Showing posts with label Endogenous money. Show all posts
Showing posts with label Endogenous money. Show all posts

Monday, July 28, 2025

Capital controls in the US?

financial Archives - Glasbergen Cartoon Service

In a recent Financial Times op-ed, Michael Pettis argued that the US should impose capital controls. In his view, the traditional view according to which capital inflows necessarily lower domestic interest rates and spur productive investment is based on a misunderstanding of how capital flows affect modern economies. This might have been true for rapidly growing developing economies with high investment needs and limited domestic savings, where foreign capital truly relieved a saving constraint. However, since the breakdown of the Bretton Woods system, modern financial systems can expand credit largely unconstrained. In this environment, capital inflows into advanced economies like the US, do not primarily finance new, productive investments.

In the modern context, capital inflows often lead to an increase in household or fiscal debt. Policymakers use this credit growth to sustain domestic demand and prevent recessions that would otherwise be caused by the leakage of demand abroad due to trade deficits. This is a "beggar thy neighbour" dynamic -- a term coined by Joan Robinson, and the reason she appears in the FT piece, even though she was referring to competitive depreciation and trade restrictions, not capital flows -- where trade deficits are caused by shifts in spending to foreign goods, forcing domestic businesses to reduce output. Further, this reliance on rising household or fiscal debt to absorb foreign capital inflows and the resulting trade deficits is unsustainable in the long run. It leads to rising debt levels and distorted economic structures. He concludes that restricting capital inflows would directly address the problem of aligning a country's external position with its domestic needs.

There are many problems with these views. On a theoretical level, he does suggest, as Vicky Chick in a paper that Lance Taylor liked and used in his courses, in the earlier period savings was necessary for investment. Essentially Say's Law. That is certainly not the case. Even in the 19th century, with less developed financial markets, banks had the ability to create credit, and savings (a flow) did not finance investment. Also, interest rates do not depend on the capital flows and the available funds, and are essentially an exogenous variable controlled to a great extent by the monetary authority (that was true in the past too).

More importantly, it is unclear that the external situation of the US, indebted in its own currency is unsustainable. What is the problem that this would be solving? There is no fiscal problem either, irrespective of the downgrade of US debt by Moody's recently (Standard & Poor's and Fitch had done it years ago). In fact, capital controls would affect the international role of the dollar and would be a major misstep, since it would directly affect the ability of foreigners to use dollars, and restrict its use in international financial markets. Not that this would have any chance of happening with Bessent, a Wall Street operator, as Treasury Secretary.

Private debt (not public) is considerably more dangerous than public debt, since when the government gets indebted, if it uses the money to promote growth, it directly affects its ability to pay back the debt, since its revenue is tied to the level of economic activity. That is why public debt tends to fall not by cutting spending and promoting adjustment and reducing the amount of debt, but by promoting growth and reducing the relevance of debt with respect to ability to repay. So, Pettis is not incorrect in noting that the US has depended more on private debt, which is riskier. But capital controls would do little to limit this dynamic. Policies that expand the remuneration (wages) of the people at the bottom (i.e. better income distribution) and that are more lenient with private debtors would have better results.

Regulation of financial markets too should play a role. In particular, the predatory lending practices that are still rampant in the US more than a decade and half after the 2008-9 financial crisis. But in all fairness, if there is something the US can do to grow faster and avoid financial problems, it would simply be more spending (perhaps a mix of infrastructure and social transfers) and lower interest rates. One can hope.

Sunday, March 11, 2018

Basil Moore (1933-2018)

Basil Moore

I first met Basil in 2000 or 2001, which was quite late, since I've read his work as an undergraduate back in the late 1980s. I was Assistant Director of the Center for Economic Policy Analysis (CEPA, now the Schwartz Center) at the New  School, and we invited him for a talk, which was about his forthcoming (at that time) book Shaking the Invisible Hand: Complexity, Endogenous Money and Exogenous Interest Rates  which was published considerably later (my review here).

Basil came down from Wesleyan, were he was for most of his career before retiring to South Africa, and we had an interesting debate on the relevance of the Keynesian (not the monetary one, on that we agreed) multiplier, which he considered a mistake, and on dollarization, which, at least at the time, he favored. The biggest surprise in my conversations with him that day and after that was what seemed to be a lack of understanding of how much the mainstream had incorporated the notion of endogenous money, in Wicksellian fashion. And I should note that the mainstream has not acknowledged the relevance of Post Keynesians, like Basil, in pushing them into the endogenous money camp.

My debates with him showed how much Post Keynesians could disagree both on theoretical and policy issues, and dispelled any notion that this was a group with monolithic or closed views on economic issues. In fact, it suggests that Posties should be seen more as a collection of schools, that depart from some aspects of marginalism/neoclassical economics.

Basil's contributions were essentially associated to the notion of endogenous money, more in line with the Kaldorian tradition, in which central banks accommodate to money demand, than to the Minskian notion of financial innovation. He was, together with Paul Davidson, Alfred Eichner, Hyman Minsky and Sidney Weintraub a key founding member of the American Post Keynesian School, perhaps less recognized than the others, and being the most focused on a particular topic. I'm sure that many obituaries will discuss his contributions in depth. At any rate, a loss for the profession, and for those of us that enjoyed his pluralistic openness to alternative views.

Tuesday, July 18, 2017

Beyond the traditional monetary circuit

Slow posting will continue the rest of the Summer. Here a paper by Sergio Cesaratto that might be of interest. From the abstract:
The paper is a contribution to a long-run theory of effective demand with elements from monetary circuit theory, Modern Monetary Theory and endogenous finance analysis. Some shortcomings of the still influential neo-Kaleckian growth model and monetary circuit theory are underlined, and the Sraffian supermultiplier is indicated as the most promising heterodox approach to growth and instability in capitalism. The Sraffian supermultiplier allows full consideration of the autonomous components of aggregate demand as the ultimate sources of growth and instability in modern capitalism. Following Steindl, capital gains are included among these components. Autonomous demand and investment are typically fed by endogenous finance. The paper articulates the relation between autonomous demand and investment on one hand, and endogenous finance on the other, in the light of Keynes’s distinction between initial and final finance.
Read rest here.

Tuesday, March 7, 2017

The theory of endogenous money and the LM schedule

By Tom Palley. From the abstract:
Money is at the center of macroeconomics, which makes understanding the money supply central for macroeconomic theory. this paper presents the Post Keynesian theory of endogenous money supply and shows how it is fundamentally different from the conventional money supply theory. the conventional approach relies on the money multiplier and bank lending is invisible. Post Keynesian theory discards the money multiplier and focuses on bank lending which drives money creation. the paper emphasizes the structuralist version of Post Keynesian theory which retains Keynes’ liquidity preference theory of long term interest rates and also recognizes banks are subject to nancial constraints that limit their lending activities. the paper then shows how to derive the Lm schedule in an endogenous money economy, which is a necessary prelude to reconstructing the IsLm model.
Read full paper here. 

Friday, April 15, 2016

Kalecki's Fable

By Jan Toporowski (Full paper published by ROKE here)

Following the death, in 1935, of the Polish military dictator Józef Piłsudski, his regime continued under a group of his military cronies, known as the ‘colonels’, who increasingly modeled their regime on that of Mussolini in Italy. One of the colonels, who was responsible for economic development, wanted to understand the economic principles behind government stabilization. He called in Kalecki's colleague from the Institute for the Study of Business Cycles and Prices (Instytut Badań Konjunktur Gospodarczych i Cen), Ludwik Landau, to explain the principles behind the ‘new economics’. Landau had just been fired from the Institute and was now working at the national statistical office, Główny Urząd Statystyczny (see Kalecki 1964 [1997]; Landau 1957).

