes in money. Similarly, he finds that severe depressions are caused by a decline in the rate of change of the money stock, although the depression may have been started by nonmonetary factors. The alternative viewthat movements of the money stock are the result of price and output changes-can at best explain a few of the episodes but fails to account for the period as a whole or for many of the deep depressions. In mild cycles, however, the evidence that Cagan examined does not permit him to discriminate sharply between the two views. Both processes, stimulus and feedback, are at work, and he concludes that the rate of change of money both influences and is influenced by the behavior of the real sector. These conclusions and much of the rest of Cagan's discussion make clear that the neglect of the theory of money during most of the past thirty years cannot be explained by the depth or extent of our knowledge. Cagan presents a rich and, at times, imaginative discussion of the factors influencing the money-supply process that differs substantially from the oversimplified versions of "money creation" contained in most textbooks. Frequently, he concludes that we know very little about the forces producing secular and cyclical movements in some of the principal determinants of the money supply-for example, the public's currency ratio and the banks' reserve ratio. Most of the book develops from a simple formula, given in the first chapter, that relates the money supply (defined as currency plus total commercial-bank deposits of the public) to three determinants. Chapters ii-v analyze the combined contribution of the three determinants and examine some of the reasons for the timing of secular and cyclical changes in each. Cagan then uses the information he has assembled to reopen the long-standing disputes about the direction of causality and about the so-called Gibson paradox that has played a prominent role in previous discussions of classical monetary theory. Unfortunately, the book is uneven. Some problems of little current interest are explored in great detail while others of greater * Discussion and joint work with Karl Brunner made an important contribution to the review, and helpful comments from Phillip Cagan clarified several points. Financial assistance from the National Science Foundation supported the research underlying the review.