THE NEW PALGRAVE MONEY THE NEW PALGRAVE

MONEY

EDITED BY JOHN EATWELL . MlJRRAYMILGATE . PETER NEWMAN

W·W·NORTON I H:t NEW YORK' LONDON ISBN 978-0-333-49527-8 ISBN 978-1-349-19804-7 (eBook) DOI 10.1007/978-1-349-19804-7

©The Macmillan Press Limited, 1987, 1989 Reprint of the original edition 1989 First published in The New Palgrave: A Dictionary of Economics Edited by John Eatwell, Murray Milgate and Peter Newman in four volumes, 1987 The New Palgrave is a trademark of The Macmillan Press Limited First American Edition, 1989 All rights reserved. Pu,blished simultaneously in Canada by Penguin Books Canada Ltd. 2801 John Street Markham, Ontario L3R 1B4

ISBN 978-0-393-02726-6 ISBN 978-0-393-95851-5 PBK.

W. W. Norton & Company, Inc. 500 Fifth Avenue New York, NY 10110

W. W. Norton & Company, Ltd. 37 Great Russell Street London WC1B 3NU

6 Contents

Acknowledgements VI General Preface vii Preface Xl

Quantity theory of money Milton Friedman Banking School, Currency School, Anna J. Schwartz 41 Free Banking School Bank rate A.B. Cramp 50 Bonds Donald D. Hester 56 The Bullionist Controversy David Laidler 60 Capital, credit and money markets Benjamin M. Friedman 72 Central banking Charles Goodhart 88 Cheap money Susan Howson 93 Credit Ernst Baltensperger 97 Credit rationing Dwight M. Jaffee 103 'Currency boards Alan Walters 109 Dear money Susan Howson 115 Demand for money: theoretical studies Bennett T. McCallum and 117 Marvin S. Goodfriend Demand for money: empirical studies Stephen M. Goldfeld 131 Disintermediation Charles Goodhart 144 Endogenous and exogenous money Meghnad Desai 146 Equation of exchange Michael D. Bordo 151 Financial intermediaries James Tobin 157 High-powered money and the monetary base Karl Brunner 175 Hyperinflation Phillip Cagan 179 Liquidity A.B. Cramp 185 Loanable funds S.c. Tsiang 190 Monetarism Phillip Cagan 195

v Contents

Monetary base Charles Goodhart 206 Monetary cranks David Clark 212 Monetary disequilibrium and market Herschel I. Grossman 216 clearing Monetary equilibrium Otto Steiger 223 Monetary policy David E. Lindsey and 229 Henry C. Wallich Money illusion Peter Howitt 244 Money in economic activity D. Foley 248 Money supply K. Brunner 263 Natural rate and market rate Axel Leijonhufvud 268 Neutrality of money Don Patinkin 273 Open-market operations Stephen H. Axilrod and 288 Henry C. Wallich Optimum quantity of money Peter Howitt 294 Price level P. Bridel 298 Real balances Don Patinkin 303 Real bills doctrine Roy Green 310 Seigniorage S. Black 314 Specie-flow mechanism William R. Allen 316 Transaction costs Jiirg Niehans 320 Velocity of circulation J.S. Cramer 328

Contributors 333

Acknowledgements

The following contributors (articles shown in parentheses) acknowledge support from public bodies or permission to reprint copyright material:

Don Patinkin (Neutrality of Money), Central Research Fund of the Hebrew University of Jerusalem.

vi General Preface

The books in this series are the offspring of The New Palgrave: A Dictionary of Economics. Published in late 1987, the Dictionary has rapidly become a standard reference work in economics. However, its four heavy tomes containing over four million words on the whole range of economic thought is not a form convenient to every potential user. For many students and teachers it is simply too bulky, too comprehensive and too expensive for everyday use. By developing the present series of compact volumes of reprints from the original work, we hope that some of the intellectual wealth of The New Palgrave will become accessible to much wider groups of readers. Each of the volumes is devoted to a particular branch of economics, such as econometrics or general equilibrium or money, with a scope corresponding roughly to a university course on that subject. Apart from correction of misprints, etc. the content of each of its reprinted articles is exactly the same as that of the original. In addition, a few brand new entries have been commissioned especially for the series, either to fill an apparent gap or more commonly to include topics that have risen to prominence since the dictionary was originally commissioned.

As The New Palgrave is the sole parent of the present series, it may be helpful to explain that it is the modern successor to the excellent Dictionary of Political Economy edited by R.H. Inglis Palgrave and published in three volumes in 1894, 1896 and 1899. A second and slightly modified version, edited by Henry Higgs, appeared during the mid-1920s. These two editions each contained almost 4,000 entries, but many of those were simply brief definitions and many of the others were devoted to peripheral topics such as foreign coinage, maritime commerce, and Scottish law. To make room for the spectacular growth in economics over the last 60 years while keeping still to a manageable length, The New Palgrave concentrated instead on economic theory, its originators, and its closely cognate disciplines. Its nearly 2,000 entries (commissioned from over 900 scholars) are all self-contained essays, sometimes brief but never mere definitions.