Landau explained at length the principles of effective demand and credit cycles underlying levels of output and employment at any one time. The colonel had evident difficulty in grasping this. So, finally, Landau explained by telling the following story:
In an impoverished Jewish shtetl in Eastern Poland, whose residents were mired in debt and living on credit, a wealthy and pious Jew arrived one day and checked into the local inn, taking care to pay his hotel bill in advance. On Friday, to avoid breaking the Sabbath injunction against carrying money, he handed over to the inn-keeper for safe-keeping a $100 note. Early on Sunday, the wealthy and pious Jew left the inn before the inn-keeper had had a chance to return the banknote.

After a few days, the inn-keeper decided that the wealthy Jew was not going to return. So he took the $100 note and used it to clear his debt with the local butcher. The butcher was delighted and gave the note for safe-keeping to his wife. She used it to clear her debts with a local seamstress who made up dresses for her. The seamstress was delighted, and took the money to repay her rent arrears with her landlord. The landlord was pleased to get his rent at last and gave the money to pay his mistress, who had been giving him her favours without any return for far too long. The mistress was pleased because she could now use the note to clear off her debt at the local inn where she occasionally rented rooms.

So it was that the bank-note finally returned to the inn-keeper. Although no new trade or production had occurred, nor any income been created, the debts in the shtetl had been cleared, and everyone looked forward to the future with renewed optimism.

A couple of weeks later, the wealthy and pious Jew returned to the inn, and the inn-keeper was able to return to him his $100 note. To his amazement and dismay, the wealthy Jew took the note, set fire to it, and used it to light his cigarette. On seeing the inn-keeper's dismay the wealthy Jew laughed and told him that the banknote was forged anyway.

Landau finished his story and waited for understanding to seize the colonel. Beads of sweat appeared on the colonel's forehead, from the intellectual effort at comprehension. Finally, as if he had stumbled on the explanation, the colonel exclaimed: ‘Ah, I knew from the very beginning that there was something wrong with that Jew. Of course, the money was forged!’
Kalecki's conclusion from this was that unfortunately too many people think like the colonel, and very few people understand the story as we do.

References:

M. Kalecki, '‘Ludwik Landau – Economist and Statistician’', in J. Osiatyński , Collected Works of Michał Kalecki Volume VII, Studies in Applied Economics 1940–1967, Miscellanea, (The Clarendon Press, Oxford (1964 [1997])) 325-329.

L. Landau, Wybór Pism, (Państwowe Wydawnictwo Naukowe, Warszawa 1957).

Friday, April 8, 2016

A Brief Sketch of the Classical-Keynesian Perspective


By David Fields

From a Classical-Keynesian perspective (Bortis, 1997, 2003), rates of interest regulate rates of profits (Panico, 1980, 1985), and, thus, real wages are endogenously determined. The presence of financial instruments, which represent titles to future flows of income, makes it so that the actual center of distributive conflict in capitalism lies not in the technical conditions of production, but is rather governed by the real rate of interest, which is a conventionally-determined exogenous variable that reflects the relative powers of finance capitalists vis-à-vis industrial capitalists & labour (Pivetti, 1985, 1991, 2001).
The rate of profit, as a ratio, has a significance, which is independent of any prices, and can well be ‘given’ before the prices are fixed. It is accordingly susceptible of being determined from outside the system of production, in particular by the level of money rates of interest. (Sraffa, 1960: 33)
In this sense, high real rates of interests induce industrial capitalists to prefer short-term speculative financial investment, instead of long-term productive real investment, since access to credit is expensive. Consequentially, industrial capitalists center attention on the pursuit of immediate surplus value realization, via speculation, in order to handle the burden of costly interest payments—the social cost being nominal wage suppression, which, by implication, exhibits an enlargement of the reserve army of labour.
[…] the credit system, which has its focus in the so-called national banks and the big money-lenders and usurers surrounding them, constitutes enormous centralisation, and gives this class of parasites the fabulous power, not only to periodically despoil industrial capitalists, but also to interfere in actual production in a most dangerous manner— and this gang knows nothing about production and has nothing to do with it. (Marx 1894: 544-45)
Along these lines, heterodox growth and distribution models have been put forward (cf. Hein, 2008), highlighting the need for a redistribution of income from finance/industrial capitalists to labour (Lavoie and Seccareccia, 1999) and making unemployment the primary policy target (Smithin, 2004). Underpinning these models are works that incorporate Keynes’ principle of effective demand and Sraffian price theory in a long-period analysis of capital accumulation (Park, n.d.; Cesaratto et al. 2003). These studies pay considerable attention to the extent to which the Hicksian supermultiplier concept effectively explicates the degree to which induced consumption and investment, via the accelerator, determine average levels of total output (Serrano, 1995) and, thus, normal capacity utilization (Amadeo, 1986; Trezzini, 1998), with the richness of a framework inspired by Kaldor and Pasinetti (Docherty, 2012) that meticulously constitutes the palpability of Kalecki’s famous aphorism that ‘capitalists get what they spend…workers spend what they get’.

Originally published in the URPE blog.

References:

Amadeo, Edward J. 1986. “Notes on Capacity Utilisation, Distribution and Accumulation.” Contributions to Political Economy 5(1):83–94.

Bortis, Heinrich. 1997. Institutions, Behaviour and Economic Theory: A Contribution to Classical-Keynesian Political Economy. Cambridge: Cambridge University Press.

Bortis, Heinrich. 2003. “Keynes and the Classics: Notes on the Monetary Theory of Production.” In Modern Theories of Money: The Nature and Role of Money in Capitalist Economies, (eds.) Louis-Philippe Rochon and Sergio Rossi. Cheltenham, UK: Edward Elgar.

Cesaratto, Sergio, Franklin Serrano, and Antonella Stirati. 2003. “Technical Change, Effective Demand and Employment.” Review of Political Economy 15(1):33.

Docherty, Peter. 2012. “Long Period Interest Rate Rules in a Demand-Led Kaldor-Pasinetti-Sraffa-Keynes Growth Model.” Journal of Post Keynesian Economics 34(3):521–46.

Hein, Eckhard. 2008. Money, Distribution Conflict and Capital Accumulation: Contributions to 'Monetary Analysis'. Basingstoke: Palgrave Macmillan.

Kalecki, Michal. 1971. Selected Essays on The Dynamics of the Capitalist Economy 1933-1970. Cambridge: Cambridge University Press

Kaldor, Nicholas. 1955. “Alternative Theories of Distribution.” The Review of Economic Studies 23(2):83–100.

Kaldor, Nicholas. 1966. “Marginal Productivity and the Macro-Economic Theories of Distribution: Comment on Samuelson and Modigliani.” The Review of Economic Studies 33(4):309–19.

Lavoie, Marc, and Seccareccia, Mario. 1999. “Interest Rate—Fair.” In Encyclopedia of Political Economy, vol. 1, (ed.) Phillip Anthony O’Hara. London: Routledge.

Marx, Karl. 1894. Capital Vol. III. New York: International Publishers.

Panico, Carlo. 1980. “Marx’s Analysis of the Relationship between the Rate of Interest and the Rate of Profits.” Cambridge Journal of Economics 4(4):363–78.

Panico, Carlo. 1985. “Market Forces and the Relation between the Rates of Interest and Profits.” Contributions to Political Economy 4(1):37–60.

Park, Man-Seop. n.d. “Towards a ‘Classical-Keynesian’ analysis of Effective Demand in the Long Period.” Retrieved May 8, 2014.

Pasinetti, Luigi L. 1962. “Rate of Profit and Income Distribution in Relation to the Rate of Economic Growth.” The Review of Economic Studies 29(4):267–79.

Pasinetti, Luigi L. 1974. Income Distribution and Growth. Cambridge: Cambridge University Press

Pivetti, Massimo. 1985. “On the Monetary Explanation of Distribution.” Political Economy: Studies in the Suplus Approach 1(2):73–104.

Pivetti, Massimo. 1991. An Essay on Money and Distribution. London: Macmillan.

