January 12, 2022
David Laidler, University of Western Ontario
*A Comment on Ch. 13 “Taking Money Seriously”, of Stephen A. Marglin (2021) Raising Keynes, Cambridge, MA. Harvard University Press
I
Fundamental to Keynes’ General Theory of Employment, Interest and Money was his belief that monetary exchange and the institutions that go with it are essential features of the market economy. Attempts to analyse such an economy “as if” it were a system organised by way of frictionless barter were bound to miss important points, in particular that economy’s capacity for generating serious and persistent unemployment. This, Keynes claimed, was what most of his predecessors and contemporaries were doing, whether self-consciously or not, and his book was intended both to persuade them of the error of their ways and to chart a new path for them to follow.
Though I would quarrel with Stephen Marglin’s acceptance of Keynes’ claims about the revolutionary originality of this basic insight, I nevertheless believe that, uniquely among his contemporaries, Keynes provided a coherent analysis of its implications which changed the future development of macroeconomics. [1] But that development did not, in the end, work out as Keynes intended, and nowadays the so-called “mainstream” of macroeconomic thought is dominated by elaborate and technically dazzling models that either ignore money altogether, or treat it as an insignificant feature of the market economy that can safely be neglected.
Like Marglin, I have long found the resulting disconnect between economic theory and economic reality, which was revealed for all to see by the crisis of 2007-9, deeply discomfiting. But, like him again, I don’t believe that this intellectual chasm can be eliminated by a return to the economics of the General Theory. 1936 was a long time ago and, if we still accept Keynes’ claims about the essential importance of monetary exchange, we must also recognise that its supporting institutions have evolved beyond recognition since then. Thus, Marglin and I are basically on the same (minority) side of current macroeconomic debates. We both believe in “Taking Money Seriously” and the questions that we disagree about only arise because we do so in different ways.[2]
II
A basic proposition about the determination of the quantity of money in circulation dominates Marglin’s contention that we need to move beyond The General Theory: namely, that, although in that book Keynes usually assumed that central banks exercised complete control over this variable, that money was “exogenous”, today’s generic central bank does not in fact set the money supply independently of forces operating in the market place where it is used. Rather, it fixes an interest rate, and allows private agents, not least financial institutions and their customers, to determine what happens next, rendering today’s money “endogenous”. Marglin is right that The General Theory’s analysis needs modifying to accommodate these facts, but I disagree with him about how to do this.
To begin with, I suspect that Marglin overestimates the significance of the exogenous money assumption so widely used in the General Theory for Keynes’ overall view of how the monetary systems of his time worked. Money was no more an exogenous variable in the 1930s than it is now, though the institutional details surrounding this fact were very different. Keynes, the author of ATreatise on Money (1930), knew much more about those details than most of his contemporaries, and the General Theory needs to be read as supplementing and sometimes correcting The Treatise, rather than as superseding it.
On my reading, Keynes resorted to what he knew very well to be the descriptively inaccurate exogenous money assumption in the General Theory because, in 1936, many of his contemporaries were still arguing that downward flexibility of money wages and prices was the key to eliminating mass unemployment. He was anxious to prove differently, to show that the problem of unemployment was rooted in interactions between the monetary system and the capital market, not in the labour market. In basing his argument on exogenous money, he adopted the simplifying assumption most favourable to his opponents, so that, by showing wage and price flexibility to be unreliable and undesirable anti-depression policies even on this premise, he would also make his general case against them. As Marglin and I would agree, he succeeded – Pace aficionados of the Pigou effect, a later theoretical patch-up of no practical significance. [3] And this assumption played the same role when Keynes made his case that conventional monetary policy itself was likely to fail in the circumstances of the time. Here, Marglin and I disagree about how much success he had, but that’s a debate for another time.
III
Money is endogenous nowadays, just as it was in 1936. Of course, procedural details have changed a lot since then, and in different ways in different jurisdictions. In recent years, the key policy interest rate has usually been the overnight rate rather than Bank Rate, and any constraints on policy imposed by the remnants of the Gold Standard are long gone. Moreover, these details continue to evolve. But, in the representative market economy, the supply of money still expands (or contracts) when the volume of loans to the public from commercial banks and similar institutions varies in response to changes in the terms of credit they offer, and/or to changes in the public’s perceptions of the benefits to be had from spending the proceeds of such loans; and the representative central bank’s influence over these factors remains, as in 1936, anything but mechanical.
In The General Theory (as in the Treatise) Keynes argued that variations in the quantity of money in circulation relative to what he called the demand for “transactions” balances, however they were brought about, could lead to cash flowing out of (into) them into (out of) what he called “speculative” balances (money held as part of an investment portfolio rather than in support of activity in markets for goods and services) thus affecting the rate of interest on bonds and ultimately expenditure, output and prices. But, as Marglin reminds us, there now exist a wide and evolving variety of interest bearing instruments, often referred to as “near monies” that, though not always immediately usable without cost as means of exchange, are quite capable of replacing money in its speculative role.
