The Treatise on Money

Various writings on the relationship between monetary phenomena and short-period production levels within the framework of the Marshallian approach were already available in the six years during which Keynes wrote his Treatise on Money (1930).[1] On many counts, the Treatise, too, belonged to this tradition; on other counts, it showed innovative elements constituting a bridge to the radical novelties of the General Theory.

Keynes avoided head-on criticism of the theoretical nucleus of the marginalist tradition, consisting of the idea of a long run equilibrium characterised by full employment of resources, labour included, and by the neutrality of money (that is, by the idea that the quantity of money in circulation affects the level of prices but not the ‘real’ variables of the system, such as production and employment levels). This view of the long period thus remained in the background. As far as the monetary and financial sector was concerned, the Treatise took up and developed the Marshallian critique of the quantity theory of money, focussing attention on the demand for liquid stocks rather than the velocity of circulation. The most interesting novelties of the Treatise concerned the connections between monetary- financial and real aspects: following the Marshallian method of short causal chains, Keynes set out to locate, link by link, the cause-and-effect connections in the interrelations between changes in prices and in produced quantities within a monetary economy in perennial movement.

In his analysis of the real side of the economy Keynes utilised a two-sector scheme: one sector produces investment goods, the other consumption goods. Keynes showed that it is not possible to attribute analytical rigour to the notion of a general level of prices: a diffidence towards aggregate notions typical of the Marshallian tradition, which should be borne in mind when confronted with interpretations of

Keynes’s theory based on the opposition between his (assumed) aggregate ‘macro’ analysis and a disaggregated ‘micro’ one, which would remain the foundation of economic theory.

The fundamental equations of the Treatise express the relations between prices and demand and supply levels in the two sectors, pointing to the elements that may cause prices to diverge from their equilibrium levels. Keynes considered a sequential scheme that connects production levels and realised profits, utilising notions of income, profits and savings at variance with those normally utilised in modern national accounting and with those that he himself was to utilise in the General Theory. At the centre of the analysis - as in the General Theory - there was the distinction between investments and savings. Insofar as they are an effect of the decisions of two different groups of economic agents (entrepreneurs and families), investments and savings may differ; their difference determines disequilibria between demand and supply in the two sectors, with price changes that generate unforeseen profits or losses,[2] to which entrepreneurs react with changes in production and employment levels. Savings are assumed to be connected to wealth, hence to be relatively stable in the face of short period changes in income. Cyclical dynamics thus depends on the variability of investments. Given the scant influence of investments in inventories, Keynes focussed attention on investments in fixed capital, mainly dependent on long-run interest rates.

The Treatise illustrated the different channels of liquidity creation, decisions on holding financial assets and international monetary relations. Keynes stressed the desirability of an international monetary standard and in the place of gold proposed a currency issued by an international central bank constrained by the obligation to keep its value stable in terms of a basket of internationally tradable goods. In this context, characterised by fixed exchange rates, national monetary policies lose any autonomy; thus it becomes necessary to resort to fiscal policies, and in particular to public works, to support employment - another theme taken up in the General Theory.

  • [1] Let us recall here the books by Dennis Robertson (1890-1963), A Study of IndustrialFluctuations (1915) and Banking Policy and the Price Level (1926); by Ralph Hawtrey(1879-1975), Currency and Credit (1919); and by Pigou, Industrial Fluctuations (1927).
  • [2] In the Treatise terminology, profits corresponded exclusively to such unforeseen gains orlosses and were not included in the definition of income. However, interest on capitaladvanced, usually included in the category of entrepreneurial income, was considered aspart of production costs and included in income.
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