Pivetti, Massimo. 2001. “Money Endogeneity and Monetary Non-Neutrality: A Sraffian Perspective.” In Credit, Interest Rates and the Open Economy, (eds.) Louis-Philippe Rochon and Matias Vernengo. Cheltenham, U.K: Edward Elgar.

Serrano, Franklin. 1995. “Long Period Effective Demand and the Sraffian Supermultiplier.” Contributions to Political Economy 14(1):67–90.

Smithin, John. 2004. “Interest Rate Operating Procedures and Income Distribution.” In Central Banking and the Modern World, (eds.) Marc Lavoie and Mario Seccareccia. Cheltenham, UK: Edward Elgar.

Sraffa, Piero. 1960. Production of Commodities by Means of Commodities. Cambridge: Cambridge University Press.

Trezzini, Attilio. 1998. “Capacity Utilisation in the Long Run: Some Further Considerations.” Contributions to Political Economy 17(1):53–67.

Saturday, May 2, 2015

Smithin on Endogenous Money, Fiscal Policy, Interest and Exchange Rates

New Working Paper by John Smithin. From the Introduction:
One of the main collective contributions of the various heterodox schools of monetary thought, such as circuit theory, Post Keynesian theory, in both its horizontalist and structuralist versions, modern money theory (now known simply by its acronym MMT), and others, has been to stress the importance of the endogeneity of money via bank credit creation. This issue was hardly discussed at all in the economics mainstream after Keynes’s death, not until the very end of twentieth century and the beginning of the twenty-first.
Read rest here.

Sunday, March 22, 2015

New Book: The Encyclopedia of Central Banking

New book on central banking, edited by L-P Rochon & Sergio Rossi, has recently been published. I have two chapters: 1. on Classical Dichotomy, & 2. on Dollar Hegemony.

See here.

PS: Posted here with an entry on Bretton Woods by Omar Hamouda.

Tuesday, September 23, 2014

Mark Blyth and Eric Lonergan on Why Central Banks Should Give Money Directly to the People

Sunday, September 21, 2014

Giancarlo Bertocco on Keynes’s criticism of the Loanable Funds Theory

Recently, Lars P. Syll posted a critique of the loanable funds theory (see here), and Matias Vernengo provides his take here. Below is a paper by Giancarlo Bertocco, in which he provides an analysis of Keynes' criticism of LFT.

From the abstract:
Contemporary monetary theory, by accepting the theses of the Loanable funds theory, distances itself from Keynes, who considered the rate of interest as an exclusively monetary phenomenon, and overlooks the arguments Keynes used, following publication of the General Theory, to respond to the criticism of supporters of the Loanable funds theory such as Ohlin and Robertson. This paper aims to assert that the explicit consideration of the role of banks in financing firms‘ investments connected with the specification of the finance motive does not imply acceptance of the LFT, which holds that the interest rate is a real phenomenon determined by saving decisions, but makes it possible to elaborate a theory of credit alternative to the LFT and a sounder theory of the non neutrality of money than the one based on the liquidity preference theory. 
Read rest here and here.

Thursday, August 21, 2014

Classic Paper by Arestis & Eichner: "The Post-Keynesian and Institutionalist Theory of Money and Credit"

Recently, (see here) Matias posted a link to Fred Lee's collection of a classic set of by papers by the late Alfred S. Eichner. He mentioned that this not a complete set of Eichner's remarkable work, and that there are plenty of other exceptional pieces; in particular is Eichner's paper with Philip Arestis: "The Post-Keynesian and Institutionalist Theory of Money and Credit." This work has influenced my research tremendously (especially concerning the authors adherence to the tradition of Veblenian Institutionalism, and their emphasis of an 'open-systems' approach to political economy).

From the Introduction (which is worth quoting at length):
The purpose of this article is two-fold: first, to identify the main elements of what constitutes post-Keynesian and institutionalist monetary theory and, second, to put forward a model general enough to encapsulate most, if not all, of the constituent elements of the post-Keynesian and institutionalist theory of money and credit. One further novel aspect of this article is that we account for the possibility of the openness of economic systems. This is an aspect that has been ignored by the literature on both post-Keynesian and institutionalist economics. 
The emphasis in post-Keynesian and institutionalist monetary theory is on the proposition that "Monetary economics cannot help being institutional economics" [Minsky 1982, p. 280] and that "Capitalism is a monetary economy" [Dilland 1987, p. 1641]. In this view money capital is an institution that is inseparable from the other institutions that comprise economic systems. Money is not merely a medium of exchange. It is tightly linked to the behavior of the enterprise sector and the economy as a whole. Therefore, the basic theme in this approach is inevitably, "The Monetary Theory of Production" [Keynes 1973; Veblen 1964]. It is in fact this Veblenian/Keynesian premise that constitutes the core of what we have labelled in this study "the post- Keynesian and institutionalist theory of money and credit." 
In this monetary theory of production, it is not surprising to find that credit rather than money is the mechanism that enables spending units to bridge any gap between their desired level of spending and the current rate of cash inflow. Money is viewed as essentially endogenous in a credit-based economy, responding to changes in the behavior of economic entities, rather than being subject to the control of the monetary
authorities. Money, in this view, is an output of the system, with the endogenous response by the financial sector governed by the borrowing needs of firms, households, and the government. Once it is recognized that money is credit-driven and therefore endogenously determined, any money creation emanating from fiscal or debt management operations initiated by the authorities or from a favorable balance of payments, can be neutralized through an equivalent reduction in commercial bank credit brought about by the actions of private economic agents.' It clearly follows that government may not be able to create money directly (see, however, Chick [1986]). 
What it can do, instead, is redistribute money among different groups of economic agents. This can happen when governments, in their attempt to increase/reduce the stock of money, set in motion the process whereby bank credit is created/destroyed by groups of economic agents. To the extent that the latter groups are different from those initially receiving/destroying money following the government's initiatives, redistribution of money between those groups takes place. 
The endogenous nature of money and credit is further elaborated upon in the next section with the constituent elements of the model under discussion being brought together in the section that follows. It is precisely here that the openness of economic systems is emphasized and its implications for the post-Keynesian and institutionalist theory of money and credit are compared with the neoclassical view. A final section summarizes the argument.
Read rest here (subscription required).

Tuesday, August 5, 2014

Kevin P. Gallagher On The Fed, Emerging Markets, & Role of The Dollar

By Kevin P. Gallagher

From Foreign Policy Magazine
Emerging-market and developing countries resented U.S. Federal Reserve Chair Ben Bernanke during his spell in office. In 2012, Brazilian President Dilma Rousseff scolded Bernanke and the Fed's loose monetary policy for creating a "tsunami" of financial flows to emerging markets that was appreciating currencies, causing asset bubbles, and exporting financial instability to the developing world. It may just turn out that they dislike Janet Yellen even more.Although it was Bernanke who started tapering the Fed's loose policy, Yellen will be the one to end quantitative easing and, eventually, raise short-term interest rates. And those could be an even bigger problem for emerging markets than the initial tsunami.Yellen's recent confirmation that quantitative easing (QE) will cease in October 2014 is the latest and firmest signal that U.S. monetary policy is reversing direction. The Fed began the year talking about the "tapering" of loose monetary policy, relaxing QE's bond-buying program and potentially raising interest rates. Now a concrete end to QE is on the horizon. The big question that emerging markets are now asking is how quickly and how suddenly interest rates will go up. Following the latest numbers that the United States' GDP grew by 4 percent during the second quarter, some monetary policy hawks are calling for interest-rate hikes soon to cool the economy. That's exactly what emerging markets are worried about....
Read rest here.

