Here our other conversation with LP Rochon, about the chapter on Classical or Surplus approach authors. My co-author, Suranjana Nabar-Bhaduri and I talk about the Real Bills Doctrine, Bullionism, Say's Law the implications for theories of crisis. And about several authors, Smith, Ricardo, Tooke and more.
Showing posts with label Tooke. Show all posts
Showing posts with label Tooke. Show all posts
Friday, February 11, 2022
Sunday, March 19, 2017
Latin American corner: Neo Fisherism, New Keynesianism and monetary policy in Latin America (II)
By Naked Keynes (Anonymous Guest Blogger)
The positive relationship between nominal interest rates and inflation is not a new stylized fact in economic theory. In the 19th Century Thomas Tooke (1774-1858) considered it a general rule illustrated by the data presented in his History of Prices and the State of Circulation, 1792-1856 (published over the period 1838-1857).
Tooke rationalized the positive relationship between inflation and interest rates by postulating that the interest rate is part of the cost of production of commodities As a result when interest rates rise so does the cost of production and hence prices. As he put it in his Inquiry into the Currency Principle (1959 (1844) p.81: “A general reduction in the rate of interest is equivalent to or rather constitutes a diminution in the cost of production…the diminished cost of production hence arising would…inevitably cause a fall of prices of all the articles into the cost of which the interest of money entered as an ingredient.” Tooke dismissed the existence of a negative relation between interest rates and commodity prices. A fall in interest rates may be synonymous with liquidity but as Tooke remarked (Ibid, p.79):“A power of purchase might thus doubtless be created; but why should it be directed to the purchase of commodities if there was nothing in the state of supply, relatively to the rate of consumption, to afford the prospect of gain on the necessary eventual resale?..The error is in supposing the disposition or will to be co-existence with the power. The limit to the motive for the exercise of the power is in the prospect of resale with a profit.” By the way the assumption of equating the disposition with the power of purchase is a fundamental tacit assumption underlying the monetarist, New-Classical and New Keynesian monetary transmission mechanisms. It´s the whole story behind real cash balances and the transactions demand for money. Tooke went further he assimilated the effect on interest rates on asset markets (Ibid, p.86):“A low rate of interest is almost synonymous with a high price of securities…”
Tooke´s views were challenged by Knut Wicksell (1851-1926): “Tooke´s thesis is certainly wrong…The argument is based on the inadmissible, not to say impossible, assumption that wages and rent would at the same time remain constant, whereas in reality a lowering of the rate of interest is equivalent to a raising of the shares of the other factors of production in the product” (Wicksell, Lectures on Political Economy, II, p. 183). Wicksell´s criticism of Tooke and his disciples led him to explain the rise in prices and inflation by the gap between the natural rate of interest (“the rate of interest at which the demand for loan capital and the supply of savings exactly agree”, Ibid, p. 193 and which depends on real as opposed to monetary factors including “the efficiency of production…the available amount of fixed and liquid capital, on the supply of labour and land…” Wicksell, Interest and Prices (1936 (1898) p. 106)) and the money rate of interest. Assuming full employment, a pure credit system and that banks respond endogenously to the demand for credit Wicksell showed that when the natural rate of interest exceeded the money rate of interest an inflationary process ensued. The inflationary process led eventually to an increase in the money rate of interest to match the natural rate of interest at which point inflation would stop. In this way Wicksell was able to resurrect the positive relation between the money rate of interest and inflation while rejecting Tooke´s theses.
The Wicksellian distinction between the natural and money rate of interest is at the heart of the New Keynesian model. It appears in the aggregate demand equation (IS) and in the Taylor rule and in fact the Central Banks that have explicit inflation targeting regimes (as well as some that do not) must obtain estimates of the natural rate for their models to be operative. Without the natural rate there would be no New Keynesian monetary models. However, it is odd, that the relation they postulate between the money rate of interest and inflation is exactly opposite to that of Wicksell.
