Post on 22-Oct-2015
description
transcript
NUMISMATIC
* MAIN IDEAS
- “The common theme between our framework and the older literature is that the money stock is a balance sheet aggregate of the financial sector. Our approach suggests that broader balance sheet aggregates such as total assets and leverage are the relevant financial intermediary variables to incorporate into macroeconomic analysis” (Adrian & Shin 2010, p.2-3).
* BANK
- Fisher (1911) and Keynes (1936) “weakened the sharp distinction previously observed
between ‘money proper’ and ‘money substitutes’ such as bank deposits. This development
gave rise to a definition of money as the aggregate of all generally accepted media of
exchange, including (some financial liabilities of commercial banks, which has created on
ongoing debate about whether the ability of thebankig system to creat media of exchange is
constrained by the supply of bank reserves (implying a key role for the cetral bank ) or by
the demand for deposits (suggesting ‘free banking”
- Goodhart (1984) describes the textbook money multiplier story with RRR as ‘absolute
baloney’. (His comments on it in Goodhart 1994, p.1424-6) Why? Because “It is extremely
unlikely that any central bank would allow a fundamentally sound financial institution under
its jurisdiction to fail simply because it lacked sufficient liquid assets during a run on its
deposits” (Dalziel 2001, p.32).
- “… modern analysis of the ultimate constraint faced by banks focuses on the risk of bad
debts” not on the bank-run (Dalziel 2001, p.32).
- Classical economists’ adherence to laissez-faire principles had an exception, i.e. note
issuance. Yet the principles were still applied to deposit banking and credit markets (Laidler
1991, p.39).
* BANKNOTES
- “…the banknote, a ‘convertible currency of credit.’ Here the illusion that the note-holder
lends capital to the bank rather than the ultimate borrower is further reinforced by the bank’s
promise to repay the principal on demand in money proper. Even more, because of
convertibility, note-holders are free to imagine that they have not lend capital at all, that the
note they hold is itself capital, that the banknote is in fact money not credit. But all this
imagining does not change the fact that the banknote is not money but only a token of the
bank’s credit. Although the banknote may in all practical respects function exactly as money,
it remains distinct from money on account of the mechanism of its supply; the banknote
enters circulation as the bank of issue discounts some capital loan.” (Merhling 1996: 334)
This is different from Wray’s notion of money as naturally credit money; “In
reality, credit money is the ‘natural’ form of money: money as a privately issued
IOU.” (Wray 1996: 445)
- Marx: “The credit given by a banker may assume various forms, such as bills of exchange
on other banks, cheques on them, credit accounts of the same kind, and finally, if the bank is
entitled to issue notes — bank-notes of the bank itself. A bank-note is nothing but a draft
upon a banker, payable at any time to the bearer, and given by the banker in place of private
drafts. This last form of credit appears particularly important and striking to the layman, first,
because this form of credit-money breaks out of the confines of mere commercial circulation
into general circulation, and serves there as money; and because in most countries the
principal banks issuing notes, being a peculiar mixture of national and private banks, actually
have the national credit to back them, and their notes are more or less legal tender; because it
is apparent here that the banker deals in credit itself, a bank-note being merely a circulating
token of credit. But the banker also has to do with credit in all its other forms, even when he
advances the cash money deposited with him. In fact, a bank-note simply represents the coin
of wholesale trade, and it is always the deposit which carries the most weight with banks”
(KIII,25)
- Wray provides a different story of development of banking from the orthodox one. He
argues that bank first emerged not as deposit banks operating as intermediaries from
‘depositors’ to ‘borrowers’ but as banks making ‘loans’ by issuing banknotes; “that is, they
financed their position in assets by creating liabilities.” (Wray 1996: 446)
- Bank deposit: entirely ideal claim on banks (Lapavitsas 1991: 314)
- Banknotes: a promise to pay by a bank. (Lapavitsas 1991: 315)
“~~~ Bank-notes, on the contrary, are never issued but on loan, and an equal amount of notes
must be returned into the bank whenever the loan becomes due. Bank-notes never, therefore,
can clog the market by their redundance, …. [The] reflux and the issue will, in the long run,
always balance each other.” (Fullarton cited in Viner 1937, 237)
- “Notes are issued based on commercial loans [i.e. trade credit] which arise only from the
needs to accommodate certain commodity trade” (Likitkijsomboon 2005, p.165).
- Decreasing role of banknote substituted by depository money: Lapavitsas 1991, p.315-16.
Especially: “Precisely this development allows the supersession of the banknote as the chief
means of payment in advanced capitalism. Given the existence of systematic hoard
collection, it is possible to transfer money ideally and without the passage of bank promises
to pay. Instead payments can be made by transferring the claims on banks directly as entries
in different bank accounts. The immediate corollary of this is that banknotes, indeed all
circulating money, are displaced from the sphere of exchange. In terms of the functions of
money, the circulating functions are diminished and the hoarding function becomes
dominant.”
- As for the function of means of payment, banknotes have been replaced by the deposit
mechanism. They have been reduced to the function of simple means of circulation,
“facilitating primarily the exchange of commodities in the area of expenditure of private
income…… Banknotes enter exchange according to how money is demanded for purposes of
income realization; hence, their entry teds to be demand-determined. Furthermore, the reflux
tends to take place as hoards out of private income are created, and not as debts to banks are
paid…. The upshot of the rise of depository credit money is to attenuate the links of the
modern banknote with the advance and repayment of credit” (Lapavitsas 1991, p.317).
- See Fisher (1911, p.35)
- “A bank note is essentially to be regarded as a kind of deposit-receipt or cheque, which
passes through a number of hands before it is presented to the bank either for redemption or
as a deposit” (Wicksell 1898, p.69).
- “The essential characteristic of notes consists in their taking the place of coin in the cash reserves of private individuals and of those banks which do not themselves issue notes” (Wicksell 1898, p.70).
* BILLS OF EXCHANGE
- The most typical private debt certificate
- “It is only on account of their relative inconvenience, and for similar reasons (taxation of
bills, etc.), that this original use of bills has gradually become less prevalent since banking
was perfected. Bills no longer pass from hand to hand so much as formerly; they are
discounted at some bank, and usually then remain in the bank's portfolio until they become
due (at any rate so far as domestic bills are concerned). In other words, the employment of a
bill of exchange has become purely a form of lending money” (Wicksell 1898, p.64). See this
page for more about bills of exchange.
-
* CENTRAL BANK
- The operations between central bank and treasury: See the references in Fiebiger et al. 2012,
p.19
*COST OF PRODUCTION THEORY
- Smith criticizes Tooke and Newmark’s explanation of the effect of 1850s discovery of gold
as contradicting Tooke’s Banking School position (p.9). Actually, their view is very similar to
Hume’s SR non-neutrality of money and Fisher’s transition period explanation. That is,
according to Tooke and Newmark: ‘Mg increase by gold discovery -> increase in expenditure
and income by increase reserves and lowering interest rate (p.7) -> increase in demand ->
increase in price’. This is nothing but QT’s SR perspective!!! Smith demonstrates the
traditional Classical view on the topic as: ‘Mg increase by gold discovery -> decrease in the
cost of production of gold through a decrease of the cost of production of the least productive
mine -> decrease in the value of gold -> increase of general level of prices -> increase in the
demand for money’. “From the standpoint of the classical approach, it is difficult to conceive
how the additional output of gold was absorbed into monetary circulation in absence of a
prior causal reduction in its cost of production which directly raised the general price level”
(p.9).
* CREDIT MONEY (CREDIT SYSTEM)
- Marx’s vs. PK
- Marx’s emphasis on hoards as a material base for the development of credit system and
the contemporary case of ex nihilo issuance of bank liabilities (Are they contradictory?):
- PK’s credit view of money is based on Keynes Post-GT articles (1937a, 1937b, 1938,
1939): “Keynes observed that an important role of the banking system is to extend credit to
finance investment goods production in advance of the saving that is necessarily generated
through Kahn’s (1930) multiplier process” (Dalziel 1999-2000, p.
- Dos Santos (2012, p.15-16)’s explanation is not satisfactory. He gives two aspects: i)
Excess credit money will reflux back to the initial issuers or the demand for credit will
decrease, ii) “Competitive capitalist accumulation systematically requires the maintenance of
money holdings as part of the social portfolio of financial and real assets. It simultaneously
generates a systematic demand for credit, if capitalists are to embark on growing scales of
investment. The credit system dynamically mediates between these two needs by creating its
own forms of money and advancing them to those demanding credit.”
-> As for the first, besides that how the two can be reconciled is unclear, it relies on the
law of reflux, whose validity is to be questioned, and moreover, the failure of reflux of excess
money may not necessarily decrease the demand for credit money. As for the second, the
question still remains that why the money holdings need to be maintained when the credit
system can create its own forms of money out of nothing.
- Lapavitsas’s explanation of Marx’s credit theory (LS 2000, p.321-22; for instance, “..the
credit system is a set of social mechanisms aimed at collecting loanable money capital and
channeling it back toward real accumulation” which is exactly the same with mainstream
loanable funds theory) directly contradicts PK’s theory. It seems to me that no Marxist writers
who are sensitive to this stark difference have directly faced this point to provide a
satisfactory discussion on how to reconcile the two. This is also true for Lapavitsas.
- Lapavitsas and Saad-Filho (2000, p.329) clearly support loanable funds theory when they
note “Banking credit involves collecting and advancing loanable capital, and results in
creation of credit money as a by-product. The sources of loanable capital comprise idle
money created in the turnover of the total social capital.”
=> I think ‘loanable funds theory vs. PK’s credit creation ex nihilo’ should not be
understood as either or. Assigning the former a dominant position implies an approach where
credit creation out of nothing is logically possible but is not unlimited as PKs think.
Lapavitsas’s position is this which I agree with. “PKs are right to stress that the supply of
credit money is credit-driven, but wrong to claim that the supply of credit itself responds
passively to its demand” (LS 2000, p.329). LS continue to note limits facing bank’s ability to
issue their liabilities.
- “…the supply of credit money is not produced by a production function relationship, but
rather as a by-product of making loans” (Moore 1998, p.8). This admits a possibility of
money supply demand discrepancy and differs from MCT. Dalziel adds “an expression is
obtained for the nominal money stock as the by-product of the demand for current investment
finance and the retirement of previous investment finance by firms” (Dalziel 1999-2000,
p.236).
- “Credit itself loosens the bond between money and commodities, just as it slackens the link
between income and expenditure.” (de Brunhoff 1978: 47)
- “Broadly speaking, the credit system is a mechanism for the internal reallocation of spare
funds among industrial and commercial capitalists; as such, it can increase the efficiency of
the process of capital accumulation, and enlarge its scope.” (Lapavitsas & Saad-Filho 2000:
321-2)
- Different forms of credit: see Wray (2007: 3)
- Pay attention to the relation between credit money and means of payment: credit money
emerges due to money’s function of means of payment. Credit money issued from the credit-
debt relation is destroyed when ‘real’ money (possessing intrinsic value) comes in as means
of paying settling the credit-debt relation.
- “rapid turnaround from creditism to metalism” (Marx; reqouted from Chae 1999:
301)
- Steuart explains the “difference between ‘real’ (metallic) and ‘symbolic’ money
[credit money] is that the former definitely settles transactions, while the latter, since
it is essentially a promise to pay, does not.” (Itoh & Lapavitsas 1999: 17)
- One of the elements that make it difficult to measure the quantity of credit money and
control it is the relative autonomy of commercial credit from banking credit and of
credit of private banks from credit of central bank. Itoh and Lapavitsas (1999: 102)
explain the autonomy as “deeply rooted in these informational relations, [i.e.
information asymmetry among these agents which is a typical feature of private
market economy.]”
- “Virtually all heterodox economists insist that money should be seen as credit money,
which simultaneously involves four balance sheet entries. Credit money (say, a bank demand
deposit) is an IOU of the issuer (the bank), offset by a loan that is held as an asset. The loan,
in turn, represents an IOU of the borrower, while the credit money is held as an asset by a
depositor. On this view, money is neither a commodity (such as coined gold), nor is it “fiat”
(an asset without a matching liability). In the first subsection, I will briefly discuss the
“creditary” nature of money. This is not (or should not be) controversial among heterodox
economists. In the second subsection, I address the nature of the money issued by the state.
Some heterodox economists have inconsistently accepted the orthodox characterization of the
state’s money as a “fiat” money, with a nominal value established by state proclamation (or
legal tender laws). It is often not recognized that even the state’s money is an IOU.” (Wray
2007: 2)
- PK’s thesis that loans make deposits: “It is worth noting that in all cases …. ‘deposit
banking develops after the public has become accustomed to using credit money. For
example, banks in Western Europe operated primarily on the basis of banknotes until the
nineteenth century, rather than as deposit banks. Knapp (1924) argues that deposit banking
cannot evolve until the public has developed the ‘banking habit’, that is, that habit of
accepting banknotes. Thus, rather than acting as intermediaries from ‘depositors’ to
‘borrowers’, early banks make ‘loans’ by issuing banknotes; that is, they financed their
position in assets by creating liabilities.
- Instability of credit money: See Grundrisse 131
- Is credit money – such as banknotes and bank deposits – different from money proper?
-> In Marx, yes, I think. “The private banknote is, after all, a mere private promise to pay by
a bank, the creditworthiness of which cannot be immediately general” (Lapavitsas 1991,
p.312). See Lapavitsas (1991, p.313; in green).
<Quantity of credit money>
- “Thornton stressed that the price at which monetary credit is traded, i.e. the rate of
interest, is critical for determination of the quantity of credit money.” (Lapavitsas 2000: 649)
- Does credit money have only means of payment as its function excluding function of
means of exchange or hoarding?
- Credit money is distinguished from money-proper (as Lapavitsas 1991 does), but in what
sense? How are they distinguished when credit money plays all three functions of money?
HW: In that the basis of credit money’s acceptability (or value), which is the creditworthiness
of, at most, the state, or the world government, which is non-existent, is much weaker than
that of money-proper, i.e. metallic money.
