Wednesday, April 16, 2014

A Quick Note on Money

Nick Rowe and David Glasner are having an interesting debate on whether it is possible to speak of excess demand (or excess supply) for money in a world where most money consists of commercial bank deposits.

Nick, naturally, argues for the affirmative. Glasner argues for the negative, drawing on Tobin's 1967 restatement of the 19th century "law of reflux."

This is a tricky question to take sides on. The problem, from my point of view, is that to get from the classical "real exchange" economy , to our actual "monetary production" economy (both phrases are Keynes's), takes not one but two steps. First, you have to see how real activity depends on liquidity conditions. And second, you have to see how liquidity conditions depend on the whole network of actual and potential balance sheet positions — liquidity as a social relation, as Mike Beggs says. A focus on the special role of money is helpful in the first step but an obstacle to the second.

I think Keynes himself contributed to the problem with his discussion money in the General Theory. He was working so hard to get people to take the first step that he pushed the second one out of view. The GT is full of language like:
Unemployment develops, that is to say, because people want the moon; -- men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot be readily choked off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. a central bank) under public control.
This is a story about exogenous money; this kind of language smoothed the the way for what Perry Mehrling calls “Monetary Walrasianism,” as you get from someone like Nick Rowe. Jorg Bibow's definitive account of Keynesian liquidity preference theory (summarized here) makes it clear that Keynes did this for clear strategic reasons, and the Treatise on Money is better in this respect. But it’s still a problem.

So for me the Tobin article (and Glasner’s summary) has an ambivalent character. They are right to criticize the idea of an exogenous stock of money, and the related idea that transaction demand for money is central to aggregate demand; but I worry that their arguments tend to tip backward toward the classical dichotomy rather than point forward toward a fuller account of liquidity.


  1. My opinion (I hope that this makes sense and is not tautological):
    In the first place, there is a problem when we speak of "excess supply/demand" for money, because it impies one equilibrium level for money.
    For example, suppose that there is a certain quantity of apples and oranges. But it is discovered that oranges are better for health than apples. Initially, more people will buy oranges, and the price of oranges will go up, while the price of apples will go down. But apple growers will wisen up and switch their production to oranges, until there are more oranges, the price of oranges falls back to its equilibrium level, and supply matches demand.
    In this example the equilibrium depends on the tastes of consumers, and we can say that for a while the production of oranges is out of equilibrium because we assume an ideal equilibrium due to those tastes.
    But, we can't apply this logic to money, because money isn't a consumption good. Also the "price of money" isn't the same thing of the price of apples and oranges, otherwise the price of 1$ would always be 1$.
    In fact what we usually call the "price of money" is the interest one has to pay to get a loan. But I think this is in facts the inverse of the usual sense of the term price.
    If we see the story from the point of view of the lender, we can see thet the lender pays an amount of money to get something (say, a bond), that will be paid later for an higer amount of money. If we assume that the lender then re-lends the same money (buys another bond, a rollover), we can see that the principal is the price for a certain cash flow (interest).
    This is the inverse than what is usually meant as "price of money", but I think that it makes more sense.
    If we see the principal as the price for interest, it becomes comparable to other capital goods. We then can say that, if interest is higer than the usual rate of profit for other capital assets, interest is underpriced (this is what is usually meant by excess demand for money - a deflationary setting, where financial capital eats a growing share of total production), whereas if interst is lower, then interest is overpriced relative to other forms of profits (this is what is usually meant by excess supply of money, an inflationary setting; the terms are reversed).
    So what is usually called "excess supply/demand" for money really is the relationship between the interest rate and the average rate of profit. But interest is fixed in nominal terms, whereas the average of profit might change, so changes in the rate of profit might cause the effect of an apparent excess of demand or supply of money.

  2. Your first example of apples and oranges is the claim that in the long run, prices are determined only by supply conditions. This implies that decreasing returns are NOT typical of production. This was of course the view of all the classical economists, including Marx; rejecting this view was the great innovation of marginalism. But the marginalist view only really makes sense if you assume fixed stocks of various assets. (Jevons apparently literally did believe this -- he notoriously hoarded things like paper on the idea they would someday run out.) In a world where commodities are produced, the classical view works better. Which, incidentally, people like Krugman concede when they acknowledge that it's ahrd to find real-world examples of upward-sloping supply curves; he doesn't realize that with that concession he's taken a big step toward the labor theory of value.

    The question of whether the interest rate is appropriately regarded as the price of money has been a major controversy in economics, which I've tried -- not very successfully I think -- to clarify on this blog:

    The view that what matters is the relationship of the interest rate and the (expected) profit rate is usually attributed to Wicksell; from what I understand, it was universally held by central banks during the early part of the 20th century. I read somewhere -- can't recall where right now -- that if you look at the minutes of Fed discussions in the early 1930s, there's a lot of talk about the relationship between the interest rate and profitability, and zero discussion of the relationship between the interest rate and inflation -- the idea of a "real interest rate" was not even considered. Wicksell also, like you, saw inflation as the result of a situation in which interest rates were below profit rates.

    The question then becomes, where does the interest rate come from?

    The answer Keynes gives in the General Theory is that it equilibrates demand for money holdings with a fixed stock of money set by the central bank. This is the "monetary Walrasian" view I mention in the post, which got taken up by mainstream postwar Keynesians and in a somewhat different way by Milton Friedman and later monetarists.

    The more authentically Keynesian answer, I think, is that it is determined by liquidity conditions throughout the financial system, or more generally by market participants degree of trust and confidence in each other. (We've discussed this before -- I know you don't like this idea.) This is one area where I think Keynes offers a genuine advance from Marx.

    Third, the interest rate could be determined by people's willingness to defer consumption, relative to the possibilities for achieving greater consumption by waiting. This is the "Austrian" view of Bohm-Bawerk, Cassel, etc., which is also taken by mainstream modern theory. In this framework, there is no possibility of a divergence between the interest rate and the profit rate -- they are two names for the same thing.

    Finally, we could just say the interest rate is set by the central bank, somehow or other. This is the view taken in mainstream modern economic policy and in undergraduate textbooks.

    Marx was not really interested in this question, since he thought (correctly at the time) that investment was normally financed directly out of profits, not by borrowing.

    Not disagreeing with anything you wrote, just adding some context.

  3. Thanks.
    What surprised me was the use of terms like excess demand or supply of money.
    Excess relative to what? What is the supposed equilibrium level? This is what I can't understand.

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