Colin Rogers’ Money, Interest and Capital, Chapter 3

Chapter 3 of Colin Rogers’ Money, Interest and Capital (1989) deals with neo-Walrasian general equilibrium theory and the role of money in that theory.

Such general equilibrium models do not take the value of capital as a given quantity, but as an array of quantities (Rogers 1989: 45).

Neo-Walrasian models reduce to ones of perfect barter in which perfect knowledge, tâtonnement and recontracting are assumed to coordinate all economic activity before trade commences (Rogers 1989: 46).

Money as a unit of account is added without disrupting or changing any of the perfect barter conditions (Rogers 1989: 46). That is, money is an inessential addition to a real model in which perfect barter is assumed (Rogers 1989: 46).

An economic model that treats money as an unnecessary addition does not adequately describe real world monetary capitalist economies, especially the problems of a modern economy with a credit and banking system (Rogers 1989: 47).

The most sophisticated neo-Walrasian model is that of Arrow-Debreu, which abolishes any problems that arise in the real world from uncertainty or shifting expectations; the Arrow-Debreu model also collapses the future into the present (Rogers 1989: 48).

Alternatively, neo-Walrasian temporary equilibrium models relax the Arrow-Debreu assumption of a complete set of futures markets for all time-dated commodities, but still face the problem of expectations (Rogers 1989: 48–49).

The solution that was adopted by many neoclassical models was the Rational Expectation hypothesis, which assumes that agents correctly predict on average the equilibrium prices of the future (Rogers 1989: 49).

Thus neo-Walrasian temporary equilibrium models are functionally equivalent to Arrow-Debreu models, and once again reduce to models where money is an inessential addition (Rogers 1989: 49).

Rogers considers the neo-Walrasian equilibrium model of Hahn (1982), in order to compare it with Wicksellian monetary theory. In Hahn’s model, equilibrium does not generate an equality of interest rates between the two commodities produced in the model (Rogers 1989: 53). The peculiar feature of the neo-Walrasian interest rate theory is that it does distinguish profit from interest (Rogers 1989: 58).

In short, all neo-Walrasian models must be rejected as irrelevant to real world economies because they ultimately have no real role for money (Rogers 1989: 67).

BIBLIOGRAPHY
Hahn, Frank. 1982. “The Neo-Ricardians,” Cambridge Journal of Economics 6.4: 353–374.

Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory. Cambridge University Press, Cambridge.

Colin Rogers’ Money, Interest and Capital, Chapter 2

Chapter 2 of Colin Rogers’ Money, Interest and Capital deals with Wicksell’s monetary theory.

Wicksellian monetary theory was widely accepted in the period before Keynes’ General Theory, and indeed Keynes himself accepted the natural rate of interest in the Treatise on Money.

The real natural rate of interest lies at the heart of Wicksell’s version of loanable funds theory, and links Wicksell’s capital theory with his monetary theory (Rogers 1989: 22). Wicksell’s monetary theory was an attempt to extend the quantity theory to an economy with credit money and loans (Rogers 1989: 23).

Wicksell’s theory of capital was in turn developed from the work of Jevons and Böhm-Bawerk (Rogers 1989: 27).

The concept of capital can be divided into two ideas:

(1) real capital, or the physical goods themselves, e.g., machines, tools, or raw materials, or

(2) capital defined in terms of a sum of exchange value (or in monetary terms). (Rogers 1989: 27).

Real capital in sense (1) can be measured in technical units, but that would mean that there would be as many technical units as there are types of capital goods (Rogers 1989: 28).

But in order to calculate the rate of interest (the return on capital), capital has to be measured in monetary terms.

Rogers continues:

“Apart from pointing out the technical necessity of defining capital in value terms, Wicksell also suggests that it is necessary for theoretical reasons; namely, that in equilibrium the rate of interest must be the same on all capital. This condition is, of course, the classical condition of long-period equilibrium defined in terms of a uniform rate of return on all assets. It is the notion of equilibrium employed by Wicksell to define the natural rate of interest. To define such an equilibrium, however, capital must be treated as a mobile homogeneous entity so that it may move between sectors to equalize the rate of interest/profit. Capital defined as value capital (financial capital) can fulfil this role but capital defined in technical or quantity terms cannot.” (Rogers 1989: 28).

Wicksell consequently argued that all capital goods can be regarded as “saved up labour and land” (Rogers 1989: 29).

When the money rate of interest at which demand for investment credit and the monetary supply of savings is equal, there is a monetary equilibrium rate. And, when this monetary equilibrium rate is also equivalent to the expected yield on new capital, then the money rate of interest and the real Wicksellian natural rate of interest are equal (Rogers 1989: 39).

