The influence of money on prices has been disputed for a long time among economists and policy makers. Money did not matter for many economists until 1970, and then almost all economists accepted that it mattered. However, in over half of the empirical studies, money has failed to convince people of its influence. The purpose of this paper is to investigate the influence of money on prices from a different point of view, and to use the Taiwan data to do empirical research.
For the sake of understanding the evolution of inflation theory, this paper firstly describes the development of inflation theory over time in accordance with the evolution of macroeconomics, and then surveys all of the related empirical literature concerning money and inflation, examining what makes money matter, and what does not. With respect to those factors and methods that make money matter, we have also carried out empirical tests using Taiwan data. Finally, we describe our “sufficient” and “necessary” condition hypothesis.
The influence of money on prices is quite different from that of the other factors. During the process of inflation, money plays two roles, when its grourth rate reaches a critical level, there will be a real balance effect, that will create a huge demand thus becoming the demand pull inflation”. This is a kind of “quantitative” effect, which we call the “sufficient” condition of inflation. If the growth rate of money does not reach the critical level, it will accumulate gradually leading to “tight” or “loose” circumstances, which will influence the price mark-up on cost push, a kind of “qualitative” effect, which we call the “necessary condition” of inflation. Traditionally, the empirical study of money and prices only took into consideration the “quantitative” effect, with no consideration of the critical level. This always leads to the conclusion that money doesn’t matter! The “qualitative” effect had been neglected completely. In reality, however, money’s qualitative effect is often more significant than the quantitative effect. This empirical study on Taiwan’s economy supports our necessary and sufficient condition hypothesis.
The “qualitative” effect of money not only influences the cost-push inflation, but also affects the time lag of monetary policy and the variability of relative prices. If the circumstances for accumulating money in the recent past have been tight, then the time lag between money and prices will be longer, and if it has been loose, the lag will be shorter. Because the monetary circumstances are changing all the time, the policy lag is likewise changing, and then the effectiveness of monetary policy is doubtful. This statement supports the Monetarists’ criticism of the Keynesians’ discretionary monetary policy. In addition, the monetary circumstances affect the variability of relative prices. Control of the money supply can not only check inflation and the unnecessary relative price changes, but can also make the necessary price adjustment owing to the changes in the supply and demand conditions being executed.
The methodologies used in this empirical study are the ordinary least square method, the dummy variable, and the Almon lag technique. The data used such as the imported price, the wholesale price, the consumer price, money, the interest rate, income, the industrial wages and prices are separately taken from the Quarterly National Income Estimates of the Republic of China (1961-1979); A Supplement to Financial Statistics Monthly, Taiwan District, the Republic of China 1983, Oct., Financial Statistics Monthly, Taiwan Distrit, the Republic of China; Commodity-Price Statistics Monthly, Taiwan Area, R. O. C.; The data on international money and prices, are taken from International Financial Statistics.
