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LIST OF CONTRIBUTORS Robert T. Anderson
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LIST OF CONTRIBUTORS Robert T. Anderson
Department of Economics, Michigan State University, East Lansing, MI, USA
Kirk D. Johnson
Department of Economics, Golden-Beacom College, Wilmington, CA, USA
Marianne Johnson
Department of Economics, University of Wisconsin-Oshkosh, Oshkosh, WI, USA
Mark Ladenson
Department of Economics, Michigan State University, East Lansing, MI, USA
Warren J. Samuels
Department of Economics, Michigan State University, East Lansing, MI, USA
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MARK LADENSON’S NOTES FROM ROBERT CLOWER’S COURSE ON ECONOMIC THEORY, ECONOMICS D-10-2, NORTHWESTERN UNIVERSITY, WINTER 1967 Edited by Warren J. Samuels and Kirk D. Johnson with the Assistance of Mark Ladenson Published below are two sets of notes taken by Mark Ladenson at Northwestern University. This first set is from Robert Clower’s course on Economic Theory, Economics D-10-2. The second set is from Frank Whitson Fetter’s course on Monetary Institutions and Policies, D-31-0. Other sets of notes will appear in subsequent volumes in this annual series.
ROBERT W. CLOWER: A BRIEF BIOGRAPHY Robert W. Clower was born in Pullman, Washington. He was educated at Washington State University (BA, 1948; MA, 1949) and Oxford University, as a Rhodes Scholar (MLitt, 1952; DLitt, 1978). His principal positions have been at Northwestern University (1957–1971) and UCLA (1972–1986), interspersed with a number of visiting professorships. Clower was managing editor of the
Further Documents from the History of Economic Thought Research in the History of Economic Thought and Methodology, Volume 25-C, 1–39 © 2007 Published by Elsevier Ltd. ISSN: 0743-4154/doi: 10.1016/S0743-4154(06)25024-7
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American Economic Review during 1981–1985. His work in monetary and macroeconomic theory established his reputation as a leading economic theorist; for example, he is included in Mark Blaug’s Great Economists since Keynes (New York: Cambridge University Press, 1988). His most fundamental work has been on the theory of disequilibrium adjustment, in which he provided an original amendment to John Maynard Keynes’ theory of unemployment equilibrium. His central idea was that households, whose actual incomes were below their expected, or notional, levels, would reduce consumption expenditures, thus sending erroneous signals to producers. In the statement of his principal contributions prepared for Blaug’s Who’s Who in Economics (Northampton, MA: Edward Elgar, 3rd ed., 1999, p. 236), Clower himself emphasizes his studies of disequilibrium adjustment processes. He further characterizes his work, which only in part identifies the larger context of his ideas, as follows: “Though regarded by some of my colleagues as an idiosyncratic iconoclast, I consider myself to be a thoroughly constructive critic of conventional wisdom. My principal contributions have, I think, shed fresh light on central questions of economics concerning the self-organising and self-adjustment capabilities of decentralized economic systems. One way and another, I think I have helped to add sense to a discipline that is (and probably always will be) remarkably full of nonsense.” Clower also did work in the history of economic thought and was President of the History of Economics Society during 1997–1998. Clower was unable to check this document; alas, his health deteriorated significantly after surgery early in 2006. Mark Ladenson (1941–) received his doctorate in economics from Northwestern University in 1970, five years after receiving his MBA from the University of Chicago and seven years after receiving the BA in economics from the University of Wisconsin. He was a member of the economics faculty of Michigan State University from 1969 to 1999. He specialized in monetary and macroeconomic theory, publishing about a dozen pieces in major journals. He has also had two other interrelated avid interests: reporting/interpreting on jazz and working as a jazz and travel photographer. Ladenson took Economics D-10-2 from Clower during the winter quarter of 1967. Ladenson’s set of notes from the course are particularly useful with regard to its record of Clower’s approach to economic concepts and to doing economics— from a course by a leading theorist taught in a leading department in the discipline. It offers one set of insights supplementary to the standard advanced texts of the time, including Clower’s interpretation of aspects of the history of economic thought. The original notes, along with Ladenson’s other original notes, will eventually be deposited with the University Archivist at Northwestern University.
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Published below are, first, the examinations in the course and, second, Ladenson’s notes. The notes have been edited in the manner of previous archival works in this annual. Minor editing, including corrections and completion of abbreviations, has been undertaken. Editorial interjections are placed within braces, { }. Mark Ladenson corrected the printout of my transcription of the notes. He also responded to my invitation to add his own comments; these are placed within double braces {{ … }}. Mark is not only gracious in responding, he is candid. Many people whose notes I have sought for possible publication are sensitive to the impression of their abilities that the notes may give readers. Mark, who has no need to be concerned, nonetheless is frank about possible mistakes on his part. In a memorandum to me, dated June 21, 2006, Mark writes that {{the algebra at the top of the first two pages of notes from Bob’s lecture of February 20 probably represents my preliminary attempt to deal with the challenge he throws out at the beginning of that lecture: “Try to prove that a per unit tax …” And in fact the unlined piece of paper with nothing but algebra that precedes the first page of notes from the February 20 lecture shows that I was able to meet that challenge. So all that algebra—at the top of those two pages, and everything that’s on the piece of paper that precedes the first page of notes from the February 29 lecture—, and the first diagram at the top of the second of the two pages with algebra in the top margin, should be deleted. An awful lot of the math in those lectures just describes constrained maximization problems without explicitly deriving the solutions, and I’m not sure what you were referring to when you said the mathematics needs correction. A ubiquitous problem with taking notes on oral presentations of mathematical models is that when some letters of the Roman alphabet are handwritten it’s difficult to tell whether they are lower or upper case and it’s easy to confuse the two. But I’m having a larger problem, of which that one’s a part, with my notes, as you accurately transcribed them, on pp. 38–39 [of the initial print-out, inclusive of initial introductory]. Either upper or lower case p (I’m not sure which as I look at my own handwriting) is defined as the money price of Green Stamps. Whether it’s upper or lower case p (M/upper or lower case p) ‘gives quantity of Green Stamps M will buy.’ So whether it’s upper or lower case, it should be the same in its own definition as it is in the definition of the variable that results when it’s used to deflate M—unlike the way you’ve transcribed it. But I have to admit that I can’t understand why, a little later, he multiplies that
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same variable, and not some other measure of price, by real consumption (c or C) to get nominal consumption spending. I have to wonder if upper and lower case p are both present and I missed the distinction.}} Inasmuch as the mathematics is principally constrained maximization, not much would be lost if we eliminated the mathematics, both the algebra and the diagrams, especially the former. Mark concludes his memorandum with the following: {{I’m afraid that in a number of cases, the diagrams as they appear in the notes, really don’t agree with what the notes say about them. These obviously were cases of my racing to get it all down and not succeeding. And since, as you can see from Bob’s exams, we didn’t come close to being tested on the details of any of this stuff, I guess I just didn’t have the motivation to go see him to try to straighten things out—or to try to get help from any of my classmates. Rather than try to change the description of the diagrams to agree with what I wrote in the notes, or to suggest how I should have drawn and labeled the diagrams, except in a very few cases I’ve simply tried to describe those diagrams, as they appear in the notes, as accurately as I can.}} The descriptions of the diagrams herein are largely those written by Mark for use in this document, as a substitute for providing the diagrams themselves. For Clower, everything is defined in terms of mathematical symbols and definitions. The economy and its agents are purely conceptual and bear no necessary relation to actual institutionalized economies. Economics is, therefore, both a purely conceptual and a logical exercise, an exercise bearing no necessary relation to the actual economy. It is intended to exemplify a conception of science that results in unique determinate, hence predictable, outcomes. It is also intended to exemplify a conception of the economy expressed in purely mathematical terms. Both conceptions were already becoming hegemonic in the discipline in the decade of his graduate training. Still, it is not always clear when Clower thought he was working, puzzle-like, within the confines of a pure abstract conceptual model and when with something either within or close to the actual economy. This difficulty does not, however, preclude the utility of his models as tools of analysis and pedagogy. The use of primitive, undefined, or unspecified terms is a legitimate mode of abstraction. However, the tendency in practice is, in drawing implications for policy, to identify the primitive conceptual terms with either existing or otherwise-specified institutions. This is improper but nonetheless widely practiced in economics: Having abstracted from institutional details, the analysis cannot be used to choose between alternative modes of institutionalization. (See Warren
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J. Samuels, “Some Problems in the Use of Language in Economics,” Review of Political Economy, vol. 13, no. 1 (2001), pp. 91–100.) The well-known irony is that unique solution-producing analysis requires a “market authority.” At least, if not more, important than the foregoing is the character of Clower’s discourse. Clower’s analysis is informed by empirical study and experience. Its character, however, is that of deductive logic, a widely used technique of analysis but, like all techniques, one with limitations. The result of deductive logic is a matter of validity, indicating that the conclusions have been properly drawn, given the postulates and the system of logic. The result may be empirically correct, but need not be. When Clower (and any theorist) conducts his or her exercise in logicality, drawing conclusions from premises, the exercise is one of logicality and need not bear any relation to an actual economy. Critics of systems of deductions sometimes refer to it as puzzle solving, having no necessary relation to actual economies. Defenders of such a mode of doing economics emphasize the rigor that correct logicality imposes. To which critics reply that rigor without realism lacks empirical substance. A related issue concerns the mathematical formalism that characterizes most deductive systems. In any event, such are some of the ways that economists do economics. {{Ladenson: Your discussion … [should] mention that beginning with the lecture of February 13 much of what Bob did (especially the last week) was to share with us material from his article, “A Reconsideration of the Microfoundations of Monetary Theory,” which would appear months later as the lead article in the December ’67 issue of the Western Economic Journal. This is an iconoclastic article in which he argued (I think convincingly) that what were presented as modern general equilibrium models of a monetary economy were indistinguishable from models of a barter economy—they gave no distinctive role to money. Simply, arbitrarily, called one of the n goods “money” and let it be the numeraire.}} Clower’s well-known and herein reported candor on a number of conceptual and methodological issues is remarkable. This candor was, perhaps, engendered or reinforced by Clower’s interests in the methodology and history of economic thought—interests that he sought to encourage in his students. His candor, and the associated strengths and limitations of his way of doing economics, are underscored by remarks presumably made by him and recorded in the notes. These include the following: We have certain terms (as does any discipline) which can’t be defined. —These include the individual, or the transactor: Households, consumers, firms and banks “are conceptualizations … [that] have no meaning except with reference
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to a set of postulates” and the mathematical symbols in which they are expressed. This is only one of the linguistic problems and limits of economics but, in pointing to the use of undefined, primitive terms, Clower stresses a major one. Not only does the economics taught in the course reflect the pure a-institutional abstract conception of the economy, Clower does not leave the matter to interpretation. He states the nature of his economics in no uncertain terms; indeed, with such apparent force that Ladenson expressed the points in capital letters. We therefore read that “AN ECONOMIC SYSTEM IS ANY SET OF #’s (xi) OF ECONOMIC MAGNITUDES,” that “THIS IS A VIRTUAL SYSTEM AS OPPOSED TO A REAL PROBLEM,” and that “We’re still dealing with a VIRTUAL PROCESS. NO TRADE.” We shall further explore these statements. Especially impressive, even striking, Clower is recorded as saying that “PRICE IS NOT A BASIC CONCEPT OF ECONOMICS or at least its not useful to treat it as such. Comes out of commodities and exchange.” Microeconomics focuses on the mechanics of price rather than its result, the allocation of resources, partly because price is more readily comports with mathematization and partly because such is equated with science. For Clower to say that price is not a central concept of economics is surely iconoclastic. If prices come out of commodities, Clower also is recorded as saying that “Commodities are what we say they are …” More is involved than abstraction. The quotation is from the beginning of the opening lecture: We have certain terms (as does any discipline) which can’t be defined. Set of I’s (1) I {I0, …,TIM} individuals, transactors. (Clower likes to think of I0 as the market authority, a human 0) (Households, Consumers, Firms, Banks) → these are conceptualizations of the I’s. These terms have no meaning except with reference to a set of postulates. (2) C {C0, C1, …, Cn} C0 is unit of account. Commodity set. Commodities are what we say they are, e.g., do we distinguish between brands. {Italics added.}
That is part of a particular larger mode of doing economics, that of working with pure abstract conceptual entities and not actual economies. As Clower put it: Useful to think of the system as having continuous time. We can think of the state of the economy at any time t0 in terms of values xi which characterize activities, consumers, commodities. Sometimes you have to know the values of these variables at all future times. AN ECONOMIC SYSTEM IS ANY SET OF #’s (xi) OF ECONOMIC MAGNITUDES.
The economy is said to consist of the commodity set, with a pure unit of account, goods and factors of production; the transaction set, involving households, firms, and the market authority; and an activity set, involving production, consumption and exchange, all planned; THIS IS A VIRTUAL SYSTEM AS OPPOSED TO A REAL SYSTEM.
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If we are to work with a pure abstract conceptual economy, which one will it be? And what is the basis of choice? Clower said, Keynes comes right out of Marshall. Could never get Keynes out of Walras. The Walrasian model does not get us too far but it is what we need to be familiar with.
This apparent disregard for Keynes’s concerns is also remarkable. The implication of this candid statement is that the analyst has considerable freedom in constructing the set of postulates or premises that define the economy for that particular analyst. On the other hand, Clower is recorded as saying that in “examining Keynesian econ{omics] and actual world data, these problems of adjustment are very important. Another problem is one of aggregation. To state that stability is implied by certain characteristics inherent in the market is quite foolish.” This course was in microeconomics and Clower, I think, established his principal reputation in macroeconomics. In that field, he insisted on more realism than he did in microeconomics. Clower admits to introducing realism. But these introductions are selective and do not change the nature of the exercise. On the one hand, these introductions can be said to render the technique of analysis rich as well as rigorous. On the other hand, one can write down a model that will yield whatever ones it to. The objective is the goal of the neoclassical research protocol, namely, to reach unique determinate optimal equilibrium solutions, and not to study the allocation of resources. The assumption of diminishing marginal productivity is “imposed;” the notes read, “it is not imposed because it is realistic. Although there are common sense reasons for supposing it is true in some range, just assume what we want in the relevant range.” The “Firm is maximizing a preference function whose preference is for profits.” The following are further examples of flexibility and realism that both elicit praise and raise questions: So far this is all planning. Nothing has been executed except the announcement of prices. The prices are PARAMETRIC. A monopolist could act as if prices were parametric. Perfect competitors could act non-parametrically with respect to prices and upset the model. The perfect competition is realistic. An ADAPTIVE LEARNING MODEL: adjusts output to where price is in market.