Needless to say, New Keynesian inflation targeting models do not have scope or space to include the type of causality between interest rate and asset markets envisage by Tooke (which is an essential component of Keynesian economics). These models do not include the banking system or asset markets. This is due to their firm commitment to the upgraded “divine coincidence”: price stability (equating the market and natural rate) is equivalent to full employment and to financial market stability.
To be continued
The positive relationship between nominal interest rates and inflation is not a new stylized fact in economic theory. In the 19th Century Thomas Tooke (1774-1858) considered it a general rule illustrated by the data presented in his History of Prices and the State of Circulation, 1792-1856 (published over the period 1838-1857).
Tooke rationalized the positive relationship between inflation and interest rates by postulating that the interest rate is part of the cost of production of commodities As a result when interest rates rise so does the cost of production and hence prices. As he put it in his Inquiry into the Currency Principle (1959 (1844) p.81: “A general reduction in the rate of interest is equivalent to or rather constitutes a diminution in the cost of production…the diminished cost of production hence arising would…inevitably cause a fall of prices of all the articles into the cost of which the interest of money entered as an ingredient.” Tooke dismissed the existence of a negative relation between interest rates and commodity prices. A fall in interest rates may be synonymous with liquidity but as Tooke remarked (Ibid, p.79):“A power of purchase might thus doubtless be created; but why should it be directed to the purchase of commodities if there was nothing in the state of supply, relatively to the rate of consumption, to afford the prospect of gain on the necessary eventual resale?..The error is in supposing the disposition or will to be co-existence with the power. The limit to the motive for the exercise of the power is in the prospect of resale with a profit.” By the way the assumption of equating the disposition with the power of purchase is a fundamental tacit assumption underlying the monetarist, New-Classical and New Keynesian monetary transmission mechanisms. It´s the whole story behind real cash balances and the transactions demand for money. Tooke went further he assimilated the effect on interest rates on asset markets (Ibid, p.86):“A low rate of interest is almost synonymous with a high price of securities…”
Tooke´s views were challenged by Knut Wicksell (1851-1926): “Tooke´s thesis is certainly wrong…The argument is based on the inadmissible, not to say impossible, assumption that wages and rent would at the same time remain constant, whereas in reality a lowering of the rate of interest is equivalent to a raising of the shares of the other factors of production in the product” (Wicksell, Lectures on Political Economy, II, p. 183). Wicksell´s criticism of Tooke and his disciples led him to explain the rise in prices and inflation by the gap between the natural rate of interest (“the rate of interest at which the demand for loan capital and the supply of savings exactly agree”, Ibid, p. 193 and which depends on real as opposed to monetary factors including “the efficiency of production…the available amount of fixed and liquid capital, on the supply of labour and land…” Wicksell, Interest and Prices (1936 (1898) p. 106)) and the money rate of interest. Assuming full employment, a pure credit system and that banks respond endogenously to the demand for credit Wicksell showed that when the natural rate of interest exceeded the money rate of interest an inflationary process ensued. The inflationary process led eventually to an increase in the money rate of interest to match the natural rate of interest at which point inflation would stop. In this way Wicksell was able to resurrect the positive relation between the money rate of interest and inflation while rejecting Tooke´s theses.
The Wicksellian distinction between the natural and money rate of interest is at the heart of the New Keynesian model. It appears in the aggregate demand equation (IS) and in the Taylor rule and in fact the Central Banks that have explicit inflation targeting regimes (as well as some that do not) must obtain estimates of the natural rate for their models to be operative. Without the natural rate there would be no New Keynesian monetary models. However, it is odd, that the relation they postulate between the money rate of interest and inflation is exactly opposite to that of Wicksell.
Needless to say, New Keynesian inflation targeting models do not have scope or space to include the type of causality between interest rate and asset markets envisage by Tooke (which is an essential component of Keynesian economics). These models do not include the banking system or asset markets. This is due to their firm commitment to the upgraded “divine coincidence”: price stability (equating the market and natural rate) is equivalent to full employment and to financial market stability.
