✐ ✐ ✐ ✐ Banks and Finance in Modern Macroeconomics A Historical Perspective Bruna Ingrao Department of Social and Economic Sciences, Sapienza University of Rome, Italy Claudio Sardoni Department of Social and Economic Sciences, Sapienza University of Rome, Italy Cheltenham, UK • Northampton, MA, USA ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ © Bruna Ingrao and Claudio Sardoni 2019 Cover image: Etching created by Bruna Ingrao 2018 All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc William Pratt House Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2018962948 This book is available electronically in the Economics subject collection DOI 10.4337/9781786431530 ISBN 978 78643 152 (cased) ISBN 978 78643 153 (eBook) ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Contents Preface vi 1 Introduction PART I FROM THE 1920s TO THE EARLY POST-WAR PERIOD Banks and the quantity theory: Wicksell and Fisher 3 Money and banking in the process of change: Schumpeter and Robertson Banks, debt and deflation in the Great Depression 5 Keynes on banks in A Treatise, The General Theory and after 6 Further discussions and criticisms of Keynes’s General Theory 24 42 68 90 114 PART II FROM THE NEOCLASSICAL SYNTHESIS TO NEW KEYNESIAN ECONOMICS 7 Finance in macroeconomics in the post-war years: the Neoclassical Synthesis 8 The Monetarist counter-revolution: from the ‘resuscitation’ to the disappearance of money Credit and finance in today’s mainstream 10 Conclusions 140 180 213 239 251 273 Bibliography Index v ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Preface Some years ago – when the profession was discussing the reasons why macroeconomics had failed so badly to understand, let alone foresee, the crisis of 2007–2008 – a group of master students of our university, highly interested in economic theory and policy, asked us to organize an extra-curricular short course on macroeconomic theory and its evolution over time, which could help them put what they were studying in other courses in a more general context as well as better understand the current economic situation Since in our university, like in most universities over the world, courses in the history of economics are no longer on offer, we promptly answered their request in the positive Together with the students, we decided to focus the lectures on the way in which mainstream macroeconomics had dealt with a number of problems strictly connected to financial and economic crises, topics on which we had already done some research in the past A crucial issue to deal with was, of course, how different economists with different theoretical backgrounds had approached the problem of the interrelation between the financial and the real sectors of the economy But equally, if not more important was to try to understand and explain why, at least since the late 1930s until the late 1980s, mainstream macroeconomics had almost completely ignored, or amply downplayed, the importance of the financial sector and its interplay with the real side of the economy After the more tentative experience of the first year, we repeated the course for two more years by extending the number of economists and topics covered in the lectures This book is largely the result of our work to prepare our lectures Over the years, we have been studying and discussing the topics and issues with which the book is concerned with many colleagues and in several seminars and conferences It would be difficult to make an exhaustive list of all the people with whom we had the benefit to discuss our ideas Therefore, here we limit ourselves to thank only a few people who have commented on the book or some of its chapters more recently First of all, we want to thank the students attending the lectures mentioned above for their enthusiasm and intellectual curiosity, which stimulated us to improve on our work The book has been presented in a mini-course at the University of São Paulo (USP) and in two seminars at the University of Brasilia in May 2018 02 vi ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Preface vii We would like to thank, in particular, Pedro Garcia Duarte, who organized the mini-course at USP and stimulated us to improve and clarify our treatment of several topics with his questions and suggestions, and Mauro Boianowsky, who organized our seminars in Brasilia and participated in the discussion with very interesting comments and observations Chapters of the book have been also presented and discussed in various seminars; we would like to thank the participants in these events for their helpful observations and comments Finally, we wish to thank Geoff Harcourt, who read a