Different Types of Economic Terminologies Discussion

Question Description

Writing must follow the rubric.

Rubric

You should reflect on what you have learned, rather than summarize or present most material in bullet point form. Although you may quote material from lectures and readings, this is best used to support your main arguments, not as a replacement for them.

Approaches in write-ups can include:

* Compare and contrast ideas from the perspective of your preexisting views

* Discuss in detail how lectures and readings surprised and challenged your previous lines of thinking and assumptions

* Think critically about ideas and lines of thought presented in lectures and reading and discuss their strengths and weaknesses

There are not “right” presentations or answers in write-ups–there are only thoughtful discussions of diverse views. Try to provide information on each lecture/reading, even if you go into some in more detail and depth than others. Apply course material in your write-ups, be analytical, and be creative. Content, clarity, and breadth are considered toward your grade.

‘ Chapter 26 FROM WICKSELL TO KEYNES: The Upsurge of Monetary and Income Analysis < – – — – – – – – – — 589 NEUTRAL MONEY The marginal revolution of the 1870s left in its wake a refurbished economics of the consumer and of the firm. Much attention was given to the behavior of relative prices but no contributions of similar significance were made to the analysis of money and of the price level. Here the rule of the quantity theory of money continued unabated, and since in this field little had been destroyed, there was little opportunity for reconstruction. Attempts were made to make money the subject of the same type of microeconomic utility analysis that was applied to commodities in general, but these attempts had the result of understating the role of money in the economy rather than bringing to the fore its i::ommanding influence. Walras, the most ambitious system builder of his time, introduced the numeraire., which singled out the value-measuring function of money but abstracted from its other important functions.

Marshall discarded monetary influences on the economy by constructing his Principles on the assumption of a stable price level. Something important was missing from the structure of the economy that the architects of the marginal revolution had built. It was a structure that resembled an imaginary barter economy more closely than the money economy of the modern world. Money was considered primarily as “neutral” instead of as an active instrument affecting the level of output and the distribution of income.

This weakness of neoclassical economics was only inadequately relieved by recourse to the quantity theory of money, which an American economist, Irving Fisher, expounded in the form of the “equation of exchange,” MV = PT-the quantity of money times its velocity equals the price level times the physical volume of trade. The quantity theory of money, it was hoped, FROM WICKSELL TO KEYNES 590 would supply the “multiplicative factor,” which would determine the price level and supply the system of relative prices with an absolute dimension. The equation of exchange, however, far from forming part of a complete theory of the price level, merely provided an overview of some of the factors related to it. The behavior of M, the quantity of money, could only be brought into a causal relationship with the price level under the most stringent of ceteris paribus assumptions, which required that V, a highly volatile element, be considered as a constant.

Monetary questions again became a subject of giscussion during the closing decades of the nineteenth century when a worldwide decline of commodity prices coincided with efforts aiming at the remonetization of silver and the establishment of a bimetallic monetary standard. Marshall’s contributions to monetary theory, which were meant to be in accord with the quantity theory of money but went beyond it, were a product of this debate, and from Marshall’s views Hawtrey and Robertson took their point of departure. Originally the new monetary debate was primarily concerned with the behavior of prices. As it went on, it became intertwined with the analysis -f cyclical fluctuations. As the overall performance of the economy became a subject of study, attention was given not only to the behavior of prices but to income and employment as well, aspects that came to the fore in the work of Keynes. WICKSELL When the Cambridge economists start~d out on their search for new ways in a territory on which the quantity theory of money shed only a dim and uncertain light, they were not fully aware that this territory had already been mapped out and that a path had been opened by someone else.

The pathbreaker was the Swedish economist Knut Wicksell (1851-1926), whose principal works, written at the turn of the century, were for many years available only in German and did not appear in English translation before the mid-thirties when Keynes’s General Theory was ready for publication. Wicksell’s writings and those of other Swedish economists, such as Myrdal and Lindahl, constituted guideposts on the road toward a theory of income and employment, but they became more widely known in the Englishspeaking countries only after Keynes had arrived at his own version of such a theory. Generally speaking, Wicksell was a contemporary of the architects of the marginal revolution as well as of Marshall, Bohm-Bawerk, and Wieser. But he turned to economic studies in a later period of his life and was thus able to use their work as a base from which he would branch out into new and untried directions. Although he was an exponent of an economic theory that was as pure as that of Walras and of the Austrians and purer than Marshall’s, his career was far more stormy than that of these sedate and dignified academicians, and it did not exhaust itself in academic work.

