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ARMEN A. ALCHIAN and

BENJAT\!1
IN KLEIN

On

Correct

Measure

of

Inflatione

Two commonly cited and newsworthyprice indices are the

Bureauof Labor Statistic's ConsumerPrice Index and the CommerceDepartment's
GNPdeflator.These indices have become an importantpart of our economic intelligence and are frequently considered to be the operational counterpartsof what
economists call "the price level." They, therefore, often are used as measuresof
inflation and often are targetsor indicatorsof monetaryand fiscal policy. Nevertheless, these price indices, which representmeasuresof current consumption service
prices and current output prices, are theoretically inappropriatefor the purposeto
which they are generallyput. The analysisin this paperbases a price index on the
Fisheriantradition of a proper definition of intertemporalconsumption and leads
to the conclusion that a price index used to measureinflation must include asset
prices. A correct measureof changesin the nominal money cost of a giverlutility
level is a price index for wealth. If monetary impulses are transmittedto the real
sector of the economy by producing transient changes in the relative prices of
service flows and assets (i.e., by producingshort-runchangesin "the" real rate of
interest), then the commonly used, incomplete, current flow price indices provide
biased short-runmeasures of changes in "the purchasingpower of money." The
inappropriateindices that dominate popularand professionalliteratureand analyses
*The authors are indebted to MichaelDePrano,MichaelHamburger,Joseph Ostroy, Earl
Thompson, Jai Hoon Yang, and participantsat seminarsat the Universityof Washington
CarletonUniversity,and the NationalBureauof EconomicResearchfor helpfulcommentsand
to Irene Abramsonfor able researchassistance.Financialassistancewas providedby the National Bureauof Economic Researchand by the Lilly Foundation,Inc. grantto UCLAfor the
study of property rights. This work has not undergonethe full criticalreviewaccordedNationalBureauStudiesandis not a NationalBureaupublication.

ArmenA. Alchianis professorof economics, Universit.vof California,Los Angeles;

BenjaminKlein is assistantprofessorof economics at the Universityof California,
Los Angeles.

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174

: MONEY,CREDIT, AND BANKING

are thereby shown to result in significanterrorsin monetary research,theory, and

policy.
I. AN ISO-UTILITY PRICE INDEX WITH INTERTEMPORAL CONSUMPTION

A well recognizedprincipleis that the appropriatenessof a price index dependson

the question to which an answeris sought.l For many situationswe are interested
in measuringthe money cost of a fixed welfare or constantutility vector of goods
as money prices change. This iso-utility price index, often called a cost-of-livingor
fslxedwelfare index, was first discussedformallyby Konus [24] . However,as early
as 1906 Irving Fisher [9] (and others earlier,we conjecture)pointed out that an
iso-utility vector included claims to future consumption. And more recently,
Samuelson [31] elegantly restated the slgnificanceof wealth-likemeasures(instead
of current income) in comparisonsof welfare. We, therefore, regardthe utility or
preferenceorderingof any situation as a function of a vector of claims to present
and future consumption,2
U= U ([q(i, t)] )

(1)

wheretheq(i, t) elementrepresentsthe quantity of the ith consumptionserviceflow

at time t.
Assume, initially, that markets exist for every consumption service flow to be
deliveredat every moment of time. At any moment an individualis assumedto be
constrainedby a scalar W(wealth),which he allocates over claims to presentand
lSee, for example Frisch [15, p. 10], Mitchell [28, p. 23], Keynes [23, book II], and Ulmer
[37, ch. 2]. Fisher, on the other hand, considered the problem of constructing a price index
independent of purpose and concluded that "from a practical standpoint, it is quite unnecessary to discuss the fanciful arguments for using 'one formula for one purpose and another for
another' in view of the great practical fact that all methods (if free of freakishness and bias)
agree !" [ 1 1, p. 231, his italics] . However, Fisher [ 10, ch. 10] earlier stated that the correctness
of an index depended on its purpose and he emphasized the theoretical importance of not basing
an index of purchasing power to be used in long-term loan contracts solely on consumer service
prices. Using an analysis similar to our own, he argued that:
Borrowers and lenders, in other words, may be more interested in purchasing factories,
railroads, land, durable houses, etc., which yield services during a long future, then in
purchasing more or better food, shelter and entertainments, which yield immediate satisfactions. To base our index number for time contracts solely on services and immediately
consumable goods would therefore be illogical.
Although he asserts that the practical differences may be inconsequential, the broad-based index
which he concludes that it is, on the whole, it is best to use the P in his equation of exchange,
which is similar to our index in terms of its inclusiveness.
2Samuelson notes that Pigou [29, p. 37] explicitly recognized that economic welfare depends
upon "total consumption" and not solely "immediate consumption." See any recent mathematical price theory textbook, e.g. Henderson and Quandt [19, pp. 229-240], for a formal
statement of this commonly accepted proposition.
While we consider present and future consumption as the sole elements in the utility function
and emphasize wealth as claims to future consumption, we do not deny the possibility that
individuals are willing to hold wealth in, and of, itself. See, for example, Dewey [8] for an
analysiswhere consumption is not the sole end of economic activity. This alternative view is not
inconsistent with the analysis of this paper.

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ALCHIANAND KLEIN :

17 5

future consumption flows at present prices quoted on these markets. If at each

(currentand future) moment there are n consumptionservices,then

Oo n
WA-j

qA

(int) PA (i,t)

(2)

dt;

i=1

where WA is the individual'scurrentnominal wealth, PA (i, t) is the currentrental

priceof the ith consumptionservicefor moment t (i.e., presentpricesinclude prices
of present claims to future consumption) and qA (i, t) is the magnitudeof the ith
consumption service flow at moment t which at the currentprice wectorand wealth
level maximizes the individual'sintertemporalutility. All of these values are describedas givenunder conditionA .3
Let present flow prices, includingpresent prices of future consumption services,
change and describe this new state as condition B. The question we are askingis
whether prices, measuredby a constant-utilityindex, have risen or fallen. We can,
in principle,compute at the new set of presentprices, l[PB(i, t)], the cost of an isoutility consumption servicevector, [qB (i, t)] . If, for example, the new cost under
price condition B, WB,is greaterthan under the initial price condition A, we can say
that the money cost of an iso-utility vector of goods has risen.4 The iso-utility price
index implicit in this can be representedby
0

LqB

PAB---

(int) PB

(i,t) dt

EqA

X
o

i=l

(3)