first draft of our book and made a number of useful suggestions To the best of our capacity, in writing the book we have tried to take account of all the comments that we received Naturally, the responsibility for any remaining errors is exclusively ours ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Introduction Should one ask the layman whether banks and finance are important to understand the working of the economy, the answer would be immediate and straightforward: Yes! In fact, the importance of financial markets and banks for the working of market economies is at the centre stage in popular discussion, as well as in current debates on economic policy Yet, as it is generally recognized (see, e.g., Gertler, 1988; Goodhart, 2005–2006), for a large part of the 20th century, spanning from the late 1930s to the 1980s, mainstream macroeconomics put banks and the financial system to backstage, or even expelled them completely from its theoretical representations of the economy.1 In the meantime, the financial system has expanded enormously in its complex interaction with the real side of the economy Banks too big to fail trade on global markets, marketing innovative financial products; a whole shadow banking industry has emerged, with complex and non-transparent links to the banking industry; financial institutions of various sizes and definitions trade in derivatives or other non-standard contracts involving massive financial flows; firms’ and families’ budgets take advantage of getting credit from the global financial system, whose poor transparency in terms of capital requirements and indebtedness suddenly became so evident since 2007 1.1 THE DISTURBING PUZZLE OF BANKS AND FINANCE An explanation of such an evolution of macroeconomic theory could be that, during the period when banks and finance were essentially ignored, the financial side of market economies worked in a relatively smooth way and, thus, economists tended to be concerned with different issues and topics, regarded as more urgent and challenging Such an explanation, though containing an element of truth, cannot be regarded as fully satisfactory The theoretical interest, or its vanishing, in the working of the financial side of the We define mainstream economics as the evolving set of theories, prominent in academic communities at the research and teaching levels, during a certain historical period For the idea of mainstream economics as a flexible, evolving core of theories, see Colander et al (2004) ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Banks and finance in modern macroeconomics economy and its interactions with the real side cannot be simply related to the occurrence, or absence, of serious disturbances like the Great Depression of the 1930s and the crisis of the late 2000s Finance and credit always play such a vital role in modern capitalism that they cannot be the concern of economic theory only at critical times There must be, in our view, deeper and more general reasons why macroeconomics evolved in the way it did Our book aims to explain such a puzzling evolution The dominant families of macroeconomic models in mainstream macroeconomics substantially avoided incorporating banks and finance in their basic analytical structures As a related and intertwined question, the debt structure within the private sector was also cancelled, either by aggregating the private debts of heterogeneous agents, or by simply assuming that the macroeconomic behaviour of the economy could be effectively represented by models with a single representative agent It was only in the last 30 years or so that the interest in the study of credit and financial markets and their interrelation with the ‘real’ economy grew significantly We propose an explanation of all this which is essentially based on the analysis of the way in which banks and financial markets have been conceptualized in mainstream economics, not only in Monetarism and New Classical macroeconomics, but also in Keynesian and Neo-Keynesian macroeconomics (the post-war Keynesianism of the Neoclassical Synthesis).2 Our historical narration reconstructs the state of affairs in contemporary macroeconomics by considering the historical context in which macroeconomists elaborated their theories, the evolution of the research technologies which they explored as effective analytical tools, and finally the vision of the market economy that different scholars had in mind when looking for operational models to be assumed as reference standards We deal with these aspects by focusing our narration on the evolution of core theories Given the long-term historical perspective of the book, we