A monopolist whose demand curve had shifted down would have been using the wrong marginal revenue function for profit maximizing. MUST AVOID INSTANTANEOUS ADJUSTMENT ASSUMPTIONS. The beauty of the perfect competition model is that all sellers are COMPLETELY IGNORANT OF MARKET DEMAND. We ought to assume it of all sellers. Eschew the notion that the firm does not have a budget constraint! Once we introduce two households, uniqueness goes out the window.
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WARREN J. SAMUELS AND KIRK D. JOHNSON Walras’ Law does not rule out begging, borrowing, unilateral transfers. This is due to some other theorem that says that in a closed set of transactions value value. What we have done: A simple model of a group of transactors who plan behavior both on household and business account and communicate preferences to a market authority. We wind up with demand functions homogeneous of degree 0 in absolute prices. This is not inevitable. Classical economists never said long-run demand is homogeneous of degree 0 in relative prices. Only in money prices. They are independent of quantity of money held by individuals since in the long run, money balances are a variable and not a parameter. Patinkin works with short-period adjustment so gets different results. The literature is a bit odd. In the same book one finds markets continually clearing and then not clearing.
This comment is odd in itself. On the one hand, it seems to assume that economists are dealing with the actual economy, which should be either clearing or not clearing. On the other hand, one is reminded of Paul Samuelson’s injunction that one could teach the economics of a full-employment economy in one course and the economics of a less-than-full-employment economy in another; i.e., the same economy can be clearing and not clearing, and/or full employment of less-thanfull-employment, at different times. Klein suggested (Keynesian Revolution) that in Keynesian unemployment situation demand predominates. This does satisfy the Keynesian definition of involuntary unemployment … The trouble with this is that any point in diagram is admissible with this. Since if you were in equilibrium at that point, and parameters shifted, you’d continue there awhile, then move to less of either quantity supplied or quantity demanded at that price.
The movement is by an adjustment process. Normally we assume the adjustment processes do not come in, or else we converge very rapidly to a point on at least one of the curves. In examining Keynesian economics and actual world data, these problems of adjustment are very important. Another problem is one of aggregation. To state that stability is implied by certain characteristics inherent in the market is quite foolish.
The adjustments considered in the notes are primarily matters of the changes in prices and quantities consequent to excess demand or excess supply. The contract curve is said to emerge “only with an auctioneer.” Discussion of situation in which “final position” is “independent of initial stocks and path to equilibrium.” Clower suggests consultation of the literature of economics, mathematics, and physics on “alternative concepts of equilibrium.” We could put anything in the utility function. Marshall’s tradition is very rich. (Usually leave stocks out—for this would always change the preference map.) Marshall’s time eschews dynamics. On the South side they use comparative statics. One problem is not putting income expectations into the utility function.
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Mark Ladenson’s Notes from Robert Clower’s Course Part of all this is that anything crazy can be in the utility functions. What is important is the budget constraint on behavior and this is what is to be analyzed. (Future prices and incomes enter in—see Debreu, Theory of Value.) The single Lagrangian equation to be maximized shows you what is happening. Considers the MARGINAL PROPENSITY TO CONSUME WEALTH and consequent changes in budget line. The agent is said to determine his own wealth by wealth–income relations. Considers wealth effects on spending and prices as well as on intersecting decision loci. This kind of thing, without technological progress and without pathological preferences, makes the stationary state inevitable. A DECISION LOCUS EVERYWHERE BELOW income locus would be pushed above it, since the excess demand would change prices. Try to prove that a per unit tax that raises the most revenue of [sic] the state occurs when the linear supply curve shifts up to halfway between the intercept of the linear supply and demand curves. (Lipsey) The fact that stocks are a dependent variable in the long run implies that people who own income-earning assets determine their income levels in the long run. So in long run utility function, Y is not a parameter—same thing can be said about distribution of income and wealth. This is determined by preferences, attitude toward holding, borrowing, lending. Concern with stability conditions. Excess demand curve is only thing known to market authority. Hicksian argument ignores true dynamics. Note there are NO RULES FOR NON-LINEAR EQUATIONS. Not true that [having] more variables than non-linear equations is necessarily overdetermined. Moral: When you observe empirical regularities these should not be explained by behavioral relations, which require very precise special-case assumptions. Look for general stability conditions. Note about Correspondence Principle: the dynamical assumption is never sufficient to get comparative statics result, since any comparative static situation is consistent with an infinity of dynamical assumptions (e.g., Cobweb versus instantaneous adjustment). Also, if you work with slightly more complicated models, assuming dynamic stability will not give information about comparative statics results. Samuelson has had second thoughts on the Correspondence Principle. In dynamics, speeds of adjustment are crucial and these just are not involved in comparative statics. Assume with Patinkin that excess demand functions are not homogeneous of degree 0 only in money prices in a money economy, but are so in a barter economy. Is this a solid ground for distinguishing between a barter and a money economy? There is no difference, you’ve ruled out money trade in a barter economy and the money prices become merely accounting prices, whereas they are NOT merely accounting prices when money is traded. There is always homogeneity of degree 0 in accounting prices if people do not suffer from accounting-price illusion. If you eliminate a good from trade, express all prices in terms of its price, then all excess demand functions are homogeneous of degree 0 in these prices. These become accounting prices. So we really have a barter model in all of these. It does not become a money economy by sticking in a product M that is traded.
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WARREN J. SAMUELS AND KIRK D. JOHNSON What Patinkin has done implicitly is to turn the numéraire in a “money” economy into a unit of account in a barter economy. Does not change the structure of the model. The structure is that of a barter economy in both cases. In Patinkin’s model, no lending or borrowing. Money is only store of value. Manna not consumed at end of period is taken away. Money is traded and is a numéraire. Imagine a world where you are paid in Green Stamps and you can redeem either in Federal Reserve Notes or in commodities. Is there one set of money prices that makes individual plans consistent? Yes. In this model there are commodities but no market. Suppose one of the manna things is bonds. There is no way of distinguishing between (say) liquidity preference and loanable funds, i.e., cannot say interest rate is determined in money market or in bond market. This economy cannot assign a function to money as a means of payment. Hence it is curious that Patinkin makes motivation for money holding depend on non-synchronization of payments and receipts. This implies a different model. Suppose only one person has positive value of M/P in his utility function. This makes no difference to market demand functions. The one guy ends up with all M. There is no trading of money in economy after first period. Then relative prices depend only on other people’s preferences. The one guy is a human Cambridge equation. He determines absolute price level. Latter must be high enough for him to hold all money. MONEY is just irrelevant in a Patinkin model. Suppose you fix the price in money of one of the manna streams (money wage rate) and reduce the quantity of money. This reduces the quantity demanded of certain goods and leads to decline in prices which are flexible. Start with an individual in equilibrium. Now reduce M. So he is only able to sell [a lower amount of money]. If he consumes as before, his money balances drop … In the next period he begins at [the lower levels of M and M/P], etc. Ultimately he runs out of money, cannot sell labor services, and everyone is left demanding money in exchange for labor … If [sic] someone says, you should work more hours at the going wage. This is like increasing M. You can get back to the original equilibrium by changing … in excess demand functions. This is a barter model. It’s silly. Leads to theorem that increase in involuntary unemployment raises P. Hicks: If we look at the function of money, means of payment is only unique one and only one that is not adequately handled in general equilibrium analysis. “True money economy: People are offering to buy and sell products for MONEY ONLY.” “Planned purchases and sales of money are equal.” “Problems of solution are worse than before.” Playing around with constraints gives a form of Walras’ Law … Important thing is that this is derived from both a precautionary and a transactions demand for money. The model gives pretty much the same results as the Patinkin model. The Walrasian appeals usually; but Friedman makes such good sense on policy, seemingly. In this latest model, money matters. (Look at versions of Walras’ Law.) When money increases, prices fall [sic]. Immediate impact on market conditions. Real Scope for financial disorganization.
One conclusion is that Clower gave his students no cook-book version of economics. He showed the interested student that the foundations of any body of theory were problematic, to say the least, and that there was much for them to mull over.
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THE EXAMINATIONS Ladenson’s materials from the course include two take-home examinations—the midterm and the final exams—and his answers; only the former are published here. The Midterm Examination Economics D-10-2
Winter 1967 Mr. Clower
1. Do some textbook and library research on alternative concepts of equilibrium and stability (any book on non-linear oscillations, Samuelson, Bushaw-Clower, Baumol) and write an essay on your findings. 2. According to Baumol, Walras’ Law “is little more than an accounting relationship (it is difficult to imagine an economy in which it does not hold)…” According to Mishan, Walras’ Law holds “only in the long run competitive equilibrium.” According to Patinkin, Walras’ Law is a theorem that is valid for certain kinds of economic models but not for all. Discuss and appraise these apparently different views and present your own conclusions about the nature and significance of “Walras’ Law.” 3. Edgeworth argued in his Mathematical Psychics that the rate of exchange was in general indeterminate in the case of barter of two commodities by two individuals. Would this view be correct if the rate of exchange were set by a third person acting as a disinterested auctioneer? Discuss, using appropriate diagrams to illustrate your argument. The Final Examination TAKE-HOME EXAMINATION: ECONOMICS D-10-2 Winter Quarter, 1966–1967. Mr. Clower Due March 10, 1967 1. Money occupies a highly uncomfortable position in contemporary general equilibrium analysis; for if prices tend rapidly to adjust to levels such that all markets clear, “liquidity,” in some general sense, rather than “money,” narrowly conceived, is the most important variable in determining the ease with which the economy adapts to exogenous changes in taste, technology, and other “shocks.” Yet many writers, particularly those that value common sense as much as or more than theoretical abstractions, argue that “money matters”
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in the real world. Write an essay explaining your own position on these issues, documenting it as you think appropriate with relevant items of theory, facts, intuition, and plain old fashioned prejudice. 2. Economics has been described by one writer as “a vast accumulation of factual knowledge organized around a central core of theoretical principle.” This description of economics has been characterized by another writer as “hogwash.” Write an essay in which your reaction to both points of view is buttressed by reference to specific works (books or journal articles)—theoretical and empirical, modern and traditional—that seem to you to represent significant contributions to economics. MARK LADENSON’S NOTES FROM ROBERT CLOWER’S COURSE ON ECONOMIC THEORY, ECONOMICS D-10-2, NORTHWESTERN UNIVERSITY, WINTER 1967 January 9 Value & Capital important. Books II & III!! P.K. Newman Theory of Exchange – Prentice-Hall – Bibliography good Samuelson – Chap. 2 Bushaw & Clower – Chap. 2 January 23 Archibald & Lipsey Rev. Econ. Stud., 1958, pp. 1–23 Symposium on Value and Monetary Theory Rev. Econ. Stud., 1960 R. Kuenne General Equilibrium Koopmans – Three Essays on the State of Economic Science Walras – Elements of Pure Economics Jones, JPE, middle of 1966 Kirschner & Wilcox – Anatomy of Mathematics, Ronald, 1950 We have certain terms (as does any discipline) which can’t be defined. Set of I’s
(1) I {I0, …,TIM} individuals, transactors. (Clower likes to think of I0 as the market authority, a human 0) (Households, Consumers, Firms, Banks) → these are conceptualizations of the I’s. These terms have no meaning except with reference to a set of postulates. (2) C {C0, C1, …, Cn} C0 is unit of account. Commodity set. Commodities are what we say they are, e.g., do we distinguish between brands.
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Activity Set
(3) A {A1, …, An, A1, …, An} Such things as Consumption, production, exchange, [Two sets since first set is planned actions, second is realized actions.] storage, transport.
Time Set Location Set
T{ − e t < e} L{L1, …, LG}
1st 3 definitely part of econ[omy] 2nd 2 physical. Traditional static econ[omics] ignores last 2 sets and last 3 of 3rd set. But more recently more interest in T. Traditional to work things out so its not necessary to distinguish between the 2 sets of activities. No action taken until all plans consistent. Tatonnement. PRICE IS NOT A BASIC CONCEPT OF ECONOMICS or at least its not useful to treat it as such. Comes out of commodities and exchange. Useful to think of the system as having continuous time. We can think of the state of the economy at any t0 in terms of values xi which characterize activities, consumers, commodities. Sometimes you have to know the values of these variables at all future times. [AN ECONOMIC SYSTEM IS ANY SET OF #’s (xi) OF ECONOMIC MAGNITUDES]. If from knowledge of all past states of the economy we could predict where the economy’ll be at any future time. We want logical machines, theoretical models, to grind out time series data (predict). Any time path can be studies as a MOTION. There are EQUILIBRIUM MOTIONS of model. If a model always grinds out the same time path. In economics we often use the horizontal motion. Steady state. Values don’t change as time passes. Another type recently popular is the EXPONENTIAL MOTION. Another (business cycle) is SINUSOIDAL MOTION. Another one looks like a sawtooth. What you’re interest in is how one of these systems works if you start it off from some point other than origin of equilibrium motion. (i.e., stability of the dynamic equilibrium.) Suppose the market authority in the adjustment mechanism follows this rule: dp/dt : p/t [d(pt) – s(pt)]t0↑ If people offer more for sale as price goes up, then there is monotonic convergence to equilibrium. There are all kinds of stability concepts in the literature.
