The chapter discusses Schumpeter’s reception of The General Theory and the criticisms he levelled at it. To what extent are these criticisms pertinent and to what extent are they based on misunderstandings and unable to be sustained? The chapter then turns briefly to the heretic elements in the analyses of Keynes and Schumpeter and shows that, important differences notwithstanding, they had more in common by temperament and vision than is typically acknowledged.
The chapter describes the equilibrium of the banking system in a modern economy, with both a central bank and a commercial banking system. Equilibrium conditions are set out for the markets in, first, base money issued by the central bank and, secondly, money in the form of bank deposits (‘the quantity of money’) created by commercial banks. The heart of the chapter is a geometrical construction demonstrating the money creation process in a modern banking environment. A four-quadrant diagram is suggested, because quadrants with isosceles triangles neatly represent the equality of assets and liabilities in financial institutions that is also a necessary feature of bank balance sheets. The resulting ‘apparatus of thought’ is intended to facilitate discussion between economists with different views on both the money creation process and the role of money in the determination of macroeconomic outcomes.
Economic theory that is relevant to the real world is always a product of its time, taking for granted the institutions and behaviours that characterise that time. Old books, like Keynes’s General Theory, present a conundrum: how much is still pertinent today and what revisions are necessary to bring the theory into line with changes in the economic system since the book was written. This chapter attempts an answer to that question. It is argued that the principle of effective demand and liquidity preference is almost unchanged, but that globalisation and changes to the banks’ behaviour pose serious questions for the theory, as does our new awareness of resource constraints and climate change. The underlying methodology remains the best on offer and should be retained in any revision.
Carlos J. Rodríguez-Fuentes
This chapter offers a personal interpretation of Victoria Chick’s monetary thought which is heavily drawn on two basic principles that have always been present in her work and should be known by every economist who really wants to understand the complex influence that theory, method and institutional context exert on the way monetary policy works. The two basic principles I want to address in my review of Victoria Chick’s monetary thought are these: 1. the notion that monetary change is only ‘one half of the story’ in our understanding of the way the economic system really works; and that 2. the development, structure and evolution of the banking system matters for the way monetary policy works and banking system promotes (or does not) economic development. Our analysis will suggest that the two aforementioned principles are part of the innovative academic legacy of Victoria Chick, which has resulted from her constant dedication to the critical analysis of theory and her strong determination to unravel the assumptions and logical foundations of theories. The analysis provided in this chapter will suggest that the explicit consideration of these two principles, namely, the way money enters the income-generating process and the historical and institutional particularities of theory, become crucial not only for a better knowledge of the way a monetary economy works, but also for understanding the evolving character of the so-called ‘monetary transmission mechanism’. In my opinion, the explicit consideration of these two principles would particularly help many conventional economists to overcome their current discomfort and desperation, for conventional monetary theory helps very little to understand the current debate over the broken transmission mechanism of monetary policy or the ineffectiveness of its conventional tools. Victoria Chick’s monetary thought explains not only the potential interrelationship of monetary and fiscal policy, for this depends on the way the monetary change takes place, but also the ‘abnormal’ time of monetary policy (Roubini 2016) that orthodox economists are unable to explain, for their conceptual framework does not conceive what Victoria Chick takes for granted: that the effect of any monetary change depends on how people behave, who issues the money and in exchange for what (Chick 1978b, pp. 55–8).
Roy J. Rotheim
After almost a decade of historically unprecedented monetary policies in response to the recession of 2007–09, there is now a growing concern among central banks that their economies are pushing ever closer to a longer-run trajectory with narrowing output gaps, low levels of unemployment, and inflation rates broaching the benchmark 2 per cent ceiling. This evidence is signalling to them that the time is ripe for policy normalisation, compelling them to restrain those accommodative monetary policies with higher nominal interest rate targets and to demonetise their balance sheets swelled by successive rounds of quantitative easing. The US Federal Open Market Committee (FOMC) began this policy shift in December 2016 with the first among now several increases in its federal funds rate policy target range. Their commitment to normalising their balance sheet was initiated with the September 2017 FOMC meeting. It is just a matter of time before other central banks follow this lead. What effect will this new direction in monetary policy have on inflation, output growth and unemployment? The mainstream theory embraced by most policy makers is that broaching the long period reflects a separation of monetary and real sectors such that monetary restraint can be expected to dampen inflation expectations and inflation, but with no effect on the natural rate of unemployment. Evidence often flies in the face of theory, and there is surely no better example of this divergence than in the extreme monetary tightening brought about by the FOMC under then chair Paul Volcker in October 1979. Volcker assured a worried public that stepping on the monetary brakes would achieve their policy goals but with no effect on the then perceived existing natural rate of unemployment. What happened, as we know, is that this exercise in extreme monetary restraint led to the greatest recession in the US since the Great Depression of the 1930s. Nominal interest rates soared, unemployment rose, although oddly enough inflation did not come down until there was a policy reversal during the subsequent year to loosen the monetary reins. Is it possible that the current and imminent move toward monetary restraint may once again not achieve the intended results expected by policy makers in terms of dampened inflation and inflation expectations with no impact on the pace of economic growth or labour demand? There is always a degree of scepticism among followers of Keynes with regard to the unlikelihood that monetary restraint will have negative employment effects. What I propose to address in this chapter is whether there may be mitigating factors on the price side of the picture that give pause to the belief held by mainstream economists (both New Classical and New Keynesian) that monetary restraint will have the predicted effects on bringing down the rate of growth of the price level. Seen from the vantage point of a more open, non-mainstream perspective, it is possible that monetary restraint may result in prices not falling, and perhaps even rising. The key factor as we explore this situation is that ongoing business activity requires a steady flow of money to finance short-term and longerterm commitments, often supported by the issuance of debt denominated in money terms. An economy is not a state, but instead an ongoing process where decisions and commitments are made in light of an uncertain future. Revenue flows in the future are uncertain to the extent that firms cannot be assured that their current and future cash flows will be sufficient to service that debt. Access to external finance must, therefore, be available at rates that will make it economically feasible to commit to the requisite contractual payment schedules. With fluctuations in output and revenue, impeded access to external finance, brought about either by central bank monetary restraint or heightened liquidity preference among banks and non-bank financial institutions, could mean the cutting back or curtailment of business operations or the necessity of selling even greater quantities of debt, thereby increasing the leverage of firms and their subsequent precariousness as creditworthy entities in the future. Production and investment flow decisions are made in the present facing an uncertain future about revenue flows. Firms who are faced with recurrent and perhaps expanded debt obligations, especially when monetary restraint may threaten the state of short- and long-term expectations with regard to revenue flows, could be forced to use their mark-ups over unit cost as a strategic variable to sustain the continued flow of finance that is becoming more costly and difficult to access through either sales revenue or external finance. To the extent that firms can engage in these defensive strategies to maintain their financial flows, monetary restraint may result in countervailing forces preventing the slowing down of prices that traditional models would suggest.