cannot deal in any detail with economic history, changing economic policies, or the sociology of research in academic communities We write a history of ideas, and we focus on selected authors and selected works without any pretence of exhaustiveness Our aim is to critically explore the threads and issues in the evolution of ideas that we regard as most relevant In doing so, we try to provide elements that can help answer some critical questions: banks and finance really make a fundamental difference for our understanding of macroeconomic events, so that ‘forgetting’ them means missing crucial aspects of phenomena like fluctuations and growth, For brevity, here we adopt the conventional label ‘Neoclassical Synthesis’; in Chapters and below, we address in some detail the differences among the various scholars, notably Patinkin, Modigliani and Tobin ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Introduction macroeconomic stability or macroeconomic policies? Can macroeconomists ignore banks and finance in their modelling and interpretative strategies with only a minor cost to bear? Should macroeconomists stick to models and theories deprived of any explicit reference to banking and finance, or even to money? By calling attention to these issues, the book aims at restoring a view of financial markets and banks as primary actors in the functioning, or malfunctioning, of market economies, to capture a more realistic vision of the ‘visible hands’ at work, rather than the impersonal operation of ‘invisible’ and impersonal market forces In monetary market economies, the entrepreneurial activities in banking and finance are among the visible hands, which operate within a complex system of institutional settings to promote the inter-temporal coordination among millions of heterogeneous, independent agents Financial networks may be exposed to major shocks and be severely disrupted, with the consequence of blocking growth or amplifying business fluctuations Notwithstanding the recent developments mentioned above, in our view, macroeconomic theory has still a long way to go to reach a satisfactory account of the complexities of financial markets in models and theories which the profession uses in education, in conceptual analysis, and in policy advice In the following sections of this chapter, we briefly outline the main issues, topics and economists that will be considered in detail in the successive chapters; but before proceeding it is worth reminding that our historical reconstruction is concerned only with mainstream macroeconomics Although well aware of the fact that some important contributions to the topics with which the book deals come from economists outside the mainstream, a systematic and detailed consideration of their work is beyond the scope of the book We limit ourselves to look only at some contributions by Minsky, one of the few non-mainstream economists whose analysis of recurrent episodes of fragility of economic systems with a well developed financial sector has attracted the attention of some mainstream economists especially after the recent crisis 1.2 FROM THE 19TH CENTURY TO THE 1930S In the 19th century, scholars addressing questions in the realm of economic theory from the systemic perspective of growth and fluctuations had again and again directed their attention to price adjustments and price instability, the regulation of the money supply, banking policy and the stability or the fragility of the financial system, the sequences of waves of credit expansion or contraction, the fluctuations of expectations and confidence in financial markets ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ 268 Banks and finance in modern macroeconomics Schumpeter, J A (1917–1918[1956]), ‘Money and the social product,’ International Economic Papers, 6, 148–213, traslated into English by A.W Marget Schumpeter, J A (1927), ‘The explanation of the business cycle,’ Economica, 21, 286–311 Schumpeter, J A (1928), ‘The instability of capitalism,’ Economic Journal, 38 (151), 361–386 Schumpeter, J A (1931), ‘The present world depression: a tentative diagnosis,’ American Economic Review, 21 (1), 179–182 Schumpeter, J A (1934[1983]), The Theory of Economic Development An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle, New Brunswick and London: Transaction Publishers Schumpeter, J A (1935), ‘The analysis of economic change,’ Review of Economic Statistics, 17 (4), 2–10 Schumpeter, J A (1939), Business Cycles A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, vol and 2, New York and London: McGraw-Hill Schumpeter, J A (1946), ‘The decade of the Twenties,’ American Economic Review, 36 (2), 1–10 Schumpeter, J