Patinkin’s monetary theory

165

represents individual experiments: it shows how desired cash balances depend
on the inverse of the price level, the total of actual nominal cash balances being
one of the magnitudes held constant.

PATINKIN ON CLASSICAL INTEREST RATE THEORY
Patinkin argues that classical and neoclassical writers held that the interest rate
is invariant with respect to changes in the money supply under the conditions
necessary for the quantity theory to hold. They recognized, for example, that
the increase in the money supply would have to be distributed among people
in proportion to their initial holdings (Patinkin, 1965; pp. 45, 164, 371). They
understood the interdependence among markets. An increase in the money
supply would cause an increase in the demand for commodities and bonds,
temporarily depressing the interest rate. As the price level increased so would
the demand for loans (supply of bonds), causing the interest rate to return to its
initial equilibrium level. (Pages above discuss this process in detail.)
Patinkin (1965, p. 371) mentions that these writers recognized one exception,
‘forced savings’, that involves distribution effects. In this case, a rise in the
money supply accrues mainly to entrepreneurs, who increase investment in
capital goods. The resulting rise in the price level causes the necessary decrease
in consumption, that is, ‘forced savings’. Furthermore, the increased capital
stock lowers its marginal productivity and hence depresses the equilibrium rate
of interest.
Patinkin (1965, pp. 371–2) argues that since classical and neoclassical writers
recognized the foregoing exception, they probably would have acknowledged
that a change in liquidity preference or open-market operations could also alter
the equilibrium rate. However, he (1965, p. 380) suggests that the following
hypothesis would represent their views:
Variations in the average long-term rate of interest...have originated primarily in technological changes which have affected the marginal productivity of capital, and in
time-preference changes which have affected the desire to save; they have not
originated primarily – or even significantly – in changes in the quantity of money or
shifts in liquidity preference.

Figure 5.6 shows how an increase in thrift can lower the equilibrium rate,
while Figure 5.10 illustrates how an increase in the productivity of capital can
raise it. Figures 5.7, 5.8, and 5.9 illuminate the different ways a change in
liquidity preference can affect the equilibrium rate of interest. An open-market
purchase by the monetary authority would increase the relative scarcity of
bonds, raising their price and lowering the interest rate.

the distribution effects associated with a one-shot change in money would tend. the same as they would otherwise be. broadly interpreted. we cannot suppose neutrality with respect to money’s very existence. Different growth rates entail different rates of rise (or fall) of prices. and different total real quantities of money in existence.5 If we take seriously the tremendous services of money reviewed in Chapter 2. it focuses on the interdependence of markets and the mutual determination of the rate. Patinkin’s contention is a curious slip in an otherwise impressive work of sustained analysis. as argued by Archibald and Lipsey (1958). different costs (or rewards) of holding real money balances. all quantities and relative prices. p. different real money supplies entail different real sizes of other magnitudes . a one-time increase in the nominal money supply could come by way of donations to holders in proportion to their existing holdings. 75) argues that mere conversion of a barter economy to one with money would not affect the real general equilibrium.166 Monetary theory Chapter 10 views the interest rate. that is what the strict quantity theory maintains. We can conceive of money’s being neutral. to become vanishingly small over time. Patinkin argues that we can get as close as we want to a barter economy while preserving the neutrality of money. the difference is the momentous qualitative one of whether money exists and functions at all. In the long run. Building on the discussions in Chapter 2. ‘Thus the limiting position that we have defined as a barter economy is one in which there exists the same real quantity of money as in a money economy!’ Actually. with regard to its nominal quantity. Even in the absence of such proportionality. BARTER AND NEUTRALITY Patinkin (1965. leaving the real equilibrium unaffected. The equilibrium values of relative prices and the interest rate remain unchanged as the quantity of money approaches zero as a limit. the difference between the two economies is no mere quantitative one concerning levels of prices and sizes of money supplies. Less plausible is neutrality with respect to money’s nominal growth rate. relative to other influences. as primarily a real phenomenon. leaving the real quantity of money unchanged. introduction of money would be ‘neutral’ – neutral in the sense of leaving all realities. MONEY. Patinkin conceives of a barter economy ‘as the limiting position of a money economy whose nominal quantity of money is made smaller and smaller’. neutrality would still hold. This proportionality would avoid the distribution effects whose absence strict neutrality presupposes. In this case. Yet he senses a flaw in his own argument: as the nominal quantity of money approaches zero. so does the price level. By the principle of general interdependence.