FROM WICKSELL TO KEYNES Unlike Marshall, who abhorred all controversy, Wicksell actively sought it, but his chosen field of battle was a wide range of social and political problems, often rather sensitive ones, rather than academic economics. Unlike the Austrians, who adhered to views that made them eligible for the highest positions in government, Wicksell was a nonconformist whose opinions often gave offense to the public authorities and who did indeed at the age of fifty-eight serve a sentence of two months’ imprisonment. Wicksell’s advocacy of unorthodox views brought him much notoriety and was of no help in his later teaching career. But it was precisely his interest in social problems, more specifically the population problem, that made him turn to economic studies in the 1880s when he was already in his thirties and had earned degrees in mathematics and natural science. Although the issues on which he was to take a stand included such diverse matters as alcoholism, prostitution, civil marriage, freedom of speech, and the institution of the monarchy, he considered overpopulation a central problem and, following Mill rather than Malthus, persevered in the advocacy of birth control. Beginning in 1885 Wicksell set out to study economics in England, France, Germany, and Austria, as well as in his native country, and earned a meager livelihood as a journalist and lecturer.

The first teaching appointment did not come his way until 1899, at the age of forty-eight, and then only after he had obtained an additional degree, in law, as was required of academic economists, who were members of the law faculty. At that time he was already the author of the three works that together with one published a few years later constitute his great achievement -: Value, Capital and Rent ( 1893, Eng. trans. 1954), a book on the theory of public finance entitled Finanztheoretische Untersuchungen ( 1896), and Interest and Prices ( 1898, Eng. trans. 1934). In 1900 Wicksell obtained an interim appointment at the University of Lund, which a deeply divided faculty regularized a year later. At Lund he taught until his retirement in 1916, and there he published two volumes of Lectures on Political Economy ( 1901, 1906; Eng. trans. 1934-35) . During his years as a wandering scholar, Wicksell became acquainted with the various approaches to economics then in vogue in different European countries-the historical economics of the Germans, the pure theory in its Austrian and Walrasian variants, and the more realistic analysis of Marshall. He reacted to them in his own way. With Marshall he shared a thorough training in mathematics, but he lacked Marshall’s touch with reality and his intimate knowledge of historical conditions.

Whereas Marshall attempted to obliterate the dividing line between theoretical and applied economics, Wicksell, on the whole, adhered to the distinction that Walras had drawn between pure, applied, and “social” economics, and he cultivated especially the pul e branch. His approach had a greater affinity with that of the Austrians and of Walras than did Marshall’s, and unlike Marshall he did not praise the efforts of the German historical economists. In its broad outline what Wicksell attempted was a fusion of Austrian and 591 FROM WICKSELL TO KEYNES 592 Walrasian thought, in which a version of Bohm-Bawerk’s capital theory, modified in line with the marginal productivity theory, was to be fitted into the general equilibrium system. In the pursuit of this attempt Wicksell introduced numerous refinements and corrections, some of which paralleled contemporary work by other scholars, for example, his marginal productivity theory, developed one year ahead of Wicksteed, and his transformatfon of utility into demand functions. Wicksell, however, was virtually the only economist of note to criticize the view, advanced by some of the architects of the marginal revolution, that competitive prices denote a social optimum. Instead he pointed out that in the presence of pronounced inequalities of income an exchange between the rich and the poor might yield a larger total utility when effected at a price suitably fixed than at the competitive price, and he cautiously expanded the argument to apply it to minimum wages and maximum hours of work established by legislation or by labor unions.