_i= 1
,^oo n

}4/A

(i,t)pA

dt

(i,t)
-

where qB (i, t) representsthe (i, t) element in the minimumcost consumptionvector that yields the same condition A utility at the new conditionB pricevector. If
PAB is greater than one, the nominal money cost of condition A utility has increased;an inflation has occurred.
To emphasizethe intertemporalnatureof this price index and the fact that it does
not refer solely to the cost of the currentmoment's consumptionit could less mis3This model, like the standard microeconomic model under which the usual price indices are
derived, assumes the absence of all information or transaction costs and therefore lacks a
theoretical justification for the value of a price index. (Introduction of uncertainty by the use of
costlessly made contingency contracts (e.g., Arrow [4] ), where all transactors know the true
state of the world when it occurs, is also economically equivalent to a world of perfect information with no rationale for a price index.) We will here ignore this fundamental question and
concentrate solely on defining what is commonly considered to be a fixed welfare price index,
recognizing that the usefulness of this or any other index depends crucially on the particular
information and transaction costs assumed.
4But we cannot, with a fixed quantity weighted index say it has risen. The analysis is exactly
parallel, indeed is identical, to the standard price index theory where q is interpreted as current
services. See Allen [ 2, pp . 19 7-20 3 ] .

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176

: MONEY,CREDIT, AND BANKING

leadinglybe called the current "cost of life" index. Currentinstantaneousprices of

currentconsumptionflows enter this index, but insignificantly.
II. FUTURES AND ASSET PRICES

Currentcashprices(to be paidnow) for future consumptionservicesarehere called

futures prices.5 Any price index that fails to include these currentfuturespricesis
deficient in not including the cost of all relevantelements of the utility function.
Its incompleteness can result in a severe (negative or positive) bias of indicated
change in the money price level of "life." Prices of current servicesmay rise while
futures prices (present money prices of claims to future services) fall more than
enough to lower the money cost-or the opposite may happen.
The major diffslcultyin makingour index operationalis that separatefuturesmarkets or contractsdo not exist for all future consumptionservices.6As a result, some
futures prices requiredfor a complete iso-utility price index will not be directly
observablein explicit market prices. But since assets are sourcesof future services,
assetpricesprovideclues to pricesof presentclaims on future consumption.Current
wealthcanbe representedby the sum of all asset values, or, equivalently,interpreted
as the sum of all present valued claims to all consumption serviceflows over time.
Symbolically,if there arem assets,wealth is denotableby:

m
WA-E

oo

PA(]) QA(/)-j

j=l

qA (i,

i=1

t)PA(i,t) dt
_

(4)

where WAis the individual'scurrent nominal wealth and [QA(X)]is the current
sThe currentfuturespriceof the ith consumptionserviceat momentt, p (i l), is relatedto the
future (or forward)price currentlyanticipatedat moment t, f t), by an implicitmarketrate
of interest,r (i, t); p (i, t) = f
t)
t) If interestratesare assumednot to varyoverdifferent
consumptionserviceflows, equation(2) restatedin termsof forward,ratherthan futures,prices
is therefore:

(i,

(i, e-r(is

E
o

qA (i,t)tA(i,

t)

eJorA(t)

dt d

(2)'

i=l

Our terminologyhere may be somewhatconfusingsince "futures"conventionallyrefersto the

price paid later but agreed to now in a futures contract on a commodity exchange,while
"forward"price is also often used to refer to a price to be paid in the future upon future
deliverybut agreed to now. With apologies to our readers,and on the assumptionthat forewarnedis forearmed,we use the word "futures"to denote a price agreedto now, "payablenow"
for servicesto be receivedin the future.
6Houthakker[21] theoreticallyexamineswhy futures marketsexist only for a rathersnzall
numberof commodities.The answerto this importantquestion must be based on the transaction costs of purchasingand sellingparticularcommodities.These costs are determined in
part,by the costs of obtaininginformationabout "characteristics"
of assetsand the distribution
of such informationamong transactorsin society (where "characteristics"
is an economicand
not a physical concept) and have implications for the essential propertiesof money (cf.
Brunnerand Meltzer[5, pp. 258-61] ).

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ALCHIANAND KLEIN * 177

vector of asset quantitiesthat would yield his intertemporalutility maximizingconsumptionservicestream, [qA (i, t)] . If assetsare standardizedin termsof their present and future service flows, the currentvector of asset prices, [PA(f)], can therefore be used as a proxy for currentfuturesprices,PA (i, t).
Whenrelativeprices change, one can, in principle,determinethe vector of assets,
[QB(X)], which will yield the minimumcost iso-utility consumptionservicestream
[qB (i, t)] at the new set of asset prices [PB(X)] andimplicit futuresprices PB(i, t ).
Currentasset prices can thereforebe used to construct our constant welfare price
index
m

5LPB (X)QB (X)

_ WB_
WA

j=l
m

SPA

(X)QA (j)

j=l

where WBis the nominalcost of the vector of assetsthat will yield a flow of present
and future consumptionservicesequal in utility to the initial conditionA consumption servicestream.
It is crucial to emphasizethat the vectors [QA (/)] and [QB (/)] must include all
assets-consumer and producer, durable and nondurable, tangible and intangible,
financialand nonfinancial,humanand nonhuman.All sourcesof present and future
consllmptionservicesmust be considered.The vectors do not represehtthe actual
assets held by the representativeindividual,but the asset combination that would
yield the individual'sdesired consumption service flows. An individualmay hold
some assets that yield the exact pattern of consumption service flows that he
demandsover time, e.g., a house that yields his presentand future desiredhousing
service flow. But, more generally, due to transaction costs individualswill hold
some assets not because they yield servicesthat coincide with their consumption
plans, but because they are an efficient form in which to hold wealth. The services
from these assets or the assets themselvesare later sold and exchanged for desired
consumptionservices.Humancapitalis the most obvious example.
Since our asset price index is not constructedon the basis of assetsactuallyowned
by an individualwe are therefore not measuringwhether the individualis better or
worse off after a change in prices, only whether he requiresmore or less money to
reach the sameutility level. We must distinguishbetween actualshifts in the budget
constraintwith correspondingwelfare changesand changesin our measureof inflation WBis comparedto WAto determinethe changein the individual'smoney cost
of a constant utility level. The individual'sactual nominalwealth under conditionB
must be comparedto WBto determineif he is better or worse off under the new set
of prices.An individual,for example,may own a coal mine not becausehe consumes
the coal yielded by the mine over time, but because the coal mine is an efficient
form in which to hold his wealth. He sells most of the coal for income to purchase