presupposes continuing changes in the money supply in an utterly implausible and pointless manner. his analysis. continuing increases in the money supply would have to come by way of donations to holders in proportion to their existing holdings. the quantity theory concept. determines the stream of spending and nominal income. is downright wrong. together with the demand for cash balances. The real world exhibits disequilibrium. the money supply. reality does not strictly satisfy the conditions necessary for the exact quantity theory result.Patinkin’s monetary theory 167 also. not the general equilibrium of Patinkin’s book. Patinkin departs from his focus on general equilibrium when he discusses involuntary unemployment in Chapters 13 and 14. thereby just canceling the price-inflation disincentive to the holding of real balances and also avoiding distribution effects. The second. He distinguishes between ‘output’ and ‘supply’ in Chapter 13 . In that case. superneutrality. On the other hand. Patinkin explains the conditions necessary for the latter version. especially of the real-balance effect. His diagrammatic apparatus can be applied and extended in illuminating ways (see pages 212–15 below). denying any real difference between barter and monetary economies. NOTES 1. contributes greatly to understanding the real world. is the most nearly plausible of the three. Yet a far-fetched case is conceivable after all in which neutrality – socalled ‘superneutrality’ – would hold even with regard to money’s growth rate. Nevertheless. Changes in the money supply affect output quantities and relative prices as well as the price level. with excess demands in some sectors matching excess supplies in others. monetary disorder can pose disturbances unknown to a barter economy. We have now considered three imaginable types of neutrality. Adjustment of barter prices to market-clearing levels is more difficult than adjustment of money prices. as we know. The third. The rigid or strict theory goes on to assert an exact proportionality between the nominal money supply and the price level. CONCLUSION According to a broad or loose version of the quantity theory. While the aggregate of excess demands for all goods and services must be zero. Money existing in a ‘correct’ or adequate quantity could lessen the effects of nonmonetary disorders by providing a kind of cushion as described on pages 109–11 above. these sectoral imbalances still could entail overall unemployment. A barter economy might get stuck away from full employment at disequilibrium relative prices. The first concept. conditions not fully met in reality. as explained in our next chapter. Yet.

commodity demand and supply functions having the supposed property that quantities demanded and supplied are unaffected by an equiproportionate change in money prices – given the money supply. 3. Homogeneous functions of degree 1. Patinkin (1989) further elaborates on his disequilibrium approach to macroeconomics. Monetary theory (see pages above).168 2. namely. he refers to particular zero-degree functions. which also include services as mentioned above. Wonnacott (1958) makes this criticism of Patinkin. A homogeneous function of degree zero has its value unaffected by an equiproportionate change in its independent variables. If f(kx. A simple example is the identity saying that real income equals nominal income divided by the price index: doubling both nominal income and prices leaves real income unchanged. We prefer getting rid of a separate labor market by aggregating labor with commodities. Looking up Mill (1848 [1965].y). 4. 653–8) is well worth the trouble. pp. The standard example is a production function exhibiting constant returns to scale: an equiproportionate change in the quantities of all inputs changes output in the same proportion. Patinkin avoids explicitly considering labor by assuming enough flexibility of nominal and real wage rates to keep its market always in equilibrium. In mathematics a function is said to be homogeneous of degree n if multiplying each of its independent variables by a positive constant k makes its value kn times its original value. also called linear homogeneous functions. are familiar in economics. abridged’. When Patinkin refutes the ‘homogeneity postulate’. 5. ky) = knf(x. In his ‘Introduction to second edition. . then the function is homogeneous of nth degree.

New Keynesians address this issue by realistically assuming imperfect competition in their models.6. and elsewhere). A second is the so-called ‘Austrian theory of the business cycle’. however. It recognizes that most markets are not and cannot be perfectly competitive. selection 1. When monetary disequilibrium occurs. Disequilibrium economics (1) THE MONETARY-DISEQUILIBRIUM HYPOTHESIS Among theories of macroeconomic fluctuations that accord a major role to money. It is a response to criticisms lodged by new classical economists that Keynesian economics lacks rigorous microeconomic foundations because it simply assumes prices and wages are rigid. as in Blinder 169 . which we review in the next section. A third is part of the ‘new classical macroeconomics’. NEW KEYNESIAN ECONOMICS New Keynesian economics contributes to our understanding of why prices and wages are sticky. Instead of adjusting rapidly. One is orthodox monetarism – ‘the monetary disequilibrium hypothesis’. so adjustment in the short run involves quantities rather than prices alone. prices and wages are ‘sticky’. No single new Keynesian theory exists. It shares some strands with new Keynesian economics. as Warburton has called it (1966. Some new Keynesians even complain about too many theories. many compete for attention. not takers as in the perfectly competitive model. Rather. This latter hypothesis consists of two strands: the theory of misperceptions in which money does have a role to play. Agents are wage-and-price setters. ‘things begin to happen’ that tend eventually to restore equilibrium. at least three rivals have confronted each other. Theories emphasizing an infectious failure of markets to clear have been criticized by adherents of the new classical macroeconomics. What monetarism offers toward understanding and perhaps improving the world becomes clearer when one compares it with its rivals. which features two main hypotheses: ‘rational expectations’ and ‘equilibrium always’ (also known as continuous market-clearing or the Walrasian generalequilibrium model). Yet a microeconomic rationale of disequilibrium behavior is available and will be presented here. and real business cycle theory.