Wicksell favored government intervention in a number of instances, suggested marginal cost rather than full cost pricing for public utilities and common carriers, and developed thoughts from which support for the selective nationalization of certain industries could be drawn. He introduced the prin. ciple of marginal utility into his analysis of public finance and supplemented the conventional theory of the shifting and incidence of taxation with many new insights relating to the effects of taxes on the distribution of income, to questions of social choice and decision making in these matters, and to the general proble:i;n of justice in taxation. THE INCOME APPROACH TO MONETARY THEORY These contributions were distinguished enough to earn Wicksell recognition as a thinker of substance and originality, but the contribution for which he is best remembered is the development of a monetary theory which went beyond the conventional quantity theory and with which business cycle and income theory could eventually be integrated.

Wicksell took as his point of departure Tooke’s income theory of prices, enunciated in 1844, according to which it is not the quantity of money but the national income designed for expenditure that determines the price level. Following Tooke in employing such macroeconomic concepts as the general demand and supply of goods, Wicksell related changes in the price level to the general monetary demand for goods exceeding, or falling short of, their supply and set himself the task of explaining how and why this would occur. WICKSELL’S INTEREST THEORY In his explanation of changes in the price level Wicksell fell back on the rate of interest, in itself not a startling idea since there was a tradition FROM WICKSELL TO KEYNES – of long standing, extending from Ricardo to Marshall, which recognized, besides the direct influence of the quantity of money on prices, an indirect one which operated via the rate of interest. If the quantity of money increased, so this argument ran, low interest rates would be accompanied by an expansion of credit, and borrowers would bid up prices when putting their new financial resources to use.

High and low rates are relative terms, however, and the argument did not provide a standard that could serve as a criterion whether the interest rate was high or low. Such a criterion Wicksell made available by distinguishing between the “natural” rate of interest and the loan rate. The natural rate was the expected return from newly constructed capital, whereas the loan rate was that which borrowers were charged by the banks. As the two rates diverged, for example, if the natural rate exceeded the loan rate, a “cumulative process” ensued in which prospective investors, eager to maximize profit, bid up the prices of productive resources, causing in turn money incomes and the prices of consumer goods to rise. In the case of an excess of the loan rate over the natural rate, the cumulative process would move in the opposite direction.

Wicksell’s theory of the two rates opened up a wealth of new insights. It contained an explanation of the investment decision in line with the maximization principle as well as an allusion to the role of expectations. And, as it later became apparent, his natural rate of interest was an analogue to Keynes’s marginal efficiency of capital. Like Keynes, Wicksell considered investment determined by the relationship between the loan rate of interest and the expected return from newly constructed capital. Pathbreaking as Wicksell’s achievement was, much remained. to be done to transform it into a full-fledged theory of income determination. His concern was with price changes occurring at full employment rather than with changes in income and employment, and what he produced was an analysis of the cumulative process rather than an analysis of income determination. In this analysis principal attention was given to investment rather than to consumption and saving, and it contained neither the consumption function nor the multiplier.

Wicksell’s policy goal was the stabilization of prices rather than the attainment of full employment. Although he intimated that the public’s desire for cash balances was related to the interest rate, this matter did not form a central point in his analysis. He was not aware of the limitations that the liquidity trap would impose on a policy of monetary · expansion and did indeed place main reliance on banking policy as a stabilization device. His analysis was formal and did not invite statistical testing, a shortcoming that gave him cause for concern and to which he alluded at the end of his life when he urged upon a new generation of economists the importance of empirical work. Wicksell’s principal achievement was that of a pioneer explorer who mapped out the broad outlines of a new territory, leaving it t others to fill in some of the detail that he saw beckoning in the distance. 593 FROM WICKSELL- TO KEYNES WICKSELL’S CONTEMPORARIES During his later years \,Vicksell’s work received generous acclaim, and he became the leading figure among tl\e growing number of economists in Sweden and other Scandinavian countries who left their mark on economic science.