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January 25 Smith viewed market mechanism as method to reconcile free desires to buy and sell of individuals with long-run necessity for aggregate supply aggregate demand. This is why he is the father of the science. – Was not developed somewhat rigorously until Cournot is worthwhile reading. Walras, Marshall, Jevons. Keynes comes right out of Marshall. Could never get Keynes out of Walras. The Walrasian model doesn’t get us too far but its what we need to be familiar with. Has been developed by Hicks, Allen, Samuelson, Uzawa, other Orientals. (1) Theoretical Principles (Demand and Supply) (2) Dogma – Established empirical and theoretical knowledge (3) Excursions – Conjectures, themes taken up to alter, modify the principles, dogma. These are the elements of any discipline. Commodity Set C {c0; G, F} c0 is a pure unit of acciunt. G goods F factors Transactor Set I (H1…i…, Hm; F1…j…, Fn; I0} Households, Firms, Market Authority Activity Set A {Production, Consumption, Exchange} all planned; THIS IS A VIRTUAL SYSTEM AS OPPOSED TO A REAL SYSTEM I0 starts out announcing prices for factors pg, pf, any positive real numbers Firm is interested in making offer to market authority to buy a certain amount of factors, and sell a certain amount of goods. And the reverse for households. Subscripts identifying which household and firm are omitted. Amount of C0
pgpf
F/dfsg
H/dgsf
These variables are all desired magnitudes [Digression: Profit maximization is implication of utility maximization. We could do away with distinction between households and firms. For contrary view see Scitovsky, Readings in Price Theory; also see deGraaf R.E.Stud., 1951 and Clower R.E.Stud. 1952, the latter are important to look at for any study on investment determinants that one might do.] {{Diagram with sg and df on vertical and horizontal axes, respectively. A line coming out of the origin with slope, pf /pg represents the real wage rate. A notwell-behaved curve coming out of the origin is labeled f(d f).}}
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Given the accounting prices any firm can figure the cost in terms of goods, or the factors it wants (real wage rate). The line in the graph is a 0-profit line; Hence a REAL-COST LINE sg f(df)—if this function is badly behaved we don’t have unique solution. Impose diminishing marginal productivity. f′ 0; f′′ 0. Clower says “NOTE diminishing marginal productivity not imposed because its realistic. Although there are common sense reasons for supposing its true in some range. Just assume what we want in the relevant range.” Then the intercepts of a set of lines parallel to the 0-profit line measure amount of profit on that particular isoprofit line. Firm is maximizing a preference function where preference is for profits. U ⬅ ⬅ pgsg – pf df. But there is a difference. Constraint doesn’t involve prices. This is why there’s no income effect when there’s a change in factor prices. The line f(df) is only combinations of (df, sg) we need care about. So far this is all planning. Nothing has been executed except the announcement of prices. The prices are PARAMETRIC. A monopolist could act as if prices were parametric. Perfect competitors could act non-parametrically with respect to prices and upset the model. The perfect competition is realistic. An ADAPTIVE LEARNING MODEL: adjusts output to where price is in market. Monopolistic Model: {{Diagram with D/AR/MR/MC, showing the analysis of output determination at the value of output where MC MR. BUT unlike in the standard presentation, the downward sloping demand curve is shown as a differ curve from the AR curve.}} Suppose demand curve were D and then shifted down. There is no mechanism for adjusting, i.e., he’d never know. D " AR at all points except intersection He had been using wrong MR all along for profit maximizing. MUST AVOID INSTANTANEOUS ADJUSTMENT ASSUMPTIONS The beauty of perfect competition model, is that all sellers are COMPLETELY IGNORANT OF MARKET DEMAND. We ought to assume it of all sellers. January 30 The solution value of df, f f(pf /pg). Also šg g(f (pf /pg)) sg (pf /pg)f /pg
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i.e., we want to max. ( ⬅ pgsg – pf df) subject to f(df) – sg 0 and 0. i.e., desired sg and df depend on pf /pg Note THAT {WHAT} WE WANT TO MAXIMIZE IS THE FIRM’S BUDGET CONSTRAINT. Eschew the notion that firm doesn’t have budget constraint! Household: maximize U(dg, sf) (Firm has opposite utility function) {arrow pointing to above maximization equation} Subject to: pgdg – pfsf – 0 determined by what firm does Notice constraint depends on prices but not in case of firms. {{Diagram with origin labeled 0, vertical axis labeled dg, horizontal axis unlabeled but undoubtedly should have been labeled sf. A vertical line rises from a particular point along the horizontal axis and the value of the variable being measured along that axis, which I believe must be sf, at that point is labeled dl* (i.e., d-lower case L*). A set of indifference curves is drawn convex to the origin.}} [Ordinarily one would have to write dl (i.e., d-lower case L) in utility function. Then you’d have to bring time in.] {{Another diagram with dg ensured on vertical axis and sf on horizontal. A line has slope, pf /pg, but unlike in the preceding it has a positive intercept, the value of which is stated as a fraction, bar/pg. Indeed, to the right of the diagram is stated the equation of that line: dg (pf /pg) sf bar/pg. The diagram also contains a family of upward sloping curves, increasing at an increasing rate.}} Now all we need is to find pf and pg but since all that is relevant is pf/pg that’s all we need. Now look at the 2 problems simultaneously {{A diagram with dg and sg, measured on the vertical axis, and df and sf on the horizontal. The same line, and set of, curves, as in the previous diagram are present. An upward sloping curve out of the origin, increasing (unlike curves from the previous diagram) at a decreasing rate, label f(dg) is also present. To the side of the diagram is the specification: “pf /pg given.” A remark below suggests very strongly that the curves from the previous diagram are indifference curves, and the curve f(dg), is the transformation curve.
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The vertical co-ordinate of the tangency point of the curve, f(dg), with one of the indifference curves is labeled dbarg, and its horizontal co-ordinate is labeled sbarf. The vertical co-ordinate of the tangency point of the curve, f(dg), with the straight line from the previous diagram is labeled sbarg and its horizontal co-ordinate is labeled dbarf.}} pf /pg and f(dg) pf /pg given {In top margin: Mishan: “Say’s Law and Walras’ Law;” QJE about 1961.} {{The reference to an article by Mishan … obviously is there because Bob mentioned it. (Only way it could have got there.)}} Say’s Principle is valid: (I 1 to n) pixi – 0 Rationality factor Say’s Principles doesn’t imply Walras’ Law or Say’s identity. (g – šg)pg ⬅ (f – šf)pf pg(g – šg) pf(f – šf)
since the equation of the profit line is This relation then becomes an identity for all sets of solution values which satisfy it.
pixi ⬅ 0 (over i 1 to n) and pixi ⬅ 0 (over i 1 to n 1) on this.
Check Newman
We have neither of these yet. Our problem is solved by Max: U(dg, sf) S.T.: (1) f(df) – sg 0 S.T.: (2) pgdg – pf df bar 0 {The pi-symbol with a bar over the top of it has exceeded the technical capacity for this system to replicate. It will hereafter be referred to as ‘bar’.} The comparative statics are such that the equilibrium level of pf /pg is such that the transformation curve intersects indifference curve. Must analyze any household equilibrium points as {{Diagram that repeats the determination of the solution values of the “horizontal axis” variables from the previous diagram as determined by a straight line, a transformation curve and an indifference curve. These three curves do
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not have a single unique tangency point. Rather, the horizontal co-ordinate of the tangency between the transformation curve and the indifference curve is labeled sbarf. And the horizontal co-ordinate of the tangency between the transformation curve and the line is labeled dbarf. This is the only labeling that appears along the axes in this diagram. The curves are totally unlabeled as well. Immediately following is a diagram with “pf /pg” measured along the vertical axis, no label on the horizontal. A downward sloping line is labeled dbarf. An upward sloping line is labeled sbarf. To the right of the diagram is the phrase, “solution values for each real wage.”}} {Arrow from profit line equation above to the following:} This identity must be satisfied in our very simple model. But whenever there is not complete parametric pricing or all kinds of other complications, it won’t be satisfied. {Diagram with appropriate downward (df) and upward sloping (sf) lines. Vertical axis labeled pf /pg; horizontal axis unlabeled.} solution values for each real wage Once we introduce two households, uniqueness goes out the window. February 1 (xbarg xbarf) are solution values of excess demand functions for goods and factors. jth firm or household xbargj ⬅ gj(pf /pg) – sbarg (r)
r pf /pg
xbarfj ⬅ fj(r) – sbarf (r) Pgxbargj Pfxbarfj ⬅ 0 Say’s Principle Def: xi ⬅ xbarij (for j 1 to m) I gf Prices factored out Pgjxbarg Pfjxbarfj ⬅ PgXg PfXf ⬅ 0 Walras’ Identity Say’s Identity
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This is only valid when circled stuff is valid. There must be parametric pricing, and every individual must have a general type budget constraint for parametric pricing. Walras’ Law does not rule out begging, borrowing, unilateral transfers. This is due to some other theorem that says that in a closed set of transactions value value. February 6 What we’ve done: a simple model of a group of transactors who plan behavior both on household and business account and communicate preferences to a market authority. We wind up with demand functions homogeneous of degree 0 in absolute prices. This is not inevitable. If we had written: U U(dg, sf, pf, pg) S.T. pgdg – pfsf – 0 g g(pf, pg) We must make certain more explicit assumptions about prices in the U function to get them to cancel out (i.e., pf /pg). Classical economists never said long run demand is homogeneous of 0 in relative prices. Only in money prices. They are independent of quantity of money held by individuals since in the long run, money balances are a variable and not parameter. Patinkin works with short-period adjustment so gets different results. We get these simple demand and supply functions. Assuming parametric prices, we can infer excess demand for one good from knowledge of relative prices and excess supply of the other. (1) Xf (pf /pg) 0 excess demand for factors is function of relative prices (2) Xg(pf /pg) 0 PgXg PfXf ⬅ 0 We can’t operate independently on (1) and (2). We don’t need to, since when one is satisfied the other must be. Pf and Pg can’t be determined independently. And no one cares what these absolute prices are. We set Pg at some arbitrary constant. {{Diagram with “r pf /pg” measured on the vertical axis, sf and df measured on the horizontal. An upward sloping line is labeled sf, a downward sloping one df. The vertical co-ordinate of the intersection point of the two lines is labeled rbar. A horizontal dashed line is drawn below the intersection point. Its vertical co-ordinate is labeled r0.}}
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If market authority can find rbar to satisfy (1), (2) must be satisfied, so need only work in the labor market. The market authority announces price r0, and his computer immediately calculates excess demand. If this value " 0, he tells people not to trade. We want a rule to give the market authority. Let him change r by some const[and] " 0 x excess demand [[i.e., multiplying by excess demand}}. So rt xft [ is in the same units as x]. If 1, you will have explosive oscillations. If 1 you converge We’re still dealing with a VIRTUAL PROCESS. NO TRADE. We can write pi fi(xi) OR pi fix (x1 … xn1) The trouble with the second formulation is that even if xi 0, if any xj 0, price keeps changing (though there is no excess demand in that market). This objection dissolves if the market authority is solving the system simultaneously. But it stands if he is working market by market. (There is some literature on this: Klein, Fellner, Brunner—about 1949–1950) The literature is a bit odd. In the same book one finds markets constantly clearing and then not clearing. Klein suggested (Keynesian Revolution) that in Keynesian unemployment situation demand predominates. This does satisfy Keynesian definition of {{Diagram, unlabelled, with downward and upward sloping curves. A horizontal line is drawn above the intersection point eastward from the vertical axis. Where it intersects the downward sloping line, a vertical line drops down to the horizontal axis.}} involuntary unemployment since Qs Qd both increase over current Qs Qd when real wage rate falls. The trouble with this is that any point in diagram is admissible with this. Since if you were in equilibrium at that point, and parameters shifted, you’d continue there awhile, then move to less of either Qs or Qd at that price. {Diagram with Cm measured on vertical axis and sg on horizontal axis. A positively sloping curve, increasing at an increasing rate, labeled Cm begins at the vertical axis above the origin. A dashed horizontal line travels eastward from a point on the vertical axis labeled pg0. Where it intersects the Cm curve
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a vertical dashed line drops down to the horizontal axis to a point labeled sg0. Below the dashed horizontal line from pg0 is another one from a point on the vertical axis, pg1. Where this dashed line intersects the Cm curve, a vertical dashed line drops down to the horizontal axis to a point labeled sg1. To the right of the diagram is the designation, “pf is constant.”} respectively; with rising Cm curve.
Pf is constant.
When pg falls from 0 to 1, how do you get from sg0 to sg1. Perhaps by an adjustment process proportional to in equilibrium value. sgt [sbargt – sbargt] Normally we assume the adjustment processes don’t come in, or else we converge very rapidly to a point on at least one of the curves. (The lesser value.) So what is relevant is just: {Diagram of intersecting upward and downward sloping, unlabelled lines. They are solid lines to left of intersection point and dashed to the right of it.} Solid lines. In examining Keynesian econ{omics] and actual world data, these problems of adjustment are very important. Another problem is one of aggregation. To state that stability is implied by certain characteristics inherent in the market is quite foolish. Let’s now make the businesses sector autonomous to system. (Like Patinkin’s manna from heaven.) Could look at it as labor supply is a parameter. {{A diagram used to analyze the case discussed at that point, of a two household-two good economy. The two households are A and B. The two goods are 1 and 2. Each household has an indifference map with its demand for and supply of good 1, on the horizontal axis, and its demand for and supply of good 2 on the vertical. B’s indifference map is turned 180 degrees with its origin set kiddy-korner from A’s origin. So the lower left origin is labeled OA. The upper right corner of the diagram is labeled OB. Measured along the bottom vertical axis are the variables d1A and s1A. Measured along the left hand vertical axis are the variables d2A and s2A. Measured (from right to left) along the top vertical axis are the variables d1B and s1B (although those labels were left out of the diagram). Measured (from top to
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bottom) along the right hand vertical axis are the variables d2B and s2B. One of A’s indifference curves is shown intersecting one of B’s indifference curves in two places. The space between these two intersection points is the trading set, or eye, that Clower refers to in the notes to the lecture. (I am not sure whether the unlabeled upward sloping, increasing at a decreasing rate, curve is the contract curve—the usual object of analysis with this kind of apparatus.)}} This is a single transactor; A and another B. 2 consumption goods. In the economy there are certain sources of services. These are now assumed untradable. Only services can be traded. We could bring in the market authority and he begins picking price ratios at random and receiving bids and offers. If a price ratio line does not go thru the trading set, the two individuals will want to move in opposite directions and there is no possibility of trade. There will be excess demand for one of the goods and the market authority behaves accordingly. Once the price line passes through the trading set, trade is possible. Suppose market authority says go ahead and trade (rather than waiting for excess demands for the 2 goods is 0). Then short side of market predominates. We get inside the trading set but not to contract curve. Now having traded, they receive the same initial endowment as last time. This time the market authority has information of what price ratio led to some trade. He modifies this ratio a little and we get some more trading. Then a new period and ultimately we get to contract curve. You’ve got to get the two price consumption curves coinciding with the contract curve at the price line. This happens only with an auctioneer. Now let people trade sources only. Then, now after trade, there is a credit of initial stocks. These keep altering with trade. You keep reducing the size of the eye. And in the limit it is a point on contract curve. And where you wind up depends on exact sequence you follow. You get a change in price reaction curves each period. When both are traded, final position will be like 1st case. Will be independent of initial stocks and path to equilibrium. In second case, expected prices are relevant. February 8 1. Do some textbook and other literature on alternative concepts of equilibrium and stability. Check math and physics literature. Write an essay on it. For Vacation get Ian Fleming’s Chitty-Chitty Bang-Bang.
