CAMBRIDGE MONETARY THOUGHT

CAMBRIDGE MONETARY THOUGHT

Cambridge Monetary Thought Development of Saving-Investment Analysis from Marshall to Keynes Pascal Bridel Professor of Economics University of Lausanne Palgrave Macmillan

ISBN 978-1-349-18664-8 ISBN 978-1-349-18662-4 (ebook) DOI 10.1007/978-1-349-18662-4 Pascal Bridel, 1987 Softcover reprint of the hardcover 1st edition 1987 978-0-333-43250-1 All rights reserved. For information, write: Scholarly & Reference Division, St. Martin's Press, Inc., 175 Fifth Avenue, New York, NY 10010 First published in the United States of America in 1987 ISBN 978-0-312-11441-1 Library of Congress Cataloging-in-Publication Data Bridel, Pascal, 1948-- Cambridge monetary thought. Revision of thesis (Ph. D.)-University of Cambridge, 1981. Bibliography: p. Includes index. 1. Saving and investment. 2. Neoclassical school of economics. L Title. HB843.B75 1987 332'.0415 86-17792 ISBN 978-0-312-11441-1

Contents Foreword by John Eatwell Preface Vlll x 1 Introduction 1 2 Supply and Demand for 'Free' Capital and the Rate of Interest: Marshall's 'Real' Analysis 7 2.1 Capital as a factor of production 8 2.2 The determinants of the schedules of supply and demand for 'free' capital 15 2.3 The rate of interest as 'the factor which brings the demand for investment and the willingness to save into equilibrium with one another' 22 3 Marshall's Monetary Theory 25 3.1 The supply of money 27 3.2 The demand for money and the determination of the value of money 28 3.3 Money, interest and prices: Marshall's primitive version of the 'cumulative process' 36 3.4 Some remarks on Marshall's trade-cycle theory 47 4 Early Contributions I: Hawtrey and Robertson (1911-24) 52 4.1 The first scattered hints along Marshallian lines (1911-13) 52 4.2 Hawtrey's contribution: from Good and Bad Trade (1913) to 1925 57 4.3 Robertson's early contribution: from A Study of Industrial Fluctuation (1915) to Money (1922) 78 5 Early Contributions II: Keynes, Lavington and Pigou (1913-24) 89 5.1 Keynes: from overinvestment (1913) to underinvestment (1924) v

vi Contents 5.2 Lavington's English Capital Market (1921): the 'threefold-margin' argument and the idea of a gap between saving and investment 96 5.3 Pigou's independent contribution (1920-4) 100 5.4 Principal conclusions 106 6 Banking Policy and the Price Level and the 'Kinds of Savings' 109 6.1 Robertson's model 111 6.2 The 'forced-saving' process 116 7 Saving, Investment and the Theoretical Framework of the Treatise (1930) 124 7.1 The fundamental equations 126 7.2 The extent of the departure from the 'forced-saving' doctrine 134 7.3 The role of profits as an expression of the gap between saving and investment 137 8 Further Reflections on the Rate of Interest (1930-5) 141 8.1 Robertson's 'Industrial Fluctuation and the "Natural" Rate of Interest'(1934) 143 8.2 Hicks's 'Suggestion for Simplifying the Theory of Money' (1935) 145 8.3 Principal conclusions 148 8.4 The Treatise and quantity adjustments 150 9 The General Theory and the Principle of Effective Demand 157 9.1 The principle of effective demand as a direct challenge to the 'forced-saving' doctrine 158 9.2 The scope of validity of the principle of effective demand 166 9.3 Liquidity preference as an 'alternative' theory of interest 170 9.4 The marginal efficiency of capital 181 9.5 Concluding remarks 185