- “Banks more often lend rights to draw (or deposit rights) than actual cash, partly because of
the greater convenience to borrowers, and partly because the banks wish to keep their cash
reserves large, in order to meet large or unexpected demands” (Fisher 1911, p.35).
- When lending, bank give the borrower either the right to draw deposits or banknotes. So in
the simplest case, banks make loans in the form of cash, banknotes, or deposit accounts.
(Fisher 1911, p.35, 38).
- Mill (1871) recognized so well the presence of other assets in the circulating medium and
the role of credit in determining prices (Laidler 1991, p.17).
- “The debts themselves can be, and usually were, private debts, but in principle, social
institutions could also step in and supply such instruments” (Arnon 2010, p.60).
+ Various methods of creating credit money, or credit instrument
-
* CURRENCY
- “If we confine our attention to present and normal conditions, and to those means of exchangewhich either are money or most nearly approximate it, we shall find that money itself belongs to a general class of property rights which we may call "currency" or "circulating media." Currency includes any type of property right which, whether generally acceptable or not, does actually, for its chief purpose and use, serve as a means of exchange. Circulating media are of two chief classes: (1) money; (2) bank deposits,” (Fisher 1911).
* CONVERTIBILITY, INCONVERTIBLE MONEY
- Laidler (1991, p.9-10) presents the same idea of mine as for the inconvertible monetary
system; there he says that in the classical period, inconvertibility was an exception and
commodity money based system was a norm. Then how should we understand the classical
economists’ adherence to the quantity theory of money when it is the case that, as Glasner
(1985) and others have shown, the QTM holds only in the inconvertible monetary system?
This can be explained from their peculiar definition of money and value, i.e. money as a mere
means of exchange and value as a fictitious value.
- Historically, inconvertibility in Marx’s day in 19 th century was only temporary, exceptional
event. But this was no longer the case since the first world war.
- “For Marx, convertibility prevents inflation not by the risk of gold drains and the
international specie-flow- mechanism as in Ricardo’s theory, but by the law of reflux: namely,
that notes are issued only when they are needed by capitalists.” (Likitkijsomboon 2005: 163)
- “Marx uses the general equivalent theory of money to analyze several outstanding problems
in monetary theory of the nineteenth century … But Marx’s treatment of the problem of paper
money issued by the State without any guarantee of convertibility into gold at fixed rate is of
considerable interest.” (Foley 1986, 25)
- “If the State issues more paper than can be absorbed by circulation, agents will try to get rid
of the excess paper money by using it to buy gold. This attempt creates a market for the
exchange of paper money and gold and a price in that market, usually called the discount of
paper against gold …. The excess issue of paper money by the State raises the prices of
commodities in terms of paper money through the mechanisms of the discount between paper
and gold.” (Foley 1986, 26; emphasis in the original.)
- As above, Foley admits the QTM result in case of paper money in Marx. But he points out
how Marx’s analysis and its result are different from QTM: i) In QTM, Q -> P holds for both
paper money and gold money while in Marx it applies only to paper money not to gold; ii)
QTM explains the mechanism of the rise in prices as lying in “excess demand in the market
for all commodities as agents try to spend excess money holdings.” Yet in Marx the
mechanism has nothing to do with such excess demand “because it works through the market
in which the paper money exchanges against gold; thus the change in paper money prices are
merely a reflection of the discount between paper and gold.” (Foley 1986, 27)
=> Both i) and ii) hold in Moseley’s approach. Then what is the point of Foley’s critique of
the latter? -> “This analysis cannot, however, be the basis of an explanation of the value of
money in contemporary monetary systems where there is no money commodity. The essence
of Marx’s treatment of this problem is that gold continues to function as the general
equivalent commodity when the paper money issued. In contemporary monetary systems
there is no comparable money commodity against which paper money can be discounted.”
(Foley 1986, 27)
=> This is a very strong critique of Moseley & Saros’ approach. What would be their answer?
Are their approach based on insisting the commodity theory of money still in the
contemporary non-commodity money regime?
- “…currency inconvertibility may also lead to extra money inflation instead or in spite of the
crisis, because it reduces the constraints imposed by convertibility upon speculative booms,
and because inconvertibility allows the mismatch between the structure of supply and the
composition of demand to increase sharply, which can be an important cause of the crisis”
(Saad-Filho 2002, p.351).
- Saad-Filho (2002, p.351) comments that inconvertibility may smooth out the cycles,
however it may lead to permanent inflation. See p.352 for the references for this statement.
- “In 1870, specie convertibility, and in Britain in particular gold convertibility, was regarded
as a sine quo non of sound monetary management” (Laidler 1991, p.42).
* CYCLE
- In pointing out that classical economists explained cycles as caused by financial fluctuation
and very gradually and slowly realized that real factors also contribute to cycle, Laidler
(1991, p .45) mentions that this is in contrast to Marx, for whom cycle was real cycle and
who ‘barely discussed price fluctuation and financial factors”. This is deadly wrong.
- Output fluctuation was systematically integrated into theories of cycle only by Marshall in
1879.
- While today’s economics has ‘business cycle’ theory which deals with fluctuations of real
variables, classical economics had ‘credit cycle’ theory dealing with those of the volume of
bank credit, money supply, interest rates and prices (Laidler 1991, p.41)
* ENDOGENOUS MONEY
- “the point made by endogenous money theorists is that we don’t live in a fiat-money
system, but in a credit-money system which has had a relatively small and subservient
fiat money system tacked onto it …. Calling our current financial system a “fiat money”
or “fractional reserve banking system” is akin to the blind man who classified an
elephant as a snake, because he felt its trunk. We live in a credit money system with a
fiat money subsystem that has some independence, but certainly doesn’t rule the monetary
roost—far from it” (Keen 2009).
- “This feature of monetary systems was already well recognised by Wicksell: “No matter
what amount of money may be demanded from the banks, that is the amount which they are
in a position to lend. . . The ‘supply of money’ is thus furnished by the demand itself.”
(Wicksell 1898 [1936, p.110-11]).
- Rousseas’ comments: “Keynes did not assume a perfectly elastic money supply, for if the
money supply is automatically endogenous all along the line, then the finance motive
becomes a trivially ephemeral and unimportant novelty” (Rousseas 1986, p.44). “And to
argue that the central bank fully accommodates any and all increases in the demand for
money not only overstates the case but eliminates banks as a barrier to increased investment.
If blame is to be apportioned properly, most of it should go to central banks captured by
monetarist counterrevolutionaries. Money does matter in the short run and it does affect the
level of investment, and hence output and employment, when, on a mistaken notion of the
cause of inflation, its quantity, is severely restricted” (45).
* FRIEDMAN
- In Friedman (1985), the position seems to have converted from the money demand
approach to QT to the original exogenous money stock approach (Rogers 1989, p.8).
- Friedman admits that Defining V as PY/M is not exactly correct but just for a convenience
due to a difficulty of measuring V, which should have independent determinants. In such
definition, V is treated as a residual or ‘statistical discrepancy’ that renders the equation
correct (Friedman 1970, p.198).
- Comparison between different versions of QT
Fisherian transaction
approach
Income approach Cambridge cash-
balances approach
Important
aspect of money
General purchasing
power; Money is
transferred; various
institutions and
technicalities of
payment is
emphasized.
Temporal abode of
purchasing power:
Money is held; Money
as asset;
Important
function of
money
Means of exchange
and payment
Store of value (Both
demand and time
deposits are included
in money
- Each of these does not exclude the other.
- Cash-balances approach fits better to Marshallian demand and supply framework.
+ Keynes’ approach
- Replaced the equation of exchange identity with income identity with stable
consumption propensity.
- Three points of Keynes in refuting QT (206).
- The first point proved false by the fact that Keynes ignored the wealth variable in
consumption function.
- On Keynes: p.207-
- Keynesians: M -> i -> k -> y (real income). For Keynes on this mechanism, there is
something unclear in Friedman’s discussion. In one place he says that Keynes actually took
changes in M being entirely reflected in change in k even though Keynes also made a general
argument that in the SR change in M would be lead to changes in k or y or both. In the other
place Friedman says that for Keynes k embodies the liquidity preference which depends on
the interest rate and that the interest rate is also a price variable and thus varies very slowly.
Then in Friedman’s discussion, Keynes’s mechanism that leads changes in M to changes in k
is missing. Keynesian some decades of Keynes no longer consider the interest rate as
institutional data and attribute more significance to the quantity of money than Keynes did
(Friedman 1970, p.211). What this means is this: For Keynes in GT, i is determined not by
the quantity of money (as according to the loanable funds theory) but by the liquidity
preference, which in turn is determined by various objective and subjective elements of the
economy and investors.
- Friedman defines the Keynesian approach as conceiving prices as institutional data;
traditional Marxian theory is on the same page with the Keynesian theory in that it also
explains prices to be determined from the real sides of the economy, not from the monetary
sides.
* DEPOSIT
- “For Marx and Cannan bank deposits are sums of money lent to banks by depositors. They
held the same view as that of the banker Walter Leaf in his book Banking (1926, p.102): The
banks can lend no more than they can borrow?in fact not nearly so much. If anyone in the
deposit banking system can be called a “creator of credit” it is the depositor: for the banks are
strictly limited in their lending operations by the amount which the depositor thinks fit to
leave with them. Opposed to this is a theory described by Cannon as “the mystical school of
banking theorists”, which holds that the bulk of bank deposits are “created” by the banks
themselves.” (Hardcastle 1983)
- Two types of deposits: i) people put their money in the bank (money that is lent to
the bank), ii) money that is lent by bank to people
Is it right to include both as deposit as most monetary economists do? Wouldn’t it
involve double counting?
“Deposits are created in the act of bank borrowing, as banks credit the loan
proceeds to the borrower’s account.” (Moore 1996: 91) -> I think the
horizontalism vs. structuralism comes down the creditworthiness of the issuer of
private bank money. If it is strong and stable borrowers would be content with
deposit money for the loan; otherwise, they will require the bank for cash in
which case loans and deposits will not equal to each other. In this sense,
horizontalism is based on an assumption that private bank money perfectly
performs various functions of money.
“depository money is credit money generated by the advance of banking credit”
(Lapavitsas 1991: 316) confusing……
- “The notes now circulating came into existence as the results of loans from the banks to
entrepreneurs, who pay out wages in advance of receiving the proceeds of selling the goods
which the workers produce” (Robinson 1956, p.226; requoted from Rossi 2001, p.115, fn.32).
“Bank notes are in fact recorded as a deposit in the central bank’s balance sheet
(references…). There is therefore identity between the stock of money and the sum total of
bank deposits existing, at any point in time, in the economy as a whole. The statistical
definition of money (M0~M4, etc.) focuses indeed on these stock-magnitudes” (Rossi 2001,
p.116, fn.32).
- “One has in fact always to remember that paper money is just the representation of a bank
deposit, and that the transmission of bank notes between agents implies the transfer of the
corresponding drawing right (purchasing power) over current production, recorded within the
banking system” (Rossi 2001, p.107). “..every bank-note corresponds to a book-entry of
which it is the mere “image”” (Cencini 1988, p.58; re-quoted from Rossi 2001, p.107). “…
any payment within the national economy is tautologically a monetary transaction carried out
through the bookkeeping records of the domestic banking system” (Rossi 2001, p.107).
- “Recall that bank notes and coins are the material representation of a bank deposit, to wit, a
deposit in central bank money” (Rossi 2001, p.158, fn.54).
- In Lapavitsas (1991) where a very good Marxist analysis of credit money – banknote and
deposit – is presented, the causal relation between bank credit (loan) and deposit is still
unclear. For instance, in one place it is stated “money deposits are claims against banks which
are generated as money hoards are concentrated and lent out” (315); while in the other
“depository money is credit money generated by the advance of banking credit” (316). From
these and others it is unclear whether Lapavitsas identifies deposits with hoards, in which
case it follows that deposits makes loans, or whether they are conceived as different based on
the proposition that loans – i.e. bank’s lending out hoarded money – makes deposits.
Lapavitsas seems to adhere to the former; for example, he writes “Hoard creation by
individuals out of private income brings banknotes back to the banks to be transformed into
depository claims” (317). But this type of confusion is prevalent even in the Post Keynesian
literature; we could understand this by distinguishing between individual perspective and that
of society. Still however, Marxian theory of credit in general seems to be closer to ‘deposit
making loan thesis’ i.e. loanable funds theory.
- Classical economists – first Pennington and Boyd – recognized the identity between
deposits and notes as for the function of means of exchange, or currency. Yet, Boyd made a
slight distinction between ‘passive circulation’ for the former and ‘active circulation’ for the
latter (Viner 1937, p.244). See Viner (1937, p.243~) for more.
- Difference between deposits and notes: Fisher (1911, p.19), For Fisher (1911, p.38; 1912,
p.137) deposits are means of exchange (or as is the same thing, currency) but not money
while banknotes are both. Further distinction is for currency; bank deposits themselves which
checks or deposits account represent are ‘currency’ while checks are not currency; “The chief
difference is a formal one, the notes circulating from hand to hand, while the deposit currency
circulates only by means of special orders called "checks”” (1911, p.32). Excluding deposits
from money represents his theoretical root in the Currency school as opposed to Banking
school? Viner writes as if treating deposits and checks on them identically.
- Fisher treats bank deposits and banknotes as similar each other in the sense that they are
liabilities of the bank, i.e. the latter has to redeem them on demand: “Besides lending deposit
rights, banks may also lend their own notes, called "bank notes." And the principle governing
bank notes is the same as the principle governing deposit rights. The holder simply gets a
pocketful of bank notes instead of a bank account. In either case the bank must be always
ready to pay the holder — to "redeem its notes" — as well as pay its depositors, on demand,
and in either case the bank exchanges a promise for a promise. In the case of the note, the
bank has exchanged its bank note for a customer's promissory note. The bank note carries no
interest, but is payable on demand. The customer's note bears interest, but is payable only at a
definite date” (Fisher 1911, p.35).
- Wicksell is an exception among the quantity theorists in that he makes a distinction, as for
functions of money, between means of exchange and store of value (Wicksell 1898, p.22).
