Money, Credit and Prices in Keynesian Perspective

Ordinary macroeconomics presents three essentially incompatible theories of investment spending, each corresponding to a separate branch of the subject. When dealing with short-run questions, investment is held to depend on the level of income and the rate of interest, in accordance with the marginal efficiency calculation. It is this function which enters into the construction of the celebrated IS curve. But when the matter of the cycle is broached, investment is suddenly seen to depend not on the level, but on the rate of change of income, appropriately lagged, while the influence of the interest rate quietly evaporates. The crucial parameters are the saving ratio, the capital— output ratio, and the time lags. However, the cycle cannot really be studied without consideration of the trend, which, of course, depends on investment. So to explain the trend we have a third theory of investment. The form of the function is the same, with the same parameters — the saving and capital-output ratios, and time lags — but now the parameters must assume different values. For one range of values will produce cycles, while another is required for exponential growth. So the textbook explanations of growth and the cycle are inconsistent with one another. They both draw on the accelerator mechanism, but they assume different ranges of values for the parameters.

Our subject is debt, credit and the rate of interest in Keynesian theory and the significance of these variables for economic policy. A particular interest is the significance of the financial structure — i.e., the impact of the particular set of financial institutions and financial relations that exist upon the behaviour of the economy. Modern capitalism is a system in which financial relations are of particular importance in determining what happens. An understanding of the movements in calendar time of contemporary capitalisms depends upon understanding the behaviour and evolution of financial practices and structures.

J. M. Keynes devoted less space in his work to the classification of financial systems than to the various motives for holding money balances. He did not try to expand on the distinction between a cash economy, a simple credit economy and a complex credit economy that was so important in Wicksell’s analysis.¹ Neither did he expressly concern himself in his work with the recently proposed distinction between an ‘overdraft’ economy and an ‘auto-economy’.² This distinction was first suggested by Hicks (1974), and was subsequently the subject of more thorough investigation in France. In my opinion it is a valuable framework for understanding some significant aspects of Keynes’s analysis and its post-Keynesian interpretation, in particular concerning the formation and the role of interest rates, and the policies designed to influence them.

Keynes does not directly discuss the behaviour of prices in the process of aggregate adjustment, and therefore the role of prices in this process remains unclear. However, we feel that Keynes does give us a few very important tools for analysing the role of prices in macroeconomic adjustment. These tools are summed up in the principal of the determination of effective demand based on the aggregate supply price and aggregate demand price curves. This formulation has a twofold interest. In connection with Say’s theory of markets, it shows that there is a unique equilibrium point and not an infinite number of possible points. The second important aspect — which is less often stressed — is connected to the quantity theory of money: the effective demand principle provides an explanation for the determination of the general price level which is also different from the ‘Classical’ explanation. Furthermore, Keynes’s explanation offers an answer to a hitherto unexplained phenomenon: the establishment of the general price level. Chapter 21 (‘The Theory of Prices’) in the General Theory opens with a discussion of this question. Keynes contrasts the usual analysis of market price determination (which he calls the theory of value) with the existence of a general price level determination which is totally independent of the first.

The various neoclassical schools share the idea that the theory of prices does constitute the centre of economic theory; it tends to merge with the theory of the general equilibrium and the distribution of resources. Prices play a part at three distinct levels. At first, they are the indicators the economic agents use in order to formulate their plans, and they synthesise in such a way the whole set of useful economic data. They are also the means of micro and macroeconomic adjustments since their changes enable firms to reconsider those plans and to make them be consistent. They express the equilibrium by summing up the results of the various adjustments and thus by providing a system of equilibrium prices.

The role of prices in the Keynesian system has long and frequently been misperceived; contemporary coexistence of inflation and unem-ployment has induced repudiation of Keynesian diagnoses and prescriptions. A re-examination of certain critical effects of flexible wages and prices and changing levels of prices is in order.

Sidney Weintraub died on 19 June 1983. Until his last breath he had hoped and planned that his health would permit him to address the conference. This is especially significant since he had already rejected an invitation to attend the Royal Economic Society’s ‘Keynes’ Centenary Conference’ at Cambridge in July 1983, despite Lord Kaldor’s generous offer to relinquish his own place on that programme to give Sidney time to set the record straight, or as Sidney would have said ‘to keep the American Keynesians honest’.