An Outline of the history of economic thought - Chapter 9 ppt

9 Contemporary Macroeconomic Theories 9.1. From the Golden Age to Stagflation During the dark years of the Second World War people were already beginning to discuss the bases on which the world economy could be rebuilt when the war was over. Between the First and Second World Wars, not only did Great Britain lose its position of economic leadership but the back- wardness of the whole of Europe became evident, while technology, capital, and organizational methods began to be massively imported from the United States. Thus the latter played a major role in determining the directions of reconstruction. There were three principal presuppositions on which the new period of prosperity was based: economic development as an instrument to solve distributive conflicts and to control Communism; European integra- tion as an insurance against the outbreak of another world war; and inter- national coordination as a condition for avoiding disruptive crises such as those of the interwar period. The Marshall Plan contributed decisively to the renewed industrial development of the European countries, pushing them towards economic collaboration, supplying the means for importing indispensable raw materials, resolving the ‘German question’ without creating problems of reparation payments and, finally , instilling in the Europeans the wish to imitate the American way of life. Also very important were the international monetary agreements concluded at Bretton Woods in 1944, with the foundation of the International Monetary Fund and the World Bank and the signing of GATT, mechanisms designed to co-ordinate monetary and commercial measures on the world scale. The great boom that followed was generalized, involving the old industrialized countries and some of the new, born from the process of decolonization. Naturally, those that had a solid industrial base were able to narrow the gap with the USA, giving rise to a real ‘economic miracle’; however, most countries which were emerging at that time from their colonial past enjoyed rather limited improvement, mainly dependent on the sale of raw materials on international markets. The push towards European integration turned out to be much more than a vague proposal: it led to the creation of the European Coal and Steel Community and later to the Common Market, and to all the other com- munity initiatives which gave life to the new European economy. The decline of the European economies was soon arrested, with important consequences for relations not only with the USA but also with Eastern Europe, which had remained largely outside the development process. These were the years of great exoduses of the labour force, from agric ul- ture to industry and from the countryside to the cities; years of great social and cultural transformations, such as the growth of urban areas, changes in consumption patterns and cultural models, increased population mobility, the large expansion in the number of cars, an d the achievement of a general rise in the standard of living. Trade union protests were limited, and this was partially due to the permanently high labour demand, which gave workers a strong opportunity to improve their economic position. Such a sustained, rapid, and widespread growth had never before been experienced. The war an d crises were rapidly forgotten; it seemed that there were no limits to economic expansion. When the first man landed on the moon in 1969, it seemed that any challenge could be met. Scientists and economists enjoyed enormous social prestige, and it seemed they could achieve anything that the human mind conceived. The golden age of the 1950s and 1960s was in fact short-lived. The land of Cocaigne, with its abundance and harmony, was not just around the corner. It was trade union protests which first brought governments back to the harsh reality of the class struggle and made them understand that there was still a fundamental co nflict, despite the rapid economic growth. Then serious disruptions in the international monetary system began to manifest them- selves; and the dollar, weakened by the costs of Vi etman War and by the strong growth in other industrialized countries, was no longer able to govern that system. At the beginning of the 1970s, the Gold Exchange Standard, as established at Bretton Woods, was abandoned, first by the devaluation of the dollar and then by the declaration of inconvertibility. As far as raw materials were concerned, the situation was also reaching boiling point. Growing realization of the exhaustibility of resources and the gradual increase in the autonomy of the producing countries led to inevitable price rises which noticeably altered the terms of trade, especially in regard to oil. In this case, the existence of a small number of producer countries favoured the creation of a strong (but not omnipotent) international cartel which helped to raise the price of oil by 400 per cent in 1973, and managed to maintain it at a high and rising level in the following years. Many countries suddenly found themselves with large balance- of-payments deficits, and had to resort to international loans and restrict- ive internal measures. Thus there was an increase in the foreign debt of many countries and, on the other hand, inflationary processes and restrictions in demand broke out. The growth rate of the world economy slowed down drastically. International co-ordination agencies showed to be incapable in dealing with the new problems. Despite a worldwide network of lenders of last resort at work, some dramatic bank collapses c ould not be avoided. There were