Thursday, September 27, 2012
Chapter 14: The Classical Theory of the Rate of Interest
Check Marshall, Cassel, Carver, Flux, Taussig, Walras: I(r) = S(r)
“Self-regulatory process of adjustment which takes place without the necessity for
any special intervention or grandmotherly care on the part of the monetary
“Unlike the neo-classical school, who believe that saving and investment can be
actually unequal, the classical school proper has accepted the view that they are
equal.” (Is Marshall classical or neoclassical?)
If Y is assumed given, does r equate I and S and is the classical view reasonable?
How does Keynes characterize the assumption that I and/or S can shift with no
effect on Y?
How could they save their story using an automatic change in the wage-unit?
What’s going on in the diagram? (Which would we typically put on the vertical axis,
r or I?) What are the X and Y curves?
Do shifts in these curves cause changes in r? Where does r come from?
Given r and
given I, do we know which Y-curve must come to be? Why or why not? “The wild
duck...” (From Ibsen play of that title.)
Appendix to Chapter 14: Appendix on the Rate of Interest in Marshall’s “Principles of
Economics,” Ricardo’s “Principles of Political Economy,” and elsewhere
Please skip. X: investment curve
higher interest rate, the less investment
higher interest rate, the more saving
with income given, changes in r have effect on saving but the main determinant of
saving is the level of income and its not enough to know level of r
but if there is change of savings curve: you are lost, not enough information to know
Chapter 15: The Psychological and Business Incentives to Liquidity
(Business can’t by psychological?)
What is the income-velocity of money?
Speed at which money changes hands
What did the “quantity theory of money” say? (MV=Py) Where does the demand for money come from? (Doesn’t everyone have an infinite
demand for money?)
Where monetary management can have its effect. Why?
Speculative-motive “shows a continuous response to gradual changes in the rate of
interest.” Banking system can usually always buy or sell bonds for money. Why is
Distinguish changes in r resulting from ΔM vs. ΔL. (Open market operations can
work through both. How?)
ΔL can be discontinuous, causing discontinuous Δr. If everyone reacts to news in
same way, r will change without need for trading; if differently, r and M will both
M = M 1 M2 = L (1) + L (2)
i. Relation of ΔM to Y and r. How does M change? Gold-mining? Printing money?
Either way, Y rises. Does income-motive absorb all the new M?
ii.1 (Y) = Y/V = M1. In short run, V more or less constant.
iii. M2 does not depend on absolute level of r but on “what is considered a fairly
safe level of r.” Explain. How does a declining r increase the riskiness of
illiquidity? Increases likelihood of capital loss
“It is evident, then, that the rate of interest is a highly psychological phenomenon.”
Monetary policy can fail if it is seen as experimental: M2 can “increase almost
without limit in response to a reduction of r below a certain figure.”
r “highly conventional ...phenomenon.” Actual value largely governed by prevailing
view of its expected value. It may fluctuate for decades above level consistent with full
employment (emphasis supplied).
Conventional: we know what r should be
“The difficulties …”- Gradually getting the public used to the idea of lower rates is possible, however:
Britain after leaving gold.
If central bank bought and sold all types of securities it would influence the whole
complex of r’s. Mainly only influences short end.
Limitations on monetary authority’s influence: