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    Money and Economic Growth

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    Money and Economic Growth James Tobin Econometrica, Volume 33, Issue 4 (Oct., 1965), 671-684. Stable URL: hup:/Minks jstor-org/sici?sici=0012-9682%28196510%2933%3A4%3C671 S3AMAEG%3E2.0.CO%3B2-E, ‘Your use of the ISTOR archive indicates your acceptance of ISTOR’s Terms and Cooditions of Use, available at bbtp:/www.jstor.org/about/tenms.htnl. ISTOR’s Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the ISTOR archive only for your personal, non-commercial use. Each copy of any part ofa JSTOR transmi printed page of such transmission, jon must contain the same copyright notice that appears on the sereen or Econometrica is published by The Beonometie Society. Please contact the publisher for further permissions regarding the use of this work. Publisher contact information may be obtained at bbnp:/seww jstor.org/joumalsveconosoc html, Econometrica ©1965 The Econometric Society ISTOR and the JSTOR logo are trademarks of JSTOR, and are Registered in the U.S. Patent and Trademark Office. For more information on JSTOR contact jstor-info@unich.edu, ©2002 JSTOR, hup:thrww jstor.orgy ‘Tue Mar 19 16:13:23 2002 ECONOMETRICA ‘Vowuwe 33 October, 1965 Nuser 4 MONEY AND ECONOMIC GROWTH! By Janes Too 1p non-monetary neo-classical growth models, the equilibrium degree of capitat {tensity and correspondingly the equibrium marginal productivity of capital and sale of interest ate detcrained by “productivity 2nd thrift” Le, by technology and ‘saving behavior. Keynesian dificalties, associated with divergence between warranted and natural ates of growth, arse when capital intensity is [mite by the wowllingness ‘of investors to acquire capital at unattractively low rates of return. But why should the ‘community wish to sase when rates of return are coo unattractive to invest? Tks ean be rationalized only if there are stores of vale exher than capital, with whase rates of ewe the marginal productivity of eapital must compel. Te paper considers mone tary debt ofthe government as one alternative store of value and shows how enough ‘sa¥ing may be chanseled into this form to bring the warranted rate of groweh of capital own to the natural ate. Equilibrium capital intensity and interest rates arethen deter- ined by portfolio behavior and monetary factors as well as by saving behavior and (echology. In such an equlibrium, the real monetary debt grows at We natural rate lo, either by deficit spending ot by defistion. The ssbility af the equilibrium is aso considered 1, Tie PURPOSE of this paper is to discuss the rte of monetary factors in determain= g the degree of capital intensity of an economy. The models I shall use in discuss- ig this question are both aggregative and primitive. But I believe they serve to illuminate the basie points I wish to make. At any rate, [have taken the designation of this talk as a “lecture” as a license to émphasize exposition rather than novelty and sophistication. And my subject falls naturally and appropriately in the tradition of Irving Fisher of my own university. Fisher and Keyses, among others, have drawa the useful and froitful analytical Aistinction between choices affecting the disposition of income and choices affecting the disposition of wealth. The first set of choices determines how much is saved rather than consumed and how much wealth is accumulated, ‘The second sct determines in what forms savers hold their savings, old as well as new. Consider able economic discussion and controversy have concerned the respective res of these two kinds of behavior, and their interactions, in determining the rate of interest. 4 This s the Fisher Lecture that was aresented at the Joint European Conference af the Bcoa- ‘ometre Society and The Insitute of Management Sciences in Zicich, September 11, 1964 on on JAMES TOBIN 2. Most models of economic growth are nonmonetary. They offer no place for significant choices of the second kind~-portfolio choices. They admit only one type of asset that ean serve wealth ovmers as a store of value, namely reproducible capital. I is true that some of these models, particularly disaggregated variants, tmay allow savers and owners of wealth ta choose between different kinds or vine tages of eapital. But this is the only scope for portfolio choice they are permitted. Different questions arise when monetary assets are available to compete with ‘ownership of real goods. I shall proceed by reviewing how the intensity and yield ‘of capital are determined in a typical aggregative nonmonetary model of economic growth, and then indicating how their determination is modified by introducing monetary assets into the model. 