David Hume (1711-76) was a Scottish philosopher and an influence on Adam Smith. His brief works on economics consisted of several serious errors, as noted by Murray Rothbard below.

As a proponent of the quantity theory of money and its corollary, the price-specie-flow mechanism, Hume recognized that the abosolute quantity of money in an economy did not matter: prices would adjust according to the quantity of money in circulation. He believed that changes to the money supply mattered in the short-term; specifically, that an injection of money would stimulate the economy in the short term. However, this effect would disappear as the new (higher) price levels reflected the increased money supply. Hume believed that this adjustment in prices would be quick and proportionate. This is problematic in the following ways.

  1. This analysis of aggregates lacks the sophistication of the micro-process analysis of his predecessor, Richard Cantillon. There is no reason why the new prices would rise in a proportionate manner to the new equilibrium. The outcome would depend on who got the new money first and what they put it towards.
  2. Unlike Cantillon, Hume failed to account for the ‘income effect’: in addition to exerting an upward pressure on local prices, the new money would lead to increased domestic income, enticing an increase in imports. This effect would, in general, work faster than the effect on prices.
  3. Hume’s analysis jumps from one equilibrium to another, with complete disregard for the intermediate dynamics. Improper treatment of dynamics lead to miscalculations about the final equilibrium. This analysis comparative statics will be a recurring error.

Recognizing that the effects of the money injection would dissipate, Hume suggests the economy should receive a continued injection, so as to maintain this stimulation phase indefinitely.

  1. It is problematic that Hume labels the distortion of the functioning of the economy caused by the monetary injection as stimulation. The added monetary balances induce economic actors to engage in consumption and investment behaviors that they would have refrained from had the price signals in the market not been distorted with the added money. When the prices eventually rise, and the money illusion disappears, they face the adverse consequences of inflation.
  2. If inflation (injection of new money) stimulates the economy through the recruitment of factors of production previously idle, why were these factors idle to begin with? Hume never bothers to ask this question. The answer may be found in William Hutt’s Theory of Idle Resources. In short, there exist many reasons why the owners of these factors might decide to withhold their employment; to induce them to utilize them through misinformation supplied by inflationary measures is grossly immoral.

On the one hand, Hume lauds inflation, but on the other hand, he advocates for the ultra-hard money policy of 100% reserve banking. There are good reasons to avoid fractional reserve banking.

  1. Nevertheless, this is not consistent with Hume’s previously described position.

Hume aptly notes that the interest rate and the rate of profit in a free market would tend to equate. As he put it, “no man will accept of low profits, where he can have high interest; and no man will accept of low interest where he can have high profits.”

  1. However, he leaves the analysis incomplete by not considering how the lowering of time preference leads to greater capital accumulation, which, in turn, leads to the lowering of interest and profits.

Consistent with the emphasis on comparative statics, Hume viewed the economy as residing for the most part in equilibrium. Futhermore, he maintained that when it moved from an equilibrium to another, it did so quickly.

  1. Long-run equilibrium, in reality, does not exist. It refers to a direction in which the economy is headed. The underlying information about supply and demand is every changing, and so is the ultimate equilibrium. The long-run refers to a series of short-run states, and analyzing the transient dynamics of these states is precisely what is important.

The final point Rothbard makes is regarding Hume’s treatment of money as mere convention, rather than something that is itself a valuable marketable commodity. Money is valuable because of the importance it holds in the minds of the economic actors, but its origin, Rothbard points out, must be as something with instrinsic value (like gold or silver). I have considered this topic in a previous post (Is Pure Money Possible?), especially considering the rise of Bitcoin. The widespread distribution of something without inherent value with the promise that it might, once sufficiently distributed, remains a problem.