Rogers argues that the Cambridge capital critique applies to Wicksell’s theory of capital, and that it has proven that Wicksell’s natural rate of interest is untenable outside a purely abstract one-commodity world (Rogers 1989: 22).

Rogers reviews the Cambridge capital controversy (Rogers 1989: 30–39), and notes the problems with the aggregative (Wicksellian) neoclassical production function (Rogers 1989: 30–32).

In essence, the major issues raised by the Cambridge Capital controversy relevant here are as follows:

(1) the problems with the treatment of capital in the neoclassical production function Q = f(K,L), and the circularity involved in defining the quantity of capital K, when to determine K one needs to know the rate of interest, but to determine the rate of interest one needs to know the value of capital K (Rogers 1989: 31). The upshot is that K cannot be an exogenous variable in the production function.

(2) it is not possible, as noted above, to define the Wicksellian natural rate outside of a one commodity world (Rogers 1989: 32);

(3) the issue of reverse capital deepening, and

(4) capital reswitching (Rogers 1989: 32).

Rogers points to three modern neoclassical responses to the Cambridge capital controversy, as follows:

(1) those neoclassical economists who accept the critique and use an alternative neo-Walrasian analysis for general equilibrium theory that is not subject to the Cambridge capital critique, but that nevertheless has insolvable problems of its own (Rogers 1989: 34–35);

(2) those neoclassical economists who use a methodological defence of the neoclassical production function and Wicksellian general equilibrium theory applied to a one commodity world, which is supposed to be a useful pedagogical tool or “parable” teaching fundamental ideas of neoclassical interest theory, although it is untrue that such an unrealistic and empirically irrelevant model has any great lessons to teach (Rogers 1989: 34).

(3) those neoclassical economists who simply accept the neoclassical production function “on faith” (Rogers 1989: 33, n. 7).

Now the Classical loanable funds model of interest is supposed to relate how interest in a monetary economy still reflects the real forces of productivity and thrift (Rogers 1989: 40).

But in a monetary economy the act of saving money does not necessarily reflect real saving (Rogers 1989: 42).

The only viable model in which the Wicksellian neoclassical interest theory is possible is one which assumes a one commodity world where that single commodity can function either a capital good or a consumption good (Rogers 1989: 32, n. 6).

The natural rate can only be defined in a one commodity world, but not in a world with heterogeneous capital goods (Rogers 1989: 32, 43). The consequence is that only the monetary rate of interest in the loanable funds model is left after the untenable natural rate is cut out, and that the money rate of interest is cut free of the real forces of productivity and thrift (Rogers 1989: 43).

BIBLIOGRAPHY
Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory. Cambridge University Press, Cambridge.

Colin Rogers’ Money, Interest and Capital, Chapter 1

Colin Rogers’ Money, Interest and Capital: A Study in the Foundations of Monetary Theory (Cambridge, 1989) is a Post Keynesian study of monetary theory and a critique of neoclassical monetary and interest rate theory.

A quick summary of Chapter 1 follows in this post.

Rogers notes that the post-WWII neoclassical synthesis attempted to reconcile the theories of Wicksell and Walras with Keynes’ General Theory, but the result was either incoherent Wicksellian theory or a Walrasian theory that does not have a proper role for money (Rogers 1989: xvii).

In essence, modern neoclassical monetary theory is divided into two strands, as follows:

(1) Wicksellian/neo-Wicksellian general equilibrium theory, and

(2) neo-Walrasian general equilibrium theory.

The Wicksellian/neo-Wicksellian general equilibrium theory is subject to devastating problems through the Cambridge Capital critique, for Wicksell’s capital theory is the basis of his idea of the natural rate of interest, and once Wicksell’s capital theory is exploded, his natural rate of interest concept is also destroyed (Rogers 1989: 5).

Since the natural rate of interest is also the fundamental basis of classical loanable funds theory, the latter too must fall (Rogers 1989: 5), a point missed by economists who have interpreted Keynes’ work like Kohn (1986) and Leijonhufvud (1981).

Rogers (1989: 5) contends that neo-Walrasian models do not use the Wicksellian concept of capital, but are utterly flawed by the way they assume money away and effectively reduce to models of perfect barter (Rogers 1989: 5).

Various strands of neoclassical theory (even the neoclassical Keynesian tradition) draw on either the Wicksellian or neo-Walrasian traditions but both are equally flawed.

