Fall 2021 - A Symposium on: Stephen A. Marglin’s Raising Keynes: A Twenty-First Century Theory
L. Randall Wray, Keynes on Money

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Forms of Money
Forms of Money by James Rose


February 4, 2022

L. Randall Wray, Bard College and Levy Economics Institute 

Professor Marglin has provided his interesting take on, and updating of, Keynes’s General Theory. As he argues, Keynes’s main purpose was to “remove the rose-colored glasses” of orthodoxy, which posited a self-regulating system of market clearing.[1] According to Keynes, there is no such tendency—a point he had made earlier in The End of Laissez-Faire (1926).[2] It was not until the publication of the GT that Keynes provided a full explication of his alternative to neoclassical theory. As we now know, even orthodoxy has failed to provide a rigorous defense of the proposition that an invisible hand could move the economy to a stable equilibrium. Yet, as Marglin argues, they cling to the notion and invent increasingly silly excuses—sticky wages, the use of long-term contracts, asymmetrical information, moral hazard—for the plainly obvious fact that markets “fail” to complete their foreordained mission to clear.[3]

Keynes found his remedy in the theory of effective demand. Hyman Minsky used to tell the story of Keynes’s visit during the depression to a Chicago bank. Unemployment was high and rising, wages and prices were falling, and the bank manager showed Keynes that all the safety deposit boxes were stuffed so full of cash, gold, and jewels that no one could open them. Voila! The culprit was exposed: liquidity preference and the existence of money with special properties made it “rule the roost” as it became a sinkhole of purchasing power. Whether or not the story is true is beside the point—it drives home the connection between the theory of effective demand and Keynes’s theory of the own rates of interest (see Galbraith, this Roundtable).

Keynes wrote the General Theory (1964) for his fellow economists, although it is clear that he considered it to represent the beginning of a revolution of economic thought—as Einstein’s General Theory had revolutionized physics.[4] It is, however, an imperfect book as was almost immediately exposed by John Hicks, who “bastardized” it with the IS-LM model. The early drafts of the GT presaged a completely different book—explicitly based on a monetary theory of production[5] that would have fit nicely with both Marx’s M-C-M’ and Veblen’s Theory of Business Enterprise approaches. The story is that Keynes’s Circus—the group of students who surrounded him at Cambridge—pushed him to use the conventional tools of supply and demand—even though he, and they, were well aware of Sraffa’s devastating critique. As a result, however, there are three flawed and ultimately misleading uses of supply and demand analysis that undercut his argument. And all three were incorporated in the bastard approach.[6] I part ways with Marglin at a fundamental level here: Marglin believes it is possible to use conventional tools, as did Keynes (in part), to arrive at a radical result. I don’t agree; the project seems to me haunted by the limits of the supply and demand framework. And they were a confusing diversion from the core of the GT—which focused on the role played by money in preventing movement of effective demand to full employment. The main argument had nothing to do with supply and demand and failure of markets to clear.

I’ll be brief on the first two uses of supply and demand as they are not so germane to the remaining discussion here. Chapter 2 of the GT is a strange and unsatisfying critique of the neoclassical labor market, accepting the demand curve but quibbling over the supply curve. The demand curve is based on a monotonic relation between the quantity of labor and its marginal productivity that is equated to a real wage,[7] and on finding a point of equilibrium based on demand and supply curves that are are independent. None of these are logically coherent presumptions, and they deserve a far greater share of the blame than Keynes’s particular choices of mathematical expression—Marglin’s minimalist assessment of the GT‘s flaws—for predisposing his arguments to misinterpretation as a “sticky wages cause unemployment” problem to later be resolved by Patinkin through “Keynes” and “Pigou” effects[8]—restoring a tendency toward full employment. The second use of conventional supply and demand analysis is the investment-interest rate relation that similarly supposes a monotonic relation between the quantity of investment and the interest rate—with a sticky interest rate acting as the barrier to full employment.

The Capital Debates between the two Cambridges proved that we cannot expect a monotonic relation between the quantity of a factor of production employed and its return—although the debate was mostly about capital, the conclusion applies also to labor. Hence both the labor “market” and what became the IS curve are flawed distractions from the central message of the GT—that flexible wages, prices, and even interest rates will not clear markets.[9]

The third erroneous use of demand and supply analysis comes in Chapters 13 and 15 of the GT—and formed the basis of the LM curve, the half of Hicks’s IS-LM model for aggregate demand driven by the demand and supply of money. Here, it certainly reads as if Keynes were proposing a vertical (that is, exogenous, fixed) money supply curve intersecting with a downward sloping money demand curve. This seems to be the interpretation adopted by Professor Marglin, and usually is based on the assumption that the central bank controls the money supply through a deposit multiplier. This then generates a single interest rate anchor that can be used in the determination of investment—and we are off to the races with the IS-LM version of Keynes, this time with monetary policy able to produce market-clearing equilibrium (except in the “liquidity trap”).