And for more on the role of the dollar in the world economy see here, here, and here

Wednesday, July 30, 2014

Notes on the Policy Implications of the New Macroeconomic Consensus

The New Macroeconomic Consensus (NMC) model is based on three simple equations. An IS equation that, contrary to what most discussions within the heterodoxy suggest, is based on a Ramsey model intertemporal approach to savings and investment, a Phillips curve (PC) equation, normally with rational expectations, and a monetary policy (MP) rule, typically Taylor’s rule. From the IS and the MP an aggregate demand (AD) curve is derived, while the PC provides an aggregate supply (AS) curve, similar to Lucas’ supply curve. Business cycles are seen as being determined by shocks, either monetary, that affect the AD curve, or real, which impact the AS curve.

A few things are important to note with respect to the NMC model. First, the IS curve now is not based on the traditional Keynesian multiplier process, by which savings adjust to investment (or in more sophisticated models with endogenous investment, to autonomous demand) as a result of variations to the income level. Agents make intertemporal decisions on consumption and savings, and investment adjusts, in the absence of imperfections, to full employment savings as in the pre-Keynesian models. That is the reason why in order to stimulate the economy it is often suggested that what is needed is higher inflationary expectations (which in this framework could be caused by the central bank announcing a higher inflation target), which would in turn lead to an increase in current consumption (since inflation would reduce future consumption possibilities; see my critique of this view, which I refer to as the inflation expectations fairy, here).

Second, both the New Keynesian Phillips Curve and the Taylor rule presuppose the existence of a natural rate of unemployment, in line with Milton Friedman. Further, stabilizing the rate of inflation around its target is tantamount to stabilizing output around its full employment level, a result sometimes referred to as the ‘Divine Coincidence.’ Thus, inflation is always the result of a level of unemployment that is below its natural level, or in other words caused by demand-pull. Supply-side shocks may eventually cause inflation too, but those are seen, at least by most New Keynesians as being of secondary importance. Even Lucas, who has accepted for the most part the Real Business Cycle story, admits that one cannot explain the Great Depression and other such crises with real shocks.

Third, the MP rule implies that money is endogenous, and that central banks control the rate of interest and NOT the quantity of money. In other words, the old Monetarist rules about the rate of growth of money supply are out, since actual central banks very rarely have behaved in that way. This ‘innovation’ (not much of an invention since Wicksell used more than a century ago) within the mainstream took place without ever acknowledging the contributions of Kaldor (accomodationist tradition to endogenous money), Minsky (financial innovation tradition to endogenous money), Moore and other post-Keynesian authors.

Finally, it is rather clear that the NMC is essentially a neo-Wicksellian model (for a simple description go here), rather than Keynesian (New or otherwise). Not only the multiplier model was abandoned (and with it even the basis for fiscal policy activism, since the logic of Barro’s Ricardian Equivalence has been incorporated; see Wren-Lewis here), but also the concept of the natural rate that Keynes at least tried to get rid of has become central for policy analysis. And here is the Achilles’ heel of the NMC model.

Note that if the natural rate is not fixed, and in particular if it presents hysteresis or path dependence, and moves with the actual level of unemployment, then the basis of the NMC model falls apart. In other words, expanding demand might reduce the natural rate of unemployment and would not trigger inflation, and as a result would not require the central bank to hike the rate of interest to lean against the wind. That was, in a sense, the rationale for not hiking the rate of interest when unemployment fell below 6%, which many identified as the natural rate, during the Clinton boom. Greenspan suggested that productivity was going up (note that he didn’t necessarily say that productivity went up, and the natural rate down, as a result of the expansion of demand).

There are good logical reasons for not believing the natural rate story, as we know, associated to the limitations of the marginalist theory (see here). However, there are also reasonably well-established empirical problems with the natural rate hypothesis. The Real Business Cycles authors, in particular Nelson and Plosser in their classic paper (here), have long ago shown that output follows a random walk. In other words, changes in output are permanent, and there is no tendency for output to revert to its former trend following a shock, contradicting the natural rate hypothesis, or suggesting if one prefers that the natural rate moves with supply-side shocks and that the business cycle is the result of agents adjusting their behavior to the change in the natural rate.

As I noted before (here), the actual measure of productivity (Total Factor Productivity, TFP) used by RBC authors does NOT measure productivity, and most of their conclusions are irrelevant really. Also, as suggested above, it would be impossible to pin down the real shock that caused the Great Depression or the Great Recession, that have structural causes that are profound (in the patterns of consumption, private indebtedness and inequality) and that were triggered by financial shocks. However, the notion that the natural rate is not fixed, and that it changes significantly is actually quite important, since as we indicated, it suggests that policies that try to lean against the wind hiking the rate of interest when the economy is below the natural rate of unemployment are without foundation.

Heterodox authors would add to the RBC empirical observation about the fact that output is not mean reverting, that the supply or capacity limit of the economy is endogenously determined by autonomous spending (the supermultiplier that extends Keynes’ effective demand to explain potential output; for more go here). This does NOT mean that one can expand the economy without limits, since if the expansion of demand is faster than the movement of the capacity limit, eventually full employment would be reached and inflation (demand-pull inflation) might follow. Note, however, than since the 1930s in the US unemployment was below 4% (to say a relatively low number) only for four short periods, during the mid-40s, early 50s, late 60s and late 90s, with inflation occurring in the first three periods. Also, it suggests that the main barrier to the use of demand policies to achieve full employment, at least in developed countries with no balance of payments problems, is political. As Kalecki noted long ago, sound finance would be the political instrument to keep workers’ demands for higher wages in line. The NMC model is the modern incarnation of what Kalecki’s referred to as sound finance. So who is really surprised with the dominance of austerity policies?

Friday, July 25, 2014

A debate on Endogenous Money and Effective Demand: Keen, Fiebiger, Lavoie and Palley


The last issue of the Review of Keynesian Economics (ROKE) has a debate between Steve Keen with Brett Fiebiger, Marc Lavoie and Tom Palley. Two papers are available for download (Keen and Lavoie's). Tom's paper is available as a working paper here.

The basis for Steve's defense of endogenous money is based on the works of Schumpeter, as developed by the latter's student Hyman Minsky. In his words:
"The proposition that effective demand exceeds income is not a new one: it can be found in both Schumpeter and Minsky (and arguably in Keynes's writings after The General Theory, though not in as definitive a form – see Keynes 1937*, p. 247). A difference between income and expenditure, with the gap filled by the endogenous creation of money, was a foundation of Schumpeter's vision of the entrepreneurial role in capitalism. Minsky's attempt to reconcile endogenous money and sectoral balances is the closest antecedent to the argument I make, but I will start in chronological order with Schumpeter's analysis."
I have noted before that the idea of endogenous money is NOT central for heterodox approaches, since Wicksell and the whole modern New Keynesian consensus adopts it. And perfectly conventional authors like Irving Fisher had introduced debt in their models too. I also noted that Schumpeter is essentially a Real Business Cycle (innovations are nothing but exogenous productivity shocks) author, which thought that both short-run output and employment and long-run growth were determined by supply-side factors. So in general I'm not a great fan of having Schumpeter as a staring point, or the notion that to introduce debt and endogenous money is per se a critique of the mainstream.

In that respect, I tend to agree with Tom's point that it is the way in which endogenous money and debt are introduced in the model that matters. Keen's use of a variation of Fisher's equation of exchange, as pointed out by Tom, is troublesome. In Tom's words:
"The Fisher equation constitutes the monetarist framework for macroeconomics. Income-expenditure accounting constitutes the Keynesian framework and it offers an alternative approach to understanding the AD, credit, endogenous money nexus."
In fact, in the equation of exchange framework the presumption is that demand would adjust (in Steve's approach with endogenous money) up to the point that it meets supply at the optimal level (also something that would be perfectly in line with  Schumpeter). The whole point of the income-expenditure framework is that it puts demand in charge of the level of activity.

At any rate, a good debate that it's worth checking out. Enjoy!