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Since we’re working in discrete time, we’re working with stocks. Assume one individual, with initial endowments of goods 1 and 2, s1 and S2. s1 is a supply of wheat or LSD pills. S2 is a Picasso. The final aim of both the consumption good and the asset are satisfaction. We don’t consume to accumulate assets. {{He is using lower case s for supply of a flow variable and upper case S for supply of a stock variable.}} {{Diagram with a downward sloping line running from vertical to horizontal axis. A particular point is denoted on that line. Its vertical co-ordinate is labeled sw. Its horizontal co-ordinate is labeled Sp. These magnitudes, denoted with an underscore, are initial values of these variables. The variables themselves would be indicated further along the respective axes without the underscores.}} Some of the wheat could be sold and used to buy more Picassos. Or he could think of giving some of the Picassos permanently in order to consume more wheat this period. The rate of exchange of the TWO STOCKS is the usual budget line. At the end of the period you have a demand for stocks of Picassos and for flows of wheat per unit of time. Pw(dw – sw) Ppv(Dp – Sp) 0 This is for continuous time, we need the v (which will be indistinguishable empirically from Dp; so always set v 1) [D S stocks d-s flows] i.e., Spt1 – Spt vDpt – Spt
Can’t look at either of these individually.
{{Note: The term vDpt is circled and an arrow runs from that circle to the text “Can’t look …}} We could write Ut U(d1t…dnt, s1t…snt, D1t…Dnt, S1t…Snt) {beneath each of the four sequences in the equation above are the following in very small print} amounts of consumption amounts of services desired holdings of stocks of assets (Bonds). Satisfaction you expect to receive in the future from holding these in the present. Proxies for all future time. (Close to Fisher’s analysis.) Stocks held. We could put anything in the utility function. Marshall’s tradition is very rich. (Usually leave stocks out – for this would always change the preference map.)
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Marshall’s time eschews dynamics. On the South side they use comparative statics. One problem of not putting income expectations into utility function. Individual has income (1) from trust fund’s holding of bonds and (2) from his own holdings. A transfer from trust fund to his own account will reduce his consumption. If you give, rather, give part of his own portfolio to a robber, his consumption is in long-run unchanged. The problem is that future income variables are all identically zero in the budget constraint and shouldn’t be. Point of all this is that anything crazy can be in the utility function. What is important is the budget constraint on behavior and this is what is to be analyzed. (Future prices and incomes enter in – see Debreu; Theory of Value.) The single LaGrangian equation to be maximized shows you what’s happening. Back to model: what is being chosen is rate of demand for wheat and Demand for Picassos (at end of period whereas sw and Sp are at beginning). U(dwt, Dpt) subject to: Pw(dw – sw Pp(Dp – Sp) 0 What you’re really choosing is Spt1 We assume indifference curves with the usual properties. With usual maximizing procedure you find desired Dbarp and dbarw. Suppose Dbarp Sp and dbarw sw, then at the end of period he converts a flow amount, sw – dbarw on income account into an asset on capital account, Dbarp – Sp. Now vary Sp keeping sw constant and prices constant and find locus of tangencies: DECISION LOCUS. The income locus is horizontal at sw. {{Diagram in which sw and dw are being measured on the vertical axis and Sp and Dp on the horizontal (though those labels don’t explicitly appear). A horizontal line is drawn from the vertical axis at a height of sw. An upward sloping line is labeled “decision locus.” A downward sloping line, the highest value of which is sw, is labeled “budget line.” The horizontal co-ordinate of the budget line with the horizontal line is labeled Sp. The horizontal co-ordinate of the of the intersection point of budget line and decision locus is labeled Dbar0p.}} Income locus (could rise if your asset yielded income) Next time Sp Dbarpt—means new budget line—[The change in wealth could be called his MARGINAL PROPENSITY TO CONSUME WEALTH.] so process is repeated and we move up along the Decision Locus. Final equilibrium he
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consumes all income and has certain stocks of Picassos. Important: He determines his wealth by wealth—income relation. Slope of Decision Locus MPC/(1 – MPC) ⬅ decision locus up to right means MPC is between 0 and 1. Suppose: {{Diagram with unlabeled vertical axis. Horizontal axis labeled “Bonds.” Upward sloping line out of the origin is labeled “Income.” Above this line upward sloping curve, 3 at decreasing rate, is labeled “D.” Where the D curve ends the co-ordinate of the horizontal axis is labeled Bbart (as best as I can read that superscript in the Xerox). A sawtooth pattern of movement is illustrated between the Income line and the D curve. I believe it’s supposed to show an individual starting with Bbart. Each period she uses up some of her bonds so the pattern of movement is to be read as leftward and up from the income line to a point on D, then a vertical drop to the income line. This pattern repeats until she’s back at the origin. As Clower said, “wind up with 0 income and 0 wealth.”}} If D intersected origin and ran always below income locus, one would accumulate endlessly. {{Diagram with origin at the center of the horizontal axis. Points to the right of it represent positive net worth, points to the left negative. A set of upward sloping lines are drawn each labeled Y and given a (different) number. Higher lines have higher numbers. A curve begins at the origin, first moves up to right but at a certain point as it continues rising it curves back to the left eventually moving into negative net worth territory. Since the numbers shown for the first three Y lines (the only ones shown) are 18, 24, 34, and the D curve is firmly in positive net worth territory as it goes through these lines, crossing the 0 net world vertical line running up from the origin two Y lines above the one labeled 34, it’s reasonable to suppose that those numbers represent a person’s age and that this diagram shows a life-cycle pattern of accumulating and then de-accumulating wealth.}} February 13, 1946 Can think of [CiECj] x {Matrix inserted with x diagonal unit, c1–cn on the upper and left borders, all other cells left blank.} {In a left margin bracketed note to the following is:} Reflexive
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February 13 Ci can be exchanged for Cj the diagonal will always be filled in. E is a symmetric relation: CiECj CjECi and reflexive CiECi Also require that E is transitive. This means there is an x in every row and column of the matrix. In a barter economy any good can be traded directly for any other. There are n! markets occurring simultaneously. With a money economy the diagonal remains. One good can be traded directly for all other commodities. Exchange relation is symmetric and reflexive BUT NOT TRANSITIVE. {A 4;4 matrix with C1–C4 labels on rows and columns and x occupying the first row, column and diagonal. To the right is the following:} C3EC1 C1EC4 {Does not imply symbol used here} C3EC4 Think of them as labor, money, and X. Can trade labor for money and money for X, but can’t trade labor for X. In the 2 commodity case you necessarily have transitivity satisfied. For a monetary economy at {strike through of “least”} 2 commodities are not money. {{Probably meant to strike through “at” also.}} C1
C2
C3
C1
x
x
x
C2
x
x
0
C3
x
0
x
With four commodities C1
C2
C3
C4
C1
x
x
x
x
C2
x
x
0
?
C3
x
0
x
x
C4
x
?
x
x
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{The lower right-corner 2;2 matrix is circled with an arrow pointing to the following note:} Barter subset in a money economy. Blocked currencies, etc. Trade credit. For a barter economy budget constant PiXi 0 {for I 1 to n} In a money economy the budget constraint must somehow preclude transitivity: Pidi {i 1 to r} Pksk {k 1 to p}and Pisi {i r 1 to n} Pldl {l 1 to p} [demand [supply of [supply of [demand for goods] money] labor] for money income] With a barter subset there would be more restraints relating products to permissible means of payments, and a series of equations embodying this. Last model with 2 individuals Q (S,D) q (s,d) {{This diagram uses the same device as an earlier one: The diagram for individual B is turned 180 degrees with its origin situated kiddy-korner from the origin of the diagram for individual A. There are two goods, Q and q. This time the axes meet each other, as in the standard exposition of the Edgeworth Box because he assumes a fixed amount of the two goods. An upward sloping curve, first rising at a decreasing rate, then increasing, runs from A’s origin to B’s. This is the contract curve. A steeply negatively sloped line is the “initial price ratio” which goes through A’s and B’s initial endowments of Q and q.}} Horizontal length is S0, there is the income line as before Steep line is initial price ratio. Ath individual and Bth individual both want to unload stocks at these terms of trade. Price line pivots thru endowment until its tangent to both ICs on contract curve. A gets more stock. Sacrifice income. B gives up stock, gets more income. Now in next period income line m is same as before, but the division of the stock is as at the end of first period. If the equilibrium exchange rate of last period begins, this period, it won’t be equilibrium because of the wealth effect of A having more stock and B having less. So price will change.
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The process continues until we get to where contract curve intersects income locus. In effect at this point, A’s and B’s DECISION LOCI must intersect. This kind of thing, without tech progress and without pathological preferences makes stationary state inevitable. DECISION LOCUS EVERYWHERE BELOW income locus would be pushed above it, since the excess demand would change prices. {In top margin: Wicksteed, Common Sense of Political Economy} {{Ladenson: The reference to Wicksteed is there because Bob mentioned it, though its connection to the subject matter of that lecture is not obvious.}} Think of a stock-flow model: {Diagram with pi measured on vertical axis and Di and Si on horizontal. A downward sloping curve is labeled D(D→ S→ ). A vertical line labeled Si rises from a seemingly arbitrarily chosen point on the horizontal axis. To the right of that line a point is denoted on the D curve. Its horizontal co-ordinate is labeled Di*. The distance between it and the horizontal co-ordinate of the vertical Si line is denoted “Zi-Holder Excess Demand.”} (The vertical co-ordinate of the point denoted on the D curve is labeled pi*t). You can have market excess demand 0, with neither the stock market nor the flow market in equilibrium, if excess supply in stock just offsets excess demand in flow. But in next period stock is reduced. This shifts all the functions. Now at old equilibrium price there is positive market excess demand. Convergence to equilibrium in both markets, price and S adjusting. In equilibrium Si is constant over time. Since market excess demand 0 and stock excess demand 0, flow excess demand must 0. Clower’s 1954 AER article talks about this. February 20 {{Ladenson: The algebra at the top of the first two pages of notes from Bob’s lecture of February 20 probably represents my preliminary attempt to deal with the challenge he throws out at the beginning of that lecture: “Try to prove that a per unit tax.” And in fact the unlined piece of paper with nothing but algebra that precedes the first page of notes from the February 20 lecture shows that I was able to meet that challenge. So all that algebra—at the top of those two pages, and everything that’s on the piece of paper that precedes the first page of notes from the February 20
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lecture—, and the first diagram at the top of the second of the two pages with algebra in the top margin, should be deleted.}} Digression: for upward sloping demand and supply curves at any point, extend the tangent backward. If it intersects Y axis above 0, its elastic, if below 0 inelastic. BUT whenever the dependent variable is on vertical and independent on horizontal, these relations are reversed. So BEWARE! if you apply this to, say, the laws of returns. Try to prove that a per unit tax that raises the most revenue of the state occurs when the linear supply curve shifts up to halfway between the intercept of the linear supply and demand curves. (Lipsey). The fact that stocks are dependent variable in long run implies that people who own income-earning assets determine their income levels in the long run. (So in long run utility function Y is not a parameter – same thing can be said about distribution of Y and wealth.) This is determined by preferences, attitudes to holding, borrowing, and lending. Most u-d-a would be well advised to tax and invest in government bonds. {{Three diagrams side-by-side: Left: p and Q measured on vertical and horizontal axes respectively; Middle: p and q measured on vertical and horizontal axes respectively; Right: p and X measured on vertical and horizontal axes respectively and negative values of X allowed for. The left diagram has downward sloping curve labeled D(p*); middle has downward sloping curve labeled d(pbar); right has unlabeled downward sloping curve. The left diagram has vertical supply curve labeled S0; middle has upward sloping supply curve labeled s(pbar, xbar); right has no supply curve but the vertical axis rises from the origin. A seemingly arbitrarily chosen initial value of p, p0, is shown on the vertical axis of the left diagram. A dashed line runs east from that point straight across all three diagrams. In the left diagram, the horizontal distance between the S0 vertical line and the intersection point of the dashed line with the D curve is denoted by a label that has been erased, but, judging by the labeling of a point on the horizontal axis of the origin diagram, should have been labeled Z. The dashed line at the height p0 extends into the middle diagram. The distance between the horizontal co-ordinates
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of the s and d curves at that height is denoted by z. The dashed line at the height p0 continues to extend into the right diagram. The horizontal co-ordinate of its intersection with the unlabeled downward sloping curve is labeled “Z z).”}} If there were larger stock it would be like pushing Y-axis of 3rd graph to right. Since Z z 0, price rises. Also notice that since z (excess flow demand) 0, stocks are being run down which means that at same time price is rising, market excess demand curve is shifting to left. Assume: .