- See Fisher (1911, p.35)
- Reserves are required for the defense of deposits but not for banknotes.
- The currency school’s case for arguing that deposits bore a fixed proportion to notes:
Norman claimed that “the volume of deposits and bills of exchange was dependent on the
volume of underlying credit, which in turn was regulated by the amount of bank notes and
coin, and that in any case the influence on prices of these "economizing expedients" was only
"trifling and transient” (Viner 1937, p.251).
-EUREKA!!!! The reason why economists – or the currency school people – have tended not
to include deposits into the category of money is strongly implied in Fisher (1911, ch.3). In
sum, deposits are not a direct represent of money but merely a right to draw. Due to a
fractional reserve practice, those rights do not have a complete correspondence to money in
banks. (Checks are a certificate of those right.) Basically, this position conceives only M1 as
money but not M2, M3, etc.
Another important reason: Classical economists conceived money mainly as means of
exchange; those that are not active in circulation are not money.1 This is why deposits are
excluded from the category of money. On the other hand, modern economists recognize the
store of value as an important function of money and thus consider deposits as money.
Laidler (1991, p.8) insightfully explains this difference from the difference in method. That
1 Laidler (1991, p.8) writes that there was only one exception to the classical economists’ ignorance of money’s function of store of value and hoard (asset); it was Mill, who only points this in passing. When he says this, Laidler seems to not have Banking School in mind for whom money is a store of value as well. In particular, Marx.
is, conceiving money as a store of value or assets presupposes an individualistic micro
framework as in the modern portfolio theory whereas money as means of exchange does not
and only requires the equation of exchange, which was the macro framework for classical
economists.
What is Wicksell’s view on this? On one hand, he shares the same view with the quantity
theory on money that its only function is the means of exchange. But he conceives deposits
broadly as means of exchange awaiting temporarily to be used in transaction (thus he was
able to include deposits into the category of money while Fisher was not). On the other hand,
in some place Wicksell recognizes money’s function of a store of value. -> Wicksell treats
the two functions of money – means of exchange and a store of value is indistinguishable.
- For a very clear explanation in comparison to banknotes:
http://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Bank-Notes-
And-Deposits-Differences.html#.UQlvOb9X2Sq
- Deposit vs. hoarding: Hoarded money is money out of circulation. Currency school writers
conceived deposits as hoarded money and excluded them from the category of money since
for them money is nothing but means of circulation and therefore money out of circulation is
not money. As private bank money tends to replace cash with the development of banking
system, we could categorize demand deposits as money in circulation while time deposits as
hoarding out of circulation since the latter cannot be immediately used for transactions.
- Schumpeter’s very insightful view and critique of the traditional view of Cannan, according
to which deposits are similar to deposit of things for safe custody (Schumpeter 1954, p.1113-
4).
* DEMAND FOR MONEY
- History of theories on demand for money: McCallum & Goodfriend 1987, 122- ;
- Literature: See section 2 of Kim, Shin, Yun (2012), Judd and Scadding (1982).
- See the TREATISE ON MONEY section
- It should be distinguished from demand for credit or demand for nonmoney financial assets.
– In PK, money is created by credit, demand for money and demand for credit is positively
related.
* DICHOTOMY
- “…the method of analysis dichotomizing economics into two specialized departments, real
and monetary, is harmful and defective. We must deal with the economy as a whole uniting
and interlinking the two subsystems” (Morishima 1992, p.184).
* EQUATION OF EXCHANGE
- Historical origin: Bordo 1987, Milgate 1987. Viner 1937, p.249, fn.613.
- Controversy on whether it is an identity or equilibrium condition: See Rossi 2001, p.67
- Extended version where M includes money outside of the sphere of circulation is suggested
in Tao (2002 “Mismatch”, p.10) Tao says that this comes closer to Fisher’s original spirit.
- “The equation of exchange is a statement, in mathematical form, of the total transactions
effected in a certain period in a given community. It is obtained simply by adding together
the equations of exchange for all individual transactions” (Fisher 1912, p.140). Fisher calls
each side of the equation, money side and goods side.
- “The equation shows that these four sets of magnitudes are mutually related. Because this
equation must be fulfilled, the prices must bear a relation to the three other sets of magnitudes
— quantity of money, rapidity of circulation, and quantities of goods exchanged.
Consequently, these prices must, as a whole, vary proportionally with the quantity of money
and with its velocity of circulation, and inversely with the quantities of goods exchanged”
(Fisher 1912, Elementary p.142).
- Hicks grumbles about the preoccupation of monetary theorists on the equation of exchange, which
“has all sorts of ingenious little arithmetical tricks performed on it”. He suggests that marginal utility
theory, which is the basic framework for the theory of value, has to be used in the theory of money as
well; in this direction the main aim would be to demonstrate that money has marginal utility and that
is why the public demand it. Hicks attributes this way of theorization to Keynes’ liquidity preference
theory and suggests that the latter’s influence on Milton Friedman’s theory of demand for money
should be well recognized. http://uneasymoney.com/2013/08/06/hicks-on-keynes-and-the-theory-of-
the-demand-for-money/
* IRVING FISHER
- “Fisher’s theory of appreciation and interest, as he advised his readers many times, was
based on the crucial distinction between periods of full equilibrium and those of transition, or
disequilibrium” (Rutledge 1977, p.204).
- Fisher’s distinction between LR and SR analysis of the equation of exchange and
recognition of the significance of the transition period (SR) can find its root in the classical
quantity theorists. Laidler (1991, p.17-19) shows that Mill and Cairnes understood the SR
transmission mechanism from monetary expansion through interest rate adjustment to some
real effects.
- “Equation (5.3) incorporates the idea of transition periods outlined above. Fisher made it
clear that velocity is far from being constant (Wood, 1995, p. 104; Fisher, [1911] 1985, pp.
55, 63, 64, 320). Moreover, velocity is a function of expected price changes or the expected
inflation rate. The positive correlation between velocity and expected inflation seems to be a
major assumption in theories following the quantity theoretic tradition, as the Chicago School
and the Cambridge approach (see Patinkin, 1969, pp. 50, 51; Laidler, 1991b, pp. 292-293;
Tavlas and Aschheim, 1985, p. 295)” (Loef & Monissen 1999, p.10).
- After a detailed elaboration on deposits (M’) Fisher arrives at a conclusion that an inclusion
of them into the equation of exchange does not change the causal relation between money
and price (Fisher 1911, p.42-43).
- In explaining the credit cycle Fisher (1911, ch.4) concludes that the most important element
that disturbs the equilibrium bringing about cyclical fluctuation is the quantity of money.
- Anti-QTM in Fisher:
- After demonstrating various cases of change in equation of exchange, “Finally, if there is
a simultaneous change in two or all of the three influences, i.e., quantity of money, velocity
of circulation, and quantities of goods exchanged, the price level will be a compound or
resultant of these various influences. If, for example, the quantity of money is doubled, and
its velocity of circulation is halved, while the quantity of goods exchanged remains constant,
the price level will be undisturbed. Likewise it will be undisturbed if the quantity of money is
doubled and the quantity of goods is doubled, while the velocity of circulation remains the
same. To double the quantity of money, therefore, is not always to double prices. We must
distinctly recognize that the quantity of money is only one of three factors, all equally
important in determining the price level” (Elementary p.145).
- Using the graphical demonstration (fulcrum) of the equation of exchange, “In general,
any change in one of these four sets of magnitudes must be accompanied by such a change or
changes in one or more of the other three as shall maintain equilibrium” (Elementary p.147).
We don’t find any logical necessity in this statement leading to QTM. But that is what Fisher
does in EPE and PPM. For example, see Fisher (Elementary p.149~); here, after stating the
above-quoted remark, it is maintained that the third element, the quantity of money, is the
most important due to the peculiar nature of money; according to Fisher’s following
explanation, its peculiarity is that, contrast to other goods, it attains its value not from itself
but from its role of medium of exchange. This is exactly the same as the logic used by the
classical quantity theorists. Hume, in this reasoning, for example, characterized money as
having ‘fictitious value’. Now, understood in this way, destroying the logic of QT becomes
very easy; just to show that what Fisher characterizes as a peculiarity of money is not
money’s only aspect, i.e. money also has a hoarding function.
- “The factors in the equation of exchange are therefore continually seeking normal
adjustment. A ship in a calm sea will "pitch" only a few times before coming to rest, but in a
high sea the pitching never ceases. While continually seeking equilibrium, the ship
continually encounters causes which accentuate the oscillation. The factors seeking mutual
adjustment are money in circulation, deposits, their velocities, the Q's and the p's. These
magnitudes must always be linked together by the equation MV + M′V′ = ΣpQ. This
represents the mechanism of exchange. But in order to conform to such a relation the
displacement of any one part of the mechanism spreads its effects during the transition period
over all parts. Since periods of transition are the rule and those of equilibrium the exception,
the mechanism of exchange is almost always in a dynamic rather than a static condition”
(Fisher 1911, p.51).
- Fisher’s description of ‘transition period’ in chapter 4 does invalidate QTM as conceded
by Laidler (1991, p.78). But Laidler insists that Fisher’s version of QTM provides insight into
the ‘secular’ behavior of price. However, Fisher also writes that transition periods are normal
conditions of the real workings of the economy.
- For Fisher, the general price level means the weighted average price of all goods
(Elementary, p.147).
- Credit cycle in PPM ch.4: “It is the lagging behind of the rate of interest which allows the
oscillations to reach so great proportions”. At the end of the chapter Fisher quotes Marshall
and it shows that Marshall’s account is exactly the same with Fisher’s credit cycle theory.
- Laidler (1991, p.64) says that Fisher was interested in analyzing the determinants of ‘the
value of money’ to invoked the title of Pigou’s 1917 paper.
- Marshall’s superiority over Fisher (on the interest rate analysis) is his demonstration of the
sequence “increase in money -> decrease in interest rate -> increase in investment which
raises prices”, which is lacking in Fisher. Notice that this is just Marshall’s analysis of
‘transition period’ while he basically treated the interest rate as a real variable, by which it
means that “the supply of gold exercises no permanent influence over the rate of discount”
(Laidler 1991, p.65-66). However, Laidler (68) points out that the first part of the chain is not
Marshall’s original contribution but could be traced to Hume. (What about Hume’s
proposition that interest rate is not determined by the quantity of money?)
- Fisher was aware of the importance of distinguishing between absolute and relative prices.
And this is similar to Marx.
- Fisher’s monetary model of ‘compenstated dollar’ and another one for price stabilization
through open market operation in 100% Money are well described in Humphrey (1990).
- A fatal fallacy of Fisher: to assume a fixed level of desired deposit holding. Even though
this can be true for money, it is not for deposits. More deposits, better it is. Can there be a
notion of surplus deposits exceeding some desired level? No.
- Emphasis on the priority of analysis of the general price level to that of individual prices:
106~
- Summary: 109-10.
- “The Business Cycle Largely a ‘Dance of the Dollar,’” (1925) where Fisher attributed business cycles
to changes in the value of money.
* INFLATION
- Dalziel (2001)’s discussion of six English-speaking countries’ experience shows that in 70s
income policy – freeze on wage and price – was used to control inflation, and in late 70s and
early 80s monetary constraint was used, and these two episodes proves they were successful.
But monetary constraint policy was abandoned in late 80s due to the break of the stable
relation between monetary growth and inflation. This abandonment led to a rebound of
inflation, which brought about in 90s a reform in monetary policy to adopt a direct control of
inflation rather than an indirect one through monetary target.
* INTEREST RATE
- Exogenous/endogenous interest rate: The Fed can determine the Federal Funds rate but
practically, it set it both according to a reaction function and in response to the economic
situation as the lender of last resort. In this sense, it is hard to say that the interest rate is
totally exogenous as horizontalists would say. See Pollin (2008, p.3,4).
- “The decision to finance expenditure by borrowing, however, is simultaneously a decision
not to run down existing holdings of liquid assets. Deficit units commonly do run
simultaneous debit even though the cost of credit exceeds (sometimes by a large margin) the
return on deposits. The difference, or “spread” between … the rate charged on advances, and
the rate paid on deposits, may be taken as indicating the real cost of liquidity.” (Howells &
Mariscal 1992, 381)
- In Hume, interest rate does not depend on the quantity of money (“Of Interest”, p.12-13).
- Interest rate and prices
i) The classical view (Ricardo, etc.): low i -> high I -> increase in P -> deficit trade balance
-> outflow of golds -> decrease in P
ii) Tooke: low i -> outflow of money capital searching for a better investment opportunity -
> decrease in P (However, Wicksell (1898, p.112 fn) reports that Tooke admitted some
validity of the Classical view. And he supports the first view)
- In Keynesian IS-LM framework, the interest rate is determined in the money market
independently of goods market; in the latter it is investment and consumption expenditures
and associated employments that are determined and ultimately the income. This is in
opposition to what Keynes called classical system where there is no separate consideration of
money, which is a mere veil, and the interest rate is determined by the interaction of
investment and saving in the goods market, which is a loanable funds theory. In this sense,
Keynesian story has the monetary interest rate contrary to classical system which has the real
interest rate. The importance of the monetary rate of interest was pointed out by Marx before
Keynes: See CIII 645, especially, “to day that the demand for money capital and hence the
interest rate rises because the profit rate is high is not the same as saying that the demand for
industrial capital rises and that this is why the interest rate is high” (CIII 645).
* ASSET & LIABILITY MANAGEMENT
- Reference: Lavoie 1992, p.212; Moore 1989 “A Simple Model of Bank Intermediation”,
p.13-20); Goodhart 1989 “Hs Moore become too horizontalist?” 30-2.
- Liability management:
- Borrowing in the interbank market. This could “provide banks with reserves
independently of the central bank. Banks borrow from the central bank when their ability to
procure reserves through liability management reaches its limits” (Lapavitsas & Saad-Filho
2000, p.311-12).
