The “Cambridge” critique of the quantity theory of money: A note on how quantitative easing vindicates it

ABSTRACT

Through quantitative easing markets have been flooded with liquidity, but rather than inflation we have witnessed a general deflation because of the liquidity trap environment in which the banking system operated; this article revisits the arguments against the quantity theory in the “Cambridge” tradition of John Maynard Keynes, Richard Kahn, and Nicholas Kaldor, and defends their soundness and topicality.

KEYWORDS:

• Cambridge Monetary Theory
• inflation
• Quantitative easing

JEL CLASSIFICATIONS:

• B31
• E31
• E40

Notes

¹Kahn Papers, King’s College Archives, Cambridge.

²An outline of Kahn’s lecture notes can be found in Kahn’s papers (RFK 4/15/4-14).

³Keynes papers, King’s College Archives, Cambridge.

⁴Kahn’s criticism of the quantity theory before the General Theory is illustrated by what Joan Robinson refers to as his “Quantity Equation for Hairpins.” It is worth quoting the relevant passage from her 1933 article: “Let P be the proportion of women with long hair, and T the total number of women. Let 1 / V be the daily loss of hairpins by earn women with long hair, and M the daily output of hairpins. Then M = PT / V and MV = PT. Now suppose that the Pope, regarding bobbed hair as contrary to good morals, wishes to increase the proportion of long-haired women in the population, and asks a student of economics what he had best do. The student sets out Mr. Kahn’s equation, and explains it to the Pope. ‘All you need do,’ he says, ‘is to increase M, the daily output of hairpins (for instance, you might give a subsidy to the factories) and the number of long-haired women is bound to increase.’ The Pope is not quite convinced. ‘Or, of course,’ the student adds, ‘if you could persuade the long-haired women to be less careless, V would increase, and the effect would be the same as though the output of hairpins had increased’” (Robinson, [1933] 1951, p. 55). See Marcuzzo (2002a).

⁵“The fundamental assumption of the classical theory, ‘supply creates its own demand,’ is that OW = OP [W = marginal prime cost of production when output is O; P = expected selling price of this output; OP = effective demand] whatever the level of O, so that effective demand is incapable of setting a limit to employment which consequently depends on the relation between marginal product in wage-good industries and marginal disutility of employment. On my theory, OW ≠ OP for all values of O, and entrepreneurs have to choose a value of O for which it is equal;—otherwise the equality of price and marginal prime cost is infringed. This is the real starting point of everything” (Keynes, [1936] 1973, pp. 422–423). On these and other points addressed here, see Marcuzzo (2002b).

⁶Even Keynes, however, appears to be sceptical about the reliability of such a mechanical description: “I do not myself attach much value to manipulations of this kind; and I would repeat the warning, which I have given above, that they involve just as much tacit assumption as to what variables are taken as independent (partial differentials being ignored throughout) as does ordinary discourse, whilst I doubt if they carry us any further than ordinary discourse can” (Keynes, [1936] 1973, p. 305).

⁷For a review of the flaws of AS/AD analysis, see Colander (1995).

⁸Also Kaldor in his evidence to the Radcliffe Committee (1958) denied that the velocity of circulation could ever be assumed to be constant and determined by factors that are independent of the supply of money or the volume of money payments (see Targetti, 1992, p. 273).

⁹Kaldor himself made this claim in an interview to the present author: “I already explained my ideas on the endogeneity of the money supply in 1939” (Kaldor, 1986, p. 73).

¹⁰Drawing on Kaldor, Wray (1990, pp. 73–74) summarized the point: “money is supplied because someone wants it. Money supply and money demand are simply different sides of the balance sheet. From the firm’s point of view, money demand is the willingness to go into debt, and money supply is the IOU it issues. Of course, the firm’s IOU is not money unless someone is willing to accept it. From the bank’s point of view, money demand is indicated by the willingness of the firm to issue an IOU, and money supply is determined by the willingness of the bank to hold that IOU and to issue its own liabilities to finance the purchase of the firm’s IOU.”.

Additional information

Notes on contributors

Maria Cristina Marcuzzo

Maria Cristina Marcuzzo is affiliated with Dipartimento di Scienze Statistiche, Sapienza, Università di Roma. The author is grateful to an anonymous referee, the editor of the journal, Alessandro Roncaglia, Annalisa Rosselli, and Anna Simonazzi for helpful comments and suggestions.