Aug 13, 2013

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".
" 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.

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