serious stock 324 contemporary macroeconomic theory exchange crises which, however, did not cause the avalanche effects that had been seen on previous occasions; and this was largely due to the speed and wisdom of central-bank and government interventions. There were attempts at strengthening co-ordination and monitoring of the international economy, for example by means of the creation of the European Monetary System and by the conferences of the ‘Big Seven’ industrialized countries. On the other hand, many countries were experimenting with new forms of industrial relations. In general, throughout the 1970s and 1980s the international scene was characterized by strong uncerta inty and instability, and this made it difficult for governments to co-ordinate and programme long-term economic policies and for large companies to formulate coherent development plans. The latter were being forced to find new organizational modules so as to make their production flows more flexible and better adapted to the consumption patterns of their customers. This process led to the construction of a network of linked companies which function in a much more complicated way than has ever been seen in the past. Finally, growing concerns about environmental issues, especially about pollution caused by the extension of mass industrial production, have added new demands for a rethink of the development model which dominated the 1950s and 1960s. 9.2. The Neoclassical Synthesis 9.2.1. Gene ralizations: the IS-LM model again In Chapter 8 we showed how attempts to normalize the Keynesian heresy began immediately after the publication of the General Theory. The speed of the neoclassical reply is surprising when we consider that Hicks’s paper, ‘Mr Keynes and the Classics’, was published in 1937 and had already been presented at a meet ing of the Econometric Society in 1936. Attempts at reabsorption and generalization were resumed immediately after the war, and occupied economists for another two decades. These attempts gave birth to the theoretical approach to macroeconomic problems which be came known as the ‘neoclassical synthesis’ and which constituted the hard core of orthodox economics after the Second World War. Many scholars define this approach as ‘neo-Keynesian’, but this is not correct, unless the term is intended as a contraction of ‘neoclassical-Keynesian’. The label used by Robinson, ‘bastard Keynesian’, is perhaps a little strong, but expresses the concept well. Here, however, in order to avoid misunderstandings, we will mainly use the term ‘neoclassical synthesis’, which seems to be the most correct. Many economists have contributed to the construction of this theoretical system, but here we will mention only the most 325 contemporary macroeconomic theory important: William Baumol, James Duesenberry, Lawrence R. Klein, Franco Modigliani, James Edward Meade, Don Patinkin, Paul Anthony Samuelson, Robert Solow, and James Tobin. We will begin by commenting on two fundamental works: Modigliani’s ‘Liquidity Preference and the Theory of Interest and Money’ (1944), which opened the dance, and Patinkin’s Money, Interest and Prices (1956), especially the largely modified second edition, of 1965, which practically closed it. Modigliani, in his article, developed Hicks’s IS-LM model with the aim of formulating a more general theory than that of Keynes. He constructed a ‘generalized classical’ model, using Hicks’s equations and limiting himself to replacing the hypothesis of fixed money wages by one of flexible wages— thereby obtaining, as special cases, the traditional (neo)classical and the Keynesian models. The former differs from the ‘generalized’ model as it adopts the Cambridge quantity equation instead of the liquidity preference equation. The latter differs from it because of its hypothesis of rigid money wages. Modigliani proved that the (neo)classical model shows the usual dichotomy between the real and the monetary sectors of the economy. Flexible wages ensure that a full employment equ ilibrium is reached in which all the real variables depend on real factors. The neutrality of money ensures that variations in the quantity in circulation only influence the level of prices and other monetary variables. With the liquidity trap set aside as a very special case, Modigliani then showed how, given the money supply, macroeconomic equilibrium could be reached in the Keynesian model at any level of employment, so that there is no guarantee of full employment. He also showed that the hypothesis of rigid money wages caused this result. The reason is very simple: with a given money supply, the constraint on money wages becomes, in fact, a constraint on real wages. Monetary conditions determine the monetary income. Real income will vary in order to equate the marginal prod uctivity of labour to the real wage; and there will be a different level of employment for each different wage level. In the years after the publication of M odigliani’s article, attention was focused on the way in which wage and price flexibility manage to neutralize Keynes’s theory. It had seemed to some students that there were at least two very special cases in which not even the flexibility of wages could defeat Keynes’s arguments. One is the liquidity trap, already mentioned in Chapter 7. The other is that of the interest inelasticity of investments. If one hypothesizes that not only saving s but also investments are independent of the interest rate, the IS curve assumes a vertical position, so that no monetary policy is able to influence the level of employment. Well, it is proved that even in these cases it is necessary to assume