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178 : MONEY,CREDIT,AND BANKING

other consumption flows, and he intends to sell the mine and retireto an Hawaiian
resort in a few years. If under condition B the only change is an increasein the
price of coal, the individual'scurrentwealth will rise more than B/B;he is better
off while he experiences an inflation. Alternatively,if the price of Hawaiianland
increasesunder condition B, the individual'snominalwealth remainsunchanged(if
he did not own any of the land) while WBincreases;he is worse off and experiences
an inflation. Any combination of inflation or deflation and better off or worse off
is possible.
III. THE SYSTEMATIC BIAS OF CURRENT SERVICE FLOW PRICE INDICES

A money price index based on considerationswe haveoutlined is fundamentally

different from the CPI, which is constructed on the basis of prices of current consumptionservices.The CPIconsidersthe prices of only a part of the utility function
and is therefore inadequatein principle as a constant utility money price measure.
The CPI attempts to measure changes in the cost of only the iso-utility current
consumption flows and therefore supplies an answer to a question distinct from
whetherthe presentmoney cost of consumerutility has changed.7
Current service flow prices are related to asset prices by implicit real rates of
interest and therefore our iso-utility price index is logically equivalent to an index
basedon currentserviceflow pricesand a broadlydefined interest ratevector. If our
representativeindieridualmoved to a new society where current servicefRowprices
areidenticalbut whererealinterestrates arehigher,our iso-utilityprice index would
fall. The individualwould substitute future consumption for present consumption
and his money cost of life would decrease.8
If we assume that society's equilibriumrate of time preferenceand real productivity of investmentremainsconstant, is there any reason to suppose that use of a
current service flow price index provides a deceptive measureof inflation? If real
interest rates remain constant and the prices of current servicesand the prices of
currentassetsmove together then, as a practicalmatter, a currentserviceprice index
can be used as a perfect proxy for the theoretically correct wealth price index.
There is, however,reasonto expect a majorsystematicdiscrepancyin the transitory
movement of a currentservicefRowprice index and a currentasset price index. And
it is this discrepancywhich makes a currentservice fRowprice index an especially
poor short-runindicatorand targetof monetarypolicy.
7It is interesting to note that a major gap between a theoretically correct constant utility price
index and the actual CPI is often said to be the improper inclusion of some consumer durable
prices, such as new and used automobiles and houses, in the index. The proper price for these
durables is said to be the current rental price or current cost of using the services from the asset
and not the purchase price of the asset itself (cf., for example, Steiner [33] ). We would claim,
on the other hand, that the CPI is inappropriate because of the emphasis on current prices and
the insufficient weight given to asset prices.
80n the contrary, nominal interest rates (current mortgage rates) enter the CPI positively. An
increase in nominal interest rates due to an increase in anticipated future (or forward) prices
which leaves real rates and current futures prices unchanged will not alter our price of wealth
index.

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ALCHIANAND KLEIN : 179

Changesin the quantity of money cause a "nonadiabatic"adjustmentprocessin

the money market which is terminated when all prices have changedproportionately. The initial price changeswill depend upon how the monetary change is accomplished; but, ignoring distributioneffects among individualswhich may cause
permanent changes in relative prices, the initial changes will "diffuse themselves
equally after a certain time through all price-levelsalike," [23, p. 90]. But all
prices may not change at the same rate. Keynes [23, ch. 7] emphasizedthe possibility that price levels might not be rapidly "diffused" and that the failure of
different price levels to move in the sameway was a crucialelement in the explanation of short-periodfluctuations. Differential adjustmentspeeds among prices, of
consumption goods and capital goods (or of service flows and durableassets) in
particular,formed a cornerstoneof his theory of the trade cycle.9
The behavior of current service flow prices relative to asset prices as a crucial
element in the transmissionprocessbetween monetarystock changesand economic
fluctuations has also been emphasizedby Friedman and Schwartz [14, pp. 229231]. They maintain that monetary changes temporarily affect real income by
producing transient changes in the interest rate structure,defined by the ratio of
currentrental prices of servicesto the price of current assets as sourcesof the services, i.e., by changing wealth relative to income. A decrease in the supply of
nominal money, for example, decreasesthe demand for and prices of financialand
non-financialassets as individualsadjust their portfolios by attempting to add to
their depleted cash holdings. This causes asset prices to fall relativeto serviceflow
prices and relative to the cost of producingnew assets.(The generalfall in the asset
price level is a rise in "the" real interest rate; wealth falls relative to income.) In
turn, the reduced profitability of producingnew assets decreasestheir production
(i.e., leads to a fall in the rate of "investment"),and the higherinterest rate implicit
in the current rental asset price ratio stimulates asset purchasesrelativeto rentals
(i.e., leads to a rise in the rate of "saving"-in the sense that consumptionof current
servicesis reduced).10
If such an "interest rate" mechanismactually operates,then short-runeffects on
"the purchasingpower of money" of a change in the rate of growth of money will
be underestimatedby a currentservice flow price index comparedto an index that
also includes asset prices. But, unfortunately,we have not been able to verify the
existence of such a mechanism.Very little reliableinformationexists on transaction
prices of used assets and almost none on a quarterlyor monthly basis.ll Given the
9Leijonhufvud'srecent interpretationof Keynes emphasizesthe importanceKeynes placed
on an "inappropriately"low relativeprice of assets (or high interest rate) as a "causeof unemployment"[26, pp. 335-338] .
lIn additionto asset pricesgenerallyadjustingmore rapidlythancurrentflow prices prices
of "liquid" (low transactioncosts) assets will adjust more rapidly than prices of "iliiquid"
assets.
Even if relativeprices are not affected by the monetarychange,realincomewill be affected
if anticipationsabout market clearingprices lag behind changingreality-which is costly to
detect and adjustto instantly.C.f., Alchian[ 1] .
1lGoldsmithand Lipsey [ 16] have constructedan annualwealthpriceindex in the context of
estimatinga nationaland sectoralbalancesheet. The componentsof their index, however,are
not based on transactionpricesbut on owner estimatesof the marketvalue of their property