A (1947), ‘The creditive response in economic history,’ Journal of Economic History, (2), 149–159 Schumpeter, J A (1950[1994]), Capitalism, Socialism and Democracy, London and New York: Routledge, 3rd edn Schumpeter, J A (1954[2006]), History of Economic Analysis, Abingdon: Taylor & Francis Shiller, R J (2000), Irrational Exuberance, New York: Broadway Books Shiller, R J (2003), ‘From efficient markets theory to behavioral finance,’ Journal of Economic Perspectives, 17 (1), 83–104 Shin, H S (2010), Risk and Liquidity, New York: Oxford University Press Shleifer, A (2000), Inefficient Markets An Introduction to Behavioral Finance, Clarendon Lectures in Economics, Oxford: Oxford University Press Skidelsky, R (1992), John Maynard Keynes, vol 2: The Economist as a Saviour, London: Macmillan Snowdown, B and Vane, H R (2005), Modern Macroeconomics Its Origins, Development and Current State, Cheltenham: Edward Elgar Publishing Solow, R M (1988), ‘Growth theory and after,’ American Economic Review, 78 (3), 307–317 Solow, R M (1998), Monopolistic Competition and Macroeconomic Theory, Federico Caffè Lectures, Cambridge: Cambridge University Press ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Bibliography 269 Solow, R M (2010), ‘Statement of Robert M Solow,’ Hearing before the Subcommittee on investigations and oversight, Committee on Science and Technology, House of Representatives of the United States Sornette, D (2003), Why Stock Markets Crash, Princeton and Oxford: Princeton University Press Stiglitz, J E (2000), ‘The contributions of the economics of information to twentieth century economics,’ Quarterly Journal of Economics, 115 (4), 1441–1478 Stiglitz, J E (2002), ‘Information and the change in the paradigm in economics,’ American Economic Review, 92 (3), 460–501 Stiglitz, J E (2018), ‘Where modern macroeconomics went wrong,’ Oxford Review of Economic Policy, 34 (1–2), 70–106 Stiglitz, J E and Greenwald, B (2003), Towards a New Paradigm in Monetary Economics, Cambridge: Cambridge University Press Stiglitz, J E and Weiss, A (1981), ‘Credit rationing in markets with imperfect information,’ American Economic Review, 71 (3), 393–410 Swedberg, R (1991), Schumpeter–A Biography, Princeton: Princeton University Press Thirlwall, A P (1987), Nicholas Kaldor, Grand Masters in Economics, Brighton, Sussex: Wheatsheaf Books Tichy, G (1984), ‘Schumpeter’s monetary theory: An unjustly neglected part of his work,’ in C Steindl (ed.), Lectures on Schumpeterian Economics, Berlin: Springer-Verlag, pp 125–138 Tobin, J (1956), ‘The interest-elasticity of transactions demand for cash,’ Review of Economics and Statistics, 38 (3), 241–247 Tobin, J (1958), ‘Liquidity preference as behavior towards risk,’ Review of Economic Studies, 25 (2), 65–86 Tobin, J (1961), ‘Money, capital and other stores of value,’ American Economic Review, (2), 26–37 Tobin, J (1963), ‘Commercial banks as creators of “money”,’ Paper 205, Cowles Foundation, New Haven Tobin, J (1969), ‘A general equilibrium approach to monetary theory,’ Journal of Money, Credit and Banking, (1), 15–29 Tobin, J (1975), ‘Keynesian models of recession and depression,’ American Economic Review, 65 (2), 195–202 Tobin, J (1980), Asset Accumulation and Economic Activity, Oxford: Basil Blackwell Tobin, J (1982), ‘Money and finance in the macroeconomic process,’ Journal of Money, Credit, and Banking, 14 (2), 171–203 Tobin, J (1984), ‘On the efficiency of the financial system,’ Lloyds Bank Review, (153), 1–15 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ 270 Banks and finance in modern macroeconomics Tobin, J and Brainard, W C (1963), ‘Financial intermediaries and the effectiveness of monetary controls,’ American Economic Review, 53 (2), 383–400 Tobin, J and Brainard, W C (1976), ‘Asset markets and the cost of capital,’ Discussion Paper 427, Cowles Foundation, New Haven Townsend, R M (1979), ‘Optimal contracts and competitive markets with costly state verification,’ Journal of Economic Theory, 21 (2), 265–293 Trautwein, H (2000), ‘The credit view, old and new,’ Journal of Economic Surveys, 14 (2), 155–189 Tsiang, S C (1956), ‘Liquidity preference and loanable funds theories, multiplier and velocity analyses: A synthesis,’ American Economic Review, 66 (4), 539–564 Turner, A (2016), Between Debt and the Devil, Princeton and Oxford: Princeton University Press Tversky, A and Kahneman, D (1974), ‘Judgment under uncertainty: Heuristics and biases,’ Science, 185 (4157), 1124–1131 Wallace, N (1998), ‘A dictum for monetary theory,’ Federal Reserve Bank of Minneapolis Quarterly Review, 22 (1), 20–26 Walras, L (1900), Éléments d’Économie Politique Pure ou Théorie de la Richesse