p x(p,S); Sdot z(p) behavior of stock a function of excess flow demand. Trading equilibrium: You can start with arbitrary stock, and find that that alone makes market excess demand 0. Satisfies pdot requirement but not Sdot. {Typesetting capacity has not permitted the creation of characters phat (a p with a ^ symbol over it) nor capital S with a dot or a bar over it.} Sbar and p苶 satisfy the 2 conditions. What are stability conditions. You’d always move counter-clockwise. But it may circle indefinitely or it may circle in toward equilibrium or may spiral out. Multiple-market stability must be put in terms of a conceptual experiment. {{Diagram with S measured on vertical axis, p on horizontal. No lines or curves in this diagram, only two points, E and B, at same height. The vertical co-ordinate of both points is Sbar. The horizontal co-ordinate of E is pbar; that of B is unlabeled.}} Excess demand curve is only thing known to market authority Hicksian argument ignores true dynamics. Inferior good has positive excess demand function and market authority must follow opposite from usual rule. Hicks’ pseudo-dynamics consists in saying market authority simply chooses p so that x(p) 0. Imagine individuals who think and try to guess the market authority’s pattern of pricing, and play a game with him. They announce false quantities. {{Two diagrams side-by-side. The vertical and horizontal axes of the left one measure, respectively, p1 and q1. The vertical and horizontal axes of the right one measure, respectively, p2 and q2. The left diagram has an upward
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sloping curve labeled s and a downward sloping curve labeled d(P20). The right diagram has only a downward sloping curve labeled d2(P10). In view of this, and of the equations given immediately below the diagrams, I believe that he probably labeled the downward sloping curve in the left diagram d1(P20), and that I just missed that first subscript.}} d1 d1(p1, p2) s1 s1(p1)
d2 d2(p2)
x1 ⬅ d1 – s1 x1(p1, p2) x2 ⬅ d2 – s2 x1(p1, p2) Note there are NO RULES FOR NON-LINEAR EQUATIONS. Not true that more variables than non-linear equations is necessarily overdetermined. Start with arbitrary value of p1. Take appropriate demand curve for second good and find p2 that makes x2 0. Use the p2 to find appropriate demand curve for first good, and find p1 that makes x1 0. Iterate. Solution values of p1 and p2 can be found by solving {arrow indicating the to equations above}. Could graph: {{Diagram with P2 measured on vertical axis and P1 on horizontal. Upward sloping line is labeled “x2 0,” downward sloping line is labeled “x1 0.”}} Use the cobweb to converge. February 21 x1 x1(p1, p2) x2 x2(p1, p2)
We want p1 and p2 to satisfy both x1 0 and x2 0
Note that in 2 commodity case since p1x1 p2x2 ⬅ 0. By Walras’ Law any p1 and p2 that make x1 0, must make x2 0, so in the graph above, the 2 lines are coincident. Upward sloping thru origin with slope p1/p2. BUT in 2 commodity case this isn’t true. Can normalize on any good we want; i.e., make acounting price of arbitrary numéraire good 1. In a system where we make p3 1 we can draw: {{Diagram with P2 measured on vertical axis and P1 on horizontal. There are two positively sloped curves. The one labeled “x2 0” first increases at an increasing, then at a decreasing rate. The one labeled “x1 0,” first above—then
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below the “x2 0” curve, increases at a decreasing rate. Where the “x2 0” curve is above the “x1 0” curve, the area between them is crosshatched. This is what is referred to just below in the notes as the “x’ed quadrant.” Alexander Gray, The Development of Economic Doctrine {1931} The Socialist Tradition from Moses to (?) [1946] x3 0 must intersect where other 2 but what else. All points to left of x1 0 are ones where x1 0 All points below x2 0 are ones where x2 0. So in x’ed quadrant there is excess demand for both. There must be x3 0. So the x3 0 line cannot be in x’ed quadrant or in its kitty-korner. xbari/ pj 0, Gross Substitution. Dji/D Xij 0 there is net substitution. If the goods satisfy this, then substitution effect alone leads to conclusion that goods are “net substitutes.” {{The notation “see Hicks’ appendix” probably is associated with this statement.}} {Diagram with no labels on axes. A straight line out of the origin is labeled “Decision Locus.” A straight-line wit positive intercept is labeled “Income Locus-Income Consumption Curve.” An initial level of income, y0, is indicated on the vertical axis. A dashed line runs east to the Income Locus. At that point a dashed vertical line droops down to the horizontal axis where the co-ordinate is labeled B0.} The diagram shows the step-by-step process of accumulating bonds described in the two sentences just below it: at the intersection point of the horizontal dashed line at the height y0, with the Income Locus, a negatively sloped line moves down and rightward to a point on the Decision Locus. The vertical co-ordinate of that point is labeled B1; a dashed vertical line runs up from that point to the Income Locus. At the intersection point of those two lines the horizontal co-ordinate is y1. From that intersection point, a negatively sloped line moves down and rightward to a point on the Decision Locus. This process repeats itself until the rightward movement gets to the intersection point of the Decision Locus and the Income Locus. The vertical coordinate of that intersection point is Bhat; the horizontal co-ordinate is “yhat chat.” At equilibrium he consumes all income. Before then he allocates some of his income to getting more bonds. If the income curve shifts up in known way with time, then at t approaching infinity you get ct /yt a/(a g) here a is MPC wealth and g is rate of growth of upward shift in y locus.
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Moral: when you observe empirical regularities these should not be explained by behavioral relations, which require very precise special case assumptions. Look for general stability conditions. Note about Correspondence Principle—the dynamical assumption is never sufficient to get comparative statics result, since any comparative static situation is consistent with an infinity of dynamical assumptions (e.g., Cobweb vs. instantaneous adjustment). Also if you work with slightly more complicated models, assuming dynamic stability will not give information about comparative statics results. February 27 Samuelson has had second thoughts on the correspondence principle. In dynamics, speeds of adjustment are crucial and these just aren’t involved in comparative statics. .
pi 0 for all i is what you want in comparative statics. The real condition is that xi 0. Imposing stability conditions generally tells you nothing about xi. Assume with Patinkin that excess demand functions are not homogeneous of 0 only in money prices in a money economy but are so in a barter economy. Is this a valid ground for distinguishing between a barter and a money economy? There’s no difference, you’ve ruled out money trades in a barter economy and the money prices become merely accounting prices, whereas they are NOT merely accounting prices when money is traded. There is always homogeneity of 0 in accounting prices if people don’t suffer from accounting price illusion: Barter: Max U(X…Xn) s.t. pixi 0 xbari xbari (p1/pn … pn1/pn) homo of 0 Now take the nth good out of the economy: s.t. pIxI xn 0 (for I 1 to n)
ri pi/pn
xbari xbari (r1 , … rn1, 1) non homo of 0
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BUT if xn ⬅ 0. Then only the is relevant, and the excess demand function is homo of 0. If you eliminate a good from trade, express all prices in terms of its price, then all excess demand functions are homogeneous of 0 in these prices. These become accounting prices. So we really have a barter model in all of these. It doesn’t become a money economy by sticking in a product M that is traded. What Patinkin has done implicitly is to turn the numéraire in a “money” economy into a unit of account in a barter economy. Doesn’t change the structure of the model. The structure is that of a barter economy in both cases. In Patinkin’s model, no lending and borrowing. Money is only store of value. Manna not consumed at end of period is taken away. Money is traded and is a numéraire. {{Diagram with “Cms” (presumably “commodities”) measured on vertical axis, M/p on horizontal. Downward-sloping budget line runs from horizontal to vertical axis. One point, tangent to an indifference curve, is denoted on that budget line. The vertical co-ordinate of that point is denoted m. The horizontal co-ordinate is denoted M/p.}} Imagine a world where you’re paid in Green Stamps and you can redeem either in Federal Reserve Notes or in commodities. m quantity of green stamps P is money price of green stamps, so M/p give quantity green stamps, M will buy. The individual has m M/p pm M. at beginning of period. Can be spent on pc or held in M. So pm M pc M. i.e., U(C, M/p) Require: pc M – M pm c M/p M/p m C (m/p) m (m/p) {The first r.h.s. term is denoted, in note in margin, as the slope and the remaining two r.h.s. terms are denoted as the intercept.}
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Find tangency of this with indifference curve. You get Cbar Cbar(M/P) Doubling P shifts budget line. These are homogeneous in money prices and stock of money. Now work with set of individuals doing this: depend on real prices, real balances, and real resources (manna) dbarij dbarij (p1/1 … pn/1, M/p, si) where Pm 1 P niPi; identical demand functions to these {An arrow is drawn from the end of the previous statement to the Cbar equation above} si constant xi ⬅ dbari sbari Get an xi for each individual and sum over the j individuals jXbari ⬅ dbari sbari xi xi(p→, M→/p, s→) the first 2 are vectors and last is a matrix Require: ij pixbari ⬅ 0
xi jxbarij
PiXi (mkt) M M 0 i.e., Xm ⬅ M – M
xi(pi→, M/p→, s→) 0 n equations Is there one set of money prices that makes individual plans consistent? Yes. In this model there are commodities but no markets. Suppose one of the manna things is bonds. There is no way distinguishing between (say) liquidity preference and loanable funds, i.e., can’t say r is determined in money market or in bond market. This economy cannot assign a function to money as a means of payment. Hence curious that Patinkin makes motivation for money holding depend on non-synchronization of payments and receipts. This implies a different model. Suppose only one person has positive value of M/P in his utility function. This makes no difference to market demand functions. The one guy winds up with all M. There is no trading of money in economy after first period. Then rel prices
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depend only on other people’s preferences. The one guy is a human Cambridge equation. He determines absolute price level. Latter must be high enough for him to hold all money. MONEY is just irrelevant in a Patinkin model. Suppose you fix the price in money of one of the manna streams (money wage rate) and reduce quantity of money. This reduces quantity demanded of certain goods and leads to decline in prices which are flexible. The {blank} {{Obviously I couldn’t keep up with him.}} {{Diagram with c measured on vertical axis, M/p on horizontal. There is a family of (parallel) downward-sloping budget lines and a family of indifference curves. The vertical co-ordinate of the tangency point between the budget line and indifference curve furthest from the origin is mbar. Its horizontal co-ordinate is M/p0. The vertical co-ordinate of the tangency point between the budget line and indifference curve closest to the origin is m. Its horizontal co-ordinate is erased. At the origin on the horizontal axis, rather than 0, is the label, “(M/p).”}} Start with an individual in equilibrium. Now reduce M. So he’s only able to sell m. If he consumes as before his money balance drop by mbar – m to (M/P1). In the next period he begins at mbar, (M/p), etc. Ultimately he runs out of money, can’t sell labor services, and everyone is left demanding money in exchange for labor when intercept mbar. If someone says, you should work more hours at the going wage, this is like increasing M. You can get back to original equilibrium by changing the s’ in excess demand functions. This is a barter model. Its silly. Leads to theorem that an increase in involuntary unemployment raises P. vi is velocity coefficient {{I squeezed this in above “3/1” but almost definitely wrote it as Bob was writing the constraint which includes vi , just below.}} March 1 Individual Problem (Patinkin): Max: U(x1 … xn; D1 … Dn; M; P1 … Pn) s.t. iPi(xi [flow account] vi{Di – Si} [stock account]) vi(M – M) [demand to hold initial stock of M] 0 (for i 1 to n)
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Note that vi and Di are operationally indistinguishable xi {An overlay character is used that exceeds capability. The three characters stacked atop one another are: , , and } 0 Di {An overlay character is used that exceeds capability. The three characters stacked atop one another are: , , and } 0 Si {An overlay character is used that exceeds capability. The three characters stacked atop one another are: , , and } 0 negative stocks of bonds M0 These conditions mean that solution can’t be gotten La Grangian wise. Is an iterative programming problem to get a solution: excess flow demand function: xbarij xbarij(P1 … Pn; Mj; S→j; vi)
jth individual
set all vi 1 so that vi drop out of this Dbarij Dbarij(P1 … Pn; Mj; S→j; vi) Summing over j, get Walras’ Law: ipi(xi xi*) M – M ⬅ 0 xi* ⬅ (Di – Si) There is presumably Mj S→j * for all j satisfying: ipi(xi xi*) M – M ⬅ 0 xi xi* 0 ( i 1, …, n) The pi’s are money prices This is the structure of Patinkin’s model. Hicks: If we look at functions of money, means of payment is only unique one and only one that’s not adequately handled in general equilibrium analysis.
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True money economy: People are offering to buy and sell products for MONEY ONLY Individual – maximizes: U(x1…xn; D1…Dn; P1…Pn; M, m) s.t. ipi(di di*) Mm – M ⬅ 0 xi di if xi 0 si if xi 0
xi* di* if xi* 0 si* if xi* 0
xi* net investment demand di* demand to add to inventory si* supply out of inventory Planned purchases and sales of money are equal also s.t. ipi(si – si*) m → (sales receipts) m is income. and to di, si, di*, si*, m, M 0 di, si ⬅ 0 di*, si* ⬅ 0 [mXm* {Complex symbol used that overlays/with ⬅} 0] [dm*sm* {Complex symbol used that overlays/with ⬅} 0] M – M0 Problems of solution are worse than before. Playing around with constraints gives a form of Walras’ Law: iPi(Xi Xi*) [M m – M] ⬅ 0 Important thing is that this is derived both from a precautionary and a transactions demand for money and iPidi ⬅ M – M
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This model gives pretty much the same results as the Patinkin. The relation xbari/ pj ⬅ xbarj/ pi of the earlier model, usually won’t hold in the money economy. The Walrasian appeals usually; but Friedman makes such good sense on policy, seemingly. In this latest model money matters. (Look at version of Walras’ Law). When money increases, prices fall. Immediate impact on market conditions. Real scope for financial disorganization.
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MARK LADENSON’S NOTES FROM FRANK WHITSON FETTER’S COURSE ON MONETARY INSTITUTIONS AND POLICIES, ECONOMICS D-31-0, NORTHWESTERN UNIVERSITY, FALL 1966 Edited by Warren J. Samuels and Marianne Johnson with the Assistance of Mark Ladenson
FRANK WHITSON FETTER: A BRIEF BIOGRAPHY Frank Fetter was born in 1899 and died in 1991. Educated at Swarthmore, Harvard and Princeton (PhD, 1926) he taught at Princeton (1924–1934), Haverford (1934–1948) and Northwestern (1948–1967). He was a member of the executive committee of the American Economic Association; a Director and Chairman of the National Bureau of Economic Research; and on the staff of the Kemmerer Commission of Financial Advisers to Government, working in Chile, Bolivia, Ecuador, Poland and China. He later worked with Lend-Lease and the Department of State. Fetter was a distinguished fellow of the History of
Further Documents from the History of Economic Thought Research in the History of Economic Thought and Methodology, Volume 25-C, 41–81 © 2007 Published by Elsevier Ltd. ISSN: 0743-4154/doi: 10.1016/S0743-4154(06 )25025-9
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Economics Society. His principal and most celebrated publications are in the history of economic thought. He is best known for his books, Development of British Monetary Orthodoxy (1965) and The Economist in Parliament (1980), several articles on the authorship of economics articles in early nineteenth-century British journals, and writings on the English Classical School and on topics in monetary and financial thought and policy. His father, Frank Albert Fetter (1863–1949), was a leading economic theorist. The collection of economists’ portraits at Duke University was largely the senior Fetter’s, who gave it to his son, who, in turn, gave it to Warren J. Samuels, in whose name the collection is kept, though it more properly should have the Fetter name. In an oral history interview Fetter illustrated his tact and sense of perspective. In China on a Kemmerer Commission financial mission during 1929, Fetter gained an “impression:” “… as I look back on it, Chiang missed a great opportunity. Nominally he had a unified China, probably on paper a China more unified than it had been for centuries. Although we didn’t have proof at the time, I think we rather sensed the way in which his wife’s relatives were simply looting the country. In retrospect, if there’s any causality in historical development, the Chinese Communists deserved to win, not in the sense that we’d like them to win, but that in view of the way in which the Chiang government behaved, it would have been very surprising if the Communists or somebody like the Communists hadn’t taken over.” (Oral History Interview with Frank W. Fetter, in Hanover, New Hampshire, July 22, 1974, by Richard D. McKinzie for the Harry S. Truman Library, Independence, Missouri, transcript, pp. 2–3.)