Few accept the exogenous money approach anymore, so the LM curve has been replaced with a Taylor rule and interest rate targeting. Add some market imperfections to create a demand gap and Keynes lives today in the garb of a New Monetary Consensus.

But the GT contains an altogether different Keynes, one that is up to the task of jettisoning the Marshallian scissors of supply and demand as well as market imperfections while providing a “theory of employment and output as a whole.” The key is the seventeenth chapter that Professor Marglin throws under the bus—with much justification!—as “impenetrable.” As interpreted by “fundamentalist” Post Keynesians led by Paul Davidson, Hyman Minsky, and Jan Kregel, however, Chapter 17 provides a theory of “own-rates” that can be generalized to anchor a powerful theory of effective demand.[10]

Keynes and Sraffa developed their approach to asset prices while speculating in commodities and exchange rates, presented in the GT as a liquidity preference theory of asset prices. Money plays an important role not because it is a medium of exchange, or simply because it is a store of value, but because it has three special properties: a high liquidity premium in excess of carrying cost, zero elasticity of production, and near zero elasticity of substitution. While the second property might sound like a “fixed money supply,” what Keynes meant was that when demand for money is high, labor cannot find jobs producing it (so, instead, ends up unemployed—think of the cash in the safety deposit boxes in Chicago with the unemployment lines at the soup kitchens on the sidewalks). The third sounds a lot like Marx (in Capital, Volume III), who argued that in a crisis the demand for money reaches its peak but the banks will not lend it. That is not exogenous money, it is a rational response by self-interested lenders to a demand for money loans not to spend but to stave off foreclosure.

As Kregel has argued, the spending multiplier (or, theory of effective demand) is the other side of the coin of the liquidity preference theory of Chapter 17.[11] The core of the argument can be found in Chapters 17 (“The Essential Properties of Interest and Money”) and Chapter 18 (“The General Theory of Employment Re-stated”). To put it as simply as possible: Capitalists (or, those with the capacity to make employment decisions) employ only the amount of labor they think[12] they need to produce the amount of output they think they can sell at profit. Expansion of employment can proceed only up to the point at which “the own-rates of own-interest of all available assets is equal to the greatest amongst the marginal efficiencies of all assets, measured in terms of the asset whose own-rate of interest is greatest”[13]—which will be that asset with the special properties normally embodied in money. In other words, employment can expand only to the point at which all expected returns are equalized—since money is likely to be the asset that sets the standard (due to its special properties), they must beat its return.

Minsky added a financial theory of investment to Keynes’s theory that holds investment to be the key determinant of the point of effective demand. This gives us a dynamic version of Keynes’s General Theory by providing a key role for financial conditions. I developed an endogenous approach to money that is consistent with Keynes’s liquidity preference theory.[14] Modern Money Theory[15] has put the state into the monetary system—not simply as another autonomous source of demand, but as the provider of the currency denominated in the money of account it has chosen.

From inception, the purpose of a sovereign monetary system is to create a system in which people need money to pay taxes and hence will provide the goods and services to obtain it. Once the economy is thoroughly monetized, money is not needed just to pay obligations to the sovereign, but to access the means of subsistence. The problem is that most people cannot obtain money except through work, which will be provided only if employment is profitable for those who have the power to make decisions over production.

As Keynes argues, it is the existence of money that opens the door to unemployment:

“in the absence of money and in the absence—we must of course also suppose—of any other commodity with the assumed characteristics of money, the rates of interest would only reach equilibrium when there is full employment.

Unemployment develops, that is to say, because people want the moon;–men cannot be employed when the object of desire is something which cannot be produced and the demand for which cannot be readily choked off.”[16] 

As your wise mom said: “If only money grew on trees…” there would never be unemployment. Unemployment is always a policy failure because we can create “a green cheese factory” to put them to work making green cheese—or even more useful things.