There was David Davidson ( 1854-1942), Wicksell’s early mentor, who taught at the University of Uppsala and . was involved with Wicksell in a running controversy about the respective merits of stable prices and of prices declining in accord with rising productivity, Wicksell being in favor of the former and Davidson of the latter. There was Gustav Cassel ( 1866-1945), professor at Stockholm and a rival of Wicksell’s, of worldwide repute at his time, who advocated an economics that was solely concerned with prices, received its orientation from the “scarcity principle,” and rejected utility analysis and value theory as futile. Although Cassel was a trained mathematician and an exponent of general equilibrium economics, he had a respectful audience among the German historical economists, who shared his aversion to the utility theory of the Austrians.

Cassel’s influence was felt in international economics, where he developed a controversial purchasing power parity theory, according to which the equilibrium rate of exchange equates the domestic purchasing power of a currency with what it can buy abroad if exchanged for a foreign currency. Cassel also made a noteworthy contribution to the theory of interest, which lent support to the view, later held by Keynes, albeit for different reasons, that there is a floor below which the_rate of interest is unlikely to fall. To Cassel this thought was a necessary consequence of the limited length of the human life span. At a rate of interest below, say, 2 percent, the length of people’s productive life would be too short to make it possible for them to provide for their old age, and with the desire for accumulation thus stifled there would be little incentive to save.

THE NEXT GENERATION The next generation of Swedish economists included a number of pupils who ranked high among the economists of Wicksell’s and Cassel’s 0 their time: Johan Akerman (b. 1891), Bertil Ohlin ‘ (b. 1899), Erik Lindahl 0 . ( 1891-1960), and Gunnar Myrdal (b. 1898). Akerman, a perceptive and erudite scholar, heeded the injunction of the aged Wicksell not to neglect the study of history. In a sweeping synthesis that drew on the resources of economic theory, history, and statistics, he set out to explore the historical causes responsible for the “structure” of an economy and its changes and thus came close to the goal pursued0 by historical economists-the theoretical explanation of historical change. Akerman’s elevation of the concept of an economic structure to a central position had its counterpart in the works of Sombart, Eucken, and Spiethoff, in which the economic “system” or the economic “style” served as a principle of classification. But he went beyond these writers since his principal purpose was not classification but FROM WICKSELL TO KEYNES 0 the investigation of change and growth. Akerman’s work supplemented Marshall’s study of the long run and set a precedent for later econometric analyses of long-term changes.

His approach struck a more resonant chord of response in continental Europe, especially in Germany and France, than in the English-speaking countries, since he accorded to the microeconomic and later macroeconomic analysis that was pursued there only a subordinate position, relevant to the study of a given economic structure but of no help in explaining how this structure came into being and how it changed. 595 OHLIN Ohlin attained worldwide recogmt1on with his reconstruction of the theory of international trade in Interregional and International Trade ( 1933), which integrated the theories of domestic and foreign trade and derived both of them from a spatial location theory that considered tradt? the result of an unequal endowment of regions and countries with productive resources. Where Ricardo had started out with a demonstration of the gain from trade, Ohlin’s point of departure was the investigation of the reasons for trade. His work and that of other Swedish economists stimulated further studies of location theory in Germany and in the United States and the type of regional analysis that emerged at mid-century.

In the 1920s and early 1930s Ohlin, Myrdal, and Lindahl contributed to the further development of Wicksell’s monetary theory by applying it to conditions of less than full employment and in their own way arrived at results partly anticipating and paralleling the income and e~ployment analysis of Keynes’s General Theory of 1936. The Stockholm school, as it came to be known, operated with the help of a new equilibrium concept, which like Keynes’s aggregate equilibrium and unlike the conventional microeconomic equilibrium was no longer defined in terms of a maximum position.

The Stockholm school’s “monetary equilibrium” referred to a situation characterized by equality of the natural and the loan rates of interest as well as-and this was somewhat controversial-by stability of the price level. Unlike the conventional microeconomic equilibrium, the monetary equilibrium was neither stable nor indicative of a tendency leading toward it. Disequilibrium was explained in terms of Wicksell’s cumulative process, which would cause a movement further and further away from equilibrium. The Stockholm school fostered a dynamic period, or sequence, analysis of income determination, in which expectations figured prominently and which preferred to employ ex ante and ex post concepts-plans and their realizations-rather than instantaneous adjustments. These concepts proved of great val…

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