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180 : MONEY,CREDIT, AND BANKING

assumed importance of asset prices in the transmissionof monetary changes, this

deficiency in the data and lack of any previoussystematicempiricalanalysisof the
behavior of asset relative to flow price is truly shocking.Some suggestiveevidence
on the existence of this cyclical relativeprice process can be obtained,however,by
examiningrecent movements in common stock price indices relativeto flow price
indtces and by examining movements in estimates of "the" real rate of interest.
Although there are significantproblems in the interpretationof the movement of
stock prtces (see section VI), they should be included in our iso-utility price index
since they implicitly measurecurrentpricesof capitalassets owned by corporations
and represent the only readily availabledata on current market prices of assets.
And changes in the real rate of interest can be consideredan indirect measureof
changesin the relativeprices of serviceflows to capitalstocks.l2
The sharp decrease in the growth rate of money during 1969 provides a classic
example of the bias involved in measuringinflation by consideringonly, for example, movementsin the CPI.Narrowlydefined money, which had grown at a 7.6 percent annual rate over the two previousyears, grew at only a 2.9 percent annualrate
from January, 1969, to February, 1970. (Most of this restraint,as recordedin the
figures revised for the unusually large volume of Eurodollarbortowing in early
1969, came in the second half of 1969). Although realmagnitudeswere clearlyaffected, this policy was generally considered to have been a failure in c1lrbingthe
rate of inflation. The CPI,which rose at a 5.8 percent annualrate duringthe second
half of I969 showed no sign of deceleratingand rose at a 6.0 percent annualrate
during the first half of 1970. Absence of any perceivedresponse of prices in the
face of rising unemployment led to the total abandonmentof monetary restraint
during1970 and early 1971 and ultimately to the imposition of wage and price controls. But there is some evidence that asset prices responded almost immedsately
and quite dramaticaltyto the changein policy.
Standardand Poor's Composite (500) Common Stock Price Index started to decline in early 1969, and by June, 1970, had fallen nearly thirty percent to the level
of early 1964. In addition, the real rate of interest as measuredby the FederalRe-

(for farm real estate and for most of the single-family house data) and on construction costs
(for commercial, industrial and residential structures and for producer and consumer durables).
Reliance on cost data limits our indexes solely to measures of new asset prices. Over long periods
this procedure may not yield biased price estimates of all existing assets but will most certainly
yield misleading current asset price measures in a short-run cyclical context when reproduction
costs are considerably more rigid than market prices. Grebler, Blank, and Winnick [ 17, appendix
C], for example, compare the market "prices" (i.e., owner estimates) of houses with the
construction costs for the 1890-1934 period and conclude that, although there is close conformity between the two series over decade-long periods, market prices fluctuate more widely than
construction costs and there are significant divergencies between the series over shorter periods
of several years.
Market transaction price data for used assets are available in trade publications and dealer
catalogues for cars, trucks, and farm equipment; and less complete price data possibly may be
collected by other trade associations.
l2It should be noted that although our discussion emphasizes that movements in asset and
service prices differ largely because of differing rates of adjustment to cyclical monetary disturbances there may also be a significant secular bias due to changing equilibrium real asset
yields. (The apparent increase in real rates of interest over the years is ignored in our discussion.)

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ALCHIANAND KLEIN : 181

serve Bank of St. Louis (the nominal corporateAaa bond yield minus the average
annual rate of change of the GNP deRatorover the previous24 months) rose about
one percentagepoint during the last half of 1969 and the Elrsthalf of 1970-from
2.3 per cent in June, 1969, to 3.3 percent in June, 1970.l3 This evidencesuggests
that asset prices declined relativeto Sow prices over the period and that movements
in the CPI severely underestimated the deRationaryeffects of the tight money
policy.

IV. CURRENTOUTPUT FLOWPRICES,STOCKPRlCES AND THE

DEMANDFOR MONEY

Another commonly employed index of inSation is the GNP deflator,which measuresthe price of currentoutput Sows. This price index includes the prices of newly
produced assets but does not include the prices of previously existing items of
wealth and thereforeis conceptuallydistinct from our iso-utility wealth price index.
Therefore,althoughit is useful for other purposes,a currentoutput price index also
provides a biased estimate of changes in the money cost of consumerutility. The
theoretical considerationsoutlined above with regardsto tlle bias in the movement
of the CPIcomparedto a wealth price index also suggesta similarsystematicbias in
the movement of the GNP deflator relative to a wealth price index. Prices of already produced assets will, we conjecture,generallybe more Rexible than pricesof
currentlyproducedgoods, which arebased on currentcosts tllat are often made less
flexible by long-termcontracts. And given the rigidity of currentproductioncosts
relativeto assetprices,a fall in the rate of growth of money decreasesthe profitability (and thereforethe rate) of new asset production.Concernduring 1969-70 about
the rigidityin the rateof rise of currentoutput flow pricesshould thereforebe based
on the evidence this gaveus on the extent of the recession,not on the extent of the
inflation.l4

l3The FederalReserveBank of St. Louisdiscontinuedpublishingtheirrealrate seriesshortly

after this episode. Although their measuredreal rate showed remarkablestability over the
1960s, this unique precipitousrise should have been expected as part of the normalrelative
price reaction to monetarydisturbances.Whatmight have been misleadingis that the previous
tight money episode of 1966, although similarin magnitudeto 1969, did not producesuch
severerelativepricechanges.(The money stock showedno changefrom April, 1966, to January
1967, afterrisingat abouta six percentannualrate over the previousyear.This produceda clear
decelerationof the rate of increasesin the CPI, which rose at a 4.5 percentannualrate from
Januaryto Augustof 1966 and only a 1.6 percent annualrate over the followingsix monthswhilestockprices,which fell more than thirteenpercentfrom Januaryto August,1966, quickly
recoveredand rose more than eight percent over the next six months, the St. Louis real rate
remainedessentiallyunchangedover the period, risingless than ten basis points from Aprilto
August 1966 and then quickly fallingback to and then below its originallevel). This dramatic
differencein the relativepricemoveient between the two most recentcontractionaryepisodes
may explain why the downturn in economic activity was much milder in 1966-67 than in
1969-70, but the surprisingflexibilityof flow pricesin 1966 remainsunexplained.
l4In a crude iimonetarist"model such as Andersonand Carlson's[3] changesin money
imply changesin nominalincome;and the movementof currentoutput prices,whichdepends
on past output price changes,determinesthe divisionof the nominalincome changebetween
real income and prices.Therefore,the flexibility of currentoutput flow pricesis an important
determinantof cyclicaleconomicactivity.

