The first use, perhaps, to which economists have put their analysis of the supply of and demand for money was to explain the price level, and variations in the price level. In an early version of the quantity theory of money, David Hume likened money to a liquid poured into a vessel and identified the level of this liquid with the price level. This is still the picture that first comes to many people's minds when the subject is mentioned; and it is not a bad picture for visualizing what happens in hyperinflations. A recent statistical study of the seven hyperinflations of history has shown that in their case, the quantity theory of money is a reasonable first approximation to reality.l
In less extreme cases, however, and especially in today's complex economy, the causal chain through which a change in the supply of money influences the price level is long and tenuous; and economists no longer believe in a relation as simple, mechanical, and invariable as Hume's simile would suggest. As a matter of fact, most modern theories of inflation go to the opposite extreme and bypass the theory
of money completely, neglecting altogether the influence of changes in the stock of money. They try instead to explain the price level as a function of such real variables as aggregate effective demand and cost conditions that determine product prices, and the institutional and other factors that influence the wage contract negotiated between management and organized labor. All these are factors outside the scope of this book; but we must deal with the influence, if any, of the stock of money on aggregate effective demand and thereby on the price level.