Keynes versus monetarists 2

Some additional distinctions : Keynes&monetarists

Keynes' theory of investment depends upon what he calls the marginal efficiency of capital. He defines the mec as follows: that rate of discount from a future stream of earnings that equates the current supply price of capital. All of this takes place under conditions of uncertainty.

For Keynes uncertainty is not strictly reducible to a quantitative calculable probability.(See His Treatise on Probability and Ana Carabelli's interpretation of it.) Because of these factors investment is unstable and strongly affected by the bank rate. Should the bank rate rise this will eliminate investment projects that have a lower rate of return. Obviously it is increasingly difficult to assess risk the further into the future one goes. In addition the stock market is highly risky because of the tendency toward speculative selling of shares and the tendency to operate on short term time horizons . Inherent values matter less than whether one can sell at a higher price than one has bought. Accurate judgement in the market is premised upon being able to judge the likely judgments of others about value and price. Therefore the markets are an unstable source of investment in capital projects.

The monetarists do not seem to have a unified theory of the investment process. Like Friedman's theory of inflation money in - prices out, what I and others call a black box theory they seem to argue that investment happens more or less naturally because the animal spirits are strong(Keynes' phrase) or the entrepreneurial knights of creative destruction(Schumpeter) or the waves of technological innovation bring it about. They also argue that statist intervention is antithetical to investment. Some of them, but not Friedman also argue that deficits raise interest rates and thereby crowd out investment. Keynesians would say au contraire deficits in recessions crowd in investment.

The classical quanity theory equation was MV=PT and then MV=PO where M was money stock, V velocity, P prices, T transactions and O output. Since V was regarded as highly stable and predictable and T and O fixed at the full employment level by Say's law then there was held to be a direct relationship between M and P.

Keynes used the Cambridge variant of the equation M= 1/k (PO) where k is the demand for money balances or the tendency to hold money rather than to part with it. He also elaborated the equation by distinguishing between money stocks, M1, M2 and M3 where M1 was income deposits, M2 business deposits and M3 savings deposits the precursors to his transactions demand, precautionary demand and speculative demand for money. Then P= V1(M-M2-M3)/O where M = M1+M2+M3 .(See his Treatise vol.1 The pure Theory of money p.150London: Macmillan, 1930 and Tract, CW)

Friedman alters the classical model by writing it in Keynesian form as the demand for equities, financial assets, real capital assets, and cash. Md = P.f(y,w;R*m,R*b,R*e;u) where Md = the demand for money and P is the price index,y income of a single wealth holder, w fraction of wealth in non human form ; R*m expected nominal return on money; R*b expected nominal rate of return on securities; R*e expected nominal rate of return on phsyical assets, u all other variables that affect the utility attached to the services of money. (See his Quantity Theory of Money in the new Palgrave Money edited by John Eatwell, M.Milgate and P.Newman, eds.London: Macmillan, 1989.p.13; also see Phillip Cagan, Persistant Inflation:Historical and Policy Essays for an interesting'' monetarist'' approach to what became inflation orthodoxy during the 1970s and 1980s.)

Key Words: "Keynes"; "monetarists"; "Milton Friedman"; "quantity theory"; and from previous entry
"Say's law" ;involuntary unemployment" "labour market clearing"