Fisher and Wicksell on money: A reconstructed conversation

Abstract

The paper offers a reconstruction of the ‘conversation’ between Irving Fisher and Knut Wicksell on money as shown by references they made to each other's works. The first phase corresponded largely to the period between 1897 and 1911, when they proposed different explanations of the interaction between interest and prices, and incorporated aspects of each other's approaches into their own respective frameworks. This was followed by Wicksell's extended criticism of Fisher's compensated dollar plan and his bewilderment at its apparent lack of relation with the quantity theory of money (1912–1919). Finally, especially after Wicksell's death, Fisher came to support a significant part of Wicksell's monetary policy proposals, particularly in connection with the Swedish stabilisation experiment in the early 1930s. Fisher and Wicksell were both heirs of Böhm-Bawerk's interest theory, but interpreted and criticised the Austrian from different perspectives, which helps to explain the differences in their approaches to monetary dynamics.     

The French Revolution and the Creation of Benthamism

Abstract

The article investigates Knut Wicksell's interpretation of aggregate economic fluctuations. It is shown that Wicksell described the business cycle as oscillations of an economy with increasing population and scarce natural resources around its steady growth path ('dynamic equilibrium'), provoked by sporadic technological progress. The ‘shocks’ bring about a wave‐like motion because of psychological and technical lags in the economic structure. Wicksell's suggestion that excess net savings in the depression take the form of stocks of commodities is compared to his contemporaries’ answers to the question ‘What happens to savings during the depression?’ The article also puts forward a relatively neglected connection between Malthus’ and Wicksell's notions of over‐production. Divergences between the natural and market rates of interest — essential to his better‐known ‘cumulative process’ ‐ are not a necessary part of Wicksell's business cycle, but they are important to explain why the upper turning‐point can have the nature of a crisis, which results from wrong expectations induced by cumulative price movements.     

The Legacy of Knut Wicksell to Capital Theory

Wicksell's contributions to capital theory focused on stationary states in four distinct models intended to account for the time dimension of production in market economies. We now have a better understanding of the true challenges because of two developments: a full theory of intertemporal general equilibria and a methodology for comparative analysis as explained by Hicks. In Wicksell's equilibria, the real interest rate turns out to be equal to the marginal productivity of the volume of social capital, a concept that Wicksell could not master and hence avoided. Challenges remain, particularly regarding the best way to account for complementarities and substitutions over time.     

Feminist economics as a Postmodern Moment

Wicksell saw economics as a way to effect social change. In addition to academic writings, he produced a steady stream of pamphlets, newspaper editorials, and public lectures that brought theoretical economics to bear on social policy. In this paper, consideration is given to this wider variety of Wicksell's writings, and his unanimity rule for public goods decision making is examined within the context of his social philosophy. We argue that the unanimity rule, rather than being narrowly focused on efficiency concerns, operated as a practical mechanism to achieve Wicksell's larger goal of social justice. This stands in contrast to the interpretation of Wicksell commonly presented in the public choice literature.     

Böhm-Bawerk,Jevons and the 'Austrian' theory of capital: 'a quite different relation'

The paper examines the relationship between the interest theories of Jevons and Böhm-Bawerk. Although their results can easily be reconciled mathematically, Böhm-Bawerk's ‘misunderstanding’ of the Jevonian formula reveals a fundamental difference concerning their derivation. Despite their formal similarity, the two models exhibit a different conceptual architecture and thus also attach quite different meanings to the concept of the interest rate. Rather than trying to reconcile them, the paper suggests to analyse their relationship as part of an entire transformation, which can be equally traced between the value and price theories of the two authors.     

The Wicksell-Tobin investment model

We formalize in this paper Wicksell's investment decision model and compare it with Tobin's q-theory. Wicksell's firms either compare the natural rate of interest with the prevailing market interest rate or the capital values with the replacement costs of investment projects. This exposition of Wicksell's approach reveals some striking similarities with Tobin's supply-price-of-capital model, which relates the marginal efficiency of capital to the rate of return required by portfolio investors in the well-known q-ratio. The ratio market value to replacement cost of capital should, therefore, more appropriately be termed the Wicksell-Tobin q. Our formalization of Wicksell's investment theory appears to open up a promising new avenue for further research in cases where banks provide the source of funds.     

Interest rate gaps and monetary policy in the work of Henry Thornton: Beyond a retrospective Wicksellian reading *

Abstract

This paper revisits the theory of interest rates propounded by Henry Thornton (1760 – 1815). Particular attention is paid to Thornton's examination of the inflationary effects of the gap between the Bank of England's discount rate and the current rate of profit. The paper shows that Thornton is also concerned, unlike Wicksell, about the consequences of a gap between the Bank of England's discount rate and the effective bank lending rate on the market for loanable funds, which results mainly from the usury laws. Thornton's analyses offer then a framework for regulating the value of money through adjustments to the bank rate.     

Wicksell's lecture notes on economic crises (1902/05)

The article brings to light Knut Wicksell's Lund lecture notes of 1902 and 1905 on economic crises. In these notes, written a few years after his book on interest and prices but before most of his published work on business cycles, Wicksell made an attempt to bridge the gap between monetary and real theories of crises. The notes are remarkable for a discussion of how partial overproduction is generalized through the credit mechanism and for an assessment and diagrammatic treatment of the controversies between Malthus, Say and Owen on general overproduction.     

Testing Böhm-Bawerk’s theory of capital: Some evidence from the Finnish economy

This paper considers the pure labour theory of value and Böhm-Bawerk’s theory of capital as approximations of Sraffa’s model of single production, and tests them with data from the Symmetric Input-output Tables of the Finnish economy. The results show that (i) in comparison with the labour values, the actual Böhm-Bawerkian production prices are ‘equally’ good or even better approximations of the actual Sraffian production prices and market prices; and (ii) the Sraffian production price-profit rate relationship is, by and large, governed by the differences in the Böhm-Bawerkian average periods of production.     

A comprehensive graphical exposition of the macroeconomic theory of Böhm-Bawerk

Abstract

This paper offers a comprehensive graphical exposition of Böhm-Bawerk's formalised macroeconomic theory. This graphical model is used here for the first time to study the effects of the changes in the explanatory variables (quantity of capital, number of workers and level of technical knowledge) on the dependent variables (interest rate, wage and period of production). This systematic application of the model shows that some of the conclusions drawn by Böhm-Bawerk are incorrect and need to be amended. A comparison with Solow's model also shows that Böhm-Bawerk can legitimately be considered as one of the main originators of the standard contemporary approach in macroeconomics of equilibrium and growth.     

Discounting Nordhaus

This paper evaluates Nordhaus's neoclassical complaints about the Stern Review from the vantage point of classical growth theory. Nordhaus criticizes the Stern Review because it uses a discount rate that is well below the market rate of return on capital. From the perspective of classical growth theory, Nordhaus's belief in choosing preference parameters for the social planner based on observed market rates of return is equivalent to assigning the preferences of the capitalist agents to the social planner. This equivalence is an implication of the Cambridge Theorem, which interprets the Ramsey equation as the saving function of the capitalist agents.     

Keynes and probability: An assessment

Abstract

Most interpreters agree that Keynes had a wide-ranging, complex, ‘vision of the world’, which underlies his theoretical contributions. Whenever this is forgotten, as happens in the so-called neoclassical synthesis, not only the original Keynesian spirit goes lost but also, and especially, we lose substantive bricks for our theoretical constructions. The paper considers an important instance of this general rule; namely Keynes's views on the logic of probability, meant as the field concerning human behaviour in an uncertain world (hence connected to, but distinct from, the pure theory of probability, meant as a field of mathematics). The paper begins by recalling the main aspects of the classical and frequentist approaches to probability and the main criticisms they received, pertaining among other things to the limits of their applicability. We then consider Keynes's own views, stressing three aspects: the definition of probability as pertaining to the field of logic, the notion of uncertainty and of the ‘weight of the argument’, the ‘theory of groups’. We then discuss the subjective approach of de Finetti, Ramsey and Savage, and contrast it with Keynes's own views. Finally, we consider the implications of our analysis for the interpretation of Keynes's General Theory, and of his attitude towards econometrics.     

Rights and relations in modern economic theory

The paper is the 1980 Böhm-Bawerk-lecture given at the University of Innsbruck. Starting from Böhm-Bawerk's book. ‘Rights and relations from the point of view of the economic theory of goods’ the paper tries to evaluate rights and phenomena like goodwill from the perspective of innovation. A framework of three levels of economic activity is developed. The three levels are: consumption (the lowest level), production and innovation (the highest level). Rights are interpreted as instruments of protection of higher level activity from lower level activity. Focus of attention are industries with very high rates of technical progress and innovation. There the most important positive externality of innovation is the increased potential for even more innovations. It is argued that competition policy, as a rule of thumb, must foster competition by innovation and must discourage competition by imitation.     

Sraffa and the Marshallian tradition*

Abstract

The paper retraces some of the stages in Sraffa's thinking about the work of Marshall, by drawing on unpublished material in the Sraffa archive from 1923 to 1930. It argues that Sraffa transformed his dissent – which was based on ideological grounds – into a ‘quest for the fatal error’ to demolish the logical construction of Marshallian theory. Some of his attacks were successful (for example, the critique of the relation between costs and output); other attempts failed (the critique of the ‘normal rate of profit’ and the critique of the concept of marginal productivity) since Sraffa could not find enough textual evidence to support his position.     

Some microfoundations of Austrian economics: Böhm-Bawerk's version

This paper investigates Böohm-Bawerk's version of Austrian microeconomics. It draws some comparisons with Carl Menger's programmatic work on the principles of economic theory which originally established a distinctive Austrian tradition. Böhm-Bawerk's microeconomics is also considered against the background of contemporary Walrasian, Edgeworthian and Marshallian thought as well as twentieth-century work on the theory of games. Böhm-Bawerk offers a theory of micro-structural dynamics. His emphasis on intentionality and imagination in value creation, the scope for bargaining and strategic behaviour in his theory of markets and the avowed indeterminacies and equilibrating tendencies in his theory of price formation, are all consistent with other first-generation Austraian contributions. There is nothing especially Walrasian or Marshallian about Böhm-Bawer's. microeconomics     

Further reflections on the 'Hidden Theology' of Adam Smith

Abstract

A re-reading of the Thousand and One Nights in light of economic thought is attempted here. These stories characterize a bazaar economy as the dark side of medieval economics. The process-view of the bazaar is discussed in relation to Smith, Walras and the Austrian School. The tacit notions of ‘market price’ and ‘natural price’ are touched upon. Auctions are then elaborated with reference to Böhm-Bawerk. Moreover, the role of asymmetric information as a recurrent theme is interpreted in relation with Akerlof's approach. Finally, the collective function of the tales in fostering confidence in a less-than-well instituted bazaar economy is emphasized.     

Hayek and the Great Depression of 1929: Did he really change his mind?

The aim of this research is to establish whether, and if so in what way, Hayek changed his mind about the Great Depression of 1929.The work is divided into two parts. In the first part, I present the ‘early’ Hayek of the 1930s. Hayek was the great rival of Keynes. Both explained the Great Depression, applying opposing business cycle theories. For Keynes, the crisis was caused by an excess of saving over investment; for Hayek, on the contrary, by an excess of investment over saving. In the early 1930s, Röpke attempted a synthesis, positing that a recession due to overinvestment can degenerate, as in 1929, into a depression caused by oversaving. Hayek examined and rejected Röpke's theory. In the second part, I present the ‘later’ Hayek of the 1970s. After years of silence and solitude, Hayek was unexpectedly awarded the Nobel Memorial Prize in Economics, precisely for the contribution he made in the 1930s to the theory of the business cycle. Hayek returned to his pursuit of the ghost of Keynes, debated with his friend and rival Friedman, re-examined Röpke's special case and, according to Haberler, changed his mind. In my conclusion, I attempt to resolve the dilemma.     

Why Do the Rich Save More? A Theory and Australian Evidence*

We provide a theory to explain the existence of inequality in an economy where agents have identical preferences and have access to the same production technology. Agents consume a ‘health’ good which determines their subjective discount factor. Depending on initial distribution of capital the economy gets separated into different permanent‐income groups. This leads to a testable hypothesis: ‘The rich save a larger proportion of their permanent‐income’. We test this implication for savings behaviour in Australia. We find that even after controlling for lifecycle and health characteristics, higher permanent income is positively related with higher savings rates and better saving habits.     

How the ECB and the US Fed set interest rates

Monetary policies of the European Central Bank (ECB) and US Fed can be characterized by ‘Taylor rules’, that is both central banks seem to be setting rates by taking into account the ‘output gap’ and inflation. We also set up and tested Taylor rules which incorporate money growth and the euro–dollar exchange rate, thereby improving the ‘fit’ between actual and Taylor rule based rates. In general, Taylor rules appear to be a much better way of describing Fed policy than ECB policy. Simulations suggest that the ECB's short-term interest rates have been at a much lower level in the last 2 years compared with what a Taylor rule would suggest.     

Firms’ money demand and monetary policy

Standard New Keynesian models for monetary policy analysis are ‘cashless’. When the nominal interest rate is the central bank's operating instrument, the LM equation is endogenous and, it is argued, can be ignored. The modern theoretical and quantitative debate on the importance of money for monetary policy conduct, however, overlooks firms’ money demand. Working in an otherwise canonical New Keynesian setup, we show that macroeconomic dynamics are critically affected by the firms’ money demand choice. Under the conventional Taylor‐rule framework, we prove that equilibrium determinacy may require either an active interest rate policy, overreacting to inflation, or a passive interest rate policy, underreacting to inflation, depending on the elasticity of production with respect to cash balances. We then develop a numerical analysis to evaluate our theoretical results. We find that macroeconomic stability is more likely to occur under an active, but not overly aggressive, monetary policy stance. We also examine the dynamic effects of forward‐looking feedback rules. We show that, in this policy regime, indeterminacy is likely to be induced by both active and passive rules, even for relatively low productivity effects of money.