Monetary Policy Committee Notifications

What is the Regression Theorem?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Regression Theorem

Mains level : Not Much

This newscard is an excerpt from the original article published in the TH e-paper edition.

Regression Theorem

  • The regression theorem refers to a theory of the origin of money.
  • It states that money must have originated as a commodity with intrinsic value in the marketplace.
  • The idea was first proposed by Austrian economist Carl Menger in his 1892 work “On the Origins of Money.”
  • This theory is offered as an alternative to the state theory of money which states that money (fiat money) can come into existence only when it is backed by the government.

Evolution of Money

  • The regression theory argues that money comes into existence through a gradual process of evolution in the marketplace, without the need for any government sanction.
  • Economists who try to explain the regression theory generally start with the question of why money, particularly fiat money which is simply just a piece of paper, has any value at all in the marketplace.
  • The most common answer to this question is that fiat money can be used to buy other useful goods such as houses, cars etc.
  • But this answer is insufficient —it tries to tackle the question of why fiat money can buy other useful goods by simply saying that it can buy other useful goods.

Why is fiat money, which has little intrinsic value, considered valuable?

  • In real life, people accept money in exchange for goods in the present because they are aware that money was accepted as a medium in exchange for other goods in the past.
  • For example, people accept wages in the US dollar today because they are aware that the dollar was used to buy cars, groceries and other goods in the market yesterday.
  • This gives them confidence in the value of their money.

What made people accept money in exchange for other useful goods in the past?

Ans. Intrinsic Value

  • Economists who advocate the regression theory of money argue that money must have originated as a useful commodity like gold or silver or the barter system.
  • This is the only way, they argue, it could have possibly been accepted by people in exchange for other useful goods at some point in the past.
  • If a thing did not possess any intrinsic value, it is unlikely that people in the marketplace would have accepted it in exchange for other goods and services.
  • So, commodities like gold and silver must have been traded in exchange for other goods and services at some point in history purely because they offered some kind of personal utility to people.
  • For example, these precious metals could have been used to make ornaments, to fill teeth, etc., which gives them intrinsic value.
  • They maintain value over time because their supply cannot be easily ramped up as mining gold involves significant production costs.

 

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