Keynes vs. Wicksell on loanable funds theory

22 Sep, 2014 at 13:41 | Posted in Economics | 8 Comments

WicksellThe fundamental difference between Keynes and Wicksell and in general the
supporters of the LFT [Loanable Funds Theory] lies in the specification of the consequences of the presence of bank money. Introducing the distinction between the natural rate of interest and interest rate on money, Wicksell and the LFT supporters state that an economy that uses bank money converges towards the equilibrium position that characterises an economy without banks, in which there is no credit market, but just a capital market where the resources not consumed by savers are exchanged. The presence of bank money does not alter the structure of the economic system; the only element that distinguishes a pure credit economy is the presence of an adjustment mechanism that drives the rate of interest on money, determined within the credit market, towards the natural rate of interest. The working of a pure credit economy can therefore be described using a theory that applies to a world without banks.

In contrast, Keynes states that the spread of a fiat money such as bank money changes the structure of the economic system. He underscores this point by introducing the distinction between a real exchange economy and a monetary economy. As is well known, Keynes uses the former term to refer to an economy in which money is merely a tool to reduce the cost of exchange and whose presence does not alter the structure of the economic system, which remains substantially a barter economy. Keynes notes that the classical economists formulated an explanation of how the real-exchange economy works, convinced that this explanation could be easily applied to a monetary economy. He believed that this conviction was unfounded …

Giancarlo Bertocco

8 Comments

  1. Hi Dr. Syll, nice post with the excerpt from Bertocco. For more on Wicksell, see here: http://nakedkeynesianism.blogspot.com/2011/11/neo-wicksellian-macroeconomics.html

  2. another good piece by Bertocco – http://ideas.repec.org/p/ins/quaeco/qf0904.html

  3. Great paper on this:

    http://ideas.repec.org/a/elg/ejeepi/v9y2012i2p197-214.html

    See you

    Marcos

  4. I always appreciate Nick Rowe’s willingness to put things plainly and analytically — it is the best use of mathematics, and the history of economic thought lesson from Giancarlo Bertocco was interesting as well.
    .
    I write with a question, though.
    .
    The thing that troubles me about loanable funds is that it seems to rest on the same metaphor as all quantity theories of money: that money is a liquid fluid, with a definite weight and substance, which can be “supplied” or transferred in definite quantity. For example, loanable funds implies that I can “save” — that is, refrain from consumption — and take the value of the resources freed by my self-discipline and pour those resources into the magical fluid of money, and via a bank perhaps, transfer my claims on those resources to some anonymous others, who wish to use those resources for their own purposes — perhaps to invest in capital factors useful for future production. There can be a market for these funds, equilibrated by an interest rate, and if I, as saver, am reluctant to save, an higher interest rate may coax me to supply more funds, while investors exhausting the possibilities for profitable investments, may seek less in funds, unless the interest rate falls.
    .
    Clearly, LFT is not a description of the operations of the actual financial system. Is it the contention of the Orthodox New Keynesian macroeconomist, using LFT as a construct, that the actual financial system functions “as if” LFT. Nick Rowe, taking after Brad DeLong, offered the idea that the Central Bank ought to manage the policy interest rate with the goal of making Says’ Law “true”. Is the ONKM generalizing this attitude, contending that the institutional financial system, within certain, unspecified bounds, by the sum of its behavior makes it “as if” loanable funds theory is true? Or, to rephrase, money is not a liquid fluid, but financial institutions manage money in ways that make money behave like a liquid, whose quantity matters.
    .
    Is that how one is meant by ONKM to understand their use of LFT?


Sorry, the comment form is closed at this time.

Blog at WordPress.com.
Entries and comments feeds.