As a consequence, he argues, speculative money holdings, that used to absorb discrepancies between the money supply and the public’s transactions demand for money (with subsequent effects on the rate of interest) no longer exist; and any influence that autonomous variations in the money supply could once have had on the broader economy by this channel have been eliminated. Monetary policy’s influence, Marglin tells us, now runs only through what is often called the “credit channel”: that is from the interest rate that the central bank sets, through those that commercial banks charge on their loans, to market interest rates in general, and thence to aggregate demand; while variations in the money supply passively accommodate whatever changes to the economy’s demand for transactions money that then ensue.
IV
I am not convinced by this argument, though it is certainly true that a much broader array of financial system liabilities than existed in Keynes’ day are available to the public nowadays. Marglin, as we have just seen, argues that these near monies do not serve transactions purposes. This is plausible if we confine the transactions under consideration to predictably smooth cash flows generated by routine expenditures, and his explicit deployment of the famous Baumol-Tobin transactions demand for money model confirms that this is what he has in mind.[4] If, however, we also pay attention to those streams of payments and receipts that are irregular and subject to unforeseeable variations, which create what Keynes called a “precautionary” motive for holding money, and if we also follow Keynes in assimilating money held for these reasons into a broader concept of transactions balances than Marglin deploys, it becomes plausible to argue, against Marglin, that a wide variety of todays near monies are in fact capable of serving both transactions and speculative purposes.[5]
Hence, instead of extending Keynes’ ideas about the demand for money to cope with the development of near monies by treating near monies as a barrier separating “money” from other financial assets, perhaps we should regard them as components of a broader concept of “money” than is compatible with the Baumol-Tobin transaction demand model. This would permit us to preserve, as a basis for monetary analysis, a theory of the demand for money that is integrated into a more general theory of portfolio choice, a starting point which has served us so well since Keynes proposed it in the 1930s.
V
To pursue this argument further, consider what consequences might follow if the central bank of our generic modern economy were to lower its policy interest rate. Commercial banks (and similar institutions) will respond by easing their lending terms, new loans will be negotiated, and new money, at this stage of the proceedings in the form of traditional chequable deposits, will be created to finance them. This will not happen because borrowers want to add this new money permanently to their broader transactions balances, but because they want to exploit the improved terms on which credit is available to buy extra goods and services of all kinds (including the investment goods that Keynes focussed on), and even non-monetary assets, including equities. These borrowers’ money balances will increase at the outset, of course, as they take their loans, but only temporarily until they spend the proceeds for whatever purposes were planned.
Note, however, that when this money, which no one intends to hold onto after its creation as a by-product of credit market activity, is spent, it does not disappear. Rather it moves into the transactions balances of the sellers with whom our borrowers have just transacted, though some of it may be parked temporarily in their “near monies” component at this stage. So, what happens next? One possibility is that sellers have outstanding bank loans that are coming due, and use the proceeds of their sales to discharge them. In this case, the just created but not wanted money will be extinguished, having served its initial purpose (a case I’ll return to later). But suppose instead that some of our sellers have no loans that need discharging and that the proceeds of their newly received payments are surplus to their ordinary requirements for transactions/precautionary balances. Then they are likely to spend this unwanted cash on goods, services, or perhaps financial assets and equities.
At each subsequent stage of the spending chain that starts in this way, there is a direct (or indirect if a non-monetary asset is bought) boost to effective demand in the economy, additional to the one that came from the original borrower’s spending, (unless of course sellers further along the chain discharge bank loans). And these expenditures will continue to put upward pressure on output and prices until the latter have reached levels at which the newly created money still in circulation is willingly absorbed into transactions balances, the demand for which which will have grown in response to this expansion. It seems, then, that money created endogenously in a system where the central bank uses an interest rate as a policy tool can after all have effects on spending, and thus on output, employment and prices, once it gets into circulation. A “money” channel, albeit one broader than that envisaged by Keynes in 1936 (and 1930), can, after all, still be operative in today’s circumstances, in addition to the “credit” channel on which Marglin exclusively focuses.
Note also that if and when newly created surplus money is used along the way to repay outstanding bank loans, this is not necessarily the end of the story. If banks passively accept these repayments, then money is indeed extinguished, but banks are not usually passive agents. Given, among other factors, the setting of the central bank’s policy interest rate, and their assessment of the state of the economy, they will surely have targets for the size and the composition of their balance sheets. The volume of repaid loans might be compatible with continuing to meet these targets without further action, but if it isn’t, they will seek out new borrowers for new loans, the money extinguished by repayments will be replaced in circulation, and a new chain of causation will be set in motion.
