Vicarelli, Keynes, and the unstable nexus between investment, liquidity, and finance

ABSTRACT

The goal of this article is to reconstruct Keynes’s vision of the unstable nexus between investment, liquidity and finance, as set out by the Italian economist Fausto Vicarelli (1936–1986). As argued in the article, one of Vicarelli’s main contributions consists of explaining the inherent instability of financially sophisticated capitalist economies in terms of the interaction (and double dissociation) between investment, saving, and stock-holding decisions, within a Keynesian framework characterized by the presence of fundamental uncertainty. While Vicarelli’s interpretation of Keynes is best understood in the context of the post-Keynesian literature, its relevance goes beyond that, as its sheds light on current issues related to the post-2008 financial crisis and its policy implications.

KEYWORDS:

• Accumulation
• Fausto Vicarelli
• John Maynard Keynes
• liquidity
• uncertainty

JEL CLASSIFICATIONS:

• B31
• E12
• E40

Acknowledgments

I would like to thank Claudio Gnesutta and the other organisers of the Seminar “Keynes nel Pensiero di Fausto Vicarelli”, Università Sapienza, Rome, November 25, 2016. I would also like to thank Pierluigi Ciocca, Nicoletta Ciocca, Giulio Cifarelli, and Giovanni Michelagnoli for providing me with useful reference and Carlo Cristiano and Annalisa Rosselli for their suggestions and comments. Finally, I would like to thank Enrico Babetto for his research assistance. Standard disclaimers apply.

Notes

¹For an overview of Vicarelli’s life and scientific contribution, see Ciocca et al. (1988), Gandolfo (1999), and Gnesutta (2001) among others. On the originality of Vicarelli’s approach see Gnesutta (1996, p. 76).

²On this, see Vicarelli (1974a; 1977a), Vicarelli (1980, p. 63), quoted by Garofalo and Gnesutta (2010, p. 124), Kregel (1983) and Marzano (1999, pp. 17–18) among others.

³For an introduction to the notion of liquidity in equity, see Burke and McCormack (2015) and CFA (2015) among many others.

⁴On this, see Michelagnoli (2013) among others and the literature cited therein.

⁵As Vicarelli (1974b) observes, the apparent absence of this problem in general equilibrium representations of the Keynesian model (e.g., Modigliani, 1944) is due to the lack of a clear distinction between autonomous investment and the demand for existing capital stock, a problem, which cannot be solved by introducing equity into the model, as Tobin and the Yale monetary school do.

⁶On Keynes’s theory of probability, see Roncaglia (2009) among others.

⁷As capital goods become indistinguishable from bonds, equality between the demand for and supply of money automatically guarantees equilibrium between the supply and demand of the other assets.

⁸For an overview and a critical review of Vicarelli’s book, see Kato (1988) and Jensen (1986).

⁹On the different notions of equilibrium in the context of Keynesian and post Keynesian models contemplating the presence of uncertainty see also Kregel (1976).

¹⁰On measuring liquidity in financial markets, see Sarr and Lybek (2002), among many others, and the literature cited therein.

¹¹In a more realistic setting, σ would depend on monetary conditions, via the impact of M on speculators’ margins and scarcity of capital. Moreover, a rise in speculative activity may positively reverberate on current and expected stock prices and on trading activity (see Mei, Scheinkman, and Xiong [2009], among the others, and the literature cited therein).

¹²In general, monetary conditions indices are index numbers calculated from a linear combination of domestic interest rates and the exchange rate. On the MCI computed by the European Commission, see http://ec.europa.eu/economy_finance/db_indicators/conditions/index_en.htm. On MCI in general, see Guender (2005) among others. In the context of the present model, the monetary condition index M combines the monetary policy stance, the state of liquidity preference and the confidence of the banking sector. Any change in one of these elements will influence the liquidity of traded securities and the level of investment and net exports.

¹³More generally, liquidity in equity will depend on the microstructure and regulation of security markets, on the balance between hedgers, fundamentalist speculators, noise-traders and liquidity traders and on how each of these agent types reacts to the difference between current and expected security prices.

¹⁴On the relationship between income distribution, saving and the finance-dominated accumulation regime, see Stockhammer (2009) and the literature cited therein.

¹⁵If N = a + bλ + cM + dσ, for example, the reduced-form relation between λ and K is as follows λ = (a + bM + cσ)/(K – b).

¹⁶An increase in volatility, on the other hand, may have a positive or negative effect on λ, depending on which type of agent prevails in the market, as briefly discussed above.

¹⁷It is important to observe that, ceteris paribus, the rise in M may be the result of monetary policy expansion, of a fall in liquidity preference or of a rise in the confidence of the banking sector. In all these cases, we expect interest rates to fall, credit to expand and turnover ratios to rise as well. Any concomitant rise in security prices will magnify these effects (financial accelerator).

¹⁸It may also have an impact on investment, through the influence of monetary conditions on equity prices.

¹⁹As liquidity and speculation increase, the investment function may bend backwards, altering the relationship with private savings and the external balance, as Keynes discusses in Section VI, Chapter 12 of the General Theory.

²⁰On both these aspects, see also Vicarelli (1974a, pp. 28–42).

²¹Although Vicarelli and Minsky interpreted Keynes along broadly similar lines, they seemed to differ on the role of the Treatise on Money in the context of Keynes’s evolving thought. Whereas Minsky emphasized the break between the Treatise, still steeped in the world of the quantity theory of money, and the General Theory, Vicarelli appeared to give more emphasis to the heterodox elements of the Treatise and to the continuity between Keynes’s two main analytical works.

²²In terms of the model set out above, we could introduce this effect by having the volatility index σ co-move with the monetary condition index M according to the following law of motion σ = σ(M), σ’(M) > 0, σ’’(M) > 0.

²³On money manager capitalism, see Whalen (2012), among many others, and the literature cited therein.

²⁴On this see Roncaglia (2010) and the literature cited therein.

²⁵On monetary policy and financial stability, see Smets (2013) among many others, and the literature cited therein. The role of financial institutions as liquidity providers that mitigate some financial frictions is not considered here for reasons of space. For an introduction to financial frictions, of the type analyzed by Bernanke, Gertler and Gilchrist (1999), in Dynamic Stochastic General Equilibrium models see Gertler (2009) and Gilchrist (2014) among many others.

Additional information

Notes on contributors

Paolo Paesani

Paolo Paesani is with the Dipartimento di Economia e Finanza, Università degli Studi di Roma “Tor Vergata”, in Rome, Italy.