- Lavoie (1999, p.105)
- “One way to characterize liability management is as a means of attracting funds out of demand deposit accounts, which have relatively high reserve requirements into CDs, the federal funds market, Eurodollars, and similiar instruments within the short-term money market” (Pollin 1991, p.)“Liability management requires that intennediaries with insufficient reserves to meet loan
demand pay market interest rates for funds acquired through federal funds borrowing,
repurchase agreements, issuing certificates of deposits or similar practices.I ntermediariesw
ill acquiesce in paying marketr ates on such instruments only if they could not expect to
obtain the funds they need more cheaply and/or readily through accommodative open market
operations and discount window borrowing, frown costs included” (Pollin 1991, p.370).
* LIQUIDITY PREFERENCE
- Keynes’ formulation of liquidity preference in the GT …. was a watered down version of
his richer analysis of the demand for money in the Treatise” (Rousseas 1986, p.31). His
theory of liquidity preference in the GT was a step back from his analysis of the demand for
money in the Treatise.
* LOANABLE FUNDS THEORY
+ Criticisms:
- Schumpeter: The presence of bank “alters the analytic situation profoundly
and makes it highly inadvisable to construe bank credit on the model of
‘existing funds’ being withdrawn from previous uses by an entirely
imaginary act of saving and then lent out by their owners. It is much more
realistic to say that the banks ‘create credit’, that is, that they create
deposits in their act of lending, than to say that they lend the deposits
that have been entrusted to them. And the reason for insisting on this is
that depositors should not be invested with the insignia of a role which
they do not play. The theory to which economists clung so tenaciously
makes them out to be savers when they neither save nor intend to do so;
it attributes to them an influence on the ‘supply of credit’ which they do
not have. The theory of ‘credit creation . . . brings out the peculiar
mechanism of saving and investment that is characteristic of full fledged
capitalist society and the true role of banks in capitalist evolution. . . . this
theory therefore constitutes a definite advance in analysis” (Schumpeter
1954, 1114).
- Bertocco (2009, p.618-19) describes the loanable funds theory as
asserting ‘substantial neutrality of bank money’ for two reasons: i) the
presence of bank money does not affect the natural rate of interest, ii) the
monetary authorities can achieve money neutrality by targeting money
rate of interest at natural rate.
* MILL
- See Wicksell (1898, p.85)’s dismiss.
- Admits the validity of Banking School’s endogenous theory of money but only in the
periods of tranquility. The relies on the reflux channel of bank deposits (Wicksell 1898, p.85-
6).
* MODEL, MODELLING
- “ …… the relationships in their dynamic setting treat causality as running unidirectionally
from the independent variables on the right side of each equation to the dependent variables
on the left. True, the modern theorist versed in formal equilibrium analysis may question this
mode of reasoning. Accustomed to thinking in terms of a system of equations simultaneously
satisfied by a set of ariables, he or she would argue that it makes no sense to think of one
variable adjusting first and thus causing another to adjust, and so on. Nevertheless, it is just
this sort of chain of causation that lies at the heart of Wicksell’s inflation mechanism and of
the active versus passive money debate” (Humphrey 2002, p.65).
* MONETARISM
- “The closest the Federal Reserve came to a "monetarist experiment" began in October 1979,
when the FOMC under Chairman Paul Volcker adopted an operating procedure based on the
management of non-borrowed reserves.11 The intent was to focus policy on controlling the
growth of M1 and M2 and thereby to reduce inflation, which had been running at double-
digit rates. As you know, the disinflation effort was successful and ushered in the low-
inflation regime that the United States has enjoyed since. However, the Federal Reserve
discontinued the procedure based on non-borrowed reserves in 1982. It would be fair to say
that monetary and credit aggregates have not played a central role in the formulation of U.S.
monetary policy since that time, although policymakers continue to use monetary data as a
source of information about the state of the economy.” (Bernanke 2006)
- “….the ‘contemporary incarnation’ (Congdon, 1978, p.3) of the (still) dominated theory,
which considers the purchasing power of money as the reciprocal of the general level of
prices” (Rossi 2001, p.64).
- Achilles heel: Bernanke & Blinder (1988, p.438)
- See Friedman, B. (1988) for the breakdown of money stocks and macro variables.
* MONETARY POLICY
+ Channels:
- Expectations channel:
- Risk-taking channel: Borio & Zhu (2008)
* MONEY
- Definition:
- Fisher (1911, p.19~): Primary vs. fiduciary money “The chief quality of fiduciary
money which makes it exchangeable is its redeemability in primary money, or else its
imposed character of legal tender”.
- Relation between credit money and paper (symbolic, token) money: “Bank notes and all other fiduciary money, as well as bank deposits, circulate by certificates oftencalled "tokens." (Fisher 1911).
- Currency: coin and notes backed by specie. A broader notion would be ‘circulating medium’
that includes bank deposits.
- Difficulty with money: “In practice, money is a most convenient device, but intheory it is always a stumbling-block to the student ofeconomics, who is exceedingly prone to misunderstand itsfunctions (Fisher 1912, p.134)”.
- After discussing how early classical writers conceived money, Viner writes “But the whole
discussion as to what is and what is not "money" retains the appearance of significance only
while velocity considerations are kept in the background”. “Moreover instruments which
were not money at some particular moment could be so at some other moment. In this
connection bills of exchange, time deposits, and overdraft privileges could be regarded as a
sort of "potential money” (Viner 1937, p.248).
- “There is no denying that views on money are as difficult to describe as are shifting clouds”
(Schumpeter 1954, p.289).
- “…assets are part of the money stock if and only if they constitute claims to currency,
unrestricted (at par). This principle rationalizes the common practice of including demand
deposits in the money stock of the US, while excluding time deposits and various other
assets.” (Eatwell et al. 1987, 118)
- On the reference for ‘metallists vs. cartalists’ debate see Zazzaro 2003, fn.4.
+ Origin of Money:
- “Indeed, although [metalist and chartalist] are mostly presented as divergences on the
logical origin of money (Wray, 1993; 2000; Ingham, 2000), often it is only its historical
origin that is in dispute. More precisely, given the inevitable absence of conclusive
evidence about the true origin of money, the real problem under discussion is which of the
possible historical origins of money is the most logically convincing” (Zazzaro 2003, p.9).
“Besides the historiographic and anthropological econstructions so brilliantly summarised
by Einzig (1966), an interesting attempt to offer some statistical evidence to test the
various hypotheses on the origin of money is offered by Pryor (1977), who finds slight
evidence in favour of the theory that sees money as a means of payment precede money as
a medium of exchange on the economic development scale” (Ibid, p.33).
+ Real Money:
- “Real money is what a payee accepts without question, because he is induced to do so by
" legal tender " laws or by a well-established custom” (Fisher 1912, p.138).
- Fisher distinguishes ‘primary money vs. fiduciary money’ (Fisher 1912, p.139) for
‘commodity money vs. non-commodity money’.
- Monetary base could be conceived of as being consisted of money in reserves and money in
circulation. The former is money kept in banks such as vault cash and reserves at central
banks, the latter being coins and notes in the public. Fisher (1911, p.41-42) shows that
deposits are in a fixed ratio to each.
- Fisher distinguishes money and deposits and categorizes three goods, i) money, ii) deposits,
iii) other goods. From this, we have six different types of exchange (Fisher 1911, p.39-40). I
think this is a very useful approach.
- The gap between classical and neo-classical on money is that between money as a social
institution and money as an object of individual choice, the latter in the sense of related to
demand for money (Laidler 1991, p.41).
- Similarly to Fisher, Wicksell points out the peculiarity of money as means of exchange (29).
Remind that Fisher, in explaining why he treats the quantity of money so a special variable
within the equation of exchange, notes that money is a means of exchange.
- Keynes’ definition: “Leijonhufvud has argued, and I believe correctly, that Keynes used the
term "money" as referring not only to currency and deposits narrowly defined but to the
whole range of short-term assets that provided "liquidity" in the sense of security against
capital loss arising from changes in interest rates ….. It is therefore somewhat misleading to
regard Keynes, as most of the literature does, as distinguishing between "money" and
"bonds."” (Friedman 1970, p.).
- Debates on QT were on the determination of the value of money, i.e. the quantity theory of
money vs. cost of production theory. Since Keynes, as Milton Friedman well described, the
focus moved to the determination of nominal income, so the quantity theory of money (which
dictates that nominal income is determined by the quantity of money) vs. income-expenditure
theory (it is investment and consumption expenditure that dietermine nominal income).
+ Real vs. Monetary:
- “[Saving and investment decisions] rests basically on the fact that in making
their borrowing and lending decisions, rational households (and firms) are
fundamentally concerned with goods and services consumed or provided
at various points in time. They are basically concerned, that is, with
choices involving consumption and labor supply in the present and in the
future. But such choices must satisfy budget constraints and thus are
precisely equivalent to decisions about borrowing and lending — that is,
supply and demand choices for financial assets. . . . Consequently, there is
no need to consider both types of decisions explicitly. . . . it is seriously
misleading to discuss issues in terms of possible connections between
“the financial and real sectors of the economy”, to use a phrase that
appears occasionally in the literature on monetary policy. The phrase is
misleading because it fails to recognize that the financial sector is a real
sector” (McCallum 1989, 29-30).
- Money: banking system liabilities, credit: banking system assets
+ DEMAND FOR MONEY:
- Demand for money related to Cambridge k is different from hoard.
- Keynes’ formulation of liquidity preference in the GT …. was a watered down version of
his richer analysis of the demand for money in the Treatise” (Rousseas 1986, p.31). His
theory of liquidity preference in the GT was a step back from his analysis of the demand for
money in the Treatise. It was essentially a bond-money model where the demand for money
was a demand for earning assets. The finance motive, however, focused on the demand for
money not as a demand for a stock of assets but as a business demand for a flow of credit
(44).
-> As can be seen from Rousseas’ comments, popularized discussions on the demand for
money are not based on a commonly accepted definition of money. Therefore, any
discussions on the demand for money should start by providing a rigorous definition of
money. But is it true that GT’s discussion of demand for money was about bond-money? I
don’t think so; in the liquidity preference function L(Y,i), i is a negative argument.
+ Keynes’s concept of money
- “Perhaps anything in terms of which the factors of production contract to beremunerated, which is not and cannot be a part of current output and is capable ofbeing used otherwise than to purchase current output, is, in a sense, money. If so, butnot otherwise, the use of money is a necessary condition for fluctuations in effectivedemand” (Keynes 1933: 86; re-quoted from Hein 2006) - Hicks grumbles about the preoccupation of monetary theorists on the equation of exchange,
which “has all sorts of ingenious little arithmetical tricks performed on it”. He suggests that marginal
utility theory, which is the basic framework for the theory of value, has to be used in the theory of
money as well; in this direction the main aim would be to demonstrate that money has marginal utility
and that is why the public demand it. Hicks attributes this way of theorization to Keynes’ liquidity
preference theory and suggests that the latter’s influence on Milton Friedman’s theory of demand for
money should be well recognized. http://uneasymoney.com/2013/08/06/hicks-on-keynes-and-the-
theory-of-the-demand-for-money/
* NEOCLASSICAL APPROACH, CRITIQUES
- For references see Rossi 2001, p.76
* NUMERAIRE
- See Passinetti 1993 Structural Change and Economic Growth, p.63-4.
* QUANTITY THEORY OF MONEY
- Origin: See Wicksell (1898, p.38, fn.1),
- Literature: Edwin Kemmerer (applied QT to the Gold Standard)
- Blaug says it is striking to see how economists failed to provide rigorous statement on
QTM. (Blaug 1995: 43)
- “The QTM was born in the sixteenth century as a response to the global price revolution set
off by the gold and silver discoveries of the New World, that is, by the attempt to explain
world inflation by an exogenous increase in the money supply; exogenous, that is, in a model
sense of the term. Nevertheless, for one country considered in isolation the change in the
money supply was endogenous because it depended on the elasticity of supply of its exports
and the elasticity of demand for its imports.” (Blaug 1995: 38)
- QTM received its greatest fillip with the suspension of specie payments in 1797, which
introduced an entire generation of monetary thinkers to the notion of inconvertible fiat paper
money and floating exchange rates, a monetary regime in which the money supply is
exogenous as it had never been before.” (Blaug 1995: 30) Marx also reports the same story:
“The suspension of cash payments by the Bank of England in 1797, the rise in price of many
commodities which followed, the fall in the mint-price of gold below its market-price, and
the depreciation of bank-notes especially after 1809 were the immediate practical occasion
for a party contest within Parliament and a theoretical encounter outside it, both waged with
equal passion.” (Marx 1970: See more on this.) The convertibility of paper money was
restored in 1821
- Three elements of QTM: i) money is exogenous, it determines price, ii) demand function of
money is stable, constant income velocity of money, iii) Y or T is determined not by M or P
but by real variables. See Blaug (1995: 29)
- See Blaug (1995: 39-40) for two versions of QTM: i) Cambridge income approach (rest
theory of money) ii) Fisher’s transaction approach (motion theory of money) ‘money ->
price’ causal mechanism almost disappeared in Fisherian transaction approach to QTM.
According to M. Friedman (1987), in income approach money is a particular asset to be held,
rather than a means of circulation to be transferred. (from Brunhoff 1997) Brunhoff (1997)
notes that in both approaches, M is a stock not a flow, and “empirically the money stock is
represented by the aggregate M2 (currency and deposits).”
- It is interesting that for Hume, who was against paper money, money only has ‘fictitious
value’ and is ‘representation of labour and commodities’ in the sphere of exchange. (See Itoh
& Lapavitsas 1999: 8)
- One of the most important theoretical features of monetary theories within the tradition of
quantity theory of money seems to be accepting Hume’s notion of ‘fictitious value’ of money.
- Two values of money which Foley emphasized already had been the controversial issue in
the classical PE. For example, Hume’s notion of ‘fictitious value’ of money; Ricardo’s
automatic equilibrium mechanism which explains how the contradiction between fictitious
value of money and the intrinsic value of money (both of which Ricardo accepted) is
resolved.
- Ricardo’s money theory allows only a means of exchange function for money.
