In the comments on the Keynes and Hayek thread, Nikolaj says of me:

My response was to deny that I know better than individuals how much money they "should" hold, and then argued that the point was that whatever quantity they wished to hold at the current price level, it should be supplied.



In thinking about this some more, it strikes me that I could have gone a step farther. One could make the case that it is those who deny that MV should be stabilized who are really the ones who think they know better how much money people should want to hold. The difference is that they believe that they know what the optimal nominal money supply is rather than the demand.



Both the defenders of 100% reserves and a Friedman rule are, at least implicitly, insisting that the public's demand for real balances accommodate itself to the nominal supply of money. In the case of 100% reserves, the money supply is essentially fixed and if the demand for money changes, the adjustments should take place through the price level. (This is what Rothbard means by saying any supply of money is optimal - he's assuming costless price level adjustments.) Is this not simply saying to money holders: "I know you'd like to hold higher real money balances, but we know this nominal money supply is the right amount, given our gold supplies, so tough cookies for you - you'll have to wait out painful price adjustments to have your higher demand for real balances accommodated." In the case of a Friedman rule, the hubristic claim is that the selected growth rule is optimal no matter the short-run changes in demand. Here too, the changes in money demand are dismissed and not seen as a reason to change the supply. Both groups implicitly think they know better how much money the public should want to hold.



From a monetary equilibrium-free banking perspective, this is all very misguided. Like any other good, markets should supply the quantity of real money balances the public wishes to hold and should avoid painful price level adjustments (both up and down) by doing so through changes in the nominal money supply.



The point is that ME-FBers have no idea what the optimal money supply is other than to say it's whatever the public wishes to hold at the current price level. We are not pretending to know how much money the public "should" hold, nor are we pretending to know how much we should supply. What market institutions such as free banking do is to discover how much money people wish to hold and then supply them that amount, I would argue, in a way that minimizes the damages done from the inevitable imperfections of the process.



It is those who would tie the money supply to anything but the demand to hold it who are suffering from the pretense of knowledge or the fatal conceit.