Sociale, Lausanne: F Rouge, 4th edn Weintraub, E R (1979), Microfoundations, Cambridge: Cambridge University Press Werner, R A (2014a), ‘Can banks individually create money out of nothing? The theories and the empirical evidence,’ International Review of Financial Analysis, 36 (C), 1–19 Werner, R A (2014b), ‘How banks create money, and why can other firms not the same? An explanation for the coexistence of lending and deposit-taking,’ International Review of Financial Analysis, 36 (C), 71–77 Wicksell, K (1898[1936]), Interest and Prices, London: Macmillan, first German edition 1898 Wicksell, K (1901[1934]), Lectures on Political Economy, vol 1, London: Routledge & Sons, first Swedish edition 1901 Wicksell, K (1906[1935]), Lectures on Political Economy, vol 2, London: Routledge & Sons, first Swedish edition 1906 Wicksell, K (1907), ‘The influence of the rate of interest on prices,’ Economic Journal, 17 (66), 213–220 Wicksell, K (1907[2001]), ‘A new theory of crises,’ Structural Change and Economic Dynamics, 12 (3), 335–342 Woodford, M (2003), Interest and Prices, Princeton and Oxford: Princeton University Press ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Bibliography 271 Woodford, M (2009), ‘Convergence in macroeconomics: Elements of the new synthesis,’ American Economic Journal: Macroeconomics, (1), 267–279 Woodford, M (2010), ‘Financial intermediation and macroeconomic analysis,’ Journal of Economic Perspectives, 24 (4), 21–44 Woodford, M (2013), ‘Macroeconomic analysis without the rational expectations hypothesis,’ Annual Review of Economics, (1), 303–346 Young, W (2014), Real Business Cycle Models in Economics, London and New York: Routledge Zingales, L (2015), ‘Presidential address: Does finance benefit society?’ Journal of Finance, 70 (4), 1327–1363 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Index Adrian, T 221 Akerlof, G A 216, 232–3, 238 ‘animal spirits’ 238, 249 arbitrage 231–2 Arrow, K J 12–13, 143, 175, 198–9 Arrow-Debreu model 12–13, 15, 21, 140, 143–4, 175, 196, 198–9, 204, 207–9, 234, 242–5 asymmetric information bank role in world of 18, 86 financial institutions existing in world of 17 between financial promoters and savers 83 as intrinsic to human knowledge and action 249 between lenders and borrowers 216, 233–4 Stiglitz’s pioneering work on 216–17 auctioneer Arrow-Debreu model 196–7, 244–5 consequences of removal 19 formalization of 143 neo-Walrasian conception of 170–71 and smooth working of markets 16 Tobin’s denial of credibility of 175 Austrian school 8, 56, 88 ‘availability doctrine’ 154 Backhouse, R E 138, 234 balances active 107–8 real 131, 136, 149, 182 bank runs 72–3, 82, 173, 189–90 banking mystery of 32–5, 84–5 banking system complexity of 220–22 in trade cycle 62–6 bankruptcy of banks 72, 217–18, 223 consequences of 39 domino effects 4, 81–2 relevance of 19 risk of 73, 86, 137, 147 banks as active players/agents 10, 237 in deflationary spiral 81–5 in General Theory 91, 98–101 new view of 137, 168, 172, 177–8, 222–5 old view of 127–8, 130–31, 222–5, 237 as passive agents 8, 11, 114, 192, 225, 242 pre-1930s approaches 239–41 as profit seeking financial intermediaries 162–5, 228–9, 246 and quantity theory 24–41 retail 221, 224 in Treatise on Money 92–5 wholesale 221, 224 Baranzini, M Barro, R J 136 barter economy classical analysis 146 general equilibrium theory 5–6, 203 ideal models of 49, 203 neoclassical theory and net-money doctrine 164, 177 Schumpeter’s analysis 44 bearishness 95, 97, 161, 240 bears 123 behavioural economics 238, 247–9 behavioural finance 213, 232–3, 238 Benhabib, J 179 Bernanke, B S 10, 72, 85–7, 219–20 Berti, L 42–43 Bhaduri, A 229 Bhattacharya, S 216 Bianco, A 222 ‘black swans’ 75, 207 273 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ 274 Banks and finance in modern macroeconomics Blanchard, O J 213–15, 235 Blinder, A S 219 Böhm-Bawerk, E von 115 Boianovsky, M 31, 56, 85, 138, 234 Boldyrev, I 144 boom in 1920s America 77, 82–4 in 1990s, factors explaining 232 banks’ behaviour as exacerbating factor 31–2 behavioural approach 247 Fisher on 35–8, 40, 69, 74, 78–84, 88 Minsky on 226–7, 229 Boot, A W A 216 bootstrap problem 120–21 Borio, C 87, 224 Brainard, W C 170–73 Bridel, P 5, 43, 56 Brock, W 204, 244 Brunner, K 176, 180 Brunnermeier, M K 216 Buiter, W H 166 bullishness 97, 161 bulls 123 business cycles abandonment of monetary explanations of 14, 180–81, 193, 202, 210 Friedman and Schwarz on 192, 210 Jevons on monetary versus real theories money surprises in theory of 197–201 relevance of financial frictions in 209–10 Schumpeter on 42–4, 46–9, 53–4, 247 see also real business cycle (RBC) bust behavioural approach 247 Fisher on 