Neoclassical monetary theory, in all forms, is real analysis because non-monetary factors are what determine long-period equilibrium positions and money is reduced to a neutral veil in the long run (Rogers 1989: 4), and even if monetarists and neoclassical Keynesians are willing to recognise the short-run non-neutrality of money, they remain fixated on the unrealistic long-run implications of their general equilibrium models (Rogers 1989: 7).

Moreover, even credit money – the predominant form of money in modern economies – is reduced to having the same properties as commodity money in general equilibrium models (Rogers 1989: 4). This is a serious mistake, for credit is not a commodity and the Wicksellian natural rate of interest is worthless, except as a purely logical concept in an empirically irrelevant abstract model with one commodity (Rogers 1989: 10).

A genuine monetary theory, by contrast, sees money as fundamentally non-neutral, and real and monetary forces will determine any long period equilibrium positions (Rogers 1989: 4, 8).

The key is that the money rate of interest in a modern economy with credit money cannot be usefully explained by means of either classical or neoclassical theory (Rogers 1989: 9), and must be seen as an exogenous variable (Rogers 1989: 12).

Rogers (1989: 10–11) adopts Marshallian partial equilibrium analysis and what he calls a “monetary equilibrium” approach which describes the relationship between the rate of interest and the marginal efficiencies of all assets: in short, a “monetary equilibrium” is equality between the rate of interest and the marginal efficiency of capital (Rogers 1989: 11).

In this model, the long-term money rate of interest sets the rate of return to which other marginal efficiencies adjust in the long run, and the money rate of interest plays a significant role in the production of capital goods, and hence on aggregate investment and the level of employment (Rogers 1989: 12). Since in the market economy, there is no mechanism that will adjust the exogenous rate of interest to the right investment level to create effective demand and full employment, the rate of interest must be determined by government monetary policy (Rogers 1989: 13).

Rogers’ model is dependent on Keynes’ General Theory and Kregel (1983), but differs from other Post Keynesian models, and assumes an initial static equilibrium model in which short and long period expectations are realised (Rogers 1989: 14).

But one should note the problems even with Keynes’ analytical model – and by implication with Rogers’ own – that some Post Keynesians have identified:

(1) the marginal efficiency of capital (MEC) idea. Keynes, in developing the MEC, failed to free himself from the neoclassical marginal productivity of capital (King 2002: 209). As Joan Robinson notes,

“[sc. Keynes] made a fatal mistake in offering a quasi-long-period definition of the inducement to invest as the ‘marginal efficiency of capital’, that is, the profit that will be realised on the increment to the stock of capital that results from current investment and, still worse, identified the profitability of capital with its social utility. This was an element in the old doctrine from which he failed to escape. He had an alternative concept of the inducement to invest as the expected future return on sums of finance to be devoted to investment. Minsky (1976) points out that he did not seem to recognise the difference between the two formulations. If he had stuck to his short-period brief, he would have used only the second.” (Robinson 1979: 179–180).

The MEC seems to suggest that there exists a rate of interest which is low enough to induce full utilization of capital goods. But this is just smuggling in the Wicksellian natural rate of interest, when Keynes had wanted to abandon the natural rate.

A number of Post Keynesians reject the MEC, because it is based on the neoclassical or marginalist theory of distribution.

(2) Keynes did not sufficiently stress the role of uncertainty and expectations in undermining the coordinating role of interest rates (King 2002: 14). In Chapter 18 of the General Theory, Keynes played down the role of uncertainty (which he had stressed in Chapter 12) and, if he had really maintained the crucial role of uncertainty as he did later in Keynes (1937), this would have “ruled out any stable functional relationship between investment and the interest rate” (King 2002: 14). The door was thereby left open for neoclassical synthesis Keynesians to reformulate the General Theory as a general equilibrium model where the interest rate has a pivotal role (King 2002: 14).

It seems to me that one must read Rogers’ Money, Interest and Capital with these caveats in mind too.

BIBLIOGRAPHY
Keynes, J. M. 1937. “The General Theory of Employment,” Quarterly Journal of Economics 51: 209–223.

Kohn, M. G. 1986. “Monetary Analysis, the Equilibrium Method and Keynes’s General Theory,” Journal of Political Economy 94.6: 1191–1224.

Kregel, J. A. 1983. “Effective Demand: Origins and Development of the Notion,” in J. A. Kregel (ed.), Effective Demand and International Economic Relations. Macmillan, London. 50–68.

Leijonhufvud, Axel. 1981. “The Wicksell Connection: Variations on a Theme,” in Axel Leijonhufvud, Information and Coordination: Essays in Macroeconomic Theory. Oxford University Press, New York. 131–202.

Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory. Cambridge University Press, Cambridge.