Inflation and Unemployment: Contributions to a New Macroeconomic Approach (Routledge Studies in the Modern World Economy, 3)

INFLATION AND UNEMPLOYMENT

Are inflation and unemployment inevitable? This collection challenges traditional monetary theory by focusing on the role of banks and provides a new insight into the role played by bank money and capital accumulation. An international collection of contributors with wide experience of the subject also reappraise the analyses of inflation and unemployment developed by Marshall, Keynes and Robertson. This volume is published in association with the Centre for Banking Studies of Lugano, Switzerland. Alvaro Cencini is Professor of Monetary Economics at the Centre for Banking Studies of Lugano (Switzerland) and Associate Professor of International Economics at the University of Varese (Italy). Since writing his PhD at the London School of Economics he has been working on monetary theory and macroeconomics. Among his publications are Time and the Macroeconomic Analysis of Income and Monetary Theory: National and International. Mauro Baranzini is Professor of Economics at the University of Verona and was previously Associate Professor of Economics at the Catholic University of Milan and Lecturer and Tutor in Economics at The Queen’s College, Oxford. He is the author of A Theory of Wealth Distribution and Accumulation, and the editor of (among others) The Dynamics of the Wealth of Nations: Growth, Distribution and Structural Change (with G.Harcourt).

ROUTLEDGE STUDIES IN THE MODERN WORLD ECONOMY

1 INTEREST RATES AND BUDGET DEFICITSA Study of the Advanced EconomiesKanhaya L.Gupta and Bakhtiar Moazzami 2 WORLD TRADE AFTER THE URUGUAY ROUNDProspects and Policy Options for the Twenty-first CenturyEdited by Harald Sander and András Inotai 3 THE FLOW ANALYSIS OF LABOUR MARKETSInternational perspectivesEdited by Ronald Schettkat 4 INFLATION AND UNEMPLOYMENTContributions to a New Macroeconomic ApproachEdited by Alvaro Cencini and Mauro Baranzini 5 MACROECONOMIC DIMENSIONS OF PUBLIC FINANCEEssays in Honour of Vito TanziEdited by Mario I.Blejer and Teresa Ter-Minassian 6 FISCAL POLICY AND ECONOMIC REFORMSEssays in Honour of Vito TanziEdited by Mario I.Blejer and Teresa Ter-Minassian

INFLATION AND UNEMPLOYMENT Contributions to a new macroeconomic approach

Edited by Alvaro Cencini and Mauro Baranzini Published in association with the Centre for Banking Studies of Lugano, Switzerland

London and New York

First published 1996 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an International Thomson Publishing company This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 1996 Selection and editorial matter Alvaro Cencini and Mauro Baranzini; individual chapters, the contributors All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data A catalogue record for this book has been requested ISBN 0-203-97828-5 Master e-book ISBN

ISBN 0-415-11822-0 (Print Edition)

CONTENTS

List of contributors INTRODUCTION Alvaro Cencini and Mauro Baranzini

viii 1

Part I Inflation and unemployment: a monetary and structural framework for analysis 1

INFLATION AND DEFLATION: The two faces of the same reality Alvaro Cencini

15

Introduction

15

The quantity theory of money: a reappraisal

16

The traditional analysis of inflation: a critical survey

21

Unemployment

34

Stagflation

41

Inflation and deflation as the consequences of the same anomaly 47 2

STRUCTURAL CHANGE, ECONOMIC GROWTH AND UNEMPLOYMENT IN A VERTICALLY INTEGRATED MODEL Mauro Baranzini

57

Introduction

57

Two frameworks of analysis: the circular model and the vertically 58 integrated model Technological unemployment in the vertically integrated model

61

International mobility of labour, information and technical knowledge

64

Summing up

65

vi

Part II Inflation and deflation as monetary pathologies 3

UNEMPLOYMENT: Is there a principal cause? Bernard Schmitt

70

Introduction

70

No positive measure of unemployment can occur in an economy where the definition of the national income reduces to C+I

74

The complete demonstration of the equivalence of saving and 80 investment must be founded on a revision of the concept of money

4

Profits are definitively not to blame for any measure of positive unemployment

84

Real money, nominal money and the principal cause of unemployment

90

FROM KEYNES’S TO THE MODERN ANALYSIS OF INFLATION Xavier BradleyJean-Jacques FribouletClaude Gnos