rigidity of prices and wages in order to obtain Keynes’s conclusions. A key role in this demonst ration was played by the so-called ‘wealth effect’, of which two types can be distinguished: the ‘Pigou effect’ or 326 contemporary macroeconomic theory ‘real-balance effect’ and the ‘Keynes effect’ or ‘windfall effect’. Let us assume that unemployment exists. If money wages are flexible, they will fall, and this fall will be followed by a decrease in prices. Taking the money supply as given, the liquid balances of economic agents will increase in real terms. Then the agents will reduce their demand for money in an attempt to regain their desired liquid balances. This will cause the LM curve to shift to the right. A price fall corresponds to an increase in the money supply in real terms, and this occurs automatically with unemploym ent. Second, an increase in the real cash balances makes the economic agents feel richer and, as a consequence, induces them to raise their demand for consumer goods. This will cause the IS curve to move to the right, pushing the economy towards full employ- ment. Furthermore, the increase in the money supply in real terms will cause the rate of interest to fall, and this will raise the value of financial assets. The consumers, feeling richer, are able to reduce their propensity to save and this, while pushing the IS curve further to the right by increasing the multiplier, will also modify the slope of the curve. Savings become sensitive to variations in the interest rate, and the IS curve, if it was vertical, now becomes nega- tively sloped. Finally, the addition in entrepreneurs’ financial wealth caused by interest rate reduction will induce them to spend more, even in investment activity. This is the Keynes effect, which implies an increase in the interest- sensitiveness of investments and therefore a further change in the slope of the IS curve. Moreover, if the windfall profits caused by interest rate reduction make the entrepreneurs more optimistic, then the IS curve will shift further to the right. In conclusion, horizontal LM and vertical IS curves cannot do any harm: if prices and wages are flexible, the economy has the strength automatically to bring itself towards full employment. Keynesian under-employment equilibrium is no longer admissible, not even as a special case. It was Patinkin who settled these results within a general-equilibrium model, and who, in the abovementioned book, managed to generalize the generalized neoclassical model of Hicks and Modigliani. The new general- ization consisted, on the one hand, of the introduction of a fourth market, that of financial assets, besides those of ‘national product’, money, and labour, and, on the other of the introduction of a new variable in the supply and demand functions of all four goods, i.e. the price level. This variable enters into the supply and demand functions of labour together with money wages, in such a way that only real wage s count, thus eliminating any pos- sible ‘monetary illusion’. It enters the demand functions for goods, money, and bonds as well as that of the supply function of bonds, as a deflator of liquid balances, so that only their real value coun ts. It is not surprising that in this model the neutrality of money and the usual neoclassical dichotomy are confirmed. The beauty of Patinkin’s theory is in its clear elucidation of the hypotheses on which his conclusions depend. The two principal hypotheses 327 contemporary macroeconomic theory concern the absence of monetary illusion and the perfect flexibility of prices on all markets. There seems to be no hope for Keynes: if interpreted within a general-equilibrium model, his general theory dissolves into nothing. Together with this kind of generalization work, the economists of the neoclassical synthesis carried out a series of investigations on specific aspects of Keynesian theory with the aim of correcting some of its particular flaws, refining some of its peculiar theses, and adjusting the latter to the results of empirical research. From such work some debates originated which led to the discarding or amending of certain peculiarities of Keynes’s theory in such a way that it finally became unrecognizable. Here we will consider four of the most important macroeconomic problems tackled in the 1950s and 1960s: those of the consumption function, the demand for money function, the theory of inflation, and the theory of growth. 9.2.2. Refinements: the consumption function The consumption function played a fundamental role in Keynes’s theory, as it allowed the identification of a simple relationship between consumption and income from which a measure of the margi nal propensity to consume and the multiplier could be obtained. It is important that such a function is stable, in the sense that its parameters do not vary significantly when the magnitudes of the variables change. Only if the multiplier is stable can the Keynesian procedure for explaining the variations in income and employ- ment by autonomous expenditure be considered legitimate. The Keynesian consumption function in its simplest form is: C ¼ C 0 þ cY where C 0 is a constant, C represents consumption, and Y the disposable income (i.e. the income earned net of taxes). In this function, the average propensity to consume, C/Y, is higher than the marginal propensity, c .Itis obvious that such a function cannot hold true in the long run, nor can it be applied to a long pe riod; otherwise, it would lead to negative aggregate savings corresponding to low income levels. Another function which holds true in the long run, as Simon Kuznets (1901–85) showed in Uses of National Income in Peace and War (1942), is a function of the following type: C ¼ bY in which the marginal propensity to consume, b, coinci des with the average one and is higher than that measured by c. This type of function, being well adapted to a long historical period, was soon to be known as the long-run consumption function. The other one, which is better adapted to the cross- sectional data of family budgets, became known as the short-run function. 