To be continued
Tuesday, March 19, 2013
Thomas Tooke and the Gibson Paradox
The Gibson Paradox is the name that Keynes suggested for a particular empirical regularity, namely: the positive correlation between the rate of interest and the price level. He had read about in a series of articles in the Banker's Magazine by A. H. Gibson, hence the name. Keynes suggested in his Treatise on Money that the Gibson Paradox was "one of the most completely established empirical facts in the whole field of quantitative economics." The graph below is from Gibson's 1926 piece.
However, the correlation was first noted by Thomas Tooke (for more see Pivetti's entry in the New Palgrave; subscription required), the leader of the Banking School, in the 19th century, and author of the massive and underappreciated History of Prices ( Vols. 1, 2, 3, 4, 5 and 6 available on-line).
In that book, and contrary to Ricardo and the Bullionist authors (the precursors of the Currency School), he argued that inflation during the Napoleonic Wars (1793-1814) was not caused by money printing by the Bank of England (bank notes were inconvertible from 1797 to 1821), but the result of bad crops and higher prices of agricultural goods, import restrictions associated to the blockade and higher import prices, and exchange rate depreciation that added to the costs of imported goods. The last cause he cites is associated to what Keynes called the Gibson Paradox (p. 347):
The reason that the correlation seemed like a paradox to Keynes is because he thought along marginalist lines and assumed that a higher rate of interest would lead to lower investment, and hence reduce demand pressures on prices. He expected a negative correlation between the two variables. Wicksell noted that if the economy was hit by a real shock (to the marginal productivity of capital, for example) then you would have a bank rate of interest lower than the new and higher natural rate of interest (implying higher remuneration for the more productive capital), and the excess investment associated to this situation would lead to higher prices. Eventually, banks would note that the bank rate was too low, and would raise it, leading to an increase in the rate of interest together with higher prices (a positive correlation). Of course Wicksell and the natural rate cannot survive the capital critique. For more on Wicksell go here.
In that book, and contrary to Ricardo and the Bullionist authors (the precursors of the Currency School), he argued that inflation during the Napoleonic Wars (1793-1814) was not caused by money printing by the Bank of England (bank notes were inconvertible from 1797 to 1821), but the result of bad crops and higher prices of agricultural goods, import restrictions associated to the blockade and higher import prices, and exchange rate depreciation that added to the costs of imported goods. The last cause he cites is associated to what Keynes called the Gibson Paradox (p. 347):
"A higher rate of interest, in consequence of the absorption by the war loans of a considerable proportion of the savings of individuals; such higher rate of interest constituting an increased cost of production."In other words, the rate of interest enters the costs of production [some heterodox authors, like Lance Taylor, have referred to this as the Cavallo-Patman effect]. Note that there is no particular paradox in the effect, which according to Lawrence Klein [yes the same that won the Sveriges Riksbank Prize, aka the Nobel] is still doing fine (and yes also needs subscription; sorry).
The reason that the correlation seemed like a paradox to Keynes is because he thought along marginalist lines and assumed that a higher rate of interest would lead to lower investment, and hence reduce demand pressures on prices. He expected a negative correlation between the two variables. Wicksell noted that if the economy was hit by a real shock (to the marginal productivity of capital, for example) then you would have a bank rate of interest lower than the new and higher natural rate of interest (implying higher remuneration for the more productive capital), and the excess investment associated to this situation would lead to higher prices. Eventually, banks would note that the bank rate was too low, and would raise it, leading to an increase in the rate of interest together with higher prices (a positive correlation). Of course Wicksell and the natural rate cannot survive the capital critique. For more on Wicksell go here.