INTRODUCTORY COMMENTS Frank Fetter’s lectures seem to have been constructed by him in such a way as to present to his students an approach to the subject, the deep questions which comprise the field of monetary economics, and an approach to the problems of monetary policy. Fetter’s approach to the subject treats it as mysterious in neither practice nor ontological status. In his very first lecture the notes have him bringing the subject down to earth, culminating in the first recorded statement of the second lecture, “Money a creation of social-life. Doesn’t exist without society.” Thereafter the student is introduced to the perpetual policy issues, the great controversies, and what amounts to problems of control. Instead of presenting some story basically of what “sound money” is all about, Fetter identifies the perennial issues with respect to which policies have meaning. Similarly, since he does not presume a particular desirable policy, he is able to accept policy as a dimension of actual economies. In the final exam given Ladenson’s class, he continues to
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teach, by compelling the student to deal with the network of issues and the benefits and costs associated with alternative goals and policies—ends and means— in the light of theory and history. Fetter was extraordinarily knowledgeable about monetary theory and monetary and financial history and could lecture on either in such a manner as to bring in the other. One important point he makes is that central bank policy is not only a matter of monetary theory but of the responsibility given to the central bank. On the one hand, this implies inevitable discretion even when a policy of rules is adopted. On the other hand, absent legislative stipulation of the responsible target, this illustrates the inevitability of discretion in the form of both the legislative stipulation and the Central Bank determination of conditions triggering whatever the stipulation calls for. Another important and revealing point is recorded thus in the notes: “In Monetary Theory before 1914 there is very little about unemployment. People are worried about financial panics. People go broke and unemployment is subordinate.” The clear implication is that the conduct of monetary policy, and the development of monetary theory, is a matter of class. To say that “People go broke and unemployment is subordinate” is to reflect the mindset of a class more concerned about its wealth position than about unemployment, which, it would seem, is a basis for worry by those without wealth, those who rely on jobs. {Ladenson: The implication about class that you draw from the statement you transcribe about monetary theory not dealing much with unemployment before 1914 gives me pause. [para.] First, although your transcription is accurate, the statement appears by itself as an isolated thought at the end of a lecture. And, of course, it’s my hurried (?) rendering of Fetter’s exact words, which are unknowable. I hope it’s clear from those notes that Fetter did not come across as any kind of an ideologue, obsessed with notions of class. [para.] Second, in your final sentence in that paragraph, you are attributing to the developers of pre-1914 monetary theory—and not directly to anyone else—“the mindset of a class more concerned about its wealth position than about unemployment, which, it would seem, is a basis for worry by those without wealth, those who rely on jobs.” May I respectfully suggest that an alternative interpretation, as I understand the history of economic theory, is that the study of business cycles—booms, depressions—was regarded as a separate sub-discipline from money and banking analysis. Banking panics were a recurring feature of economic life—with probable effects on the real economy, but regarded as a distinct phenomenon. Just a different area of study. My vague sense is that there was an interest in trying to explain business cycles, but most authors sought these explanations in disturbances originating in the real, not monetary\sector.} N.B. For commentary in regard to the amended text of this paragraph, from “Another important and revealing point” to the point just prior to this sentence, see the
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addendum to this Introduction, below. I add here only that I fully concur with Ladenson that Fetter was no ideologue obsessed with notions of class. Interestingly, Fetter is recorded as calling attention to the ability of commercial banks to create money by creating the money they lend, in the form of demand deposits, so that borrowers can buy government bonds. The money-creating process, in the form of demand deposits, constitutes “an interest-free loan from the public to the banks.” The implication—drawn by James M. Buchanan and A. Allan Schmid—is that banks should be required to pay for the privilege of creating money, say, by requiring them to hold non-interest-bearing bonds as reserves. {Ladenson: Regarding the point about holders of demand deposits making an interest-free loan to banks, one can of course refer to Buchanan and Schmid’s proposal. But, in addition one can note that with the passage of the Depository Institutions Deregulation and Monetary Control Act of 1980, banks were authorized to pay explicit interest on, if not traditional demand deposits, functionally equivalent checkable deposits (as they had been prevented from doing since 1933 by Regulation Q). And until the surreally low (nominal) interest rate regime of the first four years of this millennium, banks and other depository institutions did pay substantial interest on checkable depositions in the last 20 years of the last century.} From the lecture of 31 October, Ladenson reports What is the basis of preferring rising rages and stable prices to stable wages and falling prices when we get technological progress? Up to 1930 emphasis on monetary policy was question of distribution but since Keynes, monetary policy more on how to maximize production.
This position underscores three points: that the conflict over inflation versus unemployment is more complicated than was discussed during the Post-War period; that maximizing production, insofar as it involes maximizing employment, has distributional implications; and that distributional consequences were central to the policy world of the governing and ruling classes and not something introduced by radical writers. In his lecture on 7 November, Fetter is said to have argued the following: Original concept of Fed had nothing to do with maintaining Nf [full employment] and growth. Was to handle panics. In 1920’s idea of price stability through Fed’s actions came to fore. Great Depression removed price stability as goal. Nf.
This statement, plus the one just discussed, and others, indicates how once an institution (here a governmental, or quasi-governmental, certainly a governing, institution) is formed, important aspects of its existence—the theory on which it operates, the goal it pursues—can be changed from within the organization quite independent of the action of the original legislating body.
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Assuming the notes accurately reflect Fetter’s presentation, two further points warrant notice. One is that Fetter, extraordinarily widely read in monetary economics, covers the subject’s material in a manner and on topics different from the Post-World War II discussion centering on both Milton Friedman’s monetarism and the IS-LM approach to macroeconomics. {Ladenson: I assure you that the impression my notes convey of Fetter’s presentation [preceding sentence—WJS] is an accurate one.} Secondly, Fetter seemingly tends to present his subject in a methodologically rich manner. He will discuss the impact of variable A on variable B, or the operation of variable A, and then show that, in both types of cases, the economic meaning of A is also dependent on variable C. When someone points to the limits of a theory, it is the impact of variables such as C that identifies one of those limits. Fetter certainly shows by implication, by the nature of his presentation, that the Quantity Theory is more complex and open-ended than one would expect. Published below is the Syllabus for Economics D-31, Monetary Institutions and Policies, for the Fall semester 1966–1967; a handout on attitudes toward rules versus discretion in control of the money supply in Great Britain, 1800–1875; the final exam dated four years prior to the course taken by Mark Ladenson (copied in Ladenson’s handwriting) and that taken by Ladenson; and Ladenson’s notes from the course. On the handout, Fetter used “—-” to indicate Discretion and R for Rules. I have changed “—-” to “D.” I am indebted to Mark Ladenson for his careful reading of the first version of the transcription of his notes and the correction of errors, his as well as mine, and possibly Fetter’s. These corrections (except for typographical ones) are placed within braces { } at the appropriate point in either my commentary or Ladenson’s course notes. They were produced in response to my invitation for him to do so.
ADDENDUM On June 26, 2006, I sent the following in an email to a number of scholars in the field of monetary economics (here corrected for typos): Dear colleagues: The material in quotes below comes from my introduction to notes taken by Mark Ladenson in Frank Whitson Fetter’s course on monetary institutions and policies, Fall 1966, at Northwestern, specifically in part from Mark’s response to my commentary on a line in the notes presumably recording Fetter. The issue concerns differential attention to questions of socio-economic class. You folks are in a particularly well-informed position to comment on the issues and picture painted, e.g., the sub-disciplinary division of labor in economics.
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WARREN J. SAMUELS AND MARIANNE JOHNSON I would appreciate your comments on the situation posed in the material given below. Assuming the richness of your replies, I will, one way or another, combine the comment on the replies and publish the result in either the same archival volume as the notes from Fetter’s course or in the next group, appearing in RESEARCH IN THE HISTORY OF ECONOMIC THOUGHT AND METHODOLOGY. I thank you for your cooperation. No limit is placed on length, though I reserve the discretion to have length reflect substance. Thanks.
The material one which I ask you to comment: Another important and revealing point is recorded thus in the notes: “In Monetary Theory before 1914 there is very little about unemployment. People are worried about financial panics. People go broke and unemployment is subordinate.” The clear implication is that the conduct of monetary policy, and the development of monetary theory, is a matter of class. To say that “People go broke and unemployment is subordinate” is to reflect the mindset of a class more concerned about its wealth position than about unemployment, which, it would seem, is a basis for worry by those without wealth, those who rely on jobs. {Ladenson: The implication about class that you draw from the statement you transcribe about monetary theory not dealing much with unemployment before 1914 gives me pause. [para.] First, although your transcription is accurate, the statement appears by itself as an isolated thought at the end of a lecture. And, of course, it’s my hurried (?) rendering of Fetter’s exact words, which are unknowable. I hope it’s clear from those notes that Fetter did not come across as any kind of an ideologue, obsessed with notions of class. [para.] Second, in your final sentence in that paragraph, you are attributing to the developers of pre-1914 monetary theory—and not directly to anyone else—“the mindset of a class more concerned about its wealth position than about unemployment, which, it would seem, is a basis for worry by those without wealth, those who rely on jobs.” May I respectfully suggest that an alternative interpretation, as I understand the history of economic theory, is that the study of business cycles—booms, depressions—was regarded as a separate sub-discipline from money and banking analysis. Banking panics were a recurring feature of economic life—with probable effects on the real economy, but regarded as a distinct phenomenon. Just a different area of study. My vague sense is that there was an interest in trying to explain business cycles, but most authors sought these explanations in disturbances originating in the real, not monetary sector.}
The first response was from David Laidler: It’s a bit more complicated than that. The monetary approach to cycle theory evolved slowly, beginning from discussions of financial crises roughly speaking from 1797 onwards, discovering that they were rather regular events, and then noting that they were part of a broader pattern, which in due course got the label credit cycle. It’s usual to attribute the first systematic description of the cycle to Lord Overstone – (Samuel Jones Loyd) in 1837. It’s true that this credit-cycle tradition – perhaps because bankers had a big role in developing it – emphasised finacial issues rather than real issues in general and unemployment in particular. And it’s also true that in Kapital, Marx cites this attitude as a prime example of the “superificiality of political economy” (see my golden Age of the Quantity theory, p. 20 for the quotation); according to Bernard Corry with tongue only partly in cheek, political economy was Marx’s code name for Nassau Senior, and this would, I think fit.
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Mark Ladenson’s Notes from Frank Whitson Fetter’s Course However, in 1871, Marshall and Marshall beginning from what was essentially a paraphrase of Mill’s monetary account of the cycle, explicitly raised its capacity to generate unemployment, which they attributed to wage stickiness. Thereafter this idea played a pretty prominent part in Cambridge accounts, not least in Pigou’s pre-war HUL book on Unemployment, as well as Wealth and Welfare. The idea also appears in Hawtrey’s “Good and Bad Trade” See my golden Age of the Quantity theory pp. 95 et seq. on these developments. Also, in Denis O’Brien’s edition of Overstone’s papers he reprints a cartoon account of the “Overstone cycle” which he told me he thinks came from the late 1850s, which includes a panel illustrating the trough that shows workers marching with a placard the reads (again from memory) “we have no work” with a factory chimney or two in the background that are conspicuously not emitting smoke, not to mention a view through a doorway where someone – presumably a failed businessman – has killed himself by hanging himself from the rafters. So someone took the real effects of the cycle seriously! But all that being said, the monetary tradition in cycle theory took longer to emphasise unemployment than did the Marx-Schumpeter tradition. Irving Fisher pays no attention to it, for example, till after WWI. After WWI, the influences on Cambridge become complicated to trace, because Robertson started out from Aftalion and Tugan-Baranovski, not Matrshall and Pigou. Hope this helps – and that my memory hasn’t let me down seriously anywhere.
The second response was from Hans-Michael Trautwein on Laidler: David’s memory is very good, as usual and as you can see from the relative “unimportance” of my tiny corrections about the cartoon: The copy of the “Overstone Cycle of Trade” cartoon which I got from Walter Eltis some years ago shows “Stagnation”, at the lowest point of the cycle. There indeed we see workers marching with a placard that reads “We have no work to do”. There are no factory chimneys in the background (they belong to the subsequent “improvement” stage, and they are all smoking), but there is the workhouse (plus the “counting house”, or the like – it is hard to read on my copy). There is indeed someone hanging from the rafters and the figure next to him, with a cylinder hat, seems to be in the act of pointing a gun to his own head. The man with the high hat seems to be the same person that throws up his arms in shock when he sees the “Royal Bubble Bank” exploding in the preceding phase of “convulsion”. So the modern-sounding term “bubble” seems to have been around as early as the 1850s. The cartoon is a beautiful piece that I use as the first diagram in my courses on business cycle theory.
