Theory of the Demand for Money: Marx and Keynes

There was a small exchange between David Glasner (here and here) and Scott Sumner (here) on the originality of Keynes' contribution to the theory of demand for money. Main content of the contribution is to establish the connection between the demand for money and the rate of interest as a determinant of the former.

In what Keynes called classical system, the interest rate is determined within the real sector by the two schedules of investment and saving with no consideration of money; this is the loanable funds theory. As opposed to this, in Keynes's liquidity preference theory, the money market figures significantly and the interest rate is determined by the interaction between the goods market and the money market as shown in the IS-LM framework.

That is, Keynes established the monetary aspect of the interest rate determination which was missing in the Cambridge school. David Glasner and Scott Sumner were contending on whether this is Keynes's original contribution or its essence was already there in Cambridge economists' writings.

In terms of originality of highlighting the monetary aspect of the interest rate determination, the honor shoud be attributed to Karl Marx much before Marshall's Cambridge school and Keynes.

In chapter 32 of Capital Vol.3, after suggesting that "The possibility of a high rate of interest of longer duration .... is given by the high rate of profit", Marx discusses the mechanism operating behind this causal relation:

"In the period when business revives after the crisis ...... loan capital [i.e. credit] is demanded in order to buy, and to transform the money capital into productive or commercial capital. And then it is demanded either by the industrial capitalist or by the merchant. The industrial capitalist invests it in means of production and labour-power. // The rising demand for labour-power can never be in itself a reason for a rising rate of interest, in so far as this is determined by the profit rate....."

"...the demand for variable capital may increase, and thus also the demand for money capital, while this in turn increases the rate of interest".

"...to say that the demand for money capital and hence the interest rate rises because the profit rate is high is not the same as saying that the demand for industrial capital rises and that this is why the interest rate is high".

In these, Marx is identifying two explanations of why a high profit rate leads to a high interest rate: First, an increase in profit rate leads to an increase in investment, which in turn leads to a rise in the demand for money and credit, which finally raises the rate of interest. Second explanation is simply that an increase of investment generates a rise in the rate of interest. It is easily seen that the latter is nothing but the loanable funds theory, or a theory of real interest, which Keynes tried to overcome and the former is something similar to Keynes's emphasis on the monetary aspect of the interest rate determination.

However, the difference between Marx's and Keynes's theory of the demand for money is more important than their similarity. In Keynes's case, or in the Hicks's representation of it, the demand for money is determined by the marginalist framework, i.e. by comparing the marginal utility of holding money and its marginal costs. On the contrary, in Marx the demand for money is modeled within a broader context of reproduction and accumulation of capital.

A Starting Point of Developing Marxian Theory of Money and Credit

See Palley’s words on Post Keynesian theory of endogenous money:

"PK endogenous money theory emphasizes that this linkage [connection the financial and real sectors] runs predominantly from credit to money to economic activity. The important feature is that credit is placed at the beginning of this sequence. This contrasts with conventional representations that place money first, as reflected in the standard textbook money multiplier story in which bank deposits are said to create loans" (Palley 2008, p.2).

The issue is this: Which one is logically prior, money or credit? This question has a long history of monetary debate of, following Schumpeter’s categorization, ‘monetary theory of credit vs. credit theory of money’ each corresponding to 'deposits make loans' and 'loans make deposits' thesis. Depending on an answer to the question, theoretical definition of money and bank will be drastically different.

In monetary theory of credit, money is usually defined as constituted of something real - hence real money or commodity money - while credit, as a substitute money, is created based on the real money. In this view bank merely intermediates money from surplus units to deficit ones; hence banks as financial intermediaries.

In credit theory of money, on the other hand, the essential task of bank is to create money through making loans. What is it then that bank loans out when money is created simultaneously with the lending? It is its own liabilities! In this approach money is essentially nothing but bank's liabilities. 

Now, where does Marx's monetary theory fit in? It is conventionally accepted that in Marx money is logically prior to credit; thus monetary theory of credit. For example, in the initial chapters of Capital Vol.1 Marx defines money essentially as commodity money with intrinsic value; a metallic money is assumed in the analysis of the circuit of capital and reproduction scheme in Capital Vol.2 and of transformation of value into price of production in Capital Vol.3; it is only in Part 4 and 5 of Capital Vol.3 where credit system is discussed. 

In particular, as Costas Lapavitsas has strongly emphasized in various places, it is shown in Capital Vol.2 that the credit system is structurally derived from the workings of the circuit of capital; more specifically, idle capitals regularly emerge due to the turnover times and will be lent out to other capitalists in search of profit opportunity; in this sense a pool of idle capitals is the foundation of credit system. 

All these seem to suggest that Marx's monetary theory belongs to monetary theory of credit being incompatible with Post Keynesian type of endogenous money theory. According to this observation Marx's monetary theory would be rejected as invalid in the economy where credit money perform various functions of money.