Financial markets rest on the proliferation of credit, not just within formal, regulated banking channels, but also along unregulated, or shadow, banks. Unlike regular banks, shadow banks function beyond the jurisdiction of the monetary authorities. While decisions to lend and borrow are subject to risks which are systemic and unquantifiable, transactions on the part of the unregulated banks can further exacerbate these risks by encountering new types of risk within informal credit channels. Given that these channels, while providing additional credit, often lead to excess risks for lenders, additional charges are levied on borrowers. Thus there arises a need to enquire into the pattern of these credit channels, especially in developing countries where large sections of borrowers cannot afford the high cost of such loans.
Joan Robinson argued that it is the task of Post-Keynesians to reconcile the work of Keynes and Sraffa. The central difficulty is to reconcile equilibrium with uncertainty and the solution lies within Keynes’s distinction between short-, medium- and long-term expectation and furthermore between the long term and the technical long period. Recognition that the ‘expectations’ of Keynes’s state of short-term expectation are equilibrium prices, in a carefully defined and qualified sense, makes it possible to replace his Marshallian concept of normal prices with Sraffa’s prices of production. There is a definite case for seeking to recast the principle of effective demand without the Marshallian theory of value. The task is to achieve this without losing either an empirically useful concept of equilibrium or the concept of fundamental uncertainty.
John Maynard Keynes’s invaluable contribution to economic theory was to conceive a method to analyse a system whose future is fundamentally uncertain. Subjective views regarding the future play a crucial role in Keynes’s General Theory because, owing to ontological uncertainty and limited cognitive capacity, ‘there is no scientific basis on which to form any calculable probability whatever’ (Keynes  1973, p. 114). The position of the system at any point in time, accordingly, results from the forces involved in the decision the individuals have made in accordance with their subjective views: ‘Or, perhaps, we might make our line of division between the theory of stationary equilibrium and the theory of shifting equilibrium—meaning by the latter the theory of a system in which changing views about the future are capable of influencing the present situation’ (ibid., p. 293). In such a context, expectations may be unfulfilled unpredictably, although they may be fulfilled sometimes (by chance rather than by an objective knowledge). This is the reason why, although the system that emerges from private and public decisions tends to some equilibrium position at any point in time, the equilibrium is subject to endogenous change in the subjective views regarding the future. Equilibrium in this sense is intrinsically dynamic, which raises difficulties compared with the orthodox definition of equilibrium. In Macroeconomics after Keynes, Victoria Chick pinpointed the essence of the method Keynes utilised to build his ‘shifting equilibrium’ theory (Chick 1983). The method consists basically in taking the views about the future – along with other variables such as wages and the capital stock – as given at a point in time. This allows one to analyse the aggregate outcome of the individual decisions at any point in time, by means of a static – though ‘shifting’ – equilibrium model (Chick 1983, chs 2 and 13). Hence the dynamics of the system can be analysed as the change in equilibrium produced over time by the effect of the changing views about the future and other explanatory variables. This was the subject of Victoria Chick’s insightful presentation of The General Theory in terms of a static model of a dynamic process (see also Kregel 1976).
This chapter investigates the rational foundations of liquidity preference theory as sketched by Keynes in The General Theory. Mainstream theory focuses on two determinants of liquidity preference related to weak uncertainty: risk aversion and transaction flexibility. Keynes, on the other hand, focused mainly on the nexus between liquidity preference and strong uncertainty, distinguishing two basic determinants: strong uncertainty aversion, and strong intertemporal flexibility. Though each of these determinants has been the object of specific interpretations of liquidity preference theory, this chapter suggests that we may encompass their analysis within a more general conceptual framework. To this end, the Keynesian concept of weight of argument plays a crucial role. In particular, we show that its variations along different phases of the business cycle alter the impact of each of the components of liquidity preference.
Teodoro Dario Togati
This chapter addresses two key questions: why did Keynes lose his generality battle and what can be done to restore his generality claim? In answer to the first, the chapter argues that one major reason why Keynes lost his generality battle is that he did not develop a good articulation of his ‘research programme’ in Lakatosian terms. For example, unlike the Arrow–Debreu microeconomic model underlying the general equilibrium macro, the GT does not provide a unifying vision of the economy. As for the second question, this chapter seeks to identify the conditions under which the generality claim can be restored. The most important of these is the one identified by Pasinetti, namely the full-blown articulation of a ‘monetary theory of production’ research programme. This requires developing an autonomy of macro-perspective, placing the emphasis on the role of conventions, institutions and aggregate variables as emergent, persistent features of the economy.