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182 : MONEY,CREDIT, AND BANKING

The GNPdeflatoris incorrectlyusednot only as a measureof inflation,but also

almostuniversallyused as the deflatorof nominalmoneybalancesin demandfor
moneystudies.If, however,moneyis consideredto be a capitalassetandthe demandfor money treatedas an applicationof the generaltheory of wealthconportfoliochoice, the purchasingpowerof moneyis more
strainedinter-temporal
in termsof ourpriceof wealthindex.15
measured
meaningfully
Finalchoice of the properpricedeflatorin the demandfor money,however,is
fromwhichthe demandfc)r
specif1cation
conditionaluponthe particularstructural
moneyis necessarybefore
for
demand
of
the
theory
explicit
An
derived.
moneyis
conwe candeterminethe priceindexthatshouldbe used.If moneyis alternatively
sidered,for example,solely as a mediumof exchangeand the demandfor monet
model,the use of the GNP
derivedon the basisof an inventory-transactions-type
deflatoras the relevantpricevariablein the demandfor moneyfunctionremains
theoreticallyunjustified.Moneyis usedto purchaseassetsof varyingdurabilityand
age.The demandfor moneythereforecannotbe dependentsolelyon the pricesof
currentoutputflowswhichrepresentonly a partof whatmoneycanbuy.Hence,
within the context of a transactionsdemandframeworkor a wealthportfolio
choice framework,the GNPdeflatoris incompleteand the purchasingpowerof
measuredin termsof our moreinclusiveprice
moneycouldbe moremeaningfully
of wealthindex.16
If nominalmoneybalancesaredeflatedby ourassetpriceindex,thenthe connection betweenincome(not wealth)velocityof moneyandthe demandfor realcash
balancesis no longeras directas oncethought.Theratioof ourassetpriceindexto
the currentoutputpriceindexthatis usedto deflatenominalincomenowentersas
an additionalvariable,i.e., both asset pricesand currentoutputpricesenterthe
velocityfunction.Sinceassetpricesaregenerallymoreflexiblethanoutputprices,
if "real"balancesare(incorrectly)def1nedin termsof a currentoutputpriceindex
(and assetpricesignored),a decreasein the nominalstock of moneyleadsto an
overestimateof the initialresultantdeclinein realcashbalancesandhenceto an
increasein velocity.Movementsin the relativepricesof assetsto
"unexplained"
flowsmayexplainthe initialoffsettingchangesof velocityin responseto monetary
(i.e., slow
changeswithoutinvokinga presumptionof a short-rundisequilibrium
l50ne of the major developments in monetary theory in the postwar period has been the
integration of monetary theory with capital theory and the recognition of money as an asset in
an optimum wealth portfolio (cf., e.g., Friedman [12] and Tobin [36]). Friedman'sempirical
work explicitly takes account of the fact that money holders "judge the 'real' amount of cash
balances in terms of the quantity of goods and services to which the balances are equivalent,
not at any given moment of time, but over a sizable and indefinite period" [13, p. 121] by
deflating nominal balances by "permanent" or "expected" prices. But this price variable is
merely a weighted average of current and past GNP deflators and does not properly consider
anticipated future prices as embodied in current asset prices.
l6Keynes [23, ch. 6] defines two price indexes, a cash-transactions index and a cash-balances
index, that may be superior deflators of nominal balances within these theoretical frameworks.
Both of these indexes, like our iso-utility wealth price index, include all objects of possible
expenditure, but the weights applied to the objects are significantly different. The cash-transactions index weights objects in proportion to the amount of money transactions to which they
give rise per unit time and the cash-balances index weights objects in proportion to the demand
for money they occasion, representing the P in the Fisher and Cambridge quantity equations
respectively.

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ALCHIANAND KLEIN : 18 3

adjustment).
The introductionof a vectorof interestrates(to reflectrelativeprices
of currentservicesandwealth)in anincorrectlyspecifieddemandfor "real"money
may tlhenserveas a proxyfor the morecompletepriceof wealthdeflator.Thisimpliesthat use of the incompletecurrentoutputpriceindexas the pricedeflatorin
the demandfor moneyinduces,to someextent,the observedexistenceof a significantinterestrateeffect on the demandfor "real"cash balances. If a wealth
priceindexwereemployedinstead,interestrateswouldthen implicitlyenterin a
moregeneralway, while"the"observedinterestrateeffect wouldbe reducedand
possiblye}.iminated.17
The questionis essentiallyan empiricalone of whetherthe commonlyused
interestrateson financialassetsaresufficientto pickup thisshort-run
"liquidity"
effect of changesin moneyon the relativepricesof existingstocksandflows.The
significanceof the dividendyield in the demandfor money(cf. e.g., Hamburger
[18] may,in fact,be reflectingthe inabilityof the pricesof financialassetsto completelypick up this relativepricemovement.The dividendyield is statisticallysignificantin a quarterlydemandfor money regressionoverthe 1951-71period.18
Alog(Ml/P) = - .0011 + .3096 d\log(Y/P)- .0044 l\log rS - .0359 i\log rD
(4.66)
(0.78)
(2.87)
R2 = .295
D W = 1.06
SE -

.0058

(1.1)

But the significancecanbe attributedsolelyto the variabilityof realstockprices

andnot to the variability
of realdividends.If we substitutestockpricesdeflatedby
the GNPdeflatorfor the dividendyield in the aboveregression(whereS refersto
StandardandPoors500 CommonStockpriceindex),we observethatstockprices
actuallyenterslightlymoresignificantlythanthe dividendyield.Thisimpliesthat,
log (Ml/P) = - .0011 + .2914 /\log (Y/P)- .0053 i\log rS
(4.29)
(0.95)
+ .0369 Alog(S/P)
(291)

R2 = .297
DW= 1.03
SE =

.0058

(2.1)

l7This factor is taken account of most fully in Brunnerand Meltzer'sempiricalwork (e.g.

[S] and [27] ). I8hey,however,use a priceindex for nonhumanwealthnot as a measureof the
purchasingpower of money, but as a deflator of the wealth constraint.They assume the
relevant deflator of nominal balancesis the GNP deflator and it is thereforeentered as an
additionalvariablein the demandfor money.
l8Ml equalscurrencyplus demanddeposits,P is the GNPdeflator,Y is nominalGNP,rSis the
four-to-six month commercialpaper rate, rD equals Standardand Poor's dividendyield of
corporatestock, log refersto naturallogarithm,>2 is the coefficient of determinationadjusted
for degrees of freedom,DW is the Durbin-Watsonstatistic and SE is the standarderror of
estimate.The valuesin parenthesesare the t-valuesof the estimatedregressioncoefficient.The
regressionis reportedin first differenceform since rD entersa level regressionhighlypositively
with a DW less than .2, indicatingthat clearlya variableis missing.Evenin the firstdifference
form the autocorrelationof the residualsremainsdisturbinglyhigh.