[1] Stephen A. Marglin, Raising Keynes: A Twenty-First Century General Theory (Cambridge: Harvard University Press, 2020), 773. BACK TO POST

[2] A pamphlet by the Hogarth Press in July 1926, based on his Sidney Ball Lecture given at Oxford, November 1924. BACK TO POST

[3] For many orthodox economists the adoption of supply, demand, and clearing at equilibrium represents a “market fetish” developed by habit; for others it is pure apologia. See L. Randall Wray, “Wampeters, Foma, and Granfalloons: Enabling Myths and Not-So-Innocent Frauds,” Journal of Economic Issues (June 2022) (forthcoming). BACK TO POST

[4] James K. Galbraith, “Keynes, Einstein and Scientific Revolution,” in Keynes, Money and the Open Economy: Essays in Honor of Paul Davidson, Volume One, eds. Philip Arestis and Malcolm Sawyer (Aldershot: Edward Elgar, 1996), 14-21; Teodoro Dario Togati, “Keynes as the Einstein of Economic Theory,” History of Political Economy, 33, no. 1 (Spring 2001): 117-138. BACK TO POST

[5] See John Maynard Keynes, The Collected Writings of John Maynard Keynes, Vol XXIX, ed. Donald Moggridge (London and Basingstoke: MacMillan Press, 1979), 89, where he argues: “the firm is dealing throughout in terms of sums of money. It has no object in the world except to end up with more money than it started with.” BACK TO POST

[6] See Jan A. Kregel, “Keynes’s influence on Modern Economics: Some overlooked contributions of Keynes’s theory of finance and economic policy,” in The Return to Keynes, eds. BW Bateman, T. Hirai, and MC Marcuzzo (Cambridge: Harvard, 2010) and L. Randall Wray, “Money in The General Theory: The Contributions of Jan Kregel,” in Contributions to Economic Theory, Policy, Development and Finance, ed. D.B. Papadimitriou (Levy Institute Advanced Research in Economic Policy; London: Palgrave MacMillan, 2014), 65-87, for discussion of these flaws in the GT. BACK TO POST

[7] According to that proposition, as the wage falls, the quantity of labor demanded rises; similarly, as the wage rises, the quantity of labor supplied rises. Thus, the solution to unemployment is to lower wages. BACK TO POST

[8] Each postulates mechanisms (in Robinson’s “logical time” or RK’s comparative statics) that lead the economy back towards equilibrium. According to the Keynes effect, given a fixed nominal money supply falling prices increase the real money supply; that lowers the interest rate and stimulates investment. According to the Pigou effect, falling prices increase the real value of money (irrespective of money supply assumptions), which is outside wealth, thus increasing consumption—in the limit, infinitely, or enough to overcome any shortfall in demand. Together, these essentially destroyed Hicks’s representation of Keynes in the IS-LM model because it logically could no longer be believed to demonstrate equilibrium at less than full employment so long as wages, prices, and interest rates are flexible. Keynes’s own exposition did not rely on any stickiness to explain unemployment as a “state of rest” (his alternative definition of equilibrium). BACK TO POST

[9] See Avi J. Cohen & G. C. Harcourt, “Whatever Happened to the Cambridge Capital Theory Controversies?” Journal of Economic Perspectives 17, no. 1 (Winter 2003): 199-214. BACK TO POST

[10] See John Maynard Keynes, The General Theory of Employment, Interest and Money (New York and London: Harcourt Brace Jovanovich, 1964); John Maynard Keynes, “Alternative Theories of the rate of interest,” Economic Journal (1937); Hugh Townshend, “Liquidity premium and the theory of value,” Economic Journal (1937); Jan A. Kregel, “The multiplier and liquidity preference: two sides of the theory of effective demand” in The Foundation of Keynesian Analysis, ed. Barrere (1988); Hyman P. Minsky, John Maynard Keynes (New York: Columbia University Press, 1975); Paul Davidson, Money and the Real World, 2nd ed. (London and Basingstoke: MacMillan Press, 1978). BACK TO POST

[11] See Heinz D. Kurz, “Keynes, Sraffa, and the latter’s ‘secret skepticism,’” in Revisiting Classical Economics Routledge eds. Heinz Kurz & Neri Salvadori. It is a shame that Keynes threw in the demand and supply diversions, as they are logically flawed (as Sraffa complained) and unnecessary for his theory of effective demand. BACK TO POST

[12] I say “think” because the decision is based on expectations—they may find they’ve employed the wrong number and also that they’ve produced the wrong amount. BACK TO POST

[13] Marglin, Raising Keynes, 236. BACK TO POST

[14] L. Randall Wray, Money and Credit in Capitalist Economies: The Endogenous Money Approach (Aldershot: Edward Elgar Publishing, Ltd., November, 1990), pp. xx, 326. BACK TO POST

[15] L. Randall Wray, Understanding Modern Money: The Key to Full Employment and Price Stability (Edward Elgar Publishing, 1998). BACK TO POST

[16] John Maynard Keynes, The General Theory of Employment, Interest and Money (New York and London: Harcourt Brace Jovanovich, 1964), 235. BACK TO POST

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