Wednesday, June 30, 2010

The Utility of Money in Post Keynesianism

In the previous post, I described money as a possible factor of production, and I have also realised that the discussion of value there raises the question whether money has utility.

In its role as a medium of exchange, money functions as an intermediary unit of account (or numéraire) that facilitates the exchange of goods and services. From this derives the idea that money only has utility through its exchange value, a view which is held by the Austrians and neoclassicals. As the American neoclassical F. W. Taussig argued,
[t]he phrase “marginal utility of money” must … be used with caution. Money has utility in a different way from other things. It is valued not because it serves in itself to satisfy wants, but as a medium of exchange, having purchasing power over other things. Gold jewelry is subject to the law of diminishing utility precisely as other things are. But gold coin—money—is subject to it only in the sense that an individual buys first the things he prizes most, and then other things in the order of their less utility (Taussig 1911: 124).
Writing in 1911, Taussig here refers to commodity money (although it would appear that other neoclassicals admitted that commodity money like gold had utility in itself, but perhaps this is another issue).

But Post Keynesian economics shows us that money (even fiat money) does have utility:
In an uncertain world, the possession of money and other nonproducible liquid assets provides utility by protecting the holder from fear of being unable to meet future liabilities (Davidson 2003: 236).
The neoclassicals thought that only producible goods and services can provide utility. But money can have utility on its own account. So can liquid financial assets. The neoclassical view was that money has no utility, but only exchange value. The Austrian view also seems to be that money has no utility except for what can obtained in exchange for it. The idea that money has no utility in itself is part of the three fundamental neoclassical axioms that Keynes rejected. The following three fundamental axioms are the basis of neoclassical economics and of Say’s law:
(1) the neutral money axiom (i.e., holding money by itself provides no utility),
(2) the gross substitution axiom, and
(3) the ergodic axiom.
Post Keynesian economics requires the rejection of these axioms. In a fundamentally uncertain world, you have the problem of facing a possible lack of liquidity in the future (i.e., lack of money). This is why many people like to hold onto money, and precisely why money has utility – and in fact often has a great deal of utility.

In Keynes’ General Theory, an essential property of liquid assets (money being the most liquid asset) is that their “elasticity of production” is near or equal to zero. To say that financial assets and money have “a zero elasticity of production” means that commodity-producing businesses cannot engage in production of money or financial assets by hiring labour. If demand for liquidity in an economy increases, then producers of commodities cannot “produce” liquid assets by hiring workers. When the demand for non-reproducible assets as a “store” for money rises, this can induce unemployment. If there are assets in which money can be saved other than reproducible goods, then full equilibrium will not necessarily happen in a market economy: investment will not be sufficient to achieve full employment. This is why, even if wages and prices were perfectly flexible, we could still have involuntary unemployment.


Davidson, P. 2003. “Keynes’ General Theory,” in J. E. King, Elgar Companion to Post Keynesian Economics, Edward Elgar Publishing, Cheltenham, UK and Northampton, MA. 229–237.

Patinkin, D. and Steiger, O. 1989. “In Search of the ‘Veil of Money’ and the ‘Neutrality of Money’: A Note on the Origin of Terms,” Scandinavian Journal of Economics 91.1: 131–146.

Taussig, F. W. 1911. Principles of Economics, Volume 1. Macmillan Company, New York.

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