3. In @ nonmometary model of growth and capital accumulation, so long as saving continues it necessarily takes the form of real investment. And so long as saving aud investment augment the capital stock faster than the effective supplies of other factors are growing, nothing prevents the yields on capital investment from being driven to zero or below. Of course, low or negative yields may cause people to reduce or discontinue their saving or even to consume capital. This classical reaction of saving to the interest rate may help to set an upper limit co capital deepening and a lower bound to the rate of return on capital. But clearly this kind of brake on investment causes no problems of underemployment and insufficiency of aggregate demand. Increased consumption automatically replaces investment, 4. [can illustrate in Figure 1 the manner in which saving behavior determines capital intensity and the rate of interest in a nonmonetary growth model, (Por the basic construction af the diagram 1 am indebted to my Yale colleague, John Fei, but he is not responsible for my present use of i In Figure 1 the horizontal axis measures capital intensity &, the quantity of capital (measured in physicsl units of output) per efletive manhour of labor. ‘The significance of the term “effective" isto allow for improvements in the quality of labor inputs duc to “labor-augmenting” technological progress. Thus, if a 1964 mantiour is equivalent as input in the production function to two manhours in the base period, say 1920, then k measures the amount of capital per man half- hour 1968 or per manhour 1930. ‘The vertical axis measures various annual rates. Curve AA" represents y, the average annual product of capital Since output and capital are measured in the same physical unis, this variable has the dimension, pure number per year. It is the reciprocal ofthe famous capital-outut ratio. In accordance with usual assumptions about the production function, ys shown to decline as capital intensity becomes deeper. Curve MAY” represents the corresponding marginal product of capital, In MONEY AND ECONOMIC GROWTH. 613 Figure 1 this becomes zero or negative for sulficiently intense use of capital. There are, of course, some technologies—Cobb-Douglas, for example—ia which this ‘cannot occur. average product of cata sroguires® rate ofretmen 3 marginal pret Tanase Stero R, Treapial reas Fioune 1 For present purposes it will be convenient to regard the average product y, shown by 44’, and the corresponding masgival product of capital ALM’, a cefer= ring to outputnet of depreciation. If depreciation is a constant proportion 8 of the capital stock, the average grass product of capital would simply be 3-+4, and the marginal gross product. would likewise be uniformly higher than MM” by the constant 5 Even aficr this allowance for depreciation, the yield on durable capital relevant to an investment-saving decision is not always identical with the marginal product ‘of capital at the time of the decision. The two will be identical if the marginal product is expected to cemain constant over the lifetime of the new capital. But if it is expected to change because of future innovations o because of future capital & deepening or capital “shallowing” in the economy, the relevant marginal eficiency or, JANES TORN of current new investment is a weighted average of future marginal products, T shall, however, ignore this distinction in what follows and use the marginal product in Figure 1 as at least an indicator of the true rate of return on capital. For the ‘most part I shall be concerned with equilibrium situations where the two are stationary and therefore identical A curve like S, 5; reflects saving behavior. It tells the amount of net saving and investment per year, per unit of the existing capital stock. Therefore it tells how fast the capital stock is growing, In Harrod’s terminology, this is the “war- ranted rate of growth” of the capital stock. The particular curve $, 5S; is drawn so that its height is always the same proportion ofthe height of A, 4;. This represents the common assumption that net saving is proportional to net output. ‘The effective labor force, in manhours, is assumed to grow at a constant rate n, independent of the dessee of capital intensity. The “natural rate of growth” » depends on the natural increase in the labor foree and on the advance of labor- augmenting technology. This conventional growth-model assumption is indicated ‘in Figure I by the horizontal fine WN‘, 5. So much for the mechanics of Figure 1. Now what determines the develop- ‘ment and ultimate equilibrium value, if any, of capital intensity? A rate of growth ‘of capital equal to will just keep capital intensity constant. If the “warranted” rate of growth of capital exceeds the “natural” rate of growth of labor m, then capital deepening will occur. If capital grows more slowly than Jabor, & will decline. ‘These facts are indicated in the diagram by the arrows in curve S11. With the saving behavior assumed in S, S;, the equilibrium capital intensity isk, ‘The corresponding stationary marginal product is Af,. To emphasize the point suggested above, M, in the diagram is negative. A different kind of saving behavior is depioted by 5S;. Here the ratio of net investment to output declines with k. This decline could be the result of one or both of two factors which have played a r6le in the thcory of saving. One factor is that capital deepening lowers the yield on saving and therefore increases the Propensity to consume. The other is that capital deepening implies an increase in ‘wealth relative to current income; according to some theories of consumption, this should diminish the saving ratio quite apart from any accompanying decline in the rate of retura. With saving behavior S$, $5, the ultimate equilibrium has a capital intensity kz and a marginal product M;. 