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184 : MONEY,CREDIT,AND BANKING

if anything,changesin dividendpaymentsgo in the i'wrongdirection."Fllrther,

stock pricesbecomeinsignif1cant
when the sameregressionis runoverthe same
periodusingannuallyaveraged
data.l9Bothof thesepieces
Alog(M1/P) = - .0127+ .5767 i\log (Y/P)- .0266 i\log
(3.36)
( 1.68)
+ .0282 i\log (S/P)
(0.98)

rS

R2 = .429
DW= 1.01
SE =

.0138

(2.1)t

of evidencesuggestthat the dividendyield entersthe demandfor moneyfunction

not as a measureof the directcost of holdingmoneybut as a proxyfor the shortrun movementof asset prices relativeto the GNP deflator.20In addition,the
significanceof stock pricesin a short-runbut not in a long-rundemandformoney
regression
also providesevidenceagainstthe hypothesisthatstockpricesenteras a
wealthvariableas, forexample,ThompsonandPierce[35] maintain.
V. POLICYIMPLICATIONS

Nearlyfifty yearsagoKeynesemphasized
the fundamental
policymistakesrisked
by the use of an inappropriate
priceindex.He claimed[22, pp. 249-25()] Churchhill returnedEnglandto the gold standardin 1925 at the prewarparityprimarily
l9Our hypothesis implies that cycle averagedata would reduce the statistical significance
even further.The annuallyaveragedregressionfor the dividendyield indicatesslightlybetter
results.
alog (M1/P)= -.0129

.5757 alog (Y/P) - .0217 alog rS

(3.57)
(1.36)

.0420 alog rD R2 = .463

(1.42)

DW=.871
SE = .0134
(1.1)'

20Similarly,changesin the quantity of money can be expected to inRuencestock prices in

the short run not, as commonlybelieved,becausestocks areclose substitutesfor cashbalances
or because the short run liquidity effect influencesthe rate at which future earningsare discountedbut becauseof the differentialflexibilityof stock pricesto the monetarychange.Fisher
110, ch. 9] outlined a similarmechanismin the context of the transactionsversion of the
quantity theory. He emphasizedthat many prices arerigidand arelikely to changeless thanin
proportionto monetaryfluctuationsin the short-runand, therefore,other pricesmust change
more than in proportionin the short-runfor the quantity equationto hold; andhe noted that
stock prices are likely to be the most "supersensitive"of these other prices to changesin the
quantity of money. Since the quantity equationis now generallystatedin income formwhere
"the" price level that is determineddoes not include existingitems of wealth, this mechanism
cannotbe recognized.
2lThompson and Pierce [35] use a total public wealth variablebased on Goldsmithand
Lipsey'swork in a monthly demandfor money study. But month to month changesin their
variable are dominated by stock price changes. In addition, Thompson and Pierce fail to
distinguishbetween nominaland real values of wealth and money and assume(as most macro
models do) that the money market can only be clearedby movementsin a small subset of
interestrateson financialassets,ignoringthe possibleshort-runadjustmentof a broaderspectrum
of assetprices.

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ALCHIANAND KLEIN : 18 5

because Churchillwas "gravelymisled by his experts" who, by using the inappropriate but commonly employed wholesale price index, significantlyunderestimated
the extent of the necessarydeflation.
An analogous situation may exist today. Presently employed price indices are
impropermeasuresof the change in the money cost of an iso-utility consumption
package. Reliance on these biased numbers as an indicator or target of monetary
policy makes it difficult for the monetaryauthoritiesto know what they are doing,
let alone what they should be doing. And action on the basis of these numberscan
lead to inappropriatedecisions;policy changeswill often come too late and move
too far. Recent monetary policy provides an instructiveexample. The authorities'
preoccupationwith the movement of inappropriateflow prices indices to the almost complete exclusion of asset prices was partially responsiblefor a monetary
policy that was too easy for too long a period (1967-68) and then a policy that was
too tight for too long a period(1969) followed by a policy that was once againtoo
easy (1970-early 1971). A crude modification of the CPI, with say, an index of
stock prices would have provideda much more useful indicatorand targetfor price
level stability.22
Our discussion also helps explain the generalreluctanceof contractingpartiesto
adopt escalator clauses. If long-termcontracts were set in "real"terms, i.e., tied to
"the price level," economic uncertainty would seem to be decreased.23But "the
price level" must be made operational by a particular,arbitraryand incomplete,
price index. And the fact that price indices are not generally used in long-term
contracts (or a tabularstandardnot adopted) provides some evidence that the indices are poor measuresof "the price level." Only if the varianceof future anticipated price change is high will the use of, for example, a CPIprice escalatorclause
decreasethe anticipatedvarianceof the realpay off. This may explain the more frequent use of price escalatorsin foreign countries that have experiencedgreatprice
variabilityand the recent trend towardsincreaseduse of price escalatorsin the U.S.
(see [7]).
22Simons [32, p. 349], in discussingthe feasibilityof a monetarypolicy designedto stabilize
a price index, notes that the particularpriceindex chesen "mustbe highly sensitive;otherwise,
the administrative
authoritywould be compelledto postponeits actionsundulyaftersignificant
disturbances."
Realizationof our ignoranceabout movementsof the appropriateisoutilitypriceindex does
not necessarilyimply that we shouldadopt a monetaryrule. Discretionarymonetarypolicy can
still be basedon incomeand employmentstatistics,and, of course,the inappropriateflow price
indices could be used if we knew and took cognizanceof the differinglags of adjustmentof
prices to monetarydisturbances.In this context, our discussionmay supply some supportfor
those that believe that "money market conditions" (i.e., the behaviorof interest rates) is a
relevantshort-runindicatorof monetarypolicy. If the accelerationof the money supplyis not
considered,the inclusion of short-runinterest rate movementswith price movementsmay
provide a much less misleadingmonetary indicator than price movementsalone since price
anticipationsare probablyrelativelyrigid over the short term and thereforeshort-runchanges
in marketinterestrates will be relatedto short-runchangesin realratesand short-runchanges
in the relativepricesof assetsand currentflows.
23And a rationalefor administrativewage-price"jawboning,"that it is necessaryto convince
negotiatingpartiesthat the governmentintendsto reducethe futurerate of inflation,would be
eliminated.