328 contemporary macroeconomic theory A simple and reasonable explanation of the differences between short-run and long-run functions was offered by the ‘relative income’ hypothesis, which was proposed by Dorothy Brady and Rose Friedman and then developed by Duesenberry. According to this hypothesis, family consump- tion is a function of ‘relative’, besides absolute, incomes. Poor families have an average propensity to consume which is higher than rich families, so that cross-section data show a decreasing average propensity to consume. When the national income increases, without any change in its distribution, the consumption of all families will increase in the same proportion, in such a way that the distribution of consumption will also remain broadly constant. In this way, the national average of the average (family) propensities to consume can remain constant through time. In other words, with a variation in the national income the short-run consumption function would shift upwards along a long-run function. This explanation, despite its reason- ableness, did not have a great deal of success, perhaps because, being too faithful to the Keynesian spirit, it did not attribute great weight to the need to find a microeconomic foundation based on the assumption of maximizing behaviour of the consumers, or perhaps because neoclassical economists love sociological reductions less than psychological ones, or perhaps for both reasons. A suggestion which achieved more success was that advanced by Tobin in 1951, when he included wealth among the arguments of the short-run consumption function. His suggestion was taken up by Modigliani and Brumberg, who, in ‘Utility Analysis and the Consumption Function: An Interpretation of Cross-Section Data’ (1954), put forward the so-called ‘life-cycle’ hypothesis. The new theory underwent various modifications and refinements in the debates that followed, but few substantial changes. It can be presented succinctly in the following way. In the presence of an additive utility function, and with decreasing marginal utility, consumers try to dis- tribute their consumption in a uniform way over their life span, so as not consume too much when they earn a lot and too little when they earn little. Thus, during their working years they save so as to accumulate wealth to use when they are old and when they have stopped producing income. The consumption function has two arguments: wealth, W, and the life-long expected income, Y e , which is what the individual expects to earn on average, annually, over his life. The function will be: C ¼ aW þ cY e Kuznets’s problem is easily solved if the ratio between wealth and disposable income and between life income and disposable income are assumed con- stant. Then the average propensity to consume, C/Y ¼ aW/Y þ cY e /Y,willbe constant. However, this will only happen in the long run, when it is legit- imate to assume that the wealth–income ratio is constant. In the short run, 329 contemporary macroeconomic theory on the other hand, such a relationship will oscillate considerably, and with it the average propensity to co nsume. Not too dissimilar to this is Milton Friedman’s theory of ‘permanent income’, formulated in A Theo ry of Consumption Function (1957). Permanen t income is defined as the present value of future wealth. As this is unknown, the evaluation of permanent income depends on the expectations of the consumers. Assuming adaptive expectations, permanent income, Y p , can be calculated as a weighted average of the incomes earned in past years—in practice, as an average of current incomes earned in the two years of the most recent past, Y and Y À1 : Y p ¼ aY þð1 À aÞY À1 with 0 < a < 1. The long-run consumption function will depend on per- manent income, and will be: C ¼ bY p However, in the short run the current income will differ from the permanent one because of a random transitory component. If it is lower, the short-run average propensity to consume will be greater than the long-ru n one, and vice versa. Thus, the marginal propensity will be lower than the average propensity, and this can be explained by the fact that individuals do not know whether the variations observed in their current incomes will be maintained through time or are only transitory. Therefore, by regressing consumptions on current incomes the following function should be obtained: C ¼ C 0 þ cY which is the same as the simple Keynesian consumption function. But Friedman has derived it from a theory which explains it as a highly unstable function. The parameters can vary substantially with chan ges in current income, as this includes a strong random and transitory component. We will see later which important role was to be assigned by Friedman, in the attack on Keynesian theory, to the instability of the consumption function. 