6. The theory of interest sketched in Section 5 is classical. The rate of return on capital, in long-run equilibrium, is the result of the interaction of “productivity” and “theift,” or of technology and time preference. To dramatize the conflict of this theory and monetary theories of interest, I shall begin with an extreme case— so extreme that the crucial monetary factor is not even specified explicitly. Some growth models assume a lower limit on the marginal product of capital [MONEY AND ECONOMIC GROWTH os ‘of quite a diferent kind from the limit that thrift imposed in Section . Harrod, for example, argues that investors will simply not undertake new investment unless ‘they expect to receive a certain minimum rate of return. Savers, om the other hand, are not discouraged from trying to save when yields fall to or below this minimum. The result is an impasse which leads to Keynesian difficulties of deficient demand and unemployment. In Harrod's model these difficulties arise wheu the warranted rate of growth at the minimum required rate of profit exceeds the natural rate," ‘Tho rate of saving from full employment output would cause capital to accumulate faster than the labor force is growing. Consequently, the marginal product of capital would fall and push the rate of return on investraent below the required minimum. Tn Figure }, suppose HH to be the required minimum. Then, correspondingly, 4 is the maximum capital intensity investors will olerate. Yet the saving behavior depicted in the diagram would, if it were actually realized, push marginal product toward Mf, and capital intensity toward k, given saving behavior S,S! (or My and fa, given saving behavior S$). It is this excess of ex ante S over I which aives rise to the Keynesian difficulties ‘The opposite problem would arise if there were a maxinuvt return om investment below the equilibrium retum (M, oF M;) to Which saving bebavior by itself would lead. At this maximum, the warranted rate of growth would fall short of the, natural rate. So long as actual yields on investment exceeded the critical maximum, investment demand would be indefinitely large. In any event it would exceed saving. ‘The consequences of this impasse in Harrod’s model are less clear than the ‘events that follow the deflationary or Keynesian impasse. At this stage the two cases lose their symmetry, though it is possible for output to fall short of the technologically feasible, when ex ante investment is less than ax ante saving, it is not possible for output to surpass its technological limits in the opposite case. Presumably an excess of ex ante ivestment is an “inflationary gap,” and its main ‘consequence is a price inllation which somehow=-for example, through forced saving—climinates the discrepancy. But this only makes the point that monetary assets had better be introduced explicitly. For it is scarcely possible to talk about inflation im a nonmonetary model where there is no price level to inflate. 7. Lhave spoken of Harrod's model, but I have the impression that the concept of a required rate of profit plays a key réle in other theories of growth, notably those of Mrs. Robinson and Mr. Kaldor. Indeed I understand one of the key characteristics of theit models--one of the reasons their authors consider them “Keynesian” growth models in distinction to classical models of the type sketched in Section 3 above—is that they separate the investment decision from saving behavior. A minimal rate of return on capital (a required rate of profit) cannot exist in a vacuum, however. It must reflect the competition of other channels for the place- 6 SAMEES TOBIN. _» ment of saving. For a small open economy, a controlling competitive rate might be set by the yield available on investment abroad, This would, however, leave uae ‘explained the existence of such a limit for a clased economy, whether a national ‘economy ot the world as a whole. In any case the growth models under discussion are closed economy models. Ina closed economy clearly the important alternative stores of value are mone- tary assets. Te is theic yields which set limits on the acceptable rates of return on real capital and on the acceptable degree of capital intensity. To understand these limits, both how they are determined and how they may be altered, itis necessary to introduce monetary assets into the model explicitly. Tt is necessary to examine the choices of savers and wealth owners betwoen these assets and real capital. continue, T remind you, to make the useful distinction between saving-consurap- tion choices, on the one hand, and portfolio choices on the other. The choices I at about to discuss are portfolio choices; that i, they concern the forms of saving and wealth rather than their total amounts. 8. The simplest way to introduce monetary factors is to imagine that there is a ~ single monetary asset with the following properties: (@) ILis supplied only by the central government. This means that it represents neither a commodity praduced by the economy nor the debts of private individuals or institutions (&) Itis the moans of payment, the medium of exchange, of the economy. Aad it is a store of value by reason of its general acceptability in the discharge of public, and private transactions. (© Its own-yield (.