40, 74, 79 Minsky on 226 Cannan, E 52, 60 capitalism competitive 45–6, 48, 206 trustified 54 Carlin, W 221–2, 233 cash-in-advance 202 Cassel, G 145 change centrality of credit in process of 66–7 dynamic processes of 33, 41, 119, 143, 240 role of banks in processes of 42, 48, 65–6, 246 technical/technological 7, 38, 74, 77, 181, 206–7, 237 Chiodi, G 25 Christiano, L J 216, 220, 237 Churchill, W 71 circular flow 45–9, 101 circulating credit 32–5 classical dichotomy 145–6, 214 classical political economy 4, 246 classical theory of banking 49–51 Colander, D collateral 17, 34, 36–7, 75, 160, 219, 222 commercial crises 7, 37 commercial theory of banking 49–50 competition imperfect 160, 178, 213–14, 245–6 and incomplete information 249 perfect 234–5 confidence degree of 103 fluctuations of 3, 188 loss of/crisis of 4, 18, 37, 73, 76, 134, 187 negative impact of deflation 132 state of 103, 112, 227 ‘corn’ economy 223 Costabile, L 56 creative destruction 45, 54 credit organized 26, 28, 30, 137 simple 26, 28, 137 credit channel 189, 192, 224 credit creation by banks 11, 18, 45, 158 excessive private as reason for crisis 224 relation with capital formation and saving 56 credit crunch 4, 19, 70–72 credit cycle 32–3, 35–9, 79 credit multiplier see money multiplier credit rationing in current macroeconomic literature 243 Gurley and Shaw on 158, 179 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Index and imperfect information 216–18 Modigliani on 154 credit view 131, 216 creditworthiness asymmetric and costly information 17, 217 banks evaluating 18, 30, 50–51, 86 creation of deposits certifying 223 Crick, W F 129 Culbertson, J M 158–9 cumulative process 29–31, 40, 47, 133, 190–91, 239 currency-deposits ratio 188, 190 Dal-Pont Legrand, M 53 De Grauwe, P 238 De Long, J B 183, 188 De Marchi, N 181 De Vroey, M 140, 181, 201, 214 Debreu, G 12, 143–4, 196 see also Arrow-Debreu model debt/indebtedness in history of Great Depression 85–8 inter-bank indebtedness 93–4 out-of-equilibrium spiralling 77–81 over-indebtedness/excessive indebtedness 74, 79–83, 85, 247 over-indebtedness, financial intermediaries and banks 77–81 debt cycle 79 debt deflation theory of great depressions 69, 78, 85, 88, 241 default in Great Depression 85 risk of 13, 17–19, 120–21, 148, 170 deflation costs in 1920s 69–72 in history of Great Depression 85–8 deposit active 93–4, 98, 108, 112, 127–8 cash 95, 128 derivative 128 passive 93–5, 98, 128 primary 128–9 savings 95–9, 109, 111, 123 deposit multiplier 224 see also money multiplier development finance in 156–61, 178–9 275 Schumpeter’s theories on 44, 46–7, 54–5 dichotomy classical 145–6, 214 false 145–6, 151 Dimand, R W 33, 35, 73, 79, 137, 165–7, 177 Dixon, H D 213–15 Domar, E D 67 DSGE (dynamic stochastic general equilibrium) models 10, 215, 219, 224, 236–7, 243 Duarte, P G 140, 214, 234, 236–7 Düppe, T 143 dynamics and Arrow-Debreu model 199–200, 244 distinction with statics 5, 78, 137–8, 141–2 out-of-equilibrium 200–201, 241, 246–8 short-term 144, 174 tâtonnement 143, 147, 150–51 efficient markets hypothesis (EMH) 229–33, 238 Eggertsson, G B 220, 226 Eichenbaum, M S 216, 237 Eichengreen, B 72–3, 87, 89, 211–12 Eisenbach, T M 216 Enthoven, A C 159, 164 equity rationing 218 Erdem, M 87 expectations Hicks’ analysis of 121–2, 126, 142 imitative 4, 81, 173 psychological causation 104, 232, 233 self-fulfilling 34 uniform 122–3, 127 see also rational expectations external finance of firms 112, 162, 229 long-term historical perspective 156 as more costly than internal 219 new issued equities and new debts 229 premium 219 Fama, E F 86, 229, 230 Festré, A 43, 55 Filardo, A 87 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ 276 Banks and finance in modern macroeconomics finance in General Theory 98–101 hedge 228 in history of Great Depression 85–8 indirect 156–8 inside 177–9 internal 112, 219, 229 Ponzi 228 speculative 228 see also external finance finance motive 107–10, 117–18 financial accelerator 216, 218–21 financial crisis 7, 75, 87, 197, 208–11, 220–21, 231, 243 see also Great Depression financial fragility of deposit banks 189 related to short maturity of outstanding debts 79 financial innovation 11, 82–3, 158–9, 220–21 financial instability 101–2, 163–4, 189, 192, 202, 225–6, 229 see also monetary instability financial markets extent of rationality 225–33 general equilibrium approach to 165–70 monetary mechanism without 151–5 working of 101–3 financial sector complexity of 220–22, 243 and IS-LM model 151–3, 174 financial structure belonging to political and institutional structure 187, 191, 194, 203, 207, 248–9 effects of Great Depression 72–7 Gurley and Shaw on 178–9 Tobin on 165, 172–4 