- “The question, of course, is whether, in the case of inconvertible currency, changes in
the price level are in any sense caused by changes in the money supply. In the banking
school view, the answer to this question seems to depend on whether there is a channel
for reflux of an excess issue of money (i.e. fiat currency) in addition to the channel for
reflux of excess deposits.” (Merhling 1996: 337 See pp.337-8 more on this.)
- Discussion of a contradiction between the theory of money and the theory of value in
Ricardo (as pointed out by Marx): Clair 1957, A Key to Ricardo, p.299; De Vivo 1987,
“Ricardo, David”, The New Palgrave Dictionary of Economics eds. Eatwell, Milgate,
Newman
- “The quantity equation …. Must be drastically modified when we consider systems in
which credit plays an important role in financing transactions.” (Foley 1986, 24)
- In Marx in contrast to QTM the quantity of money adapts to the needs of circulation by the
expansion and contraction of hoards in commodity money system and by expansion and
contraction of credit in non-commodity money system. (Foley 1986, 25)
- “Still, Marx’s approach to the quantity equation is theoretically important. It suggests that
even in a monetary system with an abstract unit of account, that is, in a system in which
forms of credit act as means of payment, the correct order of explanation for monetary
phenomena runs from the needs of circulation to the mechanisms that meet those needs.”
(Foley 1986, 25)
=> This is so a simplification of the complex reality where finance plays more active roles in
affecting price system. Foley and other anti-QT writers tend to take money as a simple veil.
(But what about endogenous money theory of PK and MCA? How does this ‘money as a veil’
aspect of heterodox tendency towards anti-QTM relate to the general fact that the monetary
dichotomy of ‘money as veil’ is a typical idea of neoclassical mainstreams? Mainstream
economists admit money’s influence on price if not on output. Heterodox economists do not
even admit this. The latter has stronger classical dichotomy and money neutrality than the
former.) They also seem to strictly adhere to the real bills doctrine and the law of reflux. Cf.
“Money is active in positing commodities as values. This prefigures the dominance of buying
in order to sell (M-C-M’) in developed capitalist relations. In M-C-M’, money cannot
possibly be seen as passive because a monetary increment is set as the aim of the circuit.
Money is the most active thing there is in the economy, an important goal of any theory of
money should be to explain this.” (Arthur, 2006: 33) But active in what sense? In this passage
it is unclear or it refers merely to the notion of money the increment of which is the final goal
of capitalist production. Does Arthur also imply ‘active’ in that it affects either output or
price?
- As for the comparison between Marx and QTM, the similarity lies only at the phenomenal
level of causal relation between money and price. More fundamental aspects as for the
mechanism underlying the relation generate huge difference between Marx and QTM.
- Difference between M and QTM: Moseley
- Difference between extra money approach and QTM (Saad-Filho 2002, p.350-351): i)
exogenous vs. endogenous creation of money, ii) money neutrality in the short-run and long-
run, iii) simple (predictable) and complex (unpredictable) relation between money and price
- “The quantity theory has been one of the most bitterly contested theories in economics,
largely because the recognition of its truth or falsity affected powerful interests in commerce
and politics. It has been maintained – and the assertion is scarcely an exaggeration – that the
theorems of Euclid would be bitterly controverted if financial or political interests were
involved” (Fisher ch.2).
- As for ‘transaction’ and ‘income’ version of QTM, see Friedman (1987) “… the transaction
version includes the purchase of an existing asset – a house or a piece of land or a share of
equity stock – precisely on a par with an intermediate or final transaction. The income
version excludes such transactions completely.” “The transactions and income versions of the
quantity theory involve very different conceptions of the role of money.” (Friedman 1987, 7)
- One of the main reasons for the case of anti-QTM and anti-monetarism for the heterodox
tradition is the fact that no meaningful statement is possible with the quantity of money, or in
modern language, monetary aggregate; for both the difficulty in measuring the latter and the
instability of the empirical relationship between money growth and other macro variables as
inflation, nominal output growth, etc. If this so, Marxists’ general objection to QT should be
found elsewhere since Marx has a unambiguous distinction between money and non-money
which renders measuring monetary aggregate not difficult.
- Fisher maintained that the causal relation between money and price holds true even when
the other variables change (Fisher 1911, ch.5) -> Does he really says this? In this chapter
Fisher examines other factors outside of equation of exchange and see how they affect prices
through influencing the rest of the three variables.
- Fisher’s case for the QTM is always presupposed upon the premise ‘other things being
equal’ (Fisher 1965, p.14)
- Equiproportionality hypothesis holds on two grounds (Fisher 1911, ch.8 which is
summarized in Humphrey 1997, p.75). i) Full employment of resources in the long run;
Keynesian notion of underemployment equilibrium would undermine this point. ii) There is a
desired level of money velocity and people would tend to maintain it; First, it seems
unreasonable to presuppose the money velocity as having its own measure independent of
other variables; second, what is the meaning of the desired level of money velocity and why
should people have such level?
- “One can employ a simple litmus test: a person essentially is a quantity theorist if he
believes the monetary authority can stabilize the price level through control, direct or
indirect, of the stock of money or nominal purchasing power” (Humphrey 1997, p.85).
- CRITIQUE OF QT
- Tooke’s critique summarized in ‘seventeen conlcusions’; See Wicksell (1898, p.44)’s
comments on this.
- QTM is usually based on an exclusion of money’s function of hoard and store of value.
For example Fisher’s explanation “Suppose, for instance, that the quantity of money were
doubled, while its velocity of circulation and the quantity of goods exchanged remained the
same. Then it would be quite impossible for prices to remain unchanged. The money side
would now be $10,000,000 X 20 times a year, or $200,000,000 ; whereas, if prices should not
change, the goods would remain $100,000,000 and the equation would be violated. Since
exchanges, individually and collectively, always involve an equivalent quid pro quo, the two
sides must be equal” (Fisher 1912, p.143). Here the premise is that those extra money would
entirely be used in transaction, which precludes the possibility of hoards.
- In the interwar period, Stockholm School, influenced by Wicksell, rejected QTM as
outmoded and irrelevant, identifying it with the stable velocity of currency construction of
Wicksell’s pure cash economy special case” (Laidler 1991, p.148).
- Critical comments on the modern Neoclassical implication of QT in Nicholas (2011,
p.112-13). Some QT-look-like phenomenon whereby monetary expansion, such as a recent
quantitative easing, leads to speculative bubbles should be distinguished from the usual QT
mechanism whereby an increase of general price level is generated by the expansionary
monetary policy.
- A circular reasoning in Cambridge cash balance approach; demand for money already
presupposes some price level and the value of money. Austrian school came up with the same
answer with Moseley, i.e. money demand depends on expectation of future prices (Shand
1984, p.160-61, Nicholas 2011, p.113). Nicholas’ answer to this solution is very powerful: “it
would only provide an escape route for the Neoclassical approach if it can be assumed that
the future value of money does not depend on preferences to hold current balances” (113).
This also applies to Moseley’s answer; if we are to argue that the quantity of money depends
on the future prices, then it has to be shown in order to avoid a circular reasoning that those
future prices do not depend on the current quantity of money.
- “Classical quantity theorists, however, did not argue that velocity was an empirically stable
parameter in this sense. They were as much concerned with the cyclical interaction of money
and prices as with secular relations, and in this context they stressed not the role of a given
institutional structure in stabilizing velocity in the long run, but rather the short-run scope for
prices to vary independently of the quantity of money which that structure provided” (Laidler
1991, p.16). It was mainly Cairnes and Mill who modified and gave sophistication to the
classical QT (Ibid).
- Quantity theorists always start their exposition with an awkward assumption such as an
arbitrary overnight increase of money balance for all people. Example: Hume (1752, p.53)
Those changes in the money stock are taken as given and not explained. This shows their
exogenous money approach.
- In most case, whenever the causal mechanism from increase of money to rise of prices
is explained full employment is assumed implicitly or explicitly. Underemployment will
disappear through price adjustment in the long run. What about from the heterodox
perspective?
- Keynes’ income-expenditure approach is a critique of QT: Both have a different
explanation of income determination. For Keynes it is investment and consumption and for
QT the quantity of money that determines income.
- Formalization: Humphrey (2002),
+ CAMBRIDGE CASH-BALANCE APPROACH:
- Its first exposition in Marshal and Walras: See Laidler 1991, p.59-60. Keynes’s liquidity
theory as a refinement of earlier Cambridge monetary thought (Laidler 1991, fn.9 of ch.3)
- Cambridge people had an ambiguous distinction between income and wealth in dealing
with demand for money (Laidler 1991, p.61)
- Is based on the Walras’s Law according to which excess demand of goods should be
matched by excess supply of something else. For the quantity theorists the latter is money
(Humphrey 2002, p.67).
- One of the differences between income and transaction version of QT is the conception of
money. Income version: money is held, Transaction version: money is transferred (Friedman
1970, p.200). Friedman takes the income version as lying in between the transaction version
and Cambridge cash-balance approach.
- M in this approach includes all monetary assets that constitute the concept of money,
demand and time deposits, etc.
- Is money includes deposits as well?
- The notion of ‘excess supply of money’ is non-sense; desire for accumulation of money
has no limit. But this idea is widely accepted even in the heterodox literature. Examples:
Gurley & Shaw (1960, p.66),
- Blaug (ETP 4th ed.) p.636-37 for critique of Cambridge approach.
+ CAMBRIDGE K
- Critique by Patnaik (2009, p.37-38): i) its assumption of unit-elastic price expectation,
ii) with inside money, its argument about the real-balance effect becomes invalid as shown in
Johnson (1958) “Monetary Theory and Policy” AER, iii) its ambiguous time framework.
+ CASH TRANSACTION APPRAOCH
- Patnaik (2009, p.44) points out that transaction demand for money is logically
incompatible with the Walrasian equilibrium framework since for former presupposes a time
lag between sales and purchases, which however in the latter is absent.
- Clower (1967): See Patnaik (2009, p.44)’s summary
- Hool (1979): See Patnaik (2009, p.44)’s summary
+ MILTON FRIEDMAN
- As for the equation of exchange MV=PY, Friedman describes it as a tautology which
states that PY the nominal income is determined by either M or V (1970, p.195). The
underlying premise is the causation from the LHS to RHS. This is taken for granted. More
general and fair is to characterize the equation of exchange as an identity where the equality
always holds regardless of the direction of causation, which is a separate question.
- After stating that P (or Y when P is fixed, and thus nominal income PY) changes by
changes in k or M, Friedman (1970, p.195) defines QT as, in an analytical level, an analysis
of elements affecting k and, in an empirical level, a generalization of the relatively slow
change of demand for cash holding and fast and independent changes in money supply.
- Transaction version: important fact of money is that it is transferred and it is the general
purchasing power.
- Cash-balance approach: important fact of money is that it is held and it is a temporal
abode of purchasing power.
- See Patnaik (2009, ch.5, fn1) for monetarism’s separation of interest rate and money
supply.
- Marshall and Keynes have the opposite view from each other on the adjustment process:
For Marshall prices only and not quantity adjust in the short run while in the long run the
quantity also adjusts. Whereas, for Keynes it is only quantity but not price that adjusts in the
short run. See Friedman (1970, p.208-209) on this.
- “Keynes explored this penetrating insight by carrying it to the extreme: all adjustment in
quantity, none in price. He qualified this statement by assuming it to apply only to conditions
of underemployment. At "full" employment, he shifted to the quantity-theory model and
asserted that all adjustment would be in price-he designated this a situation of "true inflation."
However, Keynes paid no more than lip service to this possibility, and his disciples have
done the same; so it does not misrepresent the body of his analysis largely to neglect the
qualification” (Friedman 1970, p.209-10).
- More precise name is quantity of money theory of price.
- “the smaller quantity of money would perform the functions of a circulating medium, as
well as the larger” (Ricardo High Price of Bullion)
- Essence of QTM (Arnon 2010, p.58)
- Hume:
- “It is also evident, that the prices do not so much depend on the absolute quantity of
commodities and that of money, which are in a nation, as on that of the commodities, which
come or may come to market, and of the money which circulates. If the coin be locked up in
chests, it is the same thing with regard to prices, as if it were annihilated; if the commodities
be hoarded in emagazines and granaries, a like effect follows. As the money and
commodities, in these cases, never meet, they cannot affect each other. Were we, at any time,
to form conjectures concerning the price of provisions, the corn, which the farmer must
reserve ffor seed and for the maintenance of himself and family, ought never to enter into the
estimation. It is only the overplus,° compared to the demand, that determines the value” (Of
Money).
- “It is the proportion between the circulating money, and the commodities in the market,
which determines the prices” (Of Money).
- Dimand ()’s reading of Hume is misplaced; see its conclusion and compare it with
Humphrey (1982).
- Cantillon effect (Blaug 1985, p.21)
- While Humphrey (1982) made a distinction of "level vs. rate of change" of quantity of
money to make sense of Hume, Wennerfield (2005) came up with "exogenous vs.
endogenous" supply of money.
- QTM originally had the pure commodity money system at its background. The history of
QTM can be understood as a gradual emergence of theoretical challenges to it as the
monetary system gradually developed away from the pure commodity money system toward
mixture of gold and paper money. Hume included convertible banknotes in the category of
quantity of money. However, it the assumption was a perfect coverage of notes by metal. The
biggest challenge is the case of pure credit economy as in Wicksell.
- See Arnon 2010, p.167: “Many of the classicals thought the supply was endogenous to the
economic processes, and thus was uncontrollable. More specifically, they thought that, in line
with the famous Price-Specie-Flow mechanism, the supply of the monetary aggregate and the
price level are determined in such a way that, in the long run, the value of money is
determined by the value of the commodity-money” (167-68).
* PATNAIK (2009)
* QUANTITY OF MONEY
+ Literature
- Friedman, Benjamin (1988) “Monetary PolicyWithout Quantity Variables,” American
Economic Review 78, 440-45.
- “If the financial system is instead organized around thecapital market, then conventional measures of money representonly a small proportion of the aggregate size of the leveragedsector.” “The concept of liquidity we proposed earlier—the growthrate of aggregate balance sheets or, more precisely, thegrowth rate of outstanding repurchase agreements—is a farbetter measure for a modern, market-based financial systemthan is the money stock.” (Adrian and Shin 2008).