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186

: MONEY,CREDIT, AND BANKING

Strictlyspeakingthereis no suchthingas a "correct"priceindex.As we stated

initially,the appropriateness
of an indexcanbe judgedonly by the answerit supplies to a particular
decisionproblem.Ourpriceindexanswersthe standardtextbook questionof whetheran individualneedsmoreor lessmoneyto remainat the
same level of satisfaction.An individualin attemptingto determinehow much
moneywealthhe now needsfor a particular
level of presentandfutureconsumptionwoulduse ourindex.
But why, then, isn't therea demandfor a priceindexthat includesassetprices
and why do movementsin the CPIappearto be politicallyimportant?24
Within
the contextof ourmodelit is difficultto finda rationalefor the factthatrising
consumerserviceflow pricesare generallyunpopularwhile fallingasset pricesare
generallyunpopular.Therelevanceof ourintertemporal
iso-utilityindexappearsto
be seriouslyquestioned
by commonattitudes.Onepossibleexplanationmaybe that
individualsfail to recognizethat price changesof assetsthey do not own may
significantlyaffect their money cost of life and theirwelfare.Whileindividuals
that,for example,ownhousesareawareof the decreasein theirwealthwhenprices
of housesfall, individuals
that do not own housesdo not appearto recognizethat
such a pricechangealso affects them by loweringfuturehousingserviceprices.
Individuals
aremorefullyawareof changesin theirnominalwealththanof changes
in the nominalcost of futureconsumption,
possiblybecauseanintertemporal
consumptionindex is not now published.Alternatively,
the CPImaybe a politically
relevantindex becausemanyindividualshaveutility functionsthat only contain
currentconsumptionserviceflows.Old individuals
who do not havethe realquantity of wealththey canleavetheirheirsas an importantargumentin theirutility
functionand housewiveswho do not makeany capitaltransactions
or budgeting
decisionswithinthe family,for example,will bothbe myopicin termsof the time
horizonof consumptionservicespricesthey areconcernedwith. Thisis the major
unanswered
questionwe areleft with. Is the focus that is presentlyplacedon the
CPIas a measureof inflationmerelyan historical"accident,"or areindividuals
narrowlyconcernedonly aboutmovementsin pricesof a smallsubsetof the goods
in theirutilityfunction?2s
Woulda redefslnition
of our conceptsand the replacement
of whatis now commonlycalled"inflation"by "currentconsumerserviceflow priceinflation"alter
any of the recentdiscussionof manyjournalists,politiciansandeconomistsof the
extremerigidityof the rateof pricechangeandthe need for someformof wageprice controls?26We will be able to answerthese questionsmore satisfactorily
aftera priceof wealthindexis constructedandemployed.
24However, Kramer [25] found that movements in the CPI, holding real income and some
other variables constant, had no significant effect on the division of the national vote for the
U.S. House of Representatives over the 1896-1964 period.
2sHistorically, the original price indices were narrowly based on internationally traded commodities (e.g., spices and grains).
26It is particularly interesting to note that many of the important prices in our wealth price
index, e.g., land and security prices, are not covered under the recent wage-price controls.

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ALCHIANAND KLEIN : 187

VI. CAN THE ISOUTILITYPRICE INDEX BE MEASURED?

Ourimprecisestatementsindicatewhatwe thinkshouldideallybe (1) the modificationin presentmeasurements

of the impactof monetarypolity on the rateof
inflationusingan assetandservicepriceindexand(2) how they wouldinfluence
monetarytheoryandpolicy.Althoughthe directionof effectseemsobviousto us,
ourconjecture
thatpresentlyemployednumbersyieldmisleading
conclusionscanbe
verifiedonlyby the constructionof a superiorindexnumber(i.e., it takesa number
to beata number).
The desiredconstantutilitypriceindex,however,is difficult(expensive)to make
operational.
As we havealreadynoted,withoutfuturecontractsin all commodities,
the explicitfuturespricesandquantitiesneededfor construction
of a wealthprice
index are unavailable.
Currentpricesof assetsof differentlife lengthsprovidea
theoreticalsubstitutesincethey embodypresentpricesof expectedfutureservice
flows. But both the asset pricesand asset quantitiesnecessaryfor this indexare
extremelyexpensiveto determine.Wemusthavepricesof a verybroadspectrumof
assetson whichwe presentlyhaveverylittle information.Ourdatamustinclude
pricesof generallynonmarketable
assets,such as humancapital,andof assetsof
varyingdurability,so that we areableto producethe exact optimumcurrentand
futureconsumptionserviceflowsby adjustingthe assetmix. Wemay not be able
to determineall these priceswith any reasonableexpenditureof resources,but
surprisingly
littlereliableinformation
existson currentpricesof assetsandgiventhe
assumedimportanceof thesepricesin the transmission
of monetaryimpulses,some
effortin thisdirectionwouldseemto be clearlyeconomic.Collectionof transaction
pricedata on land,commercialandresidentialstructures,producerand consumer
durablesand other tangibleand financialassetsand the constructionof a crude
quarterly
wealthpriceindexwouldprobablybe worthwhile.27
Determinationof the asset quantityvectorsis also extremelydifficult.As we
havealreadynoted,the assetsactuallyheld by an individualcannotbe usedas an
indexof the individual's
desiredfutureconsumption.
Somewayof determining
the
compositionof the individual's
desiredintertemporal
consumption
services,i.e., of
specifyinghis utilityfunctionor fixingparticular
constantassetweightsmustthereforebe devised.In addition,a morecompletespecification
of the constraints
on the
individual's
intertemporal
transactions
is also llecessaryto determinethe relevant
assetweights.An individualmay,for example,demanda particular
timestreamof
housingservicesunderconditionsof costlessperfectfuturesor assetmarkets,but
27Stigler'sprice statisticscommittee [38, part 1, app.C. pp. 95-99] makesa similarproposal.
Consideringthe resourcesexpended on the collection of price data on, for example,current
food prices, which are such a smallelement in the relevantlydefined utility vector,a reallocation of funds would seem to have a payoff in terms of providinga relevantanswer to the
question of determiningprice level inducedchangesin consumerwelfare.CarlSnyder's[34]
attempt to measure"the generalprice level" (deElnedessentiallyas the P in the equation of
exchange) included realty values, security prices, and equipment and machinery prices in
additionto the standardcost-of-livingitems was a movementin the correctdirection.