However, this is not a proper assessment. In order to fully grasp Marx's theoretical system in its entirety we have to recognize that it is constituted of two different dimensions, i.e. method and theory. A very helpful place to look at for this is the chapter on simple reproduction in Capital Vol.2 where we find Marx's explanation why he assumed metallic money. It is worthwhile to quote.

"[The assumption of commodity money] is not made from mere considerations of method, although these are important enough, as demonstrated by the fact that Tooke and his school, as well as their opponents, were continually compelled in their controversies concerning the circulation of bank-notes to revert to the hypothesis of a purely metallic circulation. They were forced to do so post festum and did so very superficially, which was unavoidable, because the point of departure in their analysis thus played merely the role of an incidental point" (Capital Vol.2, p.290).

First of all, methodologically, commodity money is a right starting point and the analysis should then proceed to credit money. This is according to the method of presentation which captures in thought the logico-conceptual development of the object of analysis from the abstract to the concrete; it is important to note that this process does not necessarily corresponds to the actual historical development. Marx emphasizes the importance of this method by alluding to theoretical tumbling-blocks Tooke and both Banking School and Currency School had to face because they adopted a false starting point, i.e. credit money instead of purely metallic money, in the famous classical monetary debate.
Another reason than method is a theoretical consideration to emphasize that the capitalist economy systematically requires the credit system. Marx demonstrates this by showing that the supply of commodity money, due to its physical limit, cannot grow in step with the growth of the entire system. By starting with metallic money Marx was able to demonstrate effectively that extended reproduction of capital requires credit money which will bring the system beyond the metallic barrior. Marx's theory which emerges at this place states that in capitalist system money cannot but be a credit money, which is issuer's liabilities.  
 

From these considerations we have the following lessons on Marx's monetary theory: A distinction between method and theory is important; method of developing from the abstract (commodity money) to the concrete (credit money) on one hand and, on the other hand, theory of capitalist mode of production according to which credit system is a required condition for its extended reproduction. Once this is recognized we could see that both commodity money and credit money (as issuer's liabilities) perform an important role in Marx's monetary theory.

 
Recognizing these should be the starting point of any attempts to develop Marxian theory of money and credit.
 

Minsky and Marx: On Michael Roberts' Take on Minsky's FIH

Some Marxists tend to emphasize a distinction between Marx and Minsky dismissing the latter's theory of financial crisis. But I found, in many cases, this is grounded in a misunderstanding of Minsky, more or less. For example, Michael Roberts' piece on Steve Keen. (I would like to emphasize that the following is about a slight difference of opinion, on the specific issue on Minsky, I have with Michael, whose works I like to read.)

The very essence of Michael's understanding of Minsky seems to be this (if my understanding is correct): In Minsky, boom and bust in the financial sphere depend on the subjective and individual expectations of market participants and are independent of what's going on in the real; i.e. what's going on in the real rather depends on people's expectation. For Minskyians, Michael says, "profits depend on expectations and crises are the result of changed expectations by financial speculators".

I think this is an unfair rendition of Minsky. Even though Minsky himself is not crystal-clear on the related issue, I think interpreting his Financial Instability Hypothesis as a dynamics of the real and the financial interaction makes a lot of sense. Most importantly, profitability (and the resulting cash-flows) of firms is very crucial in the formation and frustration of expectation, which in turn leads to a corresponding fluctuation in the financial variables. In many Minskyian formal models, the future prospect, which affects debt level, is modeled as a function of profits relative to debt service payments.

In this sense, I think Michael's conclusion that "For Marxists, instability in the financial sector would not be enough to cause a major crisis if profitability is rising", also applies to Minskyians. In a sense, Minskyian concept of 'financial instability' cannot be conceived without in relation to profitability. For this concept describes the system's endogenous logic through which it gets financially fragile by overloading debts during good times with favorable profitability and ends up with collapses (or debt deflation) when the euphoric prospects are frustrated by unsatisfactory outcome of profit rate.

In many cases, there is a tendency for those Marxists who put Marx's TRPF and Minsky's FIH in opposition to perceive the financial sphere as secondary and peripheral despite their repeated rhetoric that money and finance are important in Marx's theory. Rather, they seem to be subject to an old dichotomy of the real vs. the financial. For instance, Michael contrasts Minskyians' focus on the financial sphere with Marxists' on the capitalist production process as the origin of the recent crisis.

However, if you understanding that money and finance are essential constituents of the totality of capital in Marx's theory, such contrast would be unnecessary. That is, for Marx, the concept of capitalist production encompasses both production and circulation spheres, and both the real and the financial sectors. And the circulation and the financial could possibly develop their own logic to disrupt the capitalist system; most typical way they do this is to distance themselves from the confines of the value space of the real, generating the systemic 'irrational' fetishism that profits appear to originate from money capital itself  (Marx showed this especially in ch.21, 30, 31, 32 of Capital Vol.3). And this is nothing but an overgrowth of financial sector which is doom to fall down.

If understood in this way, I think a better way for Marxists to appreciate Minskyian FIH is to recognize that Marx already had something similar in Das Kapital 200 years ago or so, rather than to dismiss it as foreign to Marx.