The Continuing Relevance of David Hume’s Musings on Money

public finance monetary policy value of money economics of money macroeconomics financial markets

James Broughel for AdamSmithWorks

Although David Hume's essay "On Money," came long before the term “macroeconomics” came into vogue two centuries later, it might well be considered one of the first essays of that genre. 
What is perhaps most remarkable about "Of Money," the 1752 essay by the Scottish philosopher David Hume, is how many key concepts Hume foresaw from what later came to be known as monetary economics. The notion of monetary neutrality, the distinction between the short and long runs, and problems associated with deflation, are just a few examples. Although his essay came long before the term “macroeconomics” came into vogue two centuries later, it might well be considered one of the first essays of that genre. And while Hume did fail to appreciate some of the finer aspects of what today we call monetary theory, students wishing to learn about the economics of money could do far worse than to start with Hume’s essay. Indeed, his insights into the nature and role of money continue to resonate to this day and provide a useful lens with which to view modern financial markets.

Hume's essay should be understood in terms of the historical context in which he wrote. During the 18th century, the British political system had many mercantilist factions, and Hume was trying to address certain mercantilist fallacies, such as the idea that a country with more paper money or gold was economically better off than one with less. In Hume’s words, it was wrong to think “that any particular state is weak…merely because it wants money.”

Contrary to this thinking, Hume noted, “men and commodities are the real strength of any community.” Today we would include women in that list too, of course, but what he surely meant was that it’s a nation’s labor force and its production that make it rich, not the quantity of paper or metal circulating.

Hume aimed to show in his essay that the quantity of money was in some sense irrelevant—or neutral—because if the number of commodities and workers remained the same, all that would change in response to an increase in money is a rise in prices. 

Today this notion—that prices of goods and services change proportionally with changes in the money supply—is called the Quantity Theory of Money. It is an idea most closely associated with 20th century economists like Milton Friedman and Irving Fisher, and it is still widely accepted as true by many if not most economists. Just in the last year, for example, inflation has been much higher than was the case in the previous decade. The current high inflation was preceded by a significant increase in the money supply, just as Hume would have predicted.

Hume saw money is a tool for accounting purposes, or mere “arithmetic,” with its impacts limited otherwise. “Where coin is in greater plenty,” he wrote, “it can be of no effect, either good or bad.” This does not mean Hume thought doubling or tripling the money supply would have no real consequences. Rather, he recognized that output could be affected by changes in the quantity of money, but also that these effects would be temporary. A general rise in prices is a process that plays out over time, “first of one commodity, then of another; till the whole at last reaches a just proportion with the new quantity of specie.” Moreover, the initial increase in money “is confined to the coffers of a few persons,” meaning Hume understood there can be important distributional consequences based on who gets the new money first.  

Today, when economists discuss the “short” and the “long runs,” it is this period of adjustment they are usually talking about, between when prices are changing in response to new conditions and when they settle into a final equilibrium. “It is only in this interval or intermediate situation,” wrote Hume, “that an increasing quantity of gold or silver is favorable to industry.” Today, central bankers exhibit similar thinking when they lower interest rates in response to a rise in unemployment. They recognize that chronic unemployment can’t be cured with monetary policy, but over the short term it can create a few jobs, thereby alleviating some unnecessary suffering.

Hume favored a policy of moderate inflation, thinking that “the good policy of the magistrate consists in keeping it, if possible, still increasing.” By contrast, “a nation, whose money decreases is actually at that time weak and more miserable.” Again, most modern economists would agree with the recommendation that slow and steady inflation is preferable to deflation, the latter of which can bring about gluts of unemployment and unsold goods. 

One could criticize Hume for not taking the problem of deflation more seriously, however. Although he noted that “where money is so scarce” problems do arise for business and industry, the problems he identified were somewhat trivial. For instance, he thought “prices might become so small as to be in danger of being lost,” which hardly seems realistic. Moreover, he blamed these problems mainly on “the manners and customs of the people,” rather than on the influence of money. 

Today economists would also note that changes in money’s velocity—or the speed at which one dollar turns over as it is spent and re-spent—are just as important for price stability as changes in the quantity of money. Indeed, this is an important part of the modern version of the Quantity Theory of Money. If the demand for money swings wildly, due to a lack of trust in the money or inversely because people want to hoard it—prices can swing wildly as well, leading to financial havoc.

Hume wrote at a time when Great Britain was on a gold standard, so it is understandable he may not have foreseen some of the problems with fiat moneys. Nevertheless his ideas remain relevant, especially in the form of the Quantity Theory of Money, which can be helpful for understanding developments in modern central banking or financial markets. It may not be the only model for thinking about money’s role in the economy, but it is one that has stood the test of time and for that we can thank David Hume.

Want to Read More?
Eugene Miller's Foreword to Hume's Essays
Liberty Matters online discussions on Smith, Hume, and Burke as Policy Liberals and Polity Conservatives and The Place of Liberty in David Hume’s Project
An Economics Reading List: Pre-1800 Economic Thought, Including Mercantilism
Edwin van de Haar's Unexpected Insights of David Hume