Thursday, September 20, 2012
Nick Rowe's misconceptions about Sraffians II
As promised here are my additional responses to Nick Rowe’s assumptions (here) on the Sraffian or Cambridge UK side of the capital debates. I had agreed to comment also on assumptions 3 and 4, which stated that:
Böhm-Bawerk famously argued that there are three conditions for the determination of the rate of interest, namely: (1) the differences between wants and provision in different periods of time; (2) the systematic underestimation of future wants and the means available to satisfy them; and (3) the technical superiority of present compared with future goods of the same quality and quantity. The first two are related to subjective preferences, and are behind the supply of savings or abstinence from consumption, while the third is related to productivity. With both thriftiness and productivity one gets a version of the neoclassical loanable funds theory of the natural rate of interest.*
Note that the subjective basis for the determination of the rate of interest is incredibly shaky. The marginalist approach suggests that there is a positive rate of time preference, that is people prefer to consume now rather than latter, and are willing to part with consumption now in order to get more at some future date. That is why there must be a positive rate of interest to convince consumers to postpone the immediate fruition of pleasure. Yet it is far from clear that the positive time preference precedes the positive rate of interest. It seems rather more logical to assume that given a positive rate of interest some people might be willing to postpone consumption. The neoclassical subjective analysis is no more than a tautology with very dubious assumptions about causality, to say the least. It is hard to see why one could base a theory of interest on such uncertain foundations.
Remember that classical authors were very skeptical of subjective individual behavior. They actually referred to social utility when they talked about preferences. In that sense, Sraffa, not only thought that the foundations for subjective theories were unsound, but also from a methodological point of view were not particularly relevant. Interest rates were not positive because some individual preferred things now rather than latter, but they had an institutional foundation, associated to the fact that certain social groups could extract a surplus from society as a whole.
What about the productivity part of the marginalist/neoclassical argument? That’s the part that the capital debates disqualified, as was accepted by no other than Paul Samuelson. I’m not going to discuss the whole issue again, but it suffices to say that there is no logical way to determine the quantity of capital independently of the rate of interest, which implies circular reasoning.
Sraffa had determined very early in his investigation of the determination of relative prices, as early as his first equations in 1927 (with the help of Ramsey) that he could solve the system of simultaneous equations simply with the technical coefficients of production and an exogenous rate of interest (see DeVivo, 2003; subscription required). Sraffa after several changes and developments of his basic equations eventually settled (by the 1940s) on the notion that the rate of profit was determined exogenously by the monetary rate of interest (a proposition not unlike that of certain classical authors, in particular Thomas Tooke, and similar to Keynes idea of a conventional normal rate of interest in the General Theory), in the famous paragraph 44 of PCMC.
Note that classical authors for the most part assumed that the real wage was the exogenously determined distributive variable. The reasons for why Sraffa settled with a monetary theory of distribution require a different post. However, it should be clear that the exogenous rate of interest is not an arbitrary assumption as Nick suggests, but is required for the logical solution of the system of simultaneous equations (which demand the rate of profit to be determined independently of relative prices, something that the marginalist theory is unable to do in a system with a uniform rate of profit). Finally, the important part of the exogeneity of the rate of interest, besides the fact that it fits the historical/institutional framework of the capitalist economies that we live in, where central banks actually do determine the rate of interest, is that institutions play a role in the classical-Keynesian theory of distribution. As noted above, it is class and power that are behind a positive rate of interest and not you aunt's preferences for chocolate cake tomorrow.
Regarding point 4, there is an incredible confusion in the comment by Nick. Sraffa’s system never assumes any aggregate production or a one good economy. There is a composite commodity in the construction of the standard commodity and system, but production is a circular process. Even if it has similar properties as the Ricardian corn model, it is actually composed of several commodities. It is in fact the neoclassical theory, including the disaggregate Walrasian (in its Arrow-Debreu version) model, that requires a one commodity world to bring about the equilibrium of investment (the demand for a quantity of capital) to full employment savings. It is the marginalist theory of the natural rate of interest that lacks any logical foundation.
3. But they still couldn't explain the rate of interest. Because it's hard to explain the rate of interest if you don't want to talk about time preferences. And all the other prices depend on the rate of interest, as well as on technology. So they assumed the rate of interest was exogenous;Before we get to why Sraffa argued that the rate of interest is exogenously determined by the monetary authority, let me discuss the neoclassical assumptions behind Nick’s proposition. I would argue that point 3 is exactly in reverse, that is, it is impossible (not hard) to explain the rate of interest on the basis of subjective preferences.