* J.M. Keynes (1937), "Alternative Theories of the Rate of Interest," 47, Economic Journal, pp. 241-252. Available here (subscription required).

Wednesday, June 18, 2014

What is 'Dollar Hegemony'?

Fields, David (Forthcoming), “Dollar Hegemony,” Edward Elgar Encyclopedia on Central Banking, edited by L.P. Rochon et. al, Edward Elgar

Today, the world economy operates under the artifice of US hegemony, fortified by the US dollar as an international reserve and vehicle currency. How did the United States arrive at achieving such pre-eminence?

From 1944 to 1973, the financial architecture of the world economy centered on a US engineered Keynesian accumulation agenda as a response to the devastation wrought by the Great Depression. The capitalist institutional structure, or social structure of accumulation (see Kotz et al., 1994), rested on finance being subservient to the promotion of industrial enterprise.

With socially-engineered capital–labour compromises in developed countries, neo-colonial governing institutions in the Third World, active State regulation in decisions with respect to capacity utilization, and a co-respective form of competition among large corporations set by regulations that brought together monetary authorities, large banks as well as large industrial capitalists, the post-World-War-II system was the era of “regulated capitalism”. Altogether, the world system was underpinned by the Bretton Woods arrangement, which called for globally fixed exchange rates against the US dollar tied to the price of gold and capital controls.

The international political-economic conditions were such that domestic macroeconomic autonomy, specifically with respect to monetary policy, for aggregate demand management could be feasible. Capital controls were seen as essential to reduce the volatility of capital flows and allow for low interest rates with the objective of pursuing full employment. As Keynes (1980, p. 276) argued, “we cannot hope to control rates of interest at home if movements of capital moneys out of the country are unrestricted.”

By the 1960s, however, US officials began to actively encouraging the growth of the Euromarket, that is, the pool of unregulated US dollar reserves concentrated in the City of London (Helleiner, 1994). With traditionally marginalized segments of the population in developed countries, particularly in the United States and in Western Europe, demanding social, political, and economic rights, and with national liberation movements in the Third World overthrowing US-supported oppressive governments, calls for an expanded role of the State in meeting citizens’ needs dramatically circumscribed global capital accumulation owing to heightened nominal wage–price spirals. Consequently, the global capitalist rate of profit fell (Duménil and Levy, 2004, p. 24). The Euromarket thus became the means for international financial markets to re-establish their influence, lost as a result of the Great Depression, and allow industrial enterprise to rebuild the conditions for future profitability via offshoring.

Speculative capital flows, however, began to undermine the capacity for the United States to guarantee the convertibility of US dollars into gold at fixed parity (Triffin, 1960). Even though the US dollar was the key international currency, it was fixed to gold. As such, debt was ultimately redeemable in an asset that was not directly controlled by the US monetary authority. Default was a possibility, even if a remote one, since through manipulation of the rate of interest, and through coercion and cooperation with other central banks in the world economy, the stability of the system could be maintained. With the globalization of finance via the Euromarket, nevertheless, speculation against the gold–dollar parity proliferated, making functional finance on a worldwide basis difficult to manage.

In 1971, Nixon closed the gold window and loosened capital controls. American officials concluded that it was no longer in their interests to maintain the linchpin relation between gold and the US dollar, and ipso facto withdrew support for the Bretton Woods system by which exchange rates were fixed and flows of capital were to a large degree controlled (see Helleiner, 1994; Vernengo, 2003; Ingham, 2008). The deregulation of financial markets established a global market of mobile financial capital, and the US dollar established itself as a global fiat-money standard. The world economy moved from a fixed dollar standard to a flexible dollar standard (Serrano, 2003).

For the first time in history, it is possible for the hegemonic country, in this case the United States, to be a global debtor, as national States are within their domestic economies, and to provide a default-risk-free asset to facilitate global capital accumulation. The risk that the United States would be unable to expand demand globally, because it is forced to maintain a fixed exchange rate between its currency and an external asset, is thus non-existent. It is true, however, that foreign countries and agents may show unwillingness to hold US-dollar-denominated assets, but, as in the domestic case, the US Federal Reserve (Fed) can always monetize public debt. This would be inflationary and lead to a run on the US dollar only if there is currency substitution on a massive scale, which would require a credible alternative to the US dollar (which does not exist yet). As such, the United States can therefore incur foreign debt without any reasonable limit.

Global imbalances, in particular the large US current account deficits that reflect their so-called “exorbitant privilege”, are instrumental for the functioning of the world economy, as evidenced by the dominance of the US dollar in international trade (Fields and Vernengo, 2013). An important part of this is associated to the fact that key commodities, like oil, are priced in US dollars in international markets. This not only implies that there cannot be an insufficient amount of dollars for the United States to import key commodities, but also that a depreciation of the US dollar does not reduce US imports necessarily (Parboni, 1981).

In fact, the Fed is the world economy’s central bank, which acts as the safety valve for mass amounts of international liquidity (Arrighi, 1999). The hegemonic position of the US dollar structures the world economy in such a fashion that the United States determines the international transmission mechanism for global economic activity. Hence, the role of the US dollar in international markets, and the advantages that come with it, are the spoils of structural power. The provision of this asset allows the United States to become the source of global demand, and to insulate itself from fluctuations and contradictions of perilous cumulative disequilibria that may arise in the world economy. The US dollar enables the United States to set the global social, political, and economic conditions, within which the transmission of misery (contagion) between countries, and between global and national levels, is essentially regulated.


REFERENCES:

Arrighi, G. (1999), “The global market”, Journal of World Systems Research, 5 (2), pp. 217–51.

Duménil, G. and D. Lévy (2004), Capital Resurgent: Roots of the Neoliberal Revolution, Boston: Harvard University Press.

Fields, D. and M. Vernengo (2013), “Hegemonic currencies during the crisis: the dollar versus the euro in a Cartalist perspective”, Review of International Political Economy, 20 (4), pp. 740–59.

Helleiner, E. (1994), States and the Reemergence of Global Finance: From Bretton Woods to the 1990s, Ithaca: Cornell University Press.

Ingham, G. (2008), Capitalism, Cambridge: Polity Press.

Keynes, J.M. (1980), The Collected Writings of John Maynard Keynes, Vol. XXV: Activities 1940–1944. Shaping the Post-War World: The Clearing Union, London and Cambridge: Macmillan and Cambridge University Press.

Kotz, D., T. McDonough and M. Reich (eds) (1994), Social Structures of Accumulation: The Political Economy of Growth and Crisis, Cambridge: Cambridge University Press.

Parboni, R. (1981), The Dollar and Its Rivals: Recession, Inflation, and International Finance, London: Verso.

Serrano, F. (2003), “From static gold to floating dollar”, Contributions to Political Economy, 22 (1), pp. 87–102.

Triffin, R. (1960), Gold and the Dollar Crisis: The Future of Convertibility, New Haven: Yale University Press.

Vernengo, M. (2003), “Bretton Woods”, in J. King (ed.), The Elgar Companion to Post Keynesian Economics, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 30–34.

Friday, May 30, 2014

Chick & Tily on whatever happened to Keynes’s monetary theory?

New Cambridge Journal of Eeconomics paper by Victoria Chick and Geoff Tily.

From the abstract:
Some see a return to Keynes’s ideas in response to the crisis that began in 2007, but we argue that the resurrected ideas belong to that betrayal of Keynes’s thought known as ‘Keynesian’ economics. What happened is almost a reversal of the Whig history view of economics, in which past knowledge is embodied in later theory: Keynes has been made a pre-Keynesian. We trace this transformation mainly through his monetary theory, though we range more widely where necessary. We state what we consider to be his monetary theory, then identify and summarize the key contributions to its destruction. Then, in a speculative section, we suggest a variety of motivations for this subversion of his ideas. We end by assessing what has been lost, in particular his monetary policy, and suggest social and political pressures that may have been partly responsible.
Read the rest here (subscription required).