100

Inflation from the Tract to the Treatise

101

Income and the definition of the inflationary gap

106

The General Theory and after: the confrontation between the 114 analysis of the inflationary gap and the identity between supply and demand The identity between aggregate supply and demand, the basis of 120 a new definition of the inflationary gap Part III Learning from the past 5

6

THE MARX-HAYEK CYCLE AND THE DEMISE OF OFFICIAL KEYNESIANISM Meghnad Desai

128

Introduction

128

Marx’s theory of the cycle

129

Hayek’s theory

131

Recent economc history as a Marx—Hayek cycle

134

Some analytical summing up

139

UNEMPLOYMENT AND PRICE STABILITY: Aspects of the Marshallian legacy on the monetary economy Peter Groenewegen

141

vii

Marshall and the monetary economy

143

The monetary economy in Robertson and Keynes

153

Concluding comments

160

References

167

Author index

177

Subject index

180

CONTRIBUTORS

Mauro Baranzini is Professor of Economics at the University of Verona and at the Centre for Banking Studies in Lugano. Among his main contributions are: A Theory of Wealth Distribution and Accumulation; Advances in Economic Theory and Foundations of Economics: Structures of Inquiry and Economic Theory. Xavier Bradley is Senior Research Fellow at the Centre d’Etudes Monétaires et Financières, University of Bourgogne. Among his contributions are: ‘Le multiplicateur et la formation du revenu’, ‘La finance et le circuit de la monnaie’ and ‘Définition de l’inflation: actualité de la problématique keynésienne des unités de salaire’. Alvaro Cencini is Professor of Monetary Economics at the Centre for Banking Studies in Lugano and Associate Professor of International Economics at the University of Varese. Among his publications are: Time and the Macroeconomic Analysis of Income; Money, Income and Time; and Monetary Theory: National and International. Lord Meghnad Desai is Professor of Economics and Director of the Centre for the Study of Global Governance at the London School of Economics. Among his main publications are The Life and Death of Monetarism, Political Economy (volume 1 of his selected works) and Macroeconomics and Monetary Theory (volume 1 of The Selected Essays of Meghnad Desai). Jean-Jacques Friboulet is Professor of Economics at the University of Fribourg. He is the author of Profit, investissement et inflation and of several articles, including ‘Développement économique et social’, and ‘Les économies du Tiers Monde’, both published by the Encyclopaedia Universalis. Claude Gnos is Associate Professor of Economics at the University of Dijon. He is the author of Production, répartition et monnaie. Among his main contributions to monetary economics are: ‘La transition vers l’union économique et monétaire: les vertus négligées de la monnaie commune’ and ‘Le circuit, réalité exhaustive’. Peter Groenewegen is Professor of Economics at the University of Sydney. Among his recent publications are the first full-length biography of Alfred Marshall, A Soaring Eagle: Alfred Marshall 1842–1924, and an edition of

ix

Marshall’s official papers to supplement those edited by Keynes in 1926, Official Papers of Alfred Marshall: A Supplement. Bernard Schmitt is Professor of Macroeconomics at the Universities of Fribourg and Dijon. Among his several publications are: Macroeconomic Theory, a Fundamental Revision, New Proposals for World Monetary Reform and Inflation, chômage et malformations du capital.

INTRODUCTION Alvaro Cencini and Mauro Baranzini

Despite some modest signs of recovery, it can hardly be denied that unemployment is an increasingly worrying symptom of the disorderly workings of our economic systems. Moreover, inflation is still far from being defeated and never stops asserting its close relationship with deflation. In such a context the need for a better understanding of stagflation is evident. This is not to deny, of course, the importance of the contributions economists have been providing since the seminal works of Ricardo on monetary economics. However, the coexistence of two apparently complementary disequilibria such as inflation and deflation is still a mystery, and very little progress has been made towards explaining the nature of their relationship. Phillips’ claim that inflation and unemployment are inversely correlated has never been effectively established, and the debate which arose after the publication of his famous article in Economica (1958) did not provide a solution to the problem. The very analysis of inflation is in itself not entirely satisfactory. The brilliant intuitions of Ricardo and Keynes have not been followed up by a thorough investigation into the monetary causes of this disequilibrium, which remains partially unexplained. The concept of excess demand and the idea that inflation is provoked by an anomalous increase in the money supply have not been followed to their extreme implications and there is still a lot of confusion about the role played by banks in the process of money creation. Generally speaking, it is usually claimed that inflation is the consequence of the behaviour of economic agents. Dishoarding, credit expansion, public expenditure, wage increases, devaluation and rises in foreign prices are successively put on trial and condemned according to the prevailing beliefs of the moment. Yet, it is not at all clear why an increase in consumption can lead to inflation given that what is saved is necessarily spent through the intermediation of the banks in which savings are deposited. The equality between saving and investment is a consequence of the banking nature of modern money, and not a matter of adjustment. Analogously, how can the identity between total demand and total supply be invalidated without betraying the laws of bank money? These are difficult questions which are symptomatic of the complexity of the problem and which must find an answer if we are to discover the peculiarity of inflation. The time has come to get rid of old, ill-conceived ideas which tend to reduce