- “Our results add to the literature on the role of liquidity in asset pricing. Gennotte and
Leland (1990) and Geanakoplos (2003) provide early analyses that are based on competitive
equilibrium. As well as those mentioned in the opening to our paper, recent contributions to
the role of liquidity in asset pricing include Allen and Gale (2004), Acharya and Pedersen
(2005), Brunnermeier and Pedersen (2005, 2009), Morris and Shin (2004), Diamond and
Rajan (2005). The common thread is the relationship between funding conditions and the
resulting market prices of assets. Closely related is the literature examining financial distress
and liquidity drains” (Adrian & Shin 2010, p.436).
- “… Money, on the contrary, as the medium of circulation, haunts the sphere of circulation
and constantly moves around within it. The question therefore arises of how much money this
sphere continuously absorbs” (KI, p.213). Marx starts with this statement in explaining the
equation of exchange relation and the money/price relation within it.
- Based on Post Keynesian theory of endogenous money that “the proximate cause of changes
in the money supply is the low of net new bank lending” and the empirical observation that
the fluctuation of transaction velocity is followed by monetary growth, Howells & Mariscal
(1992) tests a hypothesis that “the flow of net new bank lending to the personal sector
depends, inter alia, upon total rather than income-related transactions.”
- Three ways of effectuating change in the quantity of money (Fisher, Elementary, p.150-51):
i) Renaming coins, ii) cutting them in two, iii) duplicating them. Fisher says that all these
three increase price proportionately.
- See Laidler (1999, p.87, fn.20) for the argument that money serving a pure store of value
should be regarded as no longer in circulation, and hence irrelevant to the working of the
quantity theory.
- Hume: What matters is not the total stock of commodities and money in the economy but
commodities coming to the market and money circulating therein (Hume “Of Money”, p.6-
7).
- For Hume, what matters for QTM is the level of quantity of money while money’s real
effect has to do with its rate of change (Humphrey 1982).
- See Wicksell (1898, p.137)
- Money supply in monetarism: Problematic since there is no way to introduce the
entry of money into the model without affecting interest rate. See Patnaik 2010, ch.2
fn.5)
- Commercial banks’ lending money to shadow banks takes a form of holding such as ABCP
not directly handing over money. This practice changes the measure of narrower measures of
monetary aggregate (See 김병기 2013, p.18).
- “Whereas traditional definitions of monetary aggregates exclude the liabilities between financial intermediaries when defining monetary
aggregates, such liability aggregates turn out to be perhaps the most informative of them all” (Shin 2012, “The search for early warning indicator”).- “The role ofmonetary aggregates as the counterpart to credit developments have been well understood bycentral bankers (see, for instance, Issing (2003) and Tucker (2007)). (Kim, Shin, Yun)
* PRICE THEORY
- The reason why classical economists emphasized the price stability and thus the relation
between money and price so much: See Laidler (1991, p.9)
- “The equation shows that these four sets of magnitudes are mutually related. Because this
equation must be fulfilled, the prices must bear a relation to the three other sets of magnitudes
— quantity of money, rapidity of circulation, and quantities of goods exchanged.
Consequently, these prices must, as a whole, vary proportionally with the quantity of money
and with its velocity of circulation, and inversely with the quantities of goods exchanged”
(Fisher 1912, p.142).
- One of the main issues is ‘real vs. monetary’ theory of price. Cost of production and QT
correspond to each. While uneasy coexistence characterizes the Classical quantity theorists,
the Cambridge economists and Fisher got rid of the real aspects of price theory (Laidler 1991,
p.83)
- What role does money play in Marx’s theory of price? The usual Marxian approach posed
as opposed to the QT and monetarism emphasizes the real aspects of price fluctuation as
opposed to monetary ones. In this sense then Marxian approach treats money as a veil which
is the same with the mainstream economics. How do we deal with this?
- “The use of money to order preference by individuals, or compute returns on inputs by
entrepreneurs, does not make it the measure of the exchangeable worth of commodities. It
does not make it the general equivalent in the process of exchange and, therefore, that which
regulates the actual exchange of commodities. This is because the use of money to set prices
which directly or indirectly reflect preferences/utility would imply, given the heterogeneity of
preferences/utility, that money in some way or another also reduces preferences/utility to
equivalence. But given the nature of preferences/utility, such a reduction would appear to be
contradictory” (Howard 2011, p.95).
- Neoclassicals do not recognize that “it is not prices that govern the allocation of resources
but rather the incomes of producers and, in particular, the profits of productive
capitalists~~~” (Nicholas 2011, p.97). They don’t either see that prices reflect “the physical
requirements of reproduction of commodities” (98; see this page for more).
- Neoclassical price theory “implies money acquires its value, and commodities their money
prices, in the process of exchange, as a result of their quantitative commensuration. It implies
money come into circulation without a given magnitude of exchangeable worth and
commodities without money prices” (Nicholas 2011, p.111).
- General Price Level:
- Hume assumed it as observable. Ricardo objected this and suggested pound price of gold
or of foreign currency, i.e. exchange rate as a good proxy. This is so as, P IP=P I
G∗PgP where P
denotes price, the subscript I includes all commodities 1, 2, ….., i, subscript g denotes gold,
superscript P implies price in terms of pound, superscript G price in terms of gold. P IG can be
replaced by P IF where superscript F implies price in terms of foreign currency. Both P I
G and
P IF provide a standard level against which the domestic price level in terms of domestic
currency can be judged whether too high or too low (Of course, in case of P IG, the gold price
used in constructing the latter is the official mint price). So if we normalize P IG (or P I
F),
according to the above equation P IP and Pg
P move in a one-to-one correspondence.
- Friedman characterizes Keynesian as “who will explicitly assert that P is “really” an
institutional datum that will be completely unaffected even in short periods by changes in M”
(Friedman 1970, p.210). Friedman’s description of Keynes’s treatment of price is exactly the
same with Foley’s: “It appends to this system a historical set of prices and an institutional
structure that is assumed either to keep prices rigid or to determine changes in prices on '-the
basis of "bargaining power" or some similar set of forces Initially, the set of forces
determining prices was treated as not being incorporated in any formal body of economic
analysis. More recently, the developments symbolized by the "Phillips curve" reflect attempts
to bring the determination of prices back into the body of economic analysis, to establish a
link between real magnitudes and the rate at which prices change from their initial
historically determined level (Phillips 1958)” (Friedman 1970, p.220). The last part, where
price change is considered from its historically determined level is exactly the same with
Foley’s assertion that Marxian price theory should start with a historical analysis of the price
movement.
- “The price level is normally the one absolutely passive element in the equation of exchange.
It is controlled solely by the other elements and the causes antecedent to them, but exerts no
control over them” (Fisher 1911).
* SEIGNIORAGE
- “Originally, seigniorage was an amount collected by the seigneur minting the currency out
of previous metals. It was equal to the difference between the face value of the currency and
the value of its metallic content” (Rossi 2001, p.115, fn.23).
* STUDIES IN MONETARY AGGREGATE
- Friedman 1956 Studies in the Quantity Theory of Money; Friedman 1960 A Program for
Monetary Stability (It advocated that monetary policy engineer a constant growth rate for the
money stock.); William Abbott;
* TEXTBOOK
- Graduate level: Jordi Gali Monetary Policy, Inflation, and the Business Cycle: An
Introduction to the New-Keynesian Framework, Woodford Interest and Prices, DeJong
Structural Macroeconometrics,
- Introductory & Intermediate: Ray Bert Westerfield 1928, Banking Principles and Practice
(all the banking and financing terminology is explained with great clarity and easiness).
* VELOCITY OF MONEY
- Literature:
- Nicholas (2011, p.193, fn.52)
- Laurent, Robert. "Currency Transfers by Denominations." Ph.D. dissertation, Univ.
Chicago, 1969; Friedman says it “extremely ingenious indirect calculation of V as opposed to
V’”. (Friedman 1970, fn.3)
- Defintion:
- “This important magnitude, called the velocity of circulation or rapidity of turnover,
means simply the quotient obtained by dividing the total money payments for goods in the
course of a year by the average amount in circulation by which these payments are effected.
This velocity of circulation in an entire community is a sort of average of the rates of
turnover of different persons. Each person has his own rate of turnover which he can readily
calculate by dividing the amount of money he expends per year by the average amount he
carries” (Fisher 1911, Elementary p.141)
- Howells & Mariscal (1992): ratio of transactions to total deposits
- Keynes in Treatise on Money makes a distinction between V1 for the velocity of income
and V2 for the velocity of ‘business’ deposits, further distinguishing the latter into that used
in industrial circulation and in financial circulation (Howells & Mariscal 1992, 377) => By
‘business’ deposits Keynes means cash deposits or transaction deposits or active balance as
opposed to long-term deposits or idle balance.
“…the volume of trading in financial instruments … is not only highly variable but has no
close connection with the volume of output whether of capital goods or of consumption
goods; for the current output of fixed capital is small compared with the existing stock of
wealth, which in the present context we will call the volume of securities … and the activity
with which these securities are being passed round from hand to hand does not depend on the
rate at which they are being added to.” (Keynes 1930, vol.1, p.222) => “Fluctuations in
financial transactions both can and will cause changes in velocity, independently of changes
in the production of final goods and services ~~~~~~” (Howells & Mariscal 1992, 377)
- Friedman admits that Defining V as PY/M is not exactly correct but just for a convenience
due to a difficulty of measuring V, which should have independent determinants. In such
definition, V is treated as a residual or ‘statistical discrepancy’ that renders the equation
correct (Friedman 1970, p.198).
- As for the ‘residual approach’ (which I term the approach where the velocity of money is
defined as a ratio of the other variables of the equation of exchange), the velocity of money
would be ‘actual’ in the sense that it is what is observed; on the other hand, we could also
think of desired levels which need not equal the actual amount. This is how Friedman (1970)
proceeds.
- “it is important to remember that the growth of liability management, seen as an alternative
means of generating needed reserves, is essentially another way of viewing the phenomenon
of rising money velocity. If we define velocity as nominal GNP/M1, then clearly an increase
in lending relative to deposits and reserves will imply that GNP should similarly rise relative
to Ml.1” (Pollin 1991).
- Friedman (1987, 8) distinguishes observed, or measured, velocity and desired velocity. The
former corresponds to what Kotz refers to and the latter to Lapavitsas and Marx.
- “A measure of total transactions has to incorporate all intermediate transactions (for raw
materials, part-finished goods); all transactions in second-hand goods (including much
spending on house purchase in the United Kingdom) and by far the greater part of financial
and speculative transactions.” (Howells & Mariscal 1992, 373) Similarly, in Marx monetary
transaction is consisted of real transaction (‘real replacement of commodities’) and financial
one (‘speculation in futures on the stock exchange etc.). (Marx 1978, 417)
- Keynes in “Treatise on Money” measured velocity as for active deposits to total
transactions, not in relation to the change in the ratio of active deposits to idle ones. Howells
& Mariscal 1992, 376) “Thus it has been usual to limit the ‘velocity of circulation,’ so far as
is practicable, to the effective money or money in active circulation and not to stultify the
conception by watering down the velocity of the money in circulation by including money
which was not in circulation at all, but was being used as a ‘store of value’ and therefore had
no velocity at all.” (Keynes 1930, vol.1, p.17; emphasis in the original)
- Bank lending could be used on anything transactions, real or financial (speculative)
(Howells & Mariscal 1992, 378) “A boom in spending of this kind, if it results in a surge in
bank lending and eventually in the money stock, must result in a fall in income velocity both
absolutely and in relation to transactions velocity.” (Ibid, 378)
- One important issue in the literature on the money velocity is to explain the divergence
between transaction and income velocities in 1980s. Howells & Mariscal (1992)’s case is “the
possibility that much of it is due to a boom in financial, speculative, and second-hand
(particularly housing) transactions” as opposed to other explanations one of which is “the
disintegration of production units and a consequent rise in intermediate transactions.” (378)
- “Within a Post Keynesian framework, it is not clear, to begin with, whether velocity as a
concept remains useful for understanding the processes through which money becomes
endogenous.” (Pollin & Schaberg 1998, 136)
- “It should also be noted that many contemporary economists operating more closely within
the quantity theory framework recognize the importance of financial innovation for
explaining changes in velocity (see, for example, Laidler 1985). What is not clear is how such
recognition squares with the stronger claims of the quantity theory approach.” (Pollin &
Schaberg 1998, fn.3)
- Velocity of money as a function of interest rate: Duck 1993 “Some international evidence on
the quantity theory of money’ Journal of Money, Credit, and Banking 25-1.
- Instability of velocity: Robison 1956.
- Money in motion vs. Money at rest (Bordo 1989, Tao 2002)
- “To understand money in motion, we must inspect its quantity, quality and velocity… the
quality of money is its purchasing power adjusted by price index P.” (Tao 2002 “Mismatch”,
p.9)
- Does not include hoards: Howells (1991, p.387),
- Treating the velocity as having a measure of its own independent from the other variables –
typically in Fisher (1911) – is strange judging from the conventional measure as the ratio, say,
between the total transaction to total deposit.
- “Equation (5.3) incorporates the idea of transition periods outlined above. Fisher made it
clear that velocity is far from being constant (Wood, 1995, p. 104; Fisher, [1911] 1985, pp.
55, 63, 64, 320). Moreover, velocity is a function of expected price changes or the expected
inflation rate. The positive correlation between velocity and expected inflation seems to be a
major assumption in theories following the quantity theoretic tradition, as the Chicago School
and the Cambridge approach (see Patinkin, 1969, pp. 50, 51; Laidler, 1991b, pp. 292-293;
Tavlas and Aschheim, 1985, p. 295)…. Expected inflation may well be destabilizing by
increasing or decreasing velocity in such a way that the economic system might be far from
being stable. ‘If velocity is sufficiently sensitive to inflation, the latter, once started, can
accelerate without limit even in the absence of any monetary expansion’ (Laidler, 1991b, p.
292).” (Loef & Monissen 1999, p.10-11).