¢., the amount of the asset that is earned by holding a unit of the asset a given period of time) is arbitrarily fixed by the poverament. This may, of course, be zero but is not necessarily 50, Furthermore, it will be convenient for expository reasons to introduce money in two stages, avoiding in the first stage the complications of a variable value of money, a variable price level. Suppose, to begin with, that the value of money in teoms of goods is fixed. The community's wealth now has two components: the real goods accumulated through past real investment and fiduciary or paper “goods” manufactured by the government from thin air. Of course the nom-humaa ‘wealth of such a nation “really” consists only ofits tausible capital. Bur, as viewed by the inhabitants of the nation individually, wealth exceeds the tangible capital > stock by the size of what we might term the fiduciary issue, This is an illusion, but ‘only one of the many fallacies of composition which are basic to any economy or any society. The illusion can be maintained unimpaired s0 long as the society does mot actually try to convert all ofits paper wealth into goods. 9. The simplest kind of twonasset portfolia behavior is the following: IT the yields of te two assets differ, wealth owners will wish to place all of their wealth MONEY AND ECONOMIC GROWTH. on in the asset with the higher yield. Ifthey are the same, wealth owners do not eare in what proportions they divide their wealth between the two assets. Evidently, if there ate positive supplies of both assets, they ean be willingly held in portfolios only ifthe two yields are equal, On this assumption about portfolio behavior, itis easy to see how the institutionally determined rate of inferest on money contrals the yield of capital. In particular, itis this rate of interest which isthe minimal rate of profit that leads to the deflationary impasse discussed in Section 6 above, At the same time, we can sec two ways in which goverament policy can avoid this impasse. Returning to Figure 1, suppose that #27 is the yield on money and therefore the minimal yield acceptable to awners of capital. The corresponding. capital intensity is fy. One measure the government could take is to reduce the yield on money, say to M,. Such a reduction might—and in Figure | itdoes—entail ‘negative rate of interest on money, reminiscent ofthe “stamped money” proposals of Silvio Gesell. Manipulation of interest rates on monetary assets within more ‘normal limits is in more realistically complex models, accomplished by the usual instruments of eentral banking. Alternatively, the government could channel part of the community's excessive shrift into increased holdings of money. Thus, let us now interpret S, S; to measure, the amount by which the public wishes to increase its taal wealth relative to its existing holdings of capital. This leads to the Harrod impasse if all the saving saust take the form of capital. But if only part of it goes into capital accuraulation, if in particalar the rate of increase of the capital stock can be lowered to 5,55, then all will be well. Equilibrium capital intensity will be ky, consistent with ‘maintaining the marginal product of capital atthe required Jevel HH. This can be done if the government provides new moncy to absorb the saving represented by the diforence between SS; and $55 ‘The only way for the government to achieve this is continuously to run a deficit financed by issue of new money. The deficit must be of the proper size, as can be Saving per wat of expt ae ‘igsabie ncore per oni af epi —= Prone 2 618 + JAMES TORIN’ illustrated by Figure 2. Here saving is measured vertically, and output and income horizontally. Bath are measured in proportion to the capital stock, as in Figure 1. ‘qs the output per unit of capital corresponding to the required equilibrium capital intensity ky. Government purchases of goods and services are assumed to be & fraction g of output. Consequently, yy(1—g) is output available for private use, and if the budget is balanced it is also the disposable income of the population. Taking S; S; as the funetion relating saving to disposable income, Sy is the amount of private saving, (relative to the eapital stock) when the budact is balanced. By assumption, however, this is too much investment—it causes the warranted rate to exceed the natural rate. Now n is the natural rate of growth; itis therefore the “right” amount of investment relative to the eapital stock. A deficit of dy (pet unit of capital) will do the trick. Te increases disposable income to yy(1—2)+dus and this raises total saving to Si. But of this, dy is acquisition of government debt, Jeaving only r for new tangible investment. ‘The arithmetic is simple enough: Since QM S=sfy(l-g)+d]=d+n, @ a _alew=ny 5 ives the required deficit as a fraction of income. On these assumptions about portfotio choice, the size of the government debt, here idemtical to the stock of money,

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