4. Some economists in Cambridge US made a very special assumption that let them explain the rate of interest without talking about time preferences. They assumed that there was only one good, and it could be converted back and forth between the consumption good and the capital good by waving a wand.
Böhm-Bawerk famously argued that there are three conditions for the determination of the rate of interest, namely: (1) the differences between wants and provision in different periods of time; (2) the systematic underestimation of future wants and the means available to satisfy them; and (3) the technical superiority of present compared with future goods of the same quality and quantity. The first two are related to subjective preferences, and are behind the supply of savings or abstinence from consumption, while the third is related to productivity. With both thriftiness and productivity one gets a version of the neoclassical loanable funds theory of the natural rate of interest.*
Note that the subjective basis for the determination of the rate of interest is incredibly shaky. The marginalist approach suggests that there is a positive rate of time preference, that is people prefer to consume now rather than latter, and are willing to part with consumption now in order to get more at some future date. That is why there must be a positive rate of interest to convince consumers to postpone the immediate fruition of pleasure. Yet it is far from clear that the positive time preference precedes the positive rate of interest. It seems rather more logical to assume that given a positive rate of interest some people might be willing to postpone consumption. The neoclassical subjective analysis is no more than a tautology with very dubious assumptions about causality, to say the least. It is hard to see why one could base a theory of interest on such uncertain foundations.
Remember that classical authors were very skeptical of subjective individual behavior. They actually referred to social utility when they talked about preferences. In that sense, Sraffa, not only thought that the foundations for subjective theories were unsound, but also from a methodological point of view were not particularly relevant. Interest rates were not positive because some individual preferred things now rather than latter, but they had an institutional foundation, associated to the fact that certain social groups could extract a surplus from society as a whole.
What about the productivity part of the marginalist/neoclassical argument? That’s the part that the capital debates disqualified, as was accepted by no other than Paul Samuelson. I’m not going to discuss the whole issue again, but it suffices to say that there is no logical way to determine the quantity of capital independently of the rate of interest, which implies circular reasoning.
Sraffa had determined very early in his investigation of the determination of relative prices, as early as his first equations in 1927 (with the help of Ramsey) that he could solve the system of simultaneous equations simply with the technical coefficients of production and an exogenous rate of interest (see DeVivo, 2003; subscription required). Sraffa after several changes and developments of his basic equations eventually settled (by the 1940s) on the notion that the rate of profit was determined exogenously by the monetary rate of interest (a proposition not unlike that of certain classical authors, in particular Thomas Tooke, and similar to Keynes idea of a conventional normal rate of interest in the General Theory), in the famous paragraph 44 of PCMC.
Note that classical authors for the most part assumed that the real wage was the exogenously determined distributive variable. The reasons for why Sraffa settled with a monetary theory of distribution require a different post. However, it should be clear that the exogenous rate of interest is not an arbitrary assumption as Nick suggests, but is required for the logical solution of the system of simultaneous equations (which demand the rate of profit to be determined independently of relative prices, something that the marginalist theory is unable to do in a system with a uniform rate of profit). Finally, the important part of the exogeneity of the rate of interest, besides the fact that it fits the historical/institutional framework of the capitalist economies that we live in, where central banks actually do determine the rate of interest, is that institutions play a role in the classical-Keynesian theory of distribution. As noted above, it is class and power that are behind a positive rate of interest and not you aunt's preferences for chocolate cake tomorrow.
Regarding point 4, there is an incredible confusion in the comment by Nick. Sraffa’s system never assumes any aggregate production or a one good economy. There is a composite commodity in the construction of the standard commodity and system, but production is a circular process. Even if it has similar properties as the Ricardian corn model, it is actually composed of several commodities. It is in fact the neoclassical theory, including the disaggregate Walrasian (in its Arrow-Debreu version) model, that requires a one commodity world to bring about the equilibrium of investment (the demand for a quantity of capital) to full employment savings. It is the marginalist theory of the natural rate of interest that lacks any logical foundation.
* Irving Fisher was critical of the limitations of Böhm-Bawerk’s theory even within the neoclassical paradigm. For the debate between them see Avi Cohen (2011).
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