To which Laidler replied: Ah – the fallibility of memory! I used to have the cartoon posted on my office door, when I had an office – but this exchange maybe helps explain why I no longer do! Many thanks Michael!!!!! Cheers
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WARREN J. SAMUELS AND MARIANNE JOHNSON
THE SYLLABUS NORTHWESTERN UNIVERSITY Department of Economics Economics D-31 Monetary Institutions and Policies
Fall 1966–1967 Mr. Fetter
Suggested Readings If you are not already familiar with Gurley, John G. and Shaw, Edward S., Money in a Theory of Finance, it would be well to read Chs. 1 and 7. Even if you are familiar with this book, it would be advisable to review these chapters. Week of September 26 and October 3 Monetary Consequences of Gold and Silver from the New World in the 16th and 17th Centuries Bodin, Jean, “Reply to the Paradoxes of Malestroit,” Monroe, Early Economic Thought, pp. 122–141. Hamilton, E. J. American Treasure and the Price Revolution in Spain. Imports of Gold and Silver, pp. 38–45; Effects on Gold–Silver Ratio, pp. 70–72; Price Revolution in Spain, pp. 186–210; Why Prices Rose, pp. 293–306. Smith, Adam, The Wealth of Nations. Bk. I, Ch. xi, Part III (pp. 177–216 in Cannan ed.). If you feel like it, glance through Bishop Fleetwood’s Chronicum Preciosum, Chs. 1 and 6, as a period piece on the problems of inflation in an earlier setting. Week of October 10 Restriction Period in England and the Bussion Controversy Thornton, Henry, The Paper Credit of Great Britain, Chs. 3–5 and 9. If possible, use the Hayek ed., in which these chapters are on pp. 90–106 and 212–229. You may wish to read Hayek’s introduction, which gives a biographical account of an unusual man, and suggests the theoretical significance of his thinking. Viner, Jacob, Studies in the Theory of International Trade, Ch. 3 (pp. 119–170). Fetter, F. W., Development of British Monetary Orthodoxy, Ch. 2. Week of October 17 Controversy Over Control of Money Creation and the Bank Act of 1844 Gregory, T. E., Introduction to reprint of Tooke and Newmarch, History of Prices. Also available as a separate: No. 16 in London School of Economics, Reprints
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of Scarce Works on Political Economy. (Do not attempt to read every word of this; the part beginning on p. 49 is more important). ………, Select Statutes, Documents and Reports Relative to British Banking, 1832–1928. Vol. I, Introduction, pp. ix–lll; Vol. 1, Evidence of Samuel Jones Lloyd, pp. 27–62; Vol. ii, Petition of 1847 against Bank Act of 1844, pp. 3–7; Vol. ii, Report of Lords Committee of Secrecy of 1848, pp. 36–46. Robbins, Lionel, Robert Torrens and the Evolution of Classical Economics, Ch. VI, “The Theory of Money and Banking,” pp. 97–143. Fetter, F. W., Development of British Monetary Orthodoxy, Ch. 6. Week of October 24 Responsibility of Central Bank as Lender of Last Resort Bagehot, Walter, Lombard Street, in particular Chs. i–iii and vii–viii, although the whole book could be read to advantage. Fetter, F. W., Development on British Monetary Orthodoxy, Ch. 9. Week of October 31 The Question of the Standard and the Bimetallic Controversy Report of the Royal Commission to Inquire into the Recent Changes in the Relative Value of the Precious Metals. [Gold and Silver Commission.] (Preferably in Robey reprint.) Part I, para. 114–199; Part II, para. 103–111; Part III, para. 30–36. Some Aspects of Central Banking Policy after Bagehot R. S. Sayers, Central Banking after Bagehot, Chs. 1–2 and 9–10. Bloomfield, Arthur L., Monetary Policy under the International Gold Standard. Week of November 7 American Monetary and Banking Controversy and the Origins of the Federal Reserve System This will be covered in a lecture, but look at Chandler, Lester V., Benjamin Strong, Central Banker; in particular, Prologue (pp. 1–19) and Ch. VIII. British Experience in the Interwar Period Keynes, J. M., “The Economic Consequences of Mr. Churchill,” in Essays in Persuasion. Sayers, “The Return to Gold,” Studies in the Industrial Revolution (L. S. Pressnell, ed.), pp. 313–327. (In Reserve Room) Macmillan Committee, Report, pp. 2–24, 92–136. Minutes of Evidence. Evidence of D. H. Robertson, pp. 321–347 (Vol. 1).
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Week of November 14 The Collapse of the American Banking System: 1929–1933 Friedman, Milton, and Schwartz, A. J., A Monetary History of the United States, Chs. 1, 7, and 13. Clower, Robert, “Monetary History and Positive Economics,” A review of Friedman and Schwartz, Journal of Economic History, Sept. 1964, pp. 364–380. Week of November 21 Background and Objectives of International Monetary Fund This will be covered in a lecture. The Commission on Money and Credit Week of November 28 The Radcliffe Committee Report, pp. 1–23, 109–188, 224–269; and Minutes of Evidence of Bank of England representatives, in particular Qs. 1–971. Sayers, R. S. “Monetary Thought and Monetary Policy in England,” Economic Journal, December 1960, pp. 710–724. Some Special Problems of Central Banking and Monetary Policy Kaufman, George G., “The Demand for Currency” [Staff Memorandum of the Federal Reserve Bank of Chicago.] Noyes, Guy E., “Statistical Refinement of the Concept of Inflation” [Staff Economic Study of the Board of Governors of the Federal Reserve System.] Jacobsson, Per, International Monetary Problems, 1957–1963 (Sections in this to be read for this week and the following week will be announced later). [Added in ink (ed.): 1–17, 49–66, 310–327] Robertson, Denis A., Memorandum … to the Canadian Royal Commission. Viner, Jacob, Problems of Monetary Control. Country Reports are due November 28. Week of December 5 Machlup, Fritz, Plans for the Reform of the International Monetary System. Machlup, Fritz, and Malkiel, Burton G. (eds.), International Monetary Arrangements Roosa, Robert B., and Hirsch, Fred, Reserves, Reserve Currencies, and Vehicle Currencies; An Argument. “Treasury and Federal Reserve Foreign Exchange Operations,” Federal Reserve Bulletin, September 1966, pp. 1316–1326. (Copies of this will be distributed to the Class in early November.)
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THE HANDOUT ATTITUDES ON RULES VS. DISCRETION IN CONTROL OF MONEY SUPPLY IN GREAT BRITAIN: 1800–1875 Legend: D ⫽ Discretion R ⫽ Rules Real Bills Advocates; Anti-Bullionists; Birmingham School Banking School D R D D D
D R
Currency School R R
D
D
(But acceptance of Bagehot principle in effect imposed rule of “adequate reserves” on Bank of England) D D R
R
(No formal rules, but all accepted, with minor dissent, the self-imposed rules of London banks and London business community against notes of London Banks.) D D
R
D
D
D
D
D
R
D Economics D-31 October 12, 1966 Mr. Fetter
D
Type of Money Monetary Base Bank of England Notes Bank of England Deposits
London Bank Deposits London Bank Notes
Country Bank Notes Country Bank Deposits Scotch Bank Notes
(In principle, but for political reasons Currency School did not press point.) D Scotch Bank Deposits
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WARREN J. SAMUELS AND MARIANNE JOHNSON
THE FINAL EXAMS Fetter final—Dec. 1962 [Handwritten Copy] 1. Discuss what you consider to be the principal objectives of an ideal monetary and banking system. Answer should include analysis of the distinction, sometimes made in economic literature, between price changes due to monetary causes, and price changes due to causes of a non-monetary nature. In this analysis, should cover both: i. the theoretical basis for such a distinction between monetary and nonmonetary causes; and ii. the problems of applying in practice such a distinction between the causes of price changes. 2. The authors of the Act of 1844 apparently saw key to monetary management in control of supply of currency (as distinguished from currency and bank deposits combined); 20th century central banking theory and practice has generally placed the emphasis on controlling the total supply of money; but more recently the Radcliffe Committee stated that the monetary authorities should “regard the structure of interest rates rather than the supply of money as the centre-piece of the monetary mechanism.” Using this development as a frame of reference, discuss the problem, “The Effective Approach to Monetary Control,” bringing in both theoretical analysis and such historical material as you consider relevant. 3. In 1880, there was concern in many quarters as to whether the new gold supplies of the world were sufficient to permit, without “undesirable” economic consequences, the continuance of the gold standard; in the 1920s similar suggestions were made; and in last 5 years many suggestions to same effect have been made. a. Make clear the principal undesirable consequences feared by those who have been concerned about a gold shortage, distinguishing where you think this desirable between the emphasis in the different periods. b. Evaluate—i.e., describe, analyze, and pass judgment on—3 important proposals that have been made in past decade for dealing with this gold problem. FETTER FINAL, DECEMBER 14, 1966 ANSWER ALL QUESTIONS 1. For over a century the principal emphasis in central banking policy has been on controlling, if not the amount of money, at least the amount of banking reserves available to the banking system. More recently, the Radcliffe Report has stressed
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the liquidity position of the banks and the public, rather than the amount of money in the hands of the public or the reserves available to the banking system, as the variable most important to influence. The view of the Report is indicated by this omnibus quotation: “Though we do not regard the supply of money as an unimportant quantity, we view it as only part of the wider structure of liquidity in the economy. … The decision to spend money thus depends upon liquidity in the broad sense, not upon the immediate access to the money. … The authorities have thus to regard the structure of interest rates rather than the supply of money as the centre-piece of the monetary mechanism.”
Discuss the problem “What Should A Central Bank Control?”, supporting your discussion both by analysis and by such historical material as you consider relevant. 2. Predominant opinion as to the primary objectives of a good monetary and banking system has varied from time to time, and from country to country. Among the objectives that have been stressed are: 1. 2. 3. 4. 5. 6.
Maintenance of a fixed price of gold. Stabilizing the price level. Stabilizing the wage level. Eliminating unemployment. Maximizing the rate of growth. Increasing the money supply each year by a fixed percentage.
Discuss the relative importance of these objectives. Insofar as you believe that the most important of these objectives can be achieved only by sacrificing other objectives, explain, bringing in such historical material as you consider relevant, the theoretical or administrative-political reasons why these objectives may be incompatible. 3. In the 1880s, there was concern in many quarters as to whether the new gold supplies of the world were sufficient to permit, without “undesirable” economic consequences, the continuance of the gold standard; in the 1920s similar suggestions were made; and in the past decade many suggestions to the same effect have been made. a. Make clear the principal undesirable consequences feared by those who have been concerned about a gold shortage, distinguishing, where you think this is appropriate, between the emphasis in the different periods. b. Evaluate—that is, describe, analyze, and pass judgment on—three important proposals that have been made in the past decade for dealing with this gold problem.
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MARK LADENSON’S NOTES FROM FRANK WHITSON FETTER’S COURSE ON MONETARY INSTITUTIONS AND POLICIES, ECONOMICS D-31-0, NORTHWESTERN UNIVERSITY, FALL 1966 September 26 People concerned with monetary policy should use the Federal Reserve Bulletin as their first source. Check Princeton: Hirsch and Roosa, Robertson, Viner. Chapters 1 and 7 of Gurley and Shaw should be read. Monroe—Early Economic Thought 123–141 A. Smith—Book I, Chap. 11, Part 3 177–216 in Cannan edition E. Hamilton—American Treasure and the Price Revolution in Spain 32–45, 70–72, 186–210, 292–306 Monetary theory and policy never completely finished since people change what they use for money. Institutions are (1) things you can see, (2) laws, customs, arrangements that are well established and generally unquestioned. Policies are not as hallowed and well-established. They are “courses of action.” Practice—less important details generally—but sometimes are central to policy and even institution (e.g., how do you defend against counterfeiting). Relation between theory and policy less tight than in other areas since (1) new things used as money, not in the theory and (2) money is very emotional thing. September 28 Money a creation of social-life. Doesn’t exist without society. In the history of economic thought up to 1800 one finds a great deal of the writing relating to money. Especially, say, in Italy, where banking had its earliest development, and development of enclaves of trade and industry. Money affects production: (1) because we think that if we can control the amount of money people have we can control the payments they make. Perpetual issues in policy: (1) How much discretion will there be and where does it lie? (2) To what extent does one sector of monetary and banking system control other sectors. Are all parts of the money-creating mechanism parallel or are some dependent on others and to what extent? (Often people who are given discretionary authority are not those actually creating money.)
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(3) To what extent do changes in money supply have price effects. To what extent income and employment effects (obviously depends on state of unemployment at the time). The Great Controversies: (1) Effect of gold and silver from the New World on prices in Europe. (2) Will inflation follow issue of money on sound assets. (3) Bullion controversy—Is it money or other things that matter on relative prices in international trade. (4) Bank Act of 1844 (England) (a) nailed down that issue of hand-to-hand cash is controlled by government; (b) attempted but not nailed down that if you control one part of money supply you control the rest and have effective control. (5) Bagehot principle—somebody in a time of crisis has responsibility of creating an emergency supply of money. (6) Should we have a stability of factor payments or of prices; 1870s–1890s. (7) Fixed vs. fluctuating reserves. (8) Adequacy of international reserves. (9) Should there be attempt to maintain commodity standard. October 3 (1) What is monetary base. (2) Who has authority that can create money over and above the base. (3) Who has imposed by law and tradition the RESPONSIBILITY for preventing chaos. (4) What are methods by which you can create money in excess of the base. Look at these questions with his diagram. Money can be created (1) by increase in monetary base (increase in gold). (2) Central bank exists in most countries and generally has right to create money in relation to base ALTHOUGH it could create base. (3) Commercial banks: 85–90% in most countries of the western world. (4) Government. (5) Miscellaneous and ad hoc. The seven things on the sheet. Today you rarely find all seven. At one time in England it was true. The only part of the base you’d count as part of the money supply is the part not used for other purposes. Today in most countries none of the base is part of it. There are no commercial bank notes. [Apropos of the following diagram, Ladenson emailed Samuels on August 24, 2006 the following: The handout entitled, “Interrelations of the Money Supply” should incorporate my handwritten additions. They consist only of the seven numerals, 1–7, some of which are followed by asterisks. The paragraph just above where you wrote “{DIAGRAM—...}”, which begins, “The seven things on the sheet,” is referring to those seven items.