Saturday, April 26, 2014

Dean Baker: Bond Bubbles? Silly Season at the Fed

By Dean Baker
Throughout this [so-called] 'recovery' there have been a number of economists and policy types expressing concern about a “bond bubble.” This is the idea that bonds are overpriced and could take a sudden tumble giving financial markets and the economy the same sort of hits we saw from the collapse of the housing and stock bubbles. This is seriously misguided thinking from any conceivable perspective. At the most basic level the concern is misplaced because there is nowhere near as much money at stake. Former Fed economist Andrew Flowers put the amount of money at stake in the bond market as $40 trillion in a recent FiveThirtyEight column. This compares to a stock market valued at around $28 trillion and housing market at a bit over $20 trillion. While that may make the bond market seem more important, the $40 trillion number is hugely misleading. The $40 trillion figure refers to total debt, much of which is short-term. This is important because short-term debt doesn’t lose much value when interest rates rise. If we restrict our focus to debt that stands to lose substantial value when interest rates rise – remaining duration of five years or more – the volume of debt would be well under $20 trillion.
Read rest here.

Wednesday, April 23, 2014

Iren Levina: A Puzzling Rise in Financial Profits and the Role of Capital Gain-Like Revenues

New PERI working paper by my friend & colleague Iren Levina - From the abstract:
The paper provides an explanation for the puzzling decoupling between the rate of growth of financial profits and GDP in the 2000s. Drawing on the insights from Keynes, Minsky, and Hilferding, the paper identifies a peculiar type of profit – capital gain-like revenues that take the form of profits from underwriting, mergers and acquisitions, securitization, and trade in financial assets. These capital gain-like revenues come from the redistribution of monetary assets and lack a counterpart in current GDP. They can be thought of as wealth transfers. Based on an empirical analysis of revenues of U.S. bank holding companies, these capital gain-like revenues are shown to have contributed significantly to the decoupling between the rate of growth of financial profits and GDP. The paper identifies characteristics of these revenues that explain the puzzles around this decoupling – its very possibility, sustainability over long time, and lack of losses sufficient to offset the pre-crisis financial gains. These characteristics of capital gain-like revenues also allow one to reconcile two seemingly incompatible approaches to a rise in financial profits – as transfers (rent) and as an illusion (mirage). 
Read rest here. 

Monday, March 24, 2014

Inflation, hyperinflation and Monetarist perceptions about the functioning of the economy

I dealt before with the persistence of Monetarist views, in particular regarding economic history (here and here). Interesting thing is that recently the Bank of England admitted that money is endogenous, and, hence, at least the simplistic notions that money causes prices are clearly in the defensive. Mind you, as I noted in my post, admitting money endogeneity does not mean they are heterodox by any means, since for them the system still has very much a tendency to full employment.

At any rate, a full discussion of the several views on inflation with a taxonomy is presented here.  The second session that provides a historical overview of inflation is posted below.

Inflationary Processes in Historical Perspective

Price Revolutions are often neglected by economists, but have been central for economic historians. The conventional wisdom among economists is that monetarist views are the dominant interpretation of those long term processes. This is particularly the case about the 16th Century Price Revolution, which is the one associated with the first clear expositions of the Quantity Theory of Money (Arestis and Howells, 2001-2). This is not the case, and in general historians stress the real causes of inflation based on neo-Malthusian models that emphasize demographical forces, in which money is endogenous.

Price Revolutions begin in periods of prosperity, and end in periods of crises. The classic demographic or real model is essentially based on a Malthusian insight, was developed by Michael M. Postan (1973) and used to explain the behavior of the later-medieval western European economy, and in particular the behavior of price movements. Postan had argued that population growth and a relatively static agrarian technology led unavoidably to diminishing returns. Diminishing returns, in turn, drove grain prices up during the long thirteenth century (1180-1350), at a rate estimated by Postan to be around 0.5 percent per year. Symmetrically, population decline during the fourteenth and fifteenth centuries, caused by terrible famines, epidemics and wars, led to a fall in grain prices. In Postan’s framework monetary changes played no role in late-medieval price movements or in any of the changes that the economy underwent during the late middle-ages for that matter.

Not surprisingly, some historians disagree with Postan neo-Malthusian model. Day (1978) argues that the economies of the late middle-ages remained hard money economies – despite the incredible development of credit instruments – and that monetary contraction should be seen as the essential cause of the fourteenth and fifteenth centuries’ deflation. The decrease in money supply resulted both from Europe’s limited monetary stocks, and the permanent outflow of bullion resulting from permanent balance of payments deficits with the East (Day, 1978, p. 79). Hackett Fisher (1996, p. 19) suggests, however, that even though money and population changes both play a role, “population appears to have been the primer mover.” In this sense, the turning point in the 1380 would have more to do with harvest failures and the plague than with money shortages.

Hackett Fisher (1996, p. 72) argues subsequently that the prime mover in the following Price Revolution was the “revival of population growth, which placed heavy pressure on material resources.” Monetarist inclined authors emphasize the silver and copper mining boom in Central Europe in the 1460s – before the discovery and inflow of American bullion – as a major factor ending the European bullion famine (e.g. Munro, 2003). Hence, monetary factors would be central to explain the sixteen century inflation.

The Price Revolution of the sixteen century is well known among economists, and Earl Hamilton’s (1934) is the classic interpretation, putting emphasis on the effects on prices of American gold and silver inflows. When the price revolution became evident several explanations were developed. Jean Bodin and the authors of the Salamanca School – Martin de Azpilcueta and Tomás de Mercado more prominently - are usually credited with formulating the first clear version of the Quantity Theory of Money (QTM).[1]

Wrigley and Schofield (1981) develop a neo-Malthusian model along Postan lines. The main problem with the conventional monetarist view is that prices started to go up considerably before the American bullion arrived in Europe. Historical causality indicates that prices increased first and then the money supply followed suit. In fact, Hackett Fisher (1996, p. 84) suggests that the great inflation created such demand for monetary medium that even “old mines were reopened at heavy expense.” Arestis and Howells (2001-2) emphasize the role of endogenous money in the realist neo-Malthusian tradition. In the neo-Malthusian view bad harvests, famine, disease and war – in particular the Thirty Years War (1618-48) – led to a reversion of demographical trends and led to the end of the second price revolution.

The price revolution of the eighteen century started in the 1730s. The flow of the recently discovered Brazilian gold in Minas Gerais to London via Lisbon is seen by bullionists as the initial cause of rising price trends (Vilar, 1960).[2] It is in this period that David Hume (1752) produces his famous defense of the quantity theory of money, and the specie flow mechanism, according to which inflation resulted from increases in gold inflows related to trade surpluses.[3] On the other hand, population trends – a decline in age at marriage and a subsequent increase in the fertility ratios – suggests that demographical forces were also at play. However, the eighteen century price revolution is ultimately famous for the debates that it provoked in England in the late eighteen century and early nineteen century, known as the Bullionist debates.

David Ricardo is usually described as the main bullionist (defenders of the 1810 Bullion report) author and a champion of the view that inflation was caused by the overissue of bank notes by the Bank of England during the suspension period (1797-1821) – in which bank notes were not convertible to gold. Green (1992) notes that the classical authors – Ricardo included – believed in some variation of the labor theory of value and, hence, concluded that the price of commodities depended on technical conditions of production (labor embodied or commanded) for a given wage level (subsistence).[4] Hence, the price of gold – the numeraire – would also be determined by the technical conditions of production in that sector.

However, if the relative price of gold is determined in that way, the prices of all other commodities in terms of gold cannot be determined by the quantity of gold. Prices in terms of the standard (gold) must be determined by the costs of production of gold, so that causality is reversed and the quantity of money is endogenously determined. Green (1992, p. 56) refers to this classical view of endogenous money as the Law of Monetary Circulation. According to the Law of Monetary Circulation, even though in the long run money supply is endogenously determined, in the short run – when market prices deviate from normal prices – exogenous changes in the money supply may affect prices.