- Two broad categories determining the velocity of money:
i) the technical institutional characteristics of the trading system in general and the financial
system in particular
ii) factors conditioning individual portfolio choices
- Cambridge School abandoned the concept: See Laidler (1999, p.59)
- Empirical studies: David Kinley
- For neo-classical quantity theorists such as Marshall and Fisher the velocity of money is a
variable with its own dynamics independently of the quantity of money; however, Wicksell
took it as a passive variable. Yet, Marshall and Cambridge people are closer to Wicksell than
Fisher is in that they did not presuppose a stability of reserve-deposit and currency-deposit
ratios, as Fisher did (Laidler 1991, p.148).
- Wicksell’s discussion
i) In case of pure cash economy: Defining an individual’s velocity of circulation of money
(or its reciprocal interval of rest) as a ratio of her total payments to total cash holdings and
discussing three determinants of cash holdings, Wicksell concludes that the velocity of
money is almost constant, stable. An important question whether the velocity of money is an
independent or merely a dependent variable is posed first; admitting that it is most reasonable
to think it as dependent on M, Q, P, Wicksell mentions that some institutional, technical
factors set limits to its level (Wicksell 1898, p.54).
ii) Simple credit economy (It has no banking system but only commercial credit and
individual lending. However, the latters do not substitute money. They only accelerate the
circulation of money.): Even though the velocity of money has a much higher elasticity in
simple credit economy than in pure cash economy, it is not elastic enough to invalidate the
QT. The main reason is the loan is not open to anyone but only to those who are wealthy
enough to guarantee their creditworthiness.
iii) Cashless pure credit economy: Two important measures – use of bills of exchange and
development of banking system – do away with those obstacles which set limit for the
acceleration of velocity of money in the simple credit economy. “Notes provide in themselves
the basis for a more or less elastic system of credit, and they circulate with a velocity which is
more or less variable. It is for this reason that it was never possible for even
the older supporters of the Quantity Theory to provide a satisfactory demonstration of the
exact relationship which they held to exist between the price level and the quantity of notes
(and coin)” (Wicksell 1898, p.69-70). Yet, in this chapter (chapter 6) Wicksell does not give
a definite description of the variation of the money velocity and its implication to the QT.
Only towards the end of the chapter does he states that as for the pure credit economy case
where “no money circulates, and for the purpose of domestic trade no money need be kept
reserve”, “the Quantity Theory of Money would appear to be deprived of its very
foundations” (Wicksell 1898, p.76).
- Positive correlation with the interest rate (Wicksell 1898, p.119).
- When neo-classical writers conceived the velocity of money as independent variable with its
own dynamics, Wicksell “postulated that a modern banking system had capacity to render the
velocity of currency a passive variable in the face of real shocks” (Laidler 1991, p.147).
- “Within Keynes’s liquidity preference theory, velocity is uniquely dependent on the rate of
interest” (Rousseas 1986, p.46; See more).
- Relation between financial innovation, interest rate, velocity of money: See Rousseas (1960,
1986), Phillips (1981), Minsky (1957)
* VALUE
- Fisher’s theory of value: Fisher 1911, ch.1-1“Whenever any species of wealth is measured in its physical units, a first step is taken toward the measurement of that mysterious magnitude called "value." Sometimes value is looked upon as a physical and sometimes as a physical phenomenon. But, although the determination of value always involves a psychical process — judgment — yet the terms in which the results are expressed and measured are physical” (Fisher 1911, ch.1).
* VALUE OF MONEY
- Definition:
- Pareto: See Wicksell (1898, p.16),
- For the classical economists (especially 1820s onward), in the commodity-based monetary
system the value of money is pinned down to the cost price of production of metals – as
opposed to the demand and supply principle – in the long run, even though there was a
disagreement on the short-run story; the currency school arguing for the demand and supply
principle and thus for the impact of the quantity of money on price while banking school
rejecting them. The gold discovery in California and Victoria in 1850s supported the currency
school’s case even for the long-run scenario (Laidler 1991, p.12-13).
A difficult point for the modern reader for the first part of the above statement is that for the
classical economists the cost price of production of precious metals was marginal price as
mining was subject to the diminishing rate of return principle and that marginal price requires
the Marshallian demand and supply framework (Laidler 1991, p.10). This very important
point is also mentioned by Wicksell: “Some authors, for instance W. Roscher, attempt to
uphold the Cost of Production Theory of Money on the basis that "the value in exchange of
the precious metals is determined by the cost of producing them from the poorest mines
which must be worked in order to supply the aggregate want of them".
It is rather the Quantity Theory of Money which is involved in such an argument. For the
marginal cost of production is primarily an effect, rather than a cause, in relation to the
exchange value of money. The exchange values of the precious metals might conceivably be
subject to considerable fluctuations in either direction, on account, for instance, of changes in
the demand for money, while the natural conditions that govern their production remained
completely unaltered” (Wicksell 1898, p.33).
- There is an uneasy tension in classical monetary theory between cost of production and
quantity theory explanations of the price level. This tension is resolved through the individual
choice-theoretic approach of marginalist theory (Laidler 1991, p.41). See Ibid, p.51 as well.
- Critique of cost of production theory of value of money: See Wicksell (1898, p.25-27). “The
well-known law that the prices of commodities tend towards their costs of production is
comprehensible only if it refers to relative costs and prices” (27).
- In Fisher (1912, Elementary Principles of Economics, p.133-34), the meaning of the
purchasing power of money is explained in detail in relation to the general price level.
- According to Rossi, conceiving the value of money as determined by the prices, which are
formed in the market tells nothing about the former (Rossi 2001, p.92).
- Rossi criticizes neoclassical’s simulation determination of prices and value of money as
circular (Ibid, p.92).
- Mill’s theory of the value of money is exactly the same of Moseley: “the amount of goods
and of transactions being the same, the value of money is inversely as its quantity multiplied
by what is called the rapidity of circulation” (Mill 1871, p.513-14). However, I have to check
the monetary system Mill is assuming.
- The first exposition of Cambridge cash balance approach – in Marshall (1871, 1887) and
Walras (1886) – appeared in the context of bimetallic controversy. This is true for Fisher’s
work (1894, 1896, 1911). “Though the bimetallic controversy provided part of the
background to the evolution of the quantity theory, however, that evolution mainly involved
the resolution of theoretical tensions in the classical version of that doctrine” (Laidler 1991,
p.52).
- “The Cambridge School and Fisher alike, though the details of their analysis differed, both
developed the quantity theory which they inherited from their classical predecessors into a
general theory of the price level” (Laidler 1991, p.52).
- Classical economists have two views on the value of money: cost of production theory and
quantity theory. An uneasy existence of the two can be found for example in Mill, in whose
view they were complementary to one another; but “his attribution of rising marginal
production costs to mining, along with his lack of clarity about the stock-flow distinction, left
the details of that complementarity unclear. Marshall’s original work of 1871 on money both
clarified and completed Mill’s analysis, and in particular put cost of production
considerations in their proper place” (Laidler 1991, p.54). From Laidler’s subsequent
exposition of this, it seems that Laider is thinking that Marshall solved this by translating the
classical quantity theory into a ‘demand for currency’ theory (i.e. cash-balance approach) and
ending up with an idea that even in the long run the demand and supply principle applies
instead of cost of production. One of the main elements of the solution is a stock-flow
distinction. Laidler (83) writes “Without a firm grasp of the stock flow distinction, it is hard
indeed to put the (rising) marginal cost of extracting new supplies of the precious metals in its
proper place among the factors determining the purchasing power of commodity
money~~~~.”
- In Marshall, as a head of the Cambridge cash balance approach, the emphasis is on the
influence of demand rather than of supply on the value of currency.
- Founding Neoclassical works on the value of money: Friedman (1956), Patinkin (1956) “It
is … argued that the value of money, and, therefore, the level of money prices, reflects, on the
one hand, the preferences of individuals for money as medium of exchange, and, on the other
hand, the relative availability of money” (Nicholas 2011, p.98).
- Nicholas (2011) suggests for Marxian economics to replace the notion of equilibrium price
with reproduction price since: “If… exchange is seen as mediating a division of labour and
facilitating the reproduction of commodities, then equilibrium prices can only be
meaningfully conceived of as those which facilitate the balanced reproduction of
commodities – which is a very different notion of equilibrium prices” (100). “For Marx
equilibrium prices are those which facilitate the reproduction of commodities in the context
of the balanced reproduction of the system” (101). Then for Marx are equilibrium prices the
center of gravity of actual prices?? Nicholas (2011, p.101) says not but the their average.
- Pareto’s definition: See Wicksell (1898, p.16, fn.1)
- Identifying ‘purchasing power’ and ‘value’ of money implies a certain way of defining
money; i.e. money only as a means of exchange or means of purchase. In this understanding,
money’s value lies in its purchasing power. If money as understood as having functions other
than means of exchange, then it would gain value from those functions other than means of
exchange. “Money as such, i.e. so long as it fulfills the functions of money, is of significance
in the economic world only as an intermediary. It is its purchasing power over commodities
that determines its utility and marginal utility, and it is not determined by them” (29).
- “But even though there is nothing to determine or set limits to the exchange value of our
commodity (M), as we have called it, in the market in which it plays the part purely and
simply of a medium of exchange, there is no reason why its exchange value should not be
determined, more or less completely, through the influence of other markets in which it
appears as a commodity proper” (29). This is a very similar reasoning to Foley’s approach to
MELT.
- Short-run vs. Long-run determination of the value of money:
- For Moseley, Marx’s theory of MELT is a long-run theory. Then how would Moseley
reply to Wicksell’s following comments?
- “Now it is precisely changes in prices and fluctuations in the value of money over
relatively short periods—ten, fifteen, or twenty years—which have the most serious
consequences for trade. The more gradual changes—secular they may be called—in the value
of money are of far less importance in this connection, even though they mount up
considerably in the course of centuries. To some extent their interest is purely historical”
(Wicksell 1898, p.33).
- “Monetary theory that dealt with the long run – that which argued that the cost of
producing the commodity serving as a unit of account could not deviate from its purchasing
power – was, in fact, an implementation of the law of one price to money. If a unit of
commodity-money could buy a certain amount of goods through exchange, and the value of
those goods was different from what one had to spend in order to produce a new unit, then
naturally, someone would exploit this difference. In such situation, a long-term process of
arbitrage took place … The value of the unit of account in exchange, that is, its purchasing
power, was determined in the short run via the Quantity Theory. In case of a gap between the
cost of production and the purchasing power, forces worked to exploit the situation….. One
should note that introducing inconvertibility – fiat money or inconvertible paper money –
destroys the links between the long-run and short-run attractors just described….” (Arnon
2010, p.58).
- Wicksell’s critique of commodity money theory and the cost of production theory of the
value of money: “The Cost of Production Theory may appear sufficiently logical, and it may
indeed appear self-evident, but it is just when enlightenment is most urgently needed that this
theory leaves us sadly in the lurch. The treatment of money (or rather of the substance of
which money consists) as a commodity, and the theory of the value of money that is based on
this treatment, lead to almost entirely negative conclusions as soon as we have to deal with
these questions of real practical importance which arise in modern monetary systems. We
must therefore look for other means of elucidation” (Wicksell 1898, p.33). This is very
similar to Foley’s critique of Marx for treating the value of money as the labour value
expended in the production of money commodity in Foley (1983).
- After raising a question what determines the exchange value of money and the general price
level in the pure credit economy, Wicksell says that as for the pure credit economy case
where “no money circulates, and for the purpose of domestic trade no money need be kept
reserve”, “the Quantity Theory of Money would appear to be deprived of its very
foundations” (Wicksell 1898, p.76).
- “So if the argument that fiat money is worthless is as strong as I believe it to be, how does
one answer Hal Varian’s question why is a dollar worth anything? There are two
possibilities. First, the real world could be less rational than pure economic logic would
suggest. I no longer would dismiss this possibility out of hand, as I once did. But we should
at least recognize that a positive value for fiat money may involve an element of irrationality.
A positive value for fiat money may be no less a bubble than tulips in 17th century Holland,
or houses in 21st century America. People may be accepting money in the false expectation
that they will always be able to find some other sucker willing to accept it. If so, everyone
will eventually realize what’s going on, and the game will be over” (Glasner 2011 Blog)
- Wicksell’s explanation: Wicksell (1898, p.48). Especially p.48-49 seem very important and
similar to Fred but hard to follow.
- In reviewing Grandmont (1982), Patnaik (2009, p.42) writes “Since a positive value of
money today arises because money is expected to have a positive value, and since this
expectation in turn derives from its having had a positive value in the past, the basic question
of why money has a positive value at all remains unanswered. In other words, Grandmont’s
justification of the assumption required for a positive value of money today simply would not
do; it leaves the value of money “hanging by its own bootstraps,” to use Dennis Robertson’s
(1940) famous phrase”. Which means circular reasoning.
- “The value of a security depends on the cash flows that it is expected to pay” (Admati et al.
2011).
- “Addressing financial booms calls for stronger anchors in the financial, monetary and fiscalRegimes” (Borio 2012).
* WICKSELL
- Wicksell special: American Journal of Economics and Sociology 1999 58(3).
- Preface of Wicksell (1898) is a very good summary of the book and its main goal.
- Anti-QT: Laidler (1991, p.141)
- Wicksell’s nuanced view on QT (p.41~):
- First of all, he identifies it with the equation of exchange – which is not correct – and
says that it is a truism, understandably so since the equation of exchange is an identity. Then
he points out its weaknesses as follows:
- QT is based on unrealistic assumptions: i) almost completely individualistic system of
holding cash balances, ii) on average fixed Cambridge k, iii) M in the equation of exchange
includes only cashes excluding money substitutes (This point is overcome by Fisher’s
extended version of equation of exchange), iv) Money in circulation and money in hoards can
be sharply distinguished (Wicksell argues that they cannot be distinguished since money is
hoarded for the sake of future transactions and thus the function of hoarded money is not
different from money in circulation, i.e. means of exchange).