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WARREN J. SAMUELS AND MARIANNE JOHNSON I can’t seem to find anything in the notes relating to the asterisks, but if the numerals 2 and 3 are interpreted as corresponding, respectively, to government-issued coins and paper money, and if the asterisk in the Government Money box is interpreted as applying to both those numerals, then the items with asterisks are the actual components of the U.S. money supply. (The bottom row of items in that diagram is deficient in its design because government money held by the public, and central bank currency held by the public are part of the monetary base. So there’s an element of double-counting in that row. More generally, it was a serious shortcoming not to go through the derivation of the monetary base, which would have prevented this confusion—confusion which also shows up in the notes in the incorrect statement: “Today in most countries none of the base is part of it [i.e. of the money supply]. “Incorrect, that is, unless I failed to get down accurately what he said).] (See Table 1)
Flow of Funds Analysis—we know how much Treasury money is outstanding— some is held by central or commercial banks as reserves. Only that part not so held is part of the money supply. In U.S. it’s ordinarily a substantial amount. {Ladenson corrects as follows: You accurately transcribe what I wrote regarding Treasury money: “In U.S. it’s ordinarily a substantial amount.” I wrote that, but if Fetter really said it, it would have been grossly inaccurate. Though I didn’t know then, the only Treasury money would have been coins and the remnants of the Civil War Greenbacks. I look at that statement and think I must have gotten something down wrong.} In U.S. central bank deposits held by public are nil so these deposits aren’t part of the money supply. Problems arising out of the form in which public wants to hold its money. Historically they think notes are money, deposits aren’t, so notes have higher reserve requirements than deposits. This of course is absurd. Just opposite of what is sensible since deposits have an inflationary potential above their original value, where notes don’t. For fifty years we got into jams because people want to shift from deposits into notes and either the notes couldn’t be issued or were issued with such severe reserve requirements. (When agricultural wages had to be paid seasonally.) Henry Thornton, The Paper Credit of Great Britain, Chapters 3–5 and 9. Hayek’s Introduction Viner, Studies in …, Chapter 3, 119–170 Fetter, British Monetary Orthodoxy, Chapter 2 Any proposal for innovation must be evaluated in terms of the type of money. At what level more (less) discretion. Base? Commercial banks? Central banks? Central bankers always say money increased because prices rose. Is it the other around. Essential to identify causes and effects on each type of money.
Government
Notes
Deposits ?
? ?
Ad hoc:Creators of currency Commercial banks
Major (Metropolitan or member)
Miscellaneous financial institutions
Total monetary supply
Currency and deposits
Commercial bank money Government money
2
Monetary base
3
1
Currency i.e. commercial bank notes
6
Deposits
7
Central bank money Currency 5 held by public
5
Deposits held by public
Fin. in Deposits
Ad hoc Currency
Creation of money supply Creation of reserves
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Subsidiary (Non metropolitan or non member)
? ? ?
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Paper money
Coin
Central bank
Monetary base [may be government money or central bank money]
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If there is a rise in price level and there is fixed metallic standard, this rise discourages production of money. AND vice versa—if money is not metal—it costs less than what it’s worth. If prices go up there will be a pressure on monetary authorities to increase the nonmetallic money supply. Proportion between notes and deposits not important analytically. October 5 Latest Federal Reserve Bulletin has an article on the Money Supply Series. The issue of gold versus silver is important because the market ratios fluctuate. But for 350 years the ratio was about 16:1. When the ratio was not widely fluctuating the history can be spoken of either in silver and [sic: or] gold. The impact of gold and silver caused the first economic controversy interesting all countries of the trade-developed world. Approaching a problem: (1) collect facts (2) interactions analyzed (3) policy—sometimes follows immediately from (1) and (2). Not so often in political science or economics since objectives are not universally agreed upon (stable prices, better distribution of income etc.) Facts—Smith, Bodin, Hamilton—all found large percentage increases. Bodin suggests 5; finds the other four inconsequential. Policy called for: not much can be done since monetary base is money supply—(1) forbid importation of precious metals or (2) add to the metallic content of denominations. About the only good policy conclusion came from Fleetwood. October 10 Gregory—Introduction to Tooke’s History of Prices, p. 49 to end is most important. Gregory—Select Statutes: vol. I – Introduction – pp. ix–[x]iii pp. 27–62 vol. II – pp. 3–7, 36–76 Robbins – Robert Torrens, etc. pp. 97–143 Fetter – Chap. 6 Money went up ten times and prices four times so if quantity theory is interpreted as M ⫽ P, there is no evidence. How might we explain this phenomenon? Economic life took place outside money economy. As it was transferred [sic: transformed?] into money economy, there was really not (completely) an increase
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in P of MV ⫽ PT but simply an increase in %T in equation. (This is a general problem in economic time series in economic history.) This is the same problem as today. To what extent is increase in M not an increase in P but increase in T {[from quantity equation] and} employment. Proper basis for judging value of money: Smith said labor. Should we measure value of money in terms of commodity prices or labor prices. This is a problem when real wages are changing. What are policy implications of this question? Assume substantial amount of discretion in monetary policy. If we ignore question of distribution, it doesn’t matter which prices are taken as test, i.e., end result is same but striving for one rather than the other may be more successful. Smith touched on this and it’s a very real problem. Monetary theorists have tended to ignore the problem of stable versus rising prices (!?) Who is responsible for change in price. Say there is productivity increase so money wages are slightly up, prices are down. Was monetary authorities’ action the cause of the fall in prices. Before we pass judgment we must know what are aims of the monetary authorities. Brings us back to question as to what they use as proper test of change in monetary value. The next great controversy in money came virtually 200 years later—1790s. There had been quite a development of monetary and other economic institutions: profit, embryonic central bank, etc. Payments were suspended for 24 years and a steady continuous debate occurred for 75 years presenting all the issues that we have today (rule versus discretion, [blank]). In the UK there are eight different money creators. Since it is not known where some of these held their reserves, it is not clear what effects of some action by the Bank of England would be. Reading Thornton gives the sense of the changes that were occurring. Discussion of various instruments used as money and differences of effect in different business situations. Bullion Controversy—What was cause of rise in price of bullion? October 12 The terms “bullionist” and “anti-bullionist” are oversimplification. Since there are a number of issues with differences of views on each issue. Shades of opinion. Politics important ; Anyone who liked the War with France wouldn’t be likely to blame it for price rises, etc. Main issue—what should monetary base be? A fixed quantity of precious metals? Which ones. Rule or discretion after its been established? Issue fought out and for about 100 years decision made that monetary base should be removed
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from discretionary action. In a system where monetary base is not sole money, the matter does not end here. Ancillary to monetary base issue: Real bills doctrine (RBD)—as long as lending done only on basis of sound security (only when loan is made on sound security) this won’t be inflationary because an equivalent amount of trade is created. Limitations (1) if we’re at Nf [full employment], a loan doesn’t create business, transfers it from one person or field to another. (2) No reason why increase in business from the original loan will not be multiplied. THORNTON POINTED OUT THESE TWO THINGS. Difference between RBD as substitute for rule for monetary base (i.e., convertibility not necessary) and using RBD within an assumption that there is a specified monetary base (i.e., using RBD as a rule of thumb GIVEN some specified limitation). THESE ARE TWO VERY DIFFERENT NOTIONS. What are the causes[s] of the rise in prices of (1) foreign exchange, (2) specie, (3) commodities. Monetary base tells you nothing about commodity price rise (Spain, same base (standard), prices rose). But if price of monetary base goes up, this is significant and this was the main point of issue. Monetary versus non-monetary influences. {Ladenson: I’m sure I meant this last sentence as a new subject heading.} THORNTON says amount of money has an important effect but is not universally determining. Suppose there is no increase in nominal money supply but community changes its habits as to what is used as money, and prices go up. Are the monetary authorities responsible to take action to offset this? Depends on your view of what the Central Bank has responsibility to do. At the time the Bank of England and country banks were two clear creators of money. Suppose we agreed that Bank of England has comprehensive responsibility. Can they control what all the country banks do. Today most Central Banks, if they adjust the amount of credit they have outstanding they try to control other sectors ability to counteract these movements. If the commercial banks or public change their habits, whether Central Bank can counteract this depends on magnitude of change. Discretion-Quantity Theory ; increased prices should lead to diminishing money supply but if prices go up because of a panic maybe you should loosen credit. There is an assumption that the Central Bank can control the exchange. There was a move to limit Bank’s authority to issue notes (i.e., limit its discretion). Means of increasing M to take care of needs of trade—Question first of all as to what this means. Means different things in different settings. Often what seems to be a question of adequate money supply is a question of adequacy of shifting from one kind of money to another. In an ideal system there would be no problem here. In these matters, question of the total doesn’t arise at all. A good system is one which doesn’t break down because public on a very temporary basis wants
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to shift from one form of money to another or to or from near-money. Somebody should stand ready to handle this (Bagehot notion). Both of the notions (shifting from one form to another on ad hoc or seasonal basis) are compatible with non-discretionary standard base. But if there is nondiscretionary base there must be a large amount of discretion when these problems arise. October 17 I.e., when this shift from desire to hold money as deposits to hold money as currency, a non-discretionary system would still have someone that could or must issue more money to maintain same volume of trade as before. Play it both ways—maintain monetary unit ⫽ fixed amount of gold—but have enough money to either maintain stable prices or Nf [full employment]. If a single country does this it will soon lose monetary base to other countries. But if every country plays it this way, gold wouldn’t flow out, you would have problem of people hoarding gold. I.e., there is a range in which you can have non-discretionary standard with discretionary expansion of money supply. Depends on no major country demanding gold. Legally limit is reached when you have legal expansion but conceptually, if no other country demands gold or if people don’t demand it, the legal limit. Resumption (1821) removed discretion from monetary base. As time went on and note issue privilege removed (1844) removed discretion of individuals to create money. Also required 100% backing for new notes. Almost complete removal of discretion. This led to panics and ultimately to Bagehot principle. Central Bank must exercise discretion within a non-discretionary base. Two types of discretion: (1) How much of a monetary base is there—as long as the money = to some quantity of a precious metal, this is determined by geology and people’s hoarding habits. (2) Discretion in issuing notes. If bankers issue too few notes they lose profit. If too much notes they go broke. Seems reasonable: Smith’s invisible hand. BUT evidence is that this just doesn’t work. People suffer, why didn’t Smith’s idea work. a. Crookedness: “Freedom in banking is freedom in swindling.” b. Possible conflict between public and private interest: liberal economy just doesn’t work in this sector. Even Smith was distrustful of free enterprise where some people handle other people’s money. Pieces of paper representing goods aren’t always the goods, e.g., the New York bankers got took in the salad oil case.
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October 19 {The clarification of the following T-accounts took some time, initially because I first believed that Fetter was using them to explain the multipleexpansion-of-money process and then was corrected by Ladenson. Ladenson then, in several emails, revealed other discoveries (also see below regarding ‘Sources and Absorption of Reserve Funds’) Ladenson to Samuels: In the lecture of October 17 Fetter … was discussing the Act of 1844 which (1) created separate note-issuing and banking departments in the Bank of England, (2) set a required reserve ratio of 1.0 on all the Bank’s notes issued in excess of £14 million, and (3) didn’t apply an analogous reserve ratio to the Bank’s deposits. Fetter used those T accounts to illustrate some of the consequences flowing from this arrangement. Note particularly the one-sentence paragraph in the middle of my notes for the lecture of October 17 [the page after the T accounts]: “Previous page shows that it wasn’t the separation [into note-issuing and deposit departments] of the Bank but the nature of the note reserve requirement that created the subsequent problems.” In that sentence, “Previous page” obviously refers to that page with the T accounts. Ladenson subsequently wrote further about … those T-accounts about which we’d corresponded several times. Fetter used them in what we thought was the lecture of October 17 to illustrate some consequences flowing from an 1844 requirement that the Bank of England had to hold reserves against its note issue but not against its deposits. As I now look very carefully at that page, it appears that I wrote “10/19” at the top of it. In other words, Fetter must have begun the lecture of October 19 by writing those T accounts on the black board. The notation of that date, in my notes, is obscured by the football standings that I wrote above it. So that made me realize that I’d better go through those notes and analyze the sequence of dates more carefully. I found that not only was the notation “October 19” (understandably) missing from your transcription, but also “October 10.” I somehow missed that latter omission when I checked the transcription in June. In terms of the version of the transcription that you sent me then, the notation, “October 10,” should be inserted … just above the line that reads, “Gregory—Introduction to Tooke’s History of Prices_,…”
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Now returning to that sheet with the T accounts, as I said, I now believe that the lecture of October 17 should end with “e.g., the New York bankers got took in the salad oil case.” Then should come the insertion, “October 19,” immediately followed by those T accounts, and then my textual notes beginning with “What emerged in England after…”} (See Table 2) What emerged in England after Napoleonic Wars—non-discretionary base. Away from discretion to private people {i.e., private banks} to issue notes. Bank of England position unclear. Out of dissatisfaction with Bank performance in 1830s arose Act of 1844. Act of 1844 was favorable to rules rather than discretion. The Act for all practical purposes took away country banks’ rights to issue notes. Paper and finance tend to have easier abuses (fraud or misjudgment) than other forms of enterprise. Above £14,000,000 all notes issued by Bank of England had to be backed 100% in specie. BUT no reserve requirement whatsoever regarding the Bank’s deposits. Fetter thinks that the separation into two departments not essential. It was simply one way of operationalizing the conceptions of the Act’s authors that there should be reserve requirement against notes and none against deposits. The point as to whether deposits were the same as money was a tactical battlefield on which was fought the issue whether a large amount of discretion should be retained by the Bank. Historically runs were caused by note holders, not depositors, since in those days note holders were less able to protect themselves from depositors. Another viewpoint is simply that to keep the system from breaking down, note holders must be placated, not depositors. (This latter is Fetter’s view.) Politically it was much easier to put in a backing against notes than against deposits. Previous page shows that it wasn’t the separation of the Bank but the nature of note reserve requirement that created the subsequent problems. Why did this silly rule continue even though the Bank Act had to be suspended three times in twenty years? Why weren’t there any really serious troubles for almost sixty years? On [the] first question, the personal failure of the top officials of the Bank was not inspiring to give these men more discretion. Also the supporters of the Act, immediately yelled “Think how bad things would have been without the Act?” On [the] second question, if people hold a lot of notes relative to deposits, there is effective reserve requirement. If they hold a lot of deposits relative to notes, there is virtually no reserve requirement. As years went by the latter condition increasingly held. This seems persuasive but in principle you
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Table 2. T Accounts for Bank of England’s Two Departments. Begining Issue Dept. 14,000,000
Gold
20,000,000
Notes 34,000,000 (of which 10,000,000 in Banking Dept.)
34,000,000
Loans
20,000,000
Deposits
30,000,000
Notes 10,000,000 (Figure chosen arbitrarily)