The idea that Ricardo does not defend the Quantity Theory in the long run contradicts the popular vision that assumes that there is a stream of monetary thought that begins with Hume, Ricardo, and the Currency School (e.g. Torrens) and culminates with modern monetarism (Hicks, 1967, pp. 155-173).[5] The anti-Quantity Theory current, in this view, starts with Thornton and the Banking School (e.g. Tooke) and culminates in Keynesian economics.

The main opponent of the bullionist view of the eighteen century inflation was the economist and price historian Thomas Tooke – the leader of the Banking School.[6] According to Tooke (1844, p. 123) “the prices of commodities do not depend upon the quantity of money indicated by the amount of bank notes, nor upon the amount of the whole of the circulating medium; but … on the contrary, the amount of the circulating medium is the consequence of prices.” Prices increased, still according to Tooke, as a result of bad harvests, the depreciation of the external value of the currency that increased the price of imported goods, and higher interest rates, which led to higher financial costs. Reversal of these trends in the post-Napoleonic War period, hence, explains the deflationary forces in action, and the end of the price revolution.

The last price revolution starts with the end of the Great Depression (1873-1896), the year of William Jennings Bryan Populist bid for the presidency in the US, based on his attack on the Gold Standard, and his defense of a bimetallic monetary system. While conventional views would emphasize the role of the discovery of new sources of bullion in South Africa, alternative views would emphasize the importance of distributive conflicts in the inflationary process. Adherence to the Gold Standard, and the so-called crime of 1873 – the demonetization of silver (Goodwin, 1978, pp. 16-7) – meant that money was scarce, and led to deflationary forces, which in turn hurt debtors (mid-western and southern farmers) and benefited eastern industrialists and bankers (the Robber Barons). The agrarian revolt and the rise of populist and progressive movements – that led to the regulation of monopolies, the passing of an income tax, the creation of a central bank, and a series of other reforms – turned the tide and generated inflationary pressures. The importance of these events is that for the first occasion in modern times it became clear that inflation could result from disputes over the proverbial pie. Distributive conflict would become central for several explanations of inflation in the twentieth century.

Distributive conflict may very well have had a role on the inflationary surge in the US, but it was ultimately an American phenomena. Hackett Fisher (1996, p. 186) argues that the twentieth century price revolution has structural causes related to rising living standards, a public health revolution that led to rising population, and institutional changes that led to what Heilbronner referred to as “floors without ceilings.” The rise of corporations, and the development of a more regulated economy, with increasing participation of governments, led to an upward bias in prices. Thus, Joan Robinson (1971) famously argued that “the general price level has become a political problem.”

Distributive conflict and political disruption were particularly important in the discussion of inflation in the 1960s. Conventional wisdom presumes that the inflationary pressures were brought about by the expansionary fiscal policies in the U.S., and the propagation of these inflationary pressures through the international system (Laidler and Parkin, 1975). The increasingly expansionary fiscal policies of the 1960s – resulting both from the Vietnam War and the Great Society experiment of the Kennedy-Johnson administrations – led to growing balance of payments deficits. The U.S. deficits were initially considered instrumental for the working of the international monetary system that was desperately in need of dollars to obtain the essential imports of capital goods needed for reconstruction. However, by the late 1960s the accumulation of idle dollar balances started to put pressure on the money supply of the rest of world, leading to inflation. That is, according to the monetarist logic, inflation was caused by the U.S. fiscal and monetary policies, and transmitted to the world as a result of the system of fixed parities.

An alternative explanation for the inflationary pressures of the 1960s is possible though. This alternative explanation, compatible with the post-Keynesian view, would minimize the effects of the U.S. expansionary fiscal policy and the fixed exchange rate regime. The Golden Age accumulation regime implied a commitment to full employment and the creation of a safety net for unemployed workers. Additionally, the imposition of capital controls and the cheap money policies – which led to low real rates of interest – implied a favorable environment for workers. Parties with strong ties with the labor movement were in power in several Western countries, and this was tolerated, to a great extent, since it was considered a form of reducing the dangers of the Soviet menace. Further, full employment tended to increase the bargaining power of the working class.

In this environment, workers pressures for higher nominal wages were usually accommodated. For a given real rate of interest, and a fixed nominal exchange rate, the only effect of rising wages would be higher prices. In sum, inflation was the result of wage pressures – cost-push – rather than the expansionary fiscal and monetary policies – demand-pull – (Coutts, Tarling and Wilkinson, 1976). Note, however, that for a good part of the Golden Age, wages increased at the same pace that productivity, and hence, had a negligible inflationary impact. Hence, the inflationary process of the 1960s and 1970s seems to be related to the increases in taxes (passed to prices), competitive depreciations (more prominently after 1973), and supply side shocks, notably the two oil shocks of the 1970s. Stabilization and the end of this last price revolution would not be related then to fiscal consolidation, but to the fall in the prices of commodities, and the weakening of the labor movement (Kaldor, 1976; Eisner, 1989).

It is worth noticing in this birdseye view of inflation in historical perspective that the quantitativist tradition faces an important conundrum. If exogenous increases in money supply are the ultimate cause of inflation, then a diabolous ex machina is the culprit for increasing the money supply (Hackett Fisher, 1996 p. 83). Corrupt and incompetent politicians are the main suspects. This explanation of the ulterior causes of inflation is one that emphasizes the role of individuals at the expense of the structural constraints faced by them. Alternative theories are less dependent on methodological individualist premises, and on the moral and intellectual qualities of politicians to explain inflationary processes.

Last but not least, our brief description of the historical record of money and inflation cannot leave hyperinflationary processes out. The most famous episode of hyperinflation is the post-World War I German case. Historians, says Ferguson (1995a, p 19), have essentially followed two interpretations of the German hyperinflation. The first was offered in the 1930s by the Italian economist Constantino Bresciani-Turroni (1931),[7] who blamed poor monetary and fiscal policy and argued that the inflation had predominantly negative consequences (Camara and Vernengo, 2001). Recent scholarship among historians, however, Ferguson admits has emphasized alternative views of inflation (e.g. Kindleberger, 1985).

The view according to which deficit spending was the main cause of German inflation was named the English or allied view by Bresciani-Turroni (1931, p. 46) in his classic The Economics of Inflation.[8] The allied view, which was forcefully defended by Bresciani-Turroni, corresponds to what today would be called monetarist, and was later formalized by Cagan. In this view, the burden imposed by the internal war debt, the payment of pensions to war veterans, widows and orphans, the reconstruction of the few devastated regions, and the process of war demobilization were too heavy for the young Weimar Republic and the leftist Social Democrat government to carry. In addition, the incapacity to raise fiscal revenues implied that the increasing fiscal spending had to be financed by the Reichsbank.

According to Bresciani, the empirical evidence for his views is provided by the monetary reform of November 1923, which for him represents the moment when the German government found the necessary energy to stop the monetary issues (ibid., p. 399). One of the crucial characteristics of the monetarist interpretation of inflation is that the rise in money supply precedes the rise in the price level. Also, given the dominance of purchasing power parity as the explanation of exchange rate determination in that period, the rise in the domestic price level precedes and causes the depreciation of the deutsche mark. There is a chain of causality that runs from the exogenous money supply to the price level and then to the exchange rate.

For Bresciani-Turroni, the solution to the inflationary problem was simply to cut the fiscal deficit. Once the principles of sound finance were re-established, the price level would be stabilized. The German government was to blame then. Still, as noted by Merkin (1982, p. 25) among the defenders of the quantity theory of money there was a certain degree of acceptance that in reality the rise in the price level preceded the increase in the quantity of money, and, hence, expectations of future money supply increases played a role.