9.2.3. Corrections: money and inflation Another field in which the theorists of the neoclassical synthesis went beyond Keynes was that of the theory of the demand for money. In Keynes’s model, speculators carry out a key role. They speculate on the changes in the value of financial assets, forming expectations based over an extremely brief period and paying no atten tion to the fundamentals which should govern share prices. Such expectations assume the form of forecasts with regard to the expectations of others and, on certain occasions, when the markets are dominated by phenomena of mass psychology, they become self-fulfilling, 330 contemporary macroeconomic theory producing instability and abrupt crashes. If the demand for money is dominated, or is influenced to a substantial degree, by speculation of this type, it will be affected by drastic changes or unexpected jumps following variations in the opinions of the speculators. As these opinions can also vary unpredictably in relation to interest rate changes, the demand function for money is extremely unstable, and is unable to provide reliable support to monetary policy. In fact, Keynes was rather sceptical, not only about the efficacy, but also about the implementation of discretionary monetary policies. The neoclas sical revision of Keynes’s theory of the demand for money had three main aims: (1) to expel destabilizing speculation from the theory; (2) to find microeconomic foundations capable of linking the aggregate demand for money to some form of individual maximization behaviour; (3) to construct a stable function of the demand for money. An attempt to account for the existence of a stable relationship between the transaction demand for money and the rate of interest was made by Baumol in 1952. By applying the theory of inventory decisions to the demand for money, Baumol demonstrated that the transaction demand depends on the volume of transactions, on the costs that must be sustained to convert short- term asset s into money, and, above all, on the rate of interest. This occurs because the cash balances held by firms for the normal running of business represent a cost in terms of the yields forsaken for not having invested the wealth in less liquid assets. When the rate of interest increases, this oppor- tunity cost also increases and, all other conditions being equal, the companies are induced to reduce their cash balances. The transaction demand for money is therefore a decreasing function of the rate of interest. More ambitious attempts to find a microeconomic foundation for mon- etary theory were made by Hicks and Tobin. In the 1950s a theory of portfolio selection was developed, about which we should mentio n at least two works by Harry Markowitz, the article ‘Portfolio Selection’ (Journal of Finance, 1952) and the book Portfolio Selection (1959), and one by Tobin, ‘Liquidity Preference as Behaviour toward Risk’ (Review of Economic Studies, 1958). Tobin directly tackled the problem of the speculative demand for money, and solved it by reducing it to a problem of choice in respect to risk. The holding of non-liquid assets gives a return, which is the sum of the interest and the capital gains, that cash cannot give. Economic agents formulate expectations in regard to possible capital gains, and specify these in the form of a frequency distribution. They admit the possibility that actual values might differ from expected ones, and attribute to each of these pos- sibilities a subjective probability. Tobi n assumed, for the sake of simplicity, a normal distribution, and took its mean as a measure of the expected value 331 contemporary macroeconomic theory and its standard deviation as a measure of risk. Given the current rate of interest and the expected capital gain, the expected returns from the investment will be an increasing function of risk. As the percentage of wealth invested in non-liquid assets increases, so do the returns, but also the riski- ness of the investment. The investor will have preferences concerning the way to combine returns and risk. His problem is therefore reduced to one of maximizing satisfaction, and the way in which he divides his wealth between money and non-liquid assets will depend on his risk aversion. In order to induce a typical investor, who is assumed to be averse to risk, to increase the demand for non-liquid assets and therefore to decrease the demand for money, it is necessary to increase the interest rate. Thus, the speculative demand for money is a stable decreasing function of the interest rate. In ‘A General Equilibrium Approach to Monetary Theory’ (1969) Tobin extended the theory of portfolio choice to the general case in which agents must choose among a vast range of financial assets. Among these he included real capital stock. Furthermore, he introduced a new variable, q, which he defined as the ratio between the market valuation of a firm and the replacement cost of its capital. This is the origin of the famous ‘q-theory’ of accumulation. When q increases, firms have no difficul ty in finding external finance, which is abundant and cheap; therefore, real investments will increase. When q decreases and the stock market valuation becomes lower than the replacement cost of capital, firms which wish to invest will find it more advantageous to buy other firms or shares in other firms on the stock exchange, rather than increase their real investments. Thus, investments are an increasing function of q. It is this q that should appear in the IS-LM model, rather than a generic ‘rate of interest’. It remains true, however, that q depends, in any case, on the decisions of the monetary authorities about interest rate levels and structure. Therefore, the possibility that investments are insensitive to discretionary monetary policies must be excluded. Another field of investigation in which the neoclassical synthesis tried to improve upon Keynes was the theory of inflation. On this subject Keynes had formulated a precise theory as early as the