MONETARISM AND THE DEMISE OF KEYNESIAN ECONOMICS

Transcription

1 MONETARISM AND THE DEMISE OF KEYNESIAN ECONOMICS

2 Monetarism and the Demise of Keynesian Economics G. R. Steele Lecturer in Economics University 0/ Lancaster Palgrave Macmillan

3 ISBN ISBN (ebook) DOI / G.R. Steele, 1989 Softcover reprint of the hardcover 1 st edition 1989 All rights reserved. For information, write: Seholarly and Referenee Division, St. Martin's Press, Ine., 175 Fifth Avenue, New York, N.Y First published in the United States of Ameriea in 1989 ISBN Library of Congress Cataloging-in-Publication Data Steele, G.R. Monetarism and the demise of Keynesian economies/g. R. Steele. p. em. Bibliography: p. inc1udes index. ISBN : $35.00 (est.) 1. Classical sehool of eeonomics. 2. Keynesian eeonomics. 3. Quantity theory of money. I. Title. HB94.S '01~c CIP

4 To the memory of Margaret Nixon, schoolteacher

5 Contents Preface xi 1 Introduction 1 2 Money 7 Money, motives and the market process 7 State commodity money 9 The origins of token money 10 The emergence of a central bank 11 The evolution of modern banking 12 Bank credit and money 13 A basis for monetary policy 15 3 The Quantity Theory of Money 17 The early beginnings 17 The Yale equation 19 The Cambridge equation 20 The demand to hold money 22 The 'naive' Quantity Theory 23 The 'sophisticated' Quantity Theory 24 The Quantity Theory and the UK economy 27 4 Money, Relative Prices and the Rate of Interest 31 Hayek and the Quantity Theory 31 Forced saving 32 Hayek's Ricardo effect 34 Dynamic considerations and supply constraints 38 5 Keynes's General Theory 41 The transactions and precautionary demand to hold money 42 The speculative demand to hold money 43 Liquidity preference 44 Money, income and the rate of interest 45 Money and prices 47 vii

6 vüi Contents Liquidity Preference versus Loanable Funds 48 Liquidity Preference, money wages and unemployment 51 6 Forced Saving versus the Multiplier S3 The multiplier 53 Full employment and inflation 53 Keynes's opposition to the concept of forced saving 55 Keynes's defence of the multiplier 57 Liquidity Preference, productivity and thrift 59 General equilibrium: an uneasy reconciliation 60 The stock of money and the flow of credit 62 Liquidity Preference: a bond price interest rate theory 64 7 Monetarism 6S The asset demand for money 65 Equilibrium in the money market 67 Money, ouput and employment 68 The expectations-augmented Phillips curve 69 The interdependence of monetary and fiscal policy 71 Monetarism: the central propositions 74 8 Control of the Money Supply 7S Public sector bank borrowing 75 Private sector bank borrowing 77 Banking School versus Currency School 78 Money substitutes and the control of money 80 Hayek and the rejection of monetary policy 81 9 International Trade and Exchange Rate Policy 8S Mercantilism 86 The gold bullion standard 87 The gold-exchange standard 88 Exchange rates in the post-1945 period 90 The balance of payments accounts 92 Monetary theory of the balance of payments 93 Exchange rate targeting versus monetary control 94 The myth of the balance of payments problem 97

7 Contents ix 10 Macroeconomic Demand Management 101 Keynes's view of mercantilism 101 Lessons ofthe Keynesian experiment 102 The formation of expectations 103 Rational expectations 104 The disappearing Phillips curve 106 Crowding out 107 The New Classical School Inflation 111 Money and inflation 111 The stages of inflation 112 Money and Keynes's General Theory 113 Wages and prices at full employment 115 Incomes policy 118 Indexation and wage bargaining Free Markets, Monetarism and the Austrian School 123 The legacy of Keynes 123 Macroeconomic theories 125 Monetarism and the Austrian School 127 Change, incentives and the market process Postscript: When Keynes was a Monetarist 131 Inflation and business activity 131 Inflation and public finance 133 The course of inflation 134 Inflation and monetary policy 134 International trade, exchange rates and currency markets 135 Fixed exchange rates versus price stability 136 Appendu 139 Notes 141 References 144 Index 149

8 Preface This book attempts to integrate the most important contributions to the understanding of the modern money economy. The works of Fisher, MarshalI, Pigou, Robertson, Hayek, Keynes, Phillips, Friedman, Muth and Lucas are examined against the common theme of money, monetary disturbances and real economic activity. The crux is the intellectual battle between the established tradition of the Quantity Theory of money and twentieth-century Keynesian economics. The central issue relates to the level of economic achievement which can be attained by the competitive process, and the impact of intervention designed to manipulate patterns of expenditure in an attempt to raise that level of achievement. Monetarism holds centre stage for the reason that it has become commonplace to dassify as Monetarist the belief that Keynes was wrong to deny the importance of the relationship between money and prices, as established by the Quantity Theory. Before publication of Keynes's General Theory, Monetarism by this definition was the view held 'by almost all economists except a few dissenters and cranks' (Hayek, 1978, p. 75). In more recent parlance, Monetarists are identified by the belief that inflation is caused by the 'demand pull' unleashed by monetary expansion; and by the denial of arguments which favour 'cost push' origins of inflation. Keynes was a brilliant scholar whose influence upon academic economics and upon economic policy is second to none; but the importance of his contribution has been misunderstood, and the most dubious aspects of his analysis have had the dosest attention. It will take some years to unlearn the bad habits of the Keynesian era; for students of economics not to expect that macroeconomic aggregates should lend themselves to purposeful examination. Until then, the teaching of macroeconomics will continue to offer the aggregate income-expenditure approach; albeit with increasing degrees of qualification. So this book will be judged more suitable for undergraduates at Part 11 level, for the teaching of monetary theory and the history of economic thought. This stated, less advanced students should not be deterred by its unconventional approach. Whereas the simplified analysis of income and expenditure has readily lent itself to intro ductory courses, academic economists have kept for themselves the more xi

9 xii Preface interesting aspeets of poliey debates. If the reputation of the eeonomics profession has faltered as the inadequacy of Keynesian advice has become demonstrably more obvious, the blame lies squarely with its members. Economists talk too much among themselves; and basic truths are hidden too often by exeessively detailed, or even disingenuous, exposition. Writing this book has been very much an exercise of indulgence and self-erudition in which most things turned out to be at least a little different from that which had been anticipated. To Professor V.N. Balasubramanyam, I shall always be indebted. Not only did he persuade me that I could write, and then that I had written, something of interest, he spent much time in showing how it might be improved. His generosity reflects that of his former teacher, Professor Milton Friedman, whose encouraging comments upon an early draft were opportune. I am grateful to my own former teacher, Professor J.C. Gilbert, whose care was especially valued beeause of the high esteem in which he holds the work of John Maynard Keynes. For their reading and comments upon final drafts, I am grateful to Glenys and Paul Ferguson. For the finished text only I am responsible. G.R. STEELE