Fischer, S 235, 237 Fisher, I 6–7, 27, 31–40, 44, 68–9, 73–74, 77–85, 87–89, 138, 150, 187, 190, 192–3, 197, 227, 239, 241, 247 Forni, M 245 Friedman, B 131 Friedman, M 9, 11, 21, 40, 86, 126, 140, 147, 180–198, 200–202, 210–11, 229, 249 Frisch, R 203–4, 208, 246 fundamental equations 95–7 general equilibrium approach to financial markets 165–70 stabilization of theory in 1940s and 1950s 141–4 see also Arrow-Debreu model general price level rejection of old quantity theory 40, 92 see also quantity theory of money General Theory, The comparison with Treatise on Money 40, 90–92, 240 criticisms and rejoinders 103–11, 114–38 investment, savings, banks and finance in 76, 95–8 Gertler, M 1, 219–22 Gilchrist, S 219–20 Goetz, P von 89 Goetzmann, W N 55, 77 Goodfriend, M 10, 214 Goodhart, C A E 1, 18, 42, 191 Great Depression finance, debt and deflation in history of 85–8 financial structure impact 72–7 monetary history of 189–93 spiralling of debt and deflation 77–81 Great Recession 87–8 Greenspan, A 208 Greenwald, B 217–18, 222–24 Grossman, H I 136 Gurley, J C 21, 141, 156–65, 167–8, 170, 177–9, 242 Hagemann, H 45, 53 Hahn, F H 12, 43, 143 Hahn, L A 45, 66, 128 Handa, J 116, 120 Hansen, A H 115, 133, 166, 185 Harcourt, G C 234 Harrod, R F 67 Hawtrey, R G 7, 66 Hayek, F A von 6–7, 141–2, 199, 246, 249 Heijdra, B J 203, 215 Hellwig, M F 155 Hendry, D F 15, 215 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Index Hicks, J R 7, 55, 100, 106, 114–17, 119–26, 136, 141–7, 153, 166, 175, 247 Hiltzik, M 73, 87 Hirsch, A 181 historical analysis Fisher 68–9, 73–4, 77–85, 87–9 Friedman and Schwartz 185ff Schumpeter 53–5 hoarding 58–65, 96, 108, 117–18 Hofmann, B 87 Holt, R P F Homan, P T 185 Hoover, K D 181, 198, 234, 236 Hume, D 12, 37 illiquidity aversion to 30, 112, 157 degrees of 149 risk of 15, 34, 130, 148, 170 imperfect information and credit rationing 216–18 and financial accelerator 218–20 imperfections 213–16, 242–4 information see asymmetric information; imperfect information Ingrao, B 5, 142–4, 202, 246 insolvency bank runs precipitating 82 risk of 15, 34, 73, 75, 80–81, 86, 132 interest rate alternative theories on 114–19, 137, 241 banks mitigating price rises through 63–4 equilibrium 217–18 Keynes on 98–9, 103, 106–9, 120, 167, 240–41 liquidity preference theory of the 109, 114–15, 117–19, 241 loan 29, 32 loanable funds theory of the 114–15, 119, 215, 241 monetary 27, 116–17, 133, 172 natural 27 Ohlin on 104–6, 109 policy 10, 215–16 real 27–9, 32, 116 short-term and long-term 119–27 stock flow treatment 90 277 structure of 114, 119–20, 126, 167–8 zero lower bound of 64 investment banks’ credit creation for 44–5, 49 and liquidity 111–12 real rate of return on 8, 154, 167 and saving 49, 52, 62, 91, 95–100, 103–7, 109–10, 136, 154, 156, 175 investment banks 83, 187, 217, 220–23 investment theory of banking 49–50, 165 invisible hand 143, 205 IS-LM model 115, 127, 140–41, 144–6, 151–3, 157, 165, 173–8, 198, 214 island metaphor 70, 200 Israel, G 142–4 Jakab, Z 224–5 Jensen, M C 230 Jevons, S 4–5, 7, 208 Johnson, H G 145, 147, 159, 180–82 Kahn, G A 184 Kahn, R F 100, 126–7 Kahneman, D 232 Kaldor, N 100, 120, 122–7 Kalecki, M 126, 134–5 Kareken, J H 203 Kashyap, A K 223 Kennedy, C 126, 163 Keynes, J M 7–8, 24, 40, 55, 59, 68–77, 88–117, 120, 122–4, 126–7, 131–8, 166–7, 170, 173, 175, 180, 183–5, 193, 201, 213, 225–6, 229, 240–42 Keynes-Patinkin model 167, 170, 242 Kindleberger, C P 85, 189, 226, 229 King, M 89 King, R A 55 King, R G 10, 214 Kirman, A P 15 Kiyotaki, N 220–22 Koenig, E F 184 Koo, R 220 Krugman, P 226 Kumhof, M 224–5 Kydland, F E 202–4 lacking 58–65 Lagos, R 13 Lahart, J 226 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ 278 Banks and finance in modern macroeconomics Laidler, D E W 9, 24–5, 27, 30–31, 33, 35–7, 56–7, 59, 184, 192–3, 209–10 Lange, O 116, 145, 199 Laubach, T 10 Leeson, R 184 Leijonhufvud, A 25, 31, 79, 90, 100–101 lender of last resort 164, 185, 211 Leontief, W 111 Lerner, A P 117, 164 leverage 79–80, 82, 155, 174, 220–21 Levine, R 55 Lima, G T 234 Lindahl, E 141 Lindner, F 110 Lippi, M 245 liquidation abnormal 53–4 debt 84 normal 53 as ‘polite phrase for general bankruptcy’ 73 liquidity preference Keynes’s dilemma 111–13 and role of banks 91, 95–8 liquidity premium 107, 125–6 loanable funds 110, 116–18, 156–7, 159–61, 218, 224 Lucas, R E., Jr 9, 12, 21, 24, 41, 140, 180–81, 197–205, 208–9, 242 Machlup, F 60, 185 Macleod, H D 128 Malkiel, B G 229 manias 54, 74, 83, 189, 226, 233 Mankiw, N G 214–15 Mantel, R 144 marginalist revolution markets see efficient markets hypothesis (EMH); financial markets Marshall, A 5, 13, 79, 142, 214–15 Martel, R J 245 Marx, K 7, 246 McKenzie, L 