For some authors the rise in wage costs bring about inflation quite independently from the rise in money supply, at least in the short run. Schumpeter was among the authors that argued that “the conviction of the practical man that wage increases drive up the price level is not so wrong as one might believe” (Merkin, 1982, pp. 25–6). Wicksell (1925, p. 202) also criticizes the quantity theory, in particular the proposition that “the velocity of circulation of money at any given time is approximately constant.” Further, Wicksell is one of the first authors to introduce the idea of endogenous money in marginalist analysis. For him (ibid., p. 201) “it … stands to reason that a general rise in the market prices of both goods and services itself creates the purchasing power required for meeting the higher prices.”

Wicksell’s contributions and also those of Schumpeter and Bortkiewicz stand in a category of their own (Merkin, 1982; Laidler and Stadler, 1998). They all see velocity of circulation as an important element of hyperinflation, and they all introduce endogenous money. However, they also still believe that hyperinflation is the result of excess demand. In particular, Schumpeter and Wicksell credited excess demand to a low market rate of interest, while Bortkiewicz emphasized the acceleration of consumption caused by expectations of further monetary expansion.

The German officials that had to deal with the day-to-day problems of running an economy under hyperinflationary conditions saw the problem, not surprisingly, from a different perspective. The most notorious defender of the so-called balance of payments theory was Karl Helfferich. This view was named the German view by Bresciani-Turroni (1931, p. 47).

The disruption of the war led the German government to regulate the foreign exchange “by way of a direct control of all foreign payments and credits”, (Helfferich, 1927, p. 259). However, “as the collapse of the German nation shows, the force of circumstances proved more powerful than any policy of exchange control” (ibid., p. 262). That is, trade deficits led to depreciation despite the control of the German authorities. As correctly noted by Howard Ellis (1934, p. 224), “the balance theory takes as its point of departure the decline of German exports.” Helfferich argued that the permanent unfavorable trade balance, caused by the war and the impositions of Versailles, led to depreciation. This was the root of German problems. For him contrary to the widely held conception, not inflation but the depreciation of the mark was the beginning of this chain of cause and effect. Inflation is not the cause of the increase of prices and of the depreciation of the mark, but the depreciation of the mark is the cause of the increase of prices and of the paper mark issues (Bresciani-Turroni, 1931, p. 45).

In other words, causality runs from the exchange rate to the price level. That means that the rise in the price level cannot be related to the increase in the money supply. Graham (1930) defended Helfferich’s position in what was to become, up to the publication of Bresciani’s book in English, the most influential view of the German hyperinflation. Graham (1930, p. 172) argues that “the proximate … chain of causation, up to August 1920 at least, and perhaps at other times, ran from exchange rates to prices to volume of circulating medium rather than in the reverse direction”. According to the balance of payments view it is not possible to stabilize the economy without stabilizing the exchange rate. This was only possible if foreign reserves were available. The renegotiation of reparations in 1922 and the loans obtained through the Dawes Plan in 1924 allowed the stable foreign value of the rentemark to be maintained.[9]

It is clear that some notion of passive or endogenous money is present in the work of the defenders of the balance of payments theory. Yet, Joan Robinson (1938, p. 74) noted that there was no explanation of the role of wages in the inflationary process. In her words, “neither exchange depreciation nor a budget deficit can account for inflation by itself. But if the rise in money wages is brought into the story, the part which each plays can be clearly seen.” As correctly pointed out by Joan Robinson, there is an inverse relation between the real wage and the exchange rate, so that depreciation leads to a decline in the real wage. If workers resist the fall in the real wage, because tradables are an important component of the wage basket for example, then domestic costs will increase, and so will prices. That is, distributive conflict is an essential part of the hyperinflation story. Joan Robinson’s reformulation of the German view provided a sound basis for alternative explanations of hyperinflation.

Quantitativists and the Balance of Payments school are the two main groups with opposing views on the German hyperinflation. Cagan developed the typical monetarist view on the basis of the quantitativist or monetarist analysis. On the other hand, the Balance of Payments school argues that reparations and depreciation are the cause of hyperinflation. Joan Robinson introduces the notion of wage/foreign-exchange spirals and distributive conflict. Her contribution can be named post-Keynesian. Variations of these two views remain the canonical interpretation of hyperinflationary processes.

Notes:
[1] On the Salamanca School see Grice-Hutchinson (1952), and Popescu (1997).

[2] The Methuen Treaty established that Portugal would export wine and import manufactured goods – textile products fundamentally – from England at very low tariffs. The treaty – later used by Ricardo in his attack on the Corn Laws – implied that Portugal became dependent of British goods, which were ultimately imported with the inflows of Brazilian gold. The discovery of gold meant complete submission to British hegemony for Portugal.

[3] Hume, one should note, considered John Locke the source of his defense of what we now term the Quantity Theory and the ultimate authority of the issue (Green, 1992, p. 31). Sir James Steuart represented, on the other hand, the main opponent of the quantity theory in the eighteen century. Steuart believed that changes in the supply of money would ultimately affect the velocity of circulation rather than the price level.

[4] Marx (1859, p. 173) criticizes Ricardo for his contradiction of his theory of value and his monetary theory. That would be the case, since, according to Marx, Ricardo adopts the view that the value of gold is determined by the quantity in circulation in conformity with the quantity theory, rather than being determined by embodied labor. In contrast to Marx’s claim, Ricardo (1817, pp. 85-6) argues that “the same general rule which regulates the value of raw produce and manufactured commodities, is applicable to metals; their vale depending … on the total value of labor necessary to obtain the metal, and bring it to the market.” For a discussion of Marx’s views on money see Foley (1986).

[5] On Ricardo’s often misrepresented views on inflation and foreign exchanges see Marcuzzo and Rosselli (1986). For a conventional view see Fetter (1965).

[6] The Banking School is sometimes seen as a precursor of post-Keynesian analysis of endogenous money (Wray, 1990). The endogeneity of money is implicit in the Law of Reflux – the Banking School version of the Law of Monetary Circulation. Reflux implies that commercial banks cannot create credit above the level demanded by economic agents, since excess credit would be used by those economic agents to repay pending debts, thus canceling the rise of the means of payment.

[7] Bresciani’s book carried a foreword from Lionel Robbins describing Hitler as "the foster-child of the inflation." Hitler’s rise to power occurred only ten years after the hyperinflationary crisis, and if an economic problem should be mentioned as part of the complex causes of his rise to power the depression and the ensuing unemployment should take the prize. In other words, although the monetarist view of hyperinflation developed by Bresciani is still dominant, other aspects of his analysis are now considered inaccurate. In particular his view according to which the fall of the Weimar Republic and the rise of the Nazi regime can be attributed to hyperinflation. On the latter see Holtfrerich (1986) and Feldman (1993).

[8] Keynes shared the Allied view of inflation (Keynes, 1923). However, Ferguson (1995b, p. 445) claims that his views on German reparations – which emphasized the ability to pay as a principle to be followed by the Allies – bestowed credibility to German officials that “were deliberately exacerbating inflation to undermine reparations.” Ferguson (1995b) and Macmillan (2001, p. 192) seem to indicate that Keynes’ calculations of the burden of the transfer problem were too high, and that hyperinflation can be ultimate explained by the malice of German officials. The diabolous ex machina of all quantitativist stories shows his face. It seems, however, more reasonable to believe that the constraints imposed by reparations were a serious cause of hyperinflation, and that a more benign Treaty would have lessened the profundity of the crisis.

[9] The rentemark was introduced in November 15 1923, and had its parity fixed at 4.2 million marks per dollar. Until the monetary reform of October 1924 the rentemark circulated together with the old paper mark. The idea of maintaining two currencies circulating simultaneously was exposed by Helfferich, but the actual plan suffered some modifications. See Holtfrerich (1986), and Burdeking and Burkett (1996).