- WICKSELL’S MAIN CONTRIBUTION ON QT: Wicksell basically agrees with QT’s
explanation of price change, i.e. “M -> i -> P” as represented by Ricardo. (His understanding
of QT is based on Ricardo’s.) Then he points out that the weak point of QT is the fact that the
monetary condition is not the only factor the affects prices. That is, i alone cannot affect P
since in order to judge whether i is high or low it needs to be compare with some other
standard level. This standard level is missing in QT. And Wicksell is saying that it is provided
by somewhere else than the money market. Wichsell’s contribution to developing QT is to
introducing the natural rate on capital against which the money rate of interest can be judged
high or low.
- Wicksell’s theory of cycle is closer to Marx-Schumpeter tradition than to neo-classical one
in that it views cycle and crisis not as a monetary phenomenon and not caused by monetary
elements.
- When neo-classical writers conceived the velocity of money as independent variable with its
own dynamics, Wicksell “postulated that a modern banking system had capacity to render the
velocity of currency a passive variable in the face of real shocks” (Laidler 1991, p.147).
- HOW SIMILAR IS WICKSELL’S STATEMENT WITH MINE: “MODERN investigations
in the field of the theory of value have thrown much light on the origin and determination of
the exchange values, or relative prices, of commodities. But they have, unfortunately, done
nothing to promote directly the theory of money—of the value of money and money prices”
(Wicksell 1898, p.18).
- Absolute (artificially determined) vs. relative (naturally determined) price (1898, p.4)
- Production, exchange, and consumption do not affect absolute prices but only relative
prices or exchange value (23). Absolute prices change only by the forces outside of those
three realms, namely the money market (24).
- ENDOGENOUS THEORY OF MONEY: 110-111
- From the way Wicksell uses the words value, exchange-value, we find that Marx and
Neoclassicals have the same concept of price or exchange-value as a ratio between the value
of two commodities in exchange. The difference is the definition of value; i.e. labour vs.
utility. For example, he defines value as “The value of an object is merely the importance that
we ascribe to its possession for the purpose of gratifying our wants” (29).
- Similarly to Fisher, Wicksell points out the peculiarity of money as means of exchange (29).
Remind that Fisher, in explaining why he treats the quantity of money so a special variable
within the equation of exchange, notes that money is a means of exchange.
- Main argument in chapter 4 “The So-Called Cost of Production Theory of Money”: “~~~~It
is just because the metal used in coinage is employed so little for industrial purposes,' and
because, above all, its real consumption proceeds at so small a rate, that the value of money,
at any rate over short periods of time, is not dependent on these factors, but is governed by
quite different laws, which we still have to discuss” (Wicksell 1898, p.34). Wicksell admits
the validity of cost of production approach on two grounds. First, it is valid in the long run.
Second, it is valid when money commodity is used for non-monetary purposes to a
sufficiently large extent. And he dismisses the cost of production approach by trivializing
these two grounds. First, the long run analysis is merely out of a historical interest not of an
urgent practical need. This reminds Keynes’ “in the long run we are all dead”. Second, as
monetary use of money commodity is gradually dwindling and nowadays it is very small, the
theory is becoming useless. The second explanation is based on a misconception on the part
of Wicksell. He conceives that on one that the cost of production theory corresponds to non-
monetary uses of money commodity and on the other hand monetary uses of money
commodity should be explained by something other than the cost of production theory.
However, there is no reason why monetary use of money cannot be explained by the cost of
production theory, and this is how Marx proceeds in chapter 1, volume 1 of Capital. In this
regard, Wicksell notes “In passing, there is a point to be noticed. The growth in the use of
money, and the increase in monetary stocks, tends more and more to reduce the significance
of the commodity characteristics of money. On the other hand, the development of the
monetary system results in a displacement of specie by credit instruments and so-called
money substitutes, and there exists, therefore, an important tendency towards a strengthening
of the commodity aspect of money and of its influence on prices” (Wicksell 1898, p.34).
- On Karl Marx (p.34~)
- Wicksell’s critique of Hilderbrand’s view that even the value of inconvertible
government paper money is determined by that of metallic coin, which entirely disappeared
from the circulation is applicable to the traditional Marxists’ commodity money theory (49).
Right after, he mentions: “It does not appear to me that such a conception has any foundation.
It is not some vague ritual, but the palpable facts of exchange and of credit, of commodity
markets and of the money market, which day by day determine individual commodity prices
and consequently (in a country that has a paper standard) the average purchasing power of the
nation's paper money” (47).
- On Tooke (p.43~):
- As for Tooke’s income theory of price (“income determines price”), Wicksell points out
that the other way round is also possible.
- Tooke’s view on the determination of price has two components: supply-side analysis
based on cost of production theory and demand-side one based on his income theory of price,
which admits the validity of the quantity theory (M increase -> Income increase -> Excess
demand -> P increase). Wicksell notes that Tooke developed only the former. This is a gap in
Tooke.
- As can be verified from his critique of Tooke’s view on QT and also from his comments on
QT’s weakness, Wicksell’s primary goal is to trace out the specific mechanism that governs
the dynamic relation between money and price. See Wicksell (1898, p.44).
- Main argument: “the real cause of the rise in prices is to be looked for, not in the expansion
of the note issue as such, but in the provision by the Bank of easier credit, which is itself the
cause of the expansion” (Wicksell 1898, p.87; see this page more).
- Wicksell’s emphasis on the rate of interest instead of the quantity of money (p.87) reminds
one of PK’s credit view.
- On interest rate, Wicksell has a very similar view with Keynesians that objects to the
conventional view where investment is a negative function of interest rate. See Wicksell’s
discussion on the rate of interest to price (89-93). The main idea is that the short term rate has
no immediate impact on price but the long term rate has.
- Relative prices are subject to stable equilibrium while money prices to neutral equilibrium
(101).
- Monetary circuit approach (104-105): Wicksell here presents the monetary circuit theory to
show i) that money can be dispensable in the capitalist economy, ii) that the ordinary working
of the monetary circuit does not generate any inflationary or deflationary forces (and here
prices refer to money prices not relative prices, which could either increase or decrease
reflecting overall conditions or production and exchange),
- From his discussion on endogenous money concept in p.110-11 Wicksell concludes that
therefore the banks have power to control the price levels and interest rate.
- Summary of chapter 7, 8: p.120.
- Natural rate of interest: Entrepreneurs borrow money capital and buy real capital goods with
it. It can be thought of as they are really borrow those real capital goods since money capital
is just mediating this end. Natural rate of interest on capital is defined as the interest rate
determined by the demand and supply of the real capital goods without a mediation of money.
See p.120, Normal rate of interest: p.100, Their relation: 120.
- Wicksell (1898)’s main point is that traditional QT holds only in commodity money
economy; in his cashless economy model, money is entirely absent. The idea that the validity
of QT depends on the specifics monetary setting is same as mine but the relation is the
opposite. For me, commodity money regime corresponds to anti-QT and inconvertible credit
money to QT.
- Cumulative Process (Interest Rate Policy)
- A critique of Wicksell’s cumulative process and natural rate of interest: Mises pointed
out that banks cannot maintain long the loan rate lower than the natural rate (See Festre
2006). However, Humphrey (2002, p.65) mentions otherwise because “In the pure credit
economy, central bankers theoretically could hold the market rate—which in pure cash and
mixed cash-credit economies tends to converge to the natural rate—below or above that latter
rate forever”.
- Assumptions of the cumulative process model: Humphrey (2002, p.64-65).
- Mechanism of translating the interest rate differential through excess demand finally to
price increase: “A lower market rate stimulates planned investment by raising the present
discounted value of the stream of expected future returns to capital. The rise in this
discounted revenue stream raises the price of capital goods above their replacement cost and
makes it profitable to produce more of them. Furthermore, since the market rate is the
intertemporal relative price of consumption today in terms of consumption sacrificed
tomorrow, a fall in that price induces people to take more of consumption today.
Consumption rises and saving falls, hence the shortfall of saving below investment at lower
than natural interest rates” (Humphrey 2002, p.66).
- In Wicksell’s pure credit economy model, money supply is created entirely as
accommodating money demand by firms – more precisely, deposits instead of money. In
other words, there is no exogenous money supply. Even a quantity theorist Wicksell expert
notes this (Humphrey 2002, p.66). From this it is obvious that the unresolved debate on
whether Wicksell was a quantity theorist notwithstanding, his cumulative process model
departs from the traditional, simplistic QT, where the disturbance from the status quo starts
with changes in the quantity of money. However, Humphrey further argues that even though
excess deposits are impossible the byproduct money stock could possibly be in excess. To
show this, he uses the Cambridge cash balance equation and maintains that since M, Q, k
have not changed those newly created deposits would constitute ‘excess supply of money’,
which the public will not want to hold and thus spend on extra consumptions (Ibid, p.67).
Two errors should be noted. First, in this model, there is no money but only deposits; this is
based on Wicksell’s definition of money which does not include deposit. Second, Wicksell
notes that in the pure credit economy, which is the background of the cumulative process, the
velocity of money is highly elastic which seems to undermine the QT. Which means that k
cannot be taken as stable or constant.
- Wicksell’s interest rate model is at the center-stage of the current macroeconomic monetary
policy debate. Humphrey (1990) traces its origin in Thornton (1802) and Joplin.
- Wicksell’s critique of Marx’s theory on money: See John Cunningham Wood 1994 Knut
Wicksell: Critical Assessments Vol.2, p.86.
- I don’t quite understand why quantity of money is a meaningless concept in pure credit
economy. Number in bank’s account created by bank’s accommodation of credit demand can
definitely be aggregated. Maybe Wicksell is confining ‘money’ of QTM to metallic coins,
hard cash.
- I don’t quite understand Bertocco (2009, p.616)’s explanation of the relation between
loanable funds theory and Wicksell. Read it again.
* TREATISE ON MONEY (KEYNES 1930)
- See Rousseas (1986, p.32~)’s summary.
- Industrial Circulation vs. Financial Circulation;
- Within Industrial Circulation: income deposits vs. business deposits A, the sum of the two
being cash deposits, which are “used exclusively to meet transactions requirements for a
means of payment in that sector” (Rousseas, p.33).
- Within Financial Circulation: business deposits B vs. savings deposits (A & B)
- business deposits B: the volume of trading in financial instruments, i.e. the activity of
financial business”.
- savings deposits A: for personal reasons, extremely stable
- savings deposits B: such as highly liquid negotiable CDs, money market funds,
fluctuates with bulls and bears (““Bears” anticipates a fall in the cash value of financial
securities and increase their holding of savings deposits B, whereas “bulls” represent
movement in the opposite direction from money to securities”) -> Confusing. Speculative
bubbles (bulls) lead to excessive demand for money in the financial sector, no??? This is what
Rousseas himself writes in p.35.
- Demand for money in the financial sector is the sum of income-deposits B and savings-
deposits B
- Total demand for money: combined demand of the industrial and financial sectors – the
motive being means of payment and store of wealth respectively.
- Since while the first demand closely follow the pace of real activity the second demand is
highly unstable, “Keynes demined any stable link between money and the nominal level of
national income” (Rousseas 1986, p.34).
* LAW OF REFLUX
+ CRITIQUE
- Reference for a critique of Kaldor-Trevithick’s reflux mechanism: (Cottrell (1986, p. 17), Palley (1991, p. 397), Chick (1992, p. 205), Dalziel (2001, p. 144, n. 2))
* QUANTITATIVE EASING (QE)
+ Definitions:
- For the banks it is nothing but an asset shift from less liquid to more liquid assets (in most
cases, reserves), the result of which is an increase of balance sheet (since both assets and
liabilities change) size of the central bank.
- “This is where central banks like the US Federal Reserve, the Bank of England or the Bank
of Japan decide to buy billions of government or corporate bonds in the open market from
banks and other financial institutions.” (Michael Roberts)
+ Marxian views:
- When profitability is the main cause the monetary trick will not save the economy.
Michael Roberts represents this opinion: “The lack of demand for credit is the flipside of the
failure of the Keynesian/monetarist policy of ‘quantitative easing’”. “If average incomes and
pensions have lost from QE, are there any winners? Yes: the BoE puts it rather modestly: “As
with all changes in the stance of monetary policy, the recent period of loose monetary policy
has had distributional consequences, and its benefits have not been shared equally across all
individuals.” . The BoE found that driving up the value of government and corporate bonds
through QE purchases benefited the rich who hold most of these bonds.”
(http://thenextrecession.wordpress.com/2012/08/25/qe-uk-banks-and-the-economy/)
+ Post Keynesian views
- Ann Pettifor
* ASSET-BASED & OVERDRAFT SYSTEM
- Origin of the distinction: Keynes (Treatise, ch.32), Hicks (1974),
- Following Literature: Renversez (1996), Lavoie (2005),
- Critique of reserve-constraining view: Rochon (1999, ch.6)
+ ASSET-BASED SYSTEM
- Treasury bills (as liquid asset) act as a buffer; central bank advances are an additional
buffer.
+ OVERDRAFT SYSTEM
- In this approach the definition of reserves is wide to include Treasury bills (short-term)
and government bonds (long-term)
* RESERVES
- Nonborrowed reserves: Banks secure nonborrowed reserves through liability management
such as federal funds borrowing, repurchase agreements, issuing certificates of deposits or
similar practices. Central Bank influences the nonborrowed resereves through open market
operation.
- Borrowed reserves: Borrowed from discount window.
* NOTES
- It is now admitted that the quantity of money does not have any meaningful relation with
the macroeconomic performance, and for this reason, the Fed ceased to project ahead the
growth of monetary aggregate. Then how could we understood the Fed’s active intervention
during the current crisis such as QE?
Reference
Adrian, Shin, Hyun Song. 2010. “Liquidity and Leverage”, Journal of Financial
Intermediation 19, pp. 418-437.
Bernanke, Ben 2006, “Monetary Aggregates and Monetary Policy at the Federal Reserve: A
Historical Perspective”, At the Fourth ECB Central Banking Conference, Frankfurt,
Germany.
Goodhart, 1989, Money , Information and Uncertainty.
Laidler, David 1991, The Golden Age of the Quantity Theory, Princeton University Press