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188

: MONEY,CREDIT,AND BANKING

due to transactionscosts actuallybuy and sell housesover time and consumea

housingserviceflow thatdoesnot coincidewiththis"ideal"serviceflow.
And finally, even if asset pricesand quantitieswere available,we would have
significantproblemsin the interpretation
of assetpricechanges.A changein the
marketvalueof anassetmayreflect(i) a changein the priceof anunchanged
future
serviceflow fromthe asset,(ii) a shift in preferences
for thisassetsservicerelative
to otherassets,(iii) a shiftin preferences
for presentconsumption
relativeto future
consumption,or (iv) a changein the anticipated
magnitudeof serviceflow fromthe
asset. Any or all of these changesare likely to be occurringsimultaneously
and
thereforethe causeof a changein a particular
assetpriceis difficultto determine.
Changes(ii) and (iii) representa shift in tasteswhile (iv) representsa changein
asset quality;however,they are not conceptuallydifferentfrom the problems
encountered
in constructing
the presentlyusedindices.Changesin the preferenceor
utility mapsareruledout in the presentlyused consumptionservicecost-of-living
indices.28And the qualitychangeproblemwherebya changein the price of a
givenserviceflow must be distinguished
fromchangesin the serviceflow, is also
presentin currentindicesand has alreadybeenhandledin an innovativeway for
transactions
pricesof usedcars(cf., Cagan[6]).
For example,considerchangesin commonstock prices.The pricesof common
stockareincludedin our indexbecausewhetheran assetsuchas a houseis owned
by a singleproprietoror ownedby him as a corporationshouldhaveno effecton
the priceof the house as manifestin the priceof the stock. If the corporation
represented
notjust the housebut, asis typicallythe case,the servicesof a manager
who rentedandmaintainedthe house,then the stock pricewouldreflectalso the
manager'sspecifictalents.Changesin the priceof commonstock would reflect
changingpricesof two things:the houseservicesandthe manager's
talentsspecific
to this activity.So muchthe better,for we haveincludedhumanandnonhuman
assets;the physicalserviceflow beingpricednowhasa seconddimension,the flow
of humanservices,and that may changejust as a house may deteriorate.Stock
pricescontainno moreconceptualproblemsthando the pricesof anyassets-orfor
that matterof currentserviceflows in whichone has to separatequantitychanges
andqualitychangesfrompricechanges.
Althoughsomeof the conceptualproblemsin constructing
a wealthpriceindex
aresimilarto thoseencounteredin presentlyusedflowpriceindexes,the practical
problemsin the interpretation
of assetpricemovementsaremoredifficult.What
wouldone do, for example,withthe dropin commonstockpricesof 1969-70?Did
it reflectclaimsto reducedreal futureservices(a decreasein quality),or lower
pricesof unchangedflows of futureservices(a deflation),or a shift in demand
towardsmore presentconsumptionrelativeto futureconsumptiondue to higher
real ratesof interest(broughtaboutby "tight"monetarypolicy or by increased
uncertaintyleadingto an increasein the rate of time preference),or perhapsa
28This is not to say that there is in principleno computableindex, for thereis. One needs to
know the equivalentutility vectors under the shifted preferencemap. But the base weighted
indices (and all other for that matter) no longer can be interpretedas they are now. The
difficultyposedby shiftingpreferencesis no greaterthan for the presentincompleteindices.

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ALCHIANAND KLEIN : 18 9

combination of all of these forces? For business corporation stocks, the price
decrease reflects, at least in part) reduced or deferred outputs of future services.
Fewer future cars will be produced or more will be deferred.The stockholdermay
think of anticipatedfuture money earnings;they have fallen not necessarilybecause
future i.e. forward,prices(not futures)are expected to fall but possibly becauseof
reducedanticipatedprofitability-much as if a tree would be expected to yield fewer
apples as less fertilizeris applied in the coming years with lower demarldexpected
for apples. If, however, all prices were expected to be lower in the futureSthe
reduced earningsreflected in lower present stock prices would be truly a reduced
price level of unchangedreal claims.We conjectureboth factorswere presentin the
stock price fall-a reduction in present prices of given future servicesand a reduction in the future anticipatedoutput and earningsrelativeto what it was before.29
In other words real future servicesare reduced and also the presentprice of a unit
of future servicehas decreased.It is the latter we want to measure.
We can attemr)t to approximatethe division of an asset price change into these
two components by estimating changes in real rates of interest. A rise in the real
rate would indicate a fall in future prices relative to current serviceprices. But we
observe only nominal interest rates, which reRect the anticipated future rate of
inflation. Marketestimates of changes in the currentlyexpected rate of change of
future prices can be obtained by examining the ratio of stock prices of net monetary neutral 1rms to bond prices.30Alternatively,we could examine the movement
of money interest rates relativeto forwardprice spreads,quoted on commodity exchanges. The usefulness of these suggestions for obtaining market measures of
anticipatedinflation can only be determinedby furtherempiricalwork.
The empiricalproblemsinvolaredare enormous.But whateverefforts may be made
in this direction and whatever the results,:we believe it is an error to assign all of
the change in common stock and other asset prices to changesin anticipatedfuture
service flows with no changein presentprices of such future flows. . . which is what
is implicitly done now in commonly used price indices that ignore asset prices.
It may be cheaper to make empirical judgments about quality and quantity
changes of current than for future service flows. But what has been added is
essentially a significantlylargernumberof items that shouldbe priced;and weights
for assets in the "typical' man's portfolio of possession of claims must be ascertained. This is not a new theoretical problem-it is an enlargementof an existing
task. And we believe that the marginalcost of improvinga price index along these
lines is less than the marginalgains of improvedmonetary and fiscal policy consequent to less misleadingindicatorsof inflation.
29These two Xctors are related. Since the prices of primaryfactors (especiallylabor) purchased by a firm are generallythe most rigid,an unexpecteddecreasein the prices of future
servicessold by the flrmwill reducefutureanticipatedearnings.
30Movementsin the stock price to bond price ratio will not, however, representsolely a
changingprice anticipationseffect. If the change in the anticipatedrate of changeof prices
alters the demand for and quantity of real cash balancesand hence the savingsfunction, real
interest rates will change.Stock prices of net monetaryneutralfirmswill thereforenot remain
unchangedbut will move in the same directionas the anticipatedrate of price changemovement.

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190 : MONEY,CREDIT, AND BANKING

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