Study Guide to Man, Economy, and State with Power and Market

Chapter 11: Money and Its Purchasing Power 141
output was less than necessary for “full employment.” In
order to induce employers to hire more workers, the
community needed to spend more and save less (thus
increasing the slope of the expenditure line, so that it
intersected the 45-degree line farther to the right).
The fundamental flaw with such reasoning is that
there can only be unemployment if wage rates are higher
than the market clearing level. This can occur either
through union pressure or government edict. Only if we
assume that workers do care about money (rather than
real) wages could hoarding have such sinister effects.
G. The Purchasing-Power and Terms-of-
Trade Components in the Rate of Interest
Following Irving Fisher’s canonical treatment, it is
standard to explain the nominal interest rate as the real
rate of interest plus a “purchasing power” component.
For example, if price inflation is 5 percent and the real
interest rate is 5 percent, then (Fisher would argue) the
nominal interest rate will be 10 percent, because lenders
need to be compensated for the decline in the PPM of
their money during the time of the loan. One grave problem
with this is that (obviously) the nominal rate can
never be negative, and so Fisher’s explanation can’t be the
whole story in times of severe price deflation. Moreover,
to the extent that future changes in prices are fully anticipated,
present prices will adjust. “The purchasing power
component, then, is not the reflection, as has been
thought, of expectations of changes in purchasing power. It
is the reflection of the change itself” (p. 797).