2 ALVARO CENCINI AND MAURO BARANZINI

inflation to a problem of the price index. As is easily shown by modern monetary analysis, an increase in the cost of living is not necessarily an effect of inflation, and inflation is not necessarily reflected in an absolute variation of the price index. The loss of money’s purchasing power cannot be mixed up with the simple redistribution of income resulting, for example, from a rise in the price index due to an increase in indirect taxation (which is simply the cause of a transfer of purchasing power). Apart from the works of some great economists of the past, inflation has also benefited from the investigation carried out by the Monetarists, and from their controversy with the Keynesians. Unfortunately, the debate has not given enough relevance to the progress made by our banking systems, so that their analysis of money has remained anchored to an old-fashioned line of arguments in which money is perceived as an autonomous real asset not fully integrated in the economic system. The idea of the quantity of money as well as that of its velocity of circulation is a clear example of how money is still considered as if it were a real good, an object with a proper mass whose circulation is subject to the laws of physics. Fruitful as this material concept of money might at first appear, it takes us no nearer a better understanding of our monetary systems. On the contrary, the lack of a correct analysis of the specific nature of bank money does not allow for any satisfactory explanation of inflation. Apart from the very particular case in which Central Banks finance public debt by money creation (a case which does not apply to the majority of industrialised countries), the pathological growth of the money supply cannot be ascribed to the inadequate decisions taken by monetary authorities. The image of money being produced by Central Banks in the same way as firms produce real goods is ill-founded. Not only is money issued mainly by secondary banks, but it is also never produced. Although the Monetarists are right in claiming that inflation has to be analysed within a monetary framework, they seem to fail in providing a theory of modern bank money. The real kernel of the problem is that they are not fully aware of the a-dimensional nature of money and the way it is associated with the world of real output. Their analysis of inflation is thus seen to beg the question, since it rests on a strict dichotomy between money and output. The conceptual shortcomings of the traditional approach to inflation are present in most analyses of unemployment. Missing the centrality of Keynes’s distinction between voluntary and involuntary unemployment, mainstream economists are often led to investigate the problem of unemployment from too narrow a point of view. It is true that this disequilibrium is seen to be the consequence of a whole variety of real and monetary causes, ranging from technological progress to monetary authorities’ policies. Whether of a structural or conjunctural origin, however, unemployment pertains to the category of voluntary unemployment and is not of a pathological nature (let us remind the reader that voluntary unemployment refers to the unemployment generated by the normal working of our economic systems and has nothing to do with the willingness to be out of work). Hence, traditional attempts to explain

INTRODUCTION 3

unemployment have systematically failed to account for the category of involuntary unemployment. As suggested by Keynes, this is the true disequilibrium we should effectively worry about. It is when part of total real output cannot be sold that the system suffers from a pathological shortage in demand leading to involuntary unemployment. The problem of unemployment must therefore be related to a situation known as deflation. Any theory which only accounted for unemployment caused by real factors would be unsatisfactory. Deflation is a monetary disequilibrium which can only be explained if we are able to work out a theory in which production, distribution and final purchase are simultaneously analysed from their monetary and real points of view. To do this, we must start from the emission of bank money and follow it until its final expenditure in order to find the anomaly leading to a pathological decrease in employment. The fact that inflation and (involuntary) unemployment are both to be investigated by considering the relationship between bank money and real output is emblematic and corroborates the thesis of their common origin. Were it not so, it would be impossible to explain their coexistence, since inflation and deflation could then only be conceived as two disequilibria of the opposite sign (D>0, D