Treatise. And he remained basically faithful to that theory even after the publication of the General Theory; so much so that he reproposed it almost unchanged in How to Pay for the War (1940). He believed that inflation depends on the excess of aggregate expenditure over real output, and therefore that it becomes a relevant problem only in the presence of full employment. In such a situ- ation, an excess of aggregate demand increases profits and initiates a cumulative inflationary process which, by modifying the distribution of income in favour of the capitalists, will continue until savings have increa sed to the level necessary to finance investments. A corollary of this theory (which, however, was developed by post-Keynesians rather than by Keynes himself ) is that, in an unemployment situation, inflation cannot be explained by the forces of demand, but only by the impulses coming from costs. 332 contemporary macroeconomic theory [...]... ‘neo-Keynesian’ The monetarist counter-revolution began in 195 6, when Friedman published The Quantity Theory of Money: A Restatement’ This famous article was followed by other important works, later collected in The Optimum Quantity of Money ( 196 9), which contains the foundations of monetarist theory Friedman argued that the quantity theory had to be interpreted as a theory of demand for money and... models of the Solow–Swan type The polemic manifested itself first of all in an attack on 354 contemporary macroeconomic theory the marginalist theory of capital and distribution However, this part of the debate used as its main reference point the Sraf an theoretical approach rather than the post-Keynesian in its strict sense; and we shall therefore deal with it in Chapter 11 The specific contribution of the. .. 9. 5.3 Money and the instability of the capitalist economy Even though they can be traced back to the solid tradition of the Radcliffe Report of the Committee on the Working of the Monetary System (London, 195 9) and, even more so, to Keynes’s various ideas on the endogenous nature of the money supply, the modern post-Keynesian monetary theories were mainly formulated in the 197 0s and the early 198 0s But... systematic introduction into macroeconomics of the study of the processes of endogenous formation of expectations, together with the processes of elaboration and diffusion of information, which amounts to the addition of another important theoretical instrument to the toolbox of the economist: the economics of information The second is extremely important: it is the ‘policy-evaluation proposition’ According... on the basis of price and quantity signals observed on the markets, are compatible The demand is equal to the supply, but different from the ‘notional’ or ‘potential’ supply and demand, i.e those that would be realized in a Walrasian equilibrium On the other hand, the plans of the economic agents are actually fulfilled in a non-Walrasian equilibrium, and therefore there is no stimulus to modify them The. .. speculators may amplify the depressive effects of uncertainty and the lack of confidence of entrepreneurs Therefore it is important to study the functions it accomplishes in economic activity, above all the way in which its production and control is organized 9. 5.2 Distribution and growth A great many of the Cambridge post-Keynesian theories were developed in the 195 0s and 196 0s in opposition to the neoclassical... < 0, and the short side is that of demand q0 and q1 are the ‘effective’ supply and demand in the two cases; qà is the ‘notional’ demand Two hypotheses are made to define the method of exchange The first is the hypothesis of voluntary exchange, which states that no agent is forced to 3 49 contemporary macroeconomic theory p S E10 q1 q0 D q* q Fig 13 exchange more than he wishes The second... together in Essays in the Theory of Economic Growth ( 196 2) In the models of growth with unemployment and under-utilization of plant, the key hypothesis is that prices are fixed by applying the mark-up rule to direct costs, which are assumed constant This implies that, given the techniques, the distribution of income is determined by the price policies of the firms, and depends on the average degree of. .. can be called the theory of ‘non-Walrasian equilibrium’ or ‘equilibrium with rationing’; but some people continue to call it the theory of ‘disequilibrium’, and others the theory of the ‘K-equilibrium’ The most interesting models of this approach were formulated in the 197 0s as a development of the contributions of Patinkin, Clower, and Leijonhufvud, and are due to Robert J Barro, Herschel I Grossman,... presented the argument of the stability of the money demand function under the form of a hypothesis on the stability (and the magnitude) of the velocity of money circulation, which he renamed the ‘monetary multiplier’ He coupled this with a hypothesis on the income multiplier, which he maintained to be lower and more unstable than the monetary multiplier He justified this hypothesis with a permanent-income theory . tackled in the 195 0s and 196 0s: those of the consumption function, the demand for money function, the theory of inflation, and the theory of growth. 9. 2.2. Refinements: the consumption function The consumption. prestige, and it seemed they could achieve anything that the human mind conceived. The golden age of the 195 0s and 196 0s was in fact short-lived. The land of Cocaigne, with its abundance and harmony,. loans and restrict- ive internal measures. Thus there was an increase in the foreign debt of many countries and, on the other hand, inflationary processes and restrictions in demand broke out. The