vii General Preface

Apart from its biographical entries, The New Palgrave is concerned chiefly with theory rather than fact, doctrine rather than data; and it is not at all clear how theory and doctrine, as distinct from facts and figures, should be treated in an encyclopaedia. One way is to treat everything from a particular point of view. Broadly speaking, that was the way of Diderot's classic Encyclopedie raisonee (1751-1772), as it was also of Leon Say's Nouveau dictionnaire d'economie politique (1891-2). Sometimes, as in articles by Quesnay and Turgot in the Encyclopedie, this approach has yielded entries of surpassing brilliance. Too often, however, both the range of subjects covered and the quality of the coverage itself are seriously reduced by such a self-limiting perspective. Thus the entry called 'Methode' in the first edition of Say's Dictionnaire asserted that the use of mathematics in economics 'will only ever be in the hands of a few', and the dictionary backed up that claim by choosing not to have any entry on Cournot. Another approach is to have each entry take care to reflect within itself varying points of view. This may help the student temporarily, as when preparing for an examination. But in a subject like economics, the Olympian detachment which this approach requires often places a heavy burden on the author, asking for a scrupulous account of doctrines he or she believes to be at best wrong-headed. Even when an especially able author does produce a judicious survey article, it is surely too much to ask that it also convey just as much enthusiasm for those theories thought misguided as for those found congenial. Lacking an enthusiastic exposition, however, the disfavoured theories may then be studied less closely than they deserve. The New Palgrave did not ask its authors to treat economic theory from any particular point of view, except in one respect to be discussed below. Nor did it call for surveys. Instead, each author was asked to make clear his or her own views of the subject under discussion, and for the rest to be as fair and accurate as possible, without striving to be 'judicious'. A balanced perspective on each topic was always the aim, the ideal. But it was to be sought not internally, within each article, but externally, between articles, with the reader rather than the writer handed the task of achieving a personal balance between differing views. For a controversial topic, a set of several more or less synonymous headwords, matched by a broad diversity of contributors, was designed to produce enough variety of opinion to help form the reader's own synthesis; indeed, such diversity will be found in most of the individual volumes in this series. This approach was not without its problems. Thus, the prevalence of uncertainty in the process of commissioning entries sometimes produced a less diverse outcome than we had planned. 'I can call spirits from the vasty deep,' said Owen Glendower. 'Why, so can I,' replied Hotspur, 'or so can any man;/ But will they come when you do call for them?' In our experience, not quite as often as we would have liked. The one point of view we did urge upon everyone of Palgrave's authors was to write from an historical perspective. For each subject its contributor was asked to discuss not only present problems but also past growth and future prospects. This request was made in the belief that knowledge of the historical development viii General Preface of any theory enriches our present understanding of it, and so helps to construct better theories for the future. The authors' response to the request was generally so positive that, as the reader of any of these volumes will discover, the resulting contributions amply justified that belief.

Peter Newman Murray Milgate John Eatwell

ix Preface

'Money is not such a vital subject as is often supposed' ... 'A monetary system is like some internal organ; it should not be allowed to take up very much of our thoughts when it goes right, but it needs a deal of attention when it goes wrong.' D.H. Robertson, Money (1922) The little work from which these quotations are taken was probably the most enduring - as it is the most endearing - of all the Cambridge Economic Handbooks, a famous series edited by J.M. Keynes between the two World Wars. Robertson's sharp mind and nimble prose made his exposition so clear to countless undergraduates that a revised edition of his book was still in print thirty years later, even after the grave monetary upsets of depression and world war. Yet the two quotations above, the beginning and end respectively of the very first section of the first chapter of the first edition, are in literal contradiction. If the monetary system needs' a deal of attention' when it goes wrong, then that must be because its proper working is indeed vital to the whole body economic. This contradiction between quotations neatly exaggerates the discord between two intuitive feelings about money which are held simultaneously by most economists most of the time. The first is that, at least in the long run, 'money does not matter' to the real economy, i.e. to the determination of relative prices, output and employment. This idea is well captured in Robertson's further remark that one must 'try from the start to pierce the monetary veil in which most business transactions are shrouded '; interestingly enough, this seems to be the first use in English of the now hackneyed metaphor of money as a 'veil'. The second intuition is that 'money does matter', at least in the short run, i.e. that inappropriate management of the money supply (a concept not easily defined) can result in serious damage to the economy and society, not only via the distribution of income and wealth (which is bad enough) but also through real effects on prices and output. Just as pathology illuminates physiology, so these adverse consequences are exhibited in stark and grievous fashion by such disasters

Xl Preface as the Hungarian hyperinflations after the two World Wars, where for example in July 1946, prices rose at the monthly rate of 4.2 x 10 16 per cent. In a sense, the history of monetary theory could be written in terms of the tension between these two warring intuitions. A striking feature of monetary economics is its intertwining of practical debate and theoretical development. The earliest systematic formulations of the quantity theory of money, for example, were consequences of pressing practical concerns, beginning a pattern that has continued ever since. Debate has followed debate over the centuries, each giving rise to new theoretical understanding; to name just a few - the Bullionist Controversy; the Banking School-Currency School­ Free Banking School debates; the controversy over bimetallism; the perennial arguments over when to go off or on the gold standard, and at what parity; the contemporary many-sided disputes between Keynesians (neo-, post-, and old original), monetarists, and 'new classical macroeconomists'. Accounts of these debates, and more, will be found in the pages which follow.

The Editors

Xli