199 McLeay, M 223–4 Mehrling, P 226 Meltzer, A H 73, 176 Messori, M 42–3 microfoundations 43, 138, 140, 144, 165, 175, 198, 200, 201, 204, 208, 214–15, 234, 249 Mill, J S 4, 7, 79, 226 Miller, M H 9, 155, 219 Minsky, H P 3, 73, 163–4, 192, 226–9, 247–8 Mirman, L 204, 244 Mirowski, P 143 Mises, L von 56 Mishkin, F S 10, 14, 197, 208–10 Modigliani, F 9, 140–41, 145, 151–5, 163, 173, 177, 206, 219 Modigliani-Miller theorem 9, 155, 160, 173–4, 219 Moggridge, D E 90 monetarism 9, 11, 180–84, 198, 234 monetarism without money 9, 181 monetarist counter-revolution see monetarism monetary economics hard questions of 207–9, 211–12 monetary instability 32–3, 35–6, 38–40, 69, 73, 77, 78–9, 94, 137, 148–9, 182, 199, 209 see also financial instability monetary mechanism without financial markets 151–5 monetary stability Friedman’s programme for 184–9 during Great Moderation 89 monetary surprises 9, 180, 197–201 money balances 145–51 commodity, fiat, managed 92 creation of, ex nihilo 44–8 demand 20, 30, 97–8, 106–8, 110–12, 115–19, 124, 126–7, 132, 147, 162, 165, 177, 181–3, 191 illusion 37–9, 77, 80, 148–9, 152, 160 irrelevance in RBC 203–7, 210 neutrality of 40, 44, 70, 141 non-neutrality of 52, 85 as waving veil 193–7 money multiplier definitions 11, 35, 129, 162, 240 doctrine as misleading 169 mechanistic view of 131 see also deposit multiplier money view 131 Moore, J 220 Morgenstern, O 141 Morley, J 216 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Index Motto, R 220 Muelbauer, N J 15, 215 Myrdal, G 7, 141 Nasica, E 55 Neoclassical Synthesis 2, 8–9, 11, 40, 88, 127, 138, 140–41, 145, 165, 180, 183, 185, 195, 198, 201, 235 net-money doctrine 164, 178 New Classical Macroeconomics (NCM) 2, 9–10, 21, 88, 180, 184, 210–11, 213–15, 233–5, 242 New Deal 87 New Keynesian Macroeconomics (NKE) 10, 21, 213–14, 243 New Monetarism 13, 184–9 New Neoclassical Synthesis 10, 214–15, 237, 242–4 Ohlin, B 100, 103–6, 109–10, 113, 119, 241 Okun, A M 192 Olympian rationality 215, 249 Overstone, S J Pagano, M 179 panics 34, 53–4, 83, 173, 188–9, 226, 233 Papadimitriou, D B 226 Pareto, V 141–2, 204–5, 208 Patinkin, D 21, 24, 40, 114, 116–19, 135–8, 140, 145–53, 159, 163–5, 167, 170, 173–4, 177, 181, 199, 201–2, 241–2, 244 Pavanelli, G 33, 37, 77–8, 82, 85 perfect foresight 43, 141–2 Phelps, E S 200 Phillips, C A 127–9 Pigou, A C 14, 20, 36–7, 52, 100, 114, 132–7, 153, 202, 204, 215 Pigou effect 20, 114, 153 see also wealth effect Popov, A 179 portfolio approach 159 Posen, A S 10 Prescott, E C 181, 202–5, 207–8, 211 Presley, J R 55–6, 100 Prestipino, A 221 prices 55–7, 95–8, 100, 108, 144–51 equilibrium theory of relative 5–6, 12, 24, 28–30, 40, 142, 197 279 falling 63, 70–77, 84–5, 87, 135–6, 221–2, 227–8 and information 230–32 shadow 205–6 speculative swelling of 37–9 pure credit economy 26, 30, 34, 61, 93–4, 239 q variable 170–71, 173 quantity equation 24, 40, 145–6, 150–51, 176, 181, 196 quantity theory of money 31–2, 35–9 Friedman’s restating of 182–4, 190–91, 195–6, 210 Keynes’s rejection of 92, 97 Patinkin on 146–7 price level determination 95–8 Radia, A 223–4 Rajan, R G 223 Ramsey, F P 14, 133, 177, 202, 204, 206 Rankin, N 213–15 rational expectations as feature of New Neoclassical Synthesis 10, 215 implicit assumption ante litteram 167 revolution 153, 166, 175, 184 rationality 13, 237–38 bounded 249 far-sighted 200, 245, 249 of markets 226, 233 Olympian 215, 249 Rauchway, E 72 real business cycle (RBC) 7, 9, 10, 203–7, 210, 213, 215, 241–2, 243 from money surprises to 201–3 recession 46, 71, 77–8, 80, 86–7, 191, 192, 197, 220, 222, 224, 233, 241 representative agent model 133–4, 165, 198, 200, 204–6, 244–5 reserves 100% reserve banking 81, 85 and central banks 131, 164, 168–9 coefficient 88, 163, 191, 239 factor determining amount of money created by banks 129–30 legal 130 ratio to deposits 34–5, 56, 93–4, 128 reduction of excess 186 and wealth effect 135 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ 280 Banks and finance in modern macroeconomics Ricardo, D Riepe, M 232 risk premium 120–21 Rizvi, S A T 144, 200 Robertson, D H 6–7, 42, 48–9, 52, 55–66, 91–2, 94, 97–8, 100–101, 104, 106, 110–12, 119, 126–7, 239–40 Robinson, J V 126–7 Rocheteau, G 13 Romer, D 214–15 Roosevelt, F D 72–3, 84 Rosser, J B., Jr Rostagno, M 220 safety margins 173, 229 Samuelson, P A 12, 67, 129–31, 140, 143, 145, 147, 169, 195, 201, 229 Sardoni, C 100, 113, 115, 122–3, 222, 234, 246 Sargent, T 12–13, 202, 208 saving and investment see investment, and saving Schumpeter, J A 6, 8, 42–55, 66–7, 83, 94, 127, 137, 189, 193, 206, 239–40, 246, 249 Schwartz, A J 40, 86, 185–6, 189–94, 210, 249 Scitovsky, T 153 Shaw, E S 21, 141, 156–65, 167–8, 170