Chapter12 TheNeoclassicalSchool MonetaryEconomics JOHNGUSTAVKNUTWICKSELLIRVINGFISHERRALPHGEORGEHAWTREY PriceLevelChangesImplicationforPublicPolicyForcedSavingWicksellonImperfectCompetitionElasticityofDemand 1 JOHNGUSTAVKNUTWICKSELL Whydopricescollectivelyriseorfall Toanswerthisquestion Wicksellturnedtoananalysisofinterestrates PriceLevelChanges Thenormalornaturalrateofinterestdependsonsupplyanddemandforrealcapitalthatisnotyetinvested Theinteractionofsupplyanddemanddeterminesthenaturalinterestrate Therateofinterestatwhichthedemandforloancapitalandthesupplyofsavingsexactlyagree andwhichmoreorlesscorrespondstotheexpectedyieldonthenewlycreatedcapital willthenbethenormalornaturalrate Thenormalornaturalrateofinterestappliesonlytocreditbetweenindividuals Bankscreatecredit theycanextendloansevenatverylowratesofinterest Thebankrateofinterestmaybeeitherlessthanorgreaterthanthenormalornaturalrateofinterest Wheneitherofthesetwosituationsoccurs thepricelevelwilleventuallychange Bankrate naturalratesaving thedemandforconsumptiongoodsandservices capitalinvestments income thepricesofconsumptiongoods Bankrate naturalratesaving thedemandforconsumptiongoodsandservices capitalinvestments income thepricesofconsumptiongoods Wicksell sanalysisofinterestratesandhispredilectionforreformledhimtoemphasizetheroleofgovernmentandthecentralbankinpromotingeconomicstability Theprincipalcauseofcyclicalfluctuations hesaid isthefactthattechnologicalandcommercialprogresshasnotmaintainedthesamerateofadvanceastheincreaseinneeds especiallyofanexpandingpopulation Wickselldidnotpursuetheserealcausesofbusinessfluctuationsingreatdepth Heinsteadfocusedhisattentiononthemonetarycauses Toeliminatethislattercause headvocatedthatbanksestablisharateofinterestthatneitherraisesnorlowerscommodityprices thebankrateofinterestjustequalsthenormalornaturalrateofinterest Wicksell sanalysisofinterestratesandhispredilectionforreformledhimtoemphasizetheroleofgovernmentandthecentralbankinpromotingeconomicstability InhisInterestandPrices publishedin1898 hebecamethefirsteconomisttoadvocatestabilizingwholesalepricesbycontrollingdiscountandinterestrates ImplicationforPublicPolicy Wickselldidnotpursuetheserealcausesofbusinessfluctuationsingreatdepth Heinsteadfocusedhisattentiononthemone tarycauses Toeliminatethislattercause headvocatedthatbanksestablisharateofinterestthatneitherraisesnorlowerscommodityprices thatis oneatwhichthebankrateofinterestjustequalsthenormalornaturalrateofinterest Wicksellfearedthatthegrowingproductionandstockofgoldwouldinflatecurrency thuscausinginterestratestofallandpricestorise Therefore thefreecoinageofgoldshouldbesuspended andtheworldshouldpassovertoaninternationalpaperstandard Indiscussingaggregatesavingandinvestment Wicksellanalyzedthetheoryofforcedsaving Thiswasnotanewidea Thisenforcedrestrictionwould infact constitutetherealaccumula x0002 tionofcapitalthatmustbeachievedifcapitalinvestmentistoincrease Therealsavingwhichisnecessaryfortheperiodofinvestmenttobeincreasedisinfactenforced atexactlytherightmoment onconsumersasawhole ForcedSaving Wicksellrecognizedtheinadequacyofthepurelycompetitivemodelinretailmarkets WicksellonImperfectCompetition Withrespecttoacompletemonopoly WicksellfollowedtheleadofCournotandothersbyindicatingthatthevolumeofsalesisartificiallyrestrictedtothepointthatyieldsmaximumprofits Everyriseinpricereducesthequantityofgoodsdemanded Fisher sTheoryofInterestTheQuantityTheoryofMoneyMonetaryPolicy 2 IRVINGFISHER Fisherperceivedtwofactorsinteractingtoestablishtheinterestrate theimpatiencerateandtheinvestmentopportunityrate Fisher sTheoryofInterest Theimpatiencerateistheextentofthecommunity swillingnesstoobtainpresentconsumption income bygivingupfutureconsumption income Unliketheimpatiencerate whichinvolvessubjectivevaluations theinvestmentopportunityrateisdeterminedbyrealfactorssuchasthequantityandqualityofresourcesandthestateoftechnology Thelesswesaveandinvestasasociety theloweristherelativevalueofpresentconsumption Fisher simpatiencerate andthehigheristhemarginalrateofreturnoninvestment Theequilibriuminterestratewilloccurwheretherateofreturnoninvestmentandtherateatwhichsocietyiswillingtotradeoffpresentforfutureconsumptionareequal Fishersawfivedeterminantsofthepurchasingpowerofmoney oritsinverse thepricelevel 1 thevolumeofcurrencyincirculation 2 itsvelocityofcirculation 3 thevolumeofbankdepositssubjecttocheck 4 itsvelocity and 5 thevolumeoftrade TheQuantityTheoryofMoney Fisher sequationofexchangeisshownasEquation MV M V PT AccordingtoFisher pricesvarydirectlywiththequantityofmoney MandM andthevelocityofcirculation VandV andvaryinverselywiththevolumeoftrade T Thefirstofthesethreerelationsisthemostimportant saidFisher becauseitconstitutesthequantitytheoryofmoney FisherassumedthatM thevolumeofdemanddeposits tendstoholdafixedrelationtoM thequantityofcurrencyincirculation thatis depositsarenormallyarelativelyfixed definitemultipleofcurrency Fisheralsohadtoassumethatthevelocityofcirculationandthevolumeoftradeareconstant Theincreasein