This illustrative story is just one of several that could have been deployed here. We could, for example, have begun not with an interest rate cut, but with a spontaneous increase in would-be borrowers’ perceptions of business prospects – a step-up in animal spirits to use Keynesian terminology. But though such tales would differ in detail among themselves, they would all lead to the same basic conclusion: namely, that, provided the option of discharging pre-existing loans from banks, who then passively accept the repayment, does not quickly come to dominate the public’s actions after an increase in bank lending, endogenously created money can play a significant and active role in driving a further expansion of income, employment and prices. And the signs in these stories may be reversed as well, to show, for example, that an endogenously initiated reduction in the money supply will have further contractionary consequences unless these are offset by countervailing expansionary policies on the part of the central bank. And so on.
VI
Now stories like these stop short of demonstrating that Marglin is in error when he puts passively endogenous money at the centre of his extension of Keynesian macroeconomics. Possibilities are indeed present within today’s financial system for repaying existing bank loans with newly received money and, if these are routinely exploited to a sufficient extent, this would make it reasonable to treat Marglin’s particular case as the go-to working hypothesis for understanding how the system functions. But, as I have tried to show, other possibilities also seem to exist that could render such a simplification highly misleading.
The issues about which I disagree with Marglin are thus empirical, and their resolution requires careful study of real world evidence. It is also likely to hang on time and place specific factors such as the precise nature of the financial system and its regulatory framework, the monetary policy regime actually in place, not to mention the goals of policy makers, and even their beliefs about how the economic system works. But an author can only accomplish so much between one set of covers, and Marglin has written a theoretical work, self-consciously built on the General Theory. It would be unfair to criticise him for not having also written an empirical treatise in the style of, if not in agreement with, Friedman and Schwartz’s Monetary History of the United States. In contrast to Raising Keynes, this study kept theory in the background as it made the case that fluctuations in the quantity of money had usually played an active role in generating economic fluctuations, analyzing the empirical record of 1867-1960 one episode at a time, in the process enabling the particular evidence from each to exert a cumulative influence on the interpretation of all the others.[6]
To draw this contrast is not to ask the reader to take it for granted that Friedman and Schwartz had the right interpretation. Monetary historians are still debating these matters. But it is to highlight what I find problematic about Marglin’s theoretical framework: namely, that it rules out a priori the possibility that money can even today be playing an active role in driving economic fluctuations, and hence also pre-judges the outcome of any effort to apply the episode by episode methods of the Monetary History to later events, and update its conclusions in the light of those same institutional developments that have prompted Marglin’s efforts to update Keynes.[7]
Nor is disagreement on this issue of purely historical interest. The United States is currently experiencing its highest inflation rate in four decades. If Marglin is right that the behaviour of the quantity of money is irrelevant for the evolution of output and prices with the financial system as it is now configured, the Federal Reserve System and its supporters must be correct in their assessment that this is a cost-push phenemon, caused by supply side bottlenecks associated with the Covid epidemic. And they must also be correct to look through it to a more stable future and hence to take no action to curb it.
But note that the U.S. money supply experienced explosive growth in 2020 that is hard to explain as a passive response to the then-current behaviour of the usual factors, discussed by Marglin, affecting its demand – output, prices, and interest rates. A broader view than his of what can happen under present institutional arrangements would encompass the possibility that this burst of growth was a result of policies undertaken by the Fed in 2020 which, desirable though they may have been, were always likely to have subsequent consequences for an inflation rate that would be likely to persist and harden without remedial policy action.
This is not the place to litigate these questions, but the very fact that Marglin’s work leads so directly to them is surely a testament to the value of his unfashionable insistence on “Taking Money Seriously”.
[1] See David Laidler, Fabricating the Keynesian Revolution (Cambridge: Cambridge University Press, 1999). BACK TO POST
[2] See David Laidler, “Presidential Address: Taking Money Seriously,” Canadian Journal of Economics 21 (November 1988): 687-713. BACK TO POST
[3] See A. C. Pigou, “The Classical Stationary State,” Economic Journal 53 (June 1943): 343-351. BACK TO POST
[4] See Stephen A. Marglin, Raising Keynes: A Twenty-First Century General Theory (Cambridge: Harvard University Press, 2020), 511-13, 524-26. BACK TO POST
[5] See Laidler, “Presidential Address” for a discussion. BACK TO POST
[6] See Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1865-1960 (Princeton, N. J.: Princeton University Press, 1963) for the NBER. On the cumulative nature of their interpretation of the record, see Hugh Rockoff, “On the origins of the Monerary History,” in The Elgar Companion to the Chicago School of Economics, ed. Ross B. Emmett (Edward Elgar Publishing, 2010). BACK TO POST
[7] Robert Hetzel, The Federal Reserve, a New History (Chicago, University of Chicago Press, 2022) does precisely this, and makes a striking case for the continuing importance of money since 1960. BACK TO POST