Contents VB Conclusion Notes and References Bibliography Index 188 193 212 222

Foreword The revival of the analytical principles of classical political economy that has gathered pace since the mid-1960s has been based on the firm foundation of a logically coherent theory of value and distribution. It was the failure to provide this foundation which for many years confined the classical approach to being, at best, a repository of useful ideas on growth and technological progress (Smith's discussion of the division of labour and Marx's dissection of the labour process being good examples), or, at worst, identified with simple-minded devotion to the labour theory of value as the 'qualitative' expression of capitalist exploitationthe position to which Hilferding retreated in the face of B6hm-Bawerk's critique of Marx, so depriving the surplus approach of any quantitative significance as a theory of value and distribution. The publication of Piero Sraffa's Production of Commodities by Means of Commodities changed all that. Sraffa not only generalised the mathematical solutions to the surplus approach which had been advanced by Dmitriev and Bortkeiwicz, but also presented the analytical structure of the surplus approach with stark clarity. Moreover, Sraffa provided a critique of the neo-c1assical theory of the rate of profit and so of the entire neo-c1assical explanation of value, distribution and output - hence clearing the ground for the redevelopment of classical theory. With the analytical core now secure, attention can be turned to the development of other facets of classical and Marxian theory and to the empirical insights which this theory provides. In stark contrast to the neo-c1assical approach, which reduces all economic activity to a single principle - the competitive resolution of individual attempts to maximise utility subject to the constraints of technology and endowment - classical theory is constructed from a number of analytically separable components. The core of the theory, the surplus approach to value and distribution, takes as data the size and composition of output, the technology in use (the conditions of reproduction) and the real wage (or, in some cases, the rate of profit). These data do not, however, lie outside the realm of economics (as, for example, the neo-c1assical economists' utility functions do). We need to provide theoretical explanations of their determination. Hence Smith, Ricardo and Marx advanced theories of the real wage and of the level of output (Say's law in the case of Ricardo), and Smith and Marx presented detailed analyses of technological change. Assembled around the core, these theories are the building-blocks of a general theory of the operaviii

Foreword IX tions of the capitalist economy. There is in all this a clear danger of constructing a disjointed ad hoc collage of theories and empirical generalisations. This is avoided by enveloping the entire edifice in a general characterisation of the economic system: the clear specification, that is, of the capitalist mode of production. This serves both to cement the elements of the theory together and to eliminate propositions that do not fit. Broadly, there are two jobs to be done in developing and extending the classical framework. First, the classical theory itself must be developed and generalised. All the elements surrounding the core analysis of value and distribution - theories of output and employment, of accumulation, of technology, of the wage, of competition and so on - require reassessment and 'modernisation' in the light both of Sraffa's results and of the many changing facets of the modem capitalist system. This will involve both theoretical development and empirical analysis, for one of the important characteristics of classical theorising is the manner in which theory is grounded in the socio-economic data of the system under consideration - the institutional environment is an essential part of the theory. Second, the rejection of the now discredited neoclassical theory throws open a wide range of problems in international trade, development economics, fiscal and monetary policy and so forth, into which the classical approach can provide new insights. In part these will lead to the refreshing task of debunking the policy prescriptions of orthodox theory which revolve primarily around the fundamental theorem of welfare economics and the supposed 'efficiency' of competitive markets. But there is also a positive job to be done. The reconstruction of economic theory will inevitably precipitate a reinterpretation of economic policy and problems. Pascal Bridel uses the ideas that have grown out of Sraffa's critique of the neoclassical theory of value and distribution and the subsequent clarification of the relationship between long run and short run to dissect the interdependence of the Marshallian theory of value and distribution and Cambridge monetary theory. The interdependence of the orthodox analysis of value and distribution and its theory of money and output is little noticed, yet it is the key to a clear understanding of the true structure of the theory. Although Pascal Bridel is dealing with the history of economic ideas, the confusions which he exposes are all too present in modern monetary thought. Trinity College, Cambridge JOHN EATWELL

Preface This book is a revised version of a Ph.D. thesis written for the University of Cambridge over the period 1977 to 1981. It would be difficult to do credit to all the discussions I have had which have helped me to develop the ideas presented here. However, I should like to mention the names of my supervisors. Dr Richard M. Goodwin (Peterhouse) and Dr James Trevithick (King's College), who gave me aid and advice over these years. Above all, lowe a great debt to both my then fellow research students, Murray Milgate (Harvard University) and Bjorn Hansson (Lund University). Were it not for the countless weekly meetings of our informal study group, their incisive criticisms and their invaluable help in reading drafts at various stages of my research, this book would never have taken its present form. It goes without saying that all errors and misinterpretations are entirely my own responsibility. There would not have been any book at all without the generous financial assistance from the Fonds national suisse de la recherche scientifique. Finally, my gratitude to Claude, and to my daughters Cecile and Claire, extends far beyond the making of this book. Lausanne PASCAL BRIDEL x

'Disputes about the meanings of Saving and Investment may appear to be arid, but they are in reality of immense importance, because they involve decisions about definitions which determine the whole course upon which theory will subsequently proceed.' (Hicks, 1942, p. 54) 'the saving-investment problem... [is] the likely place to start in looking for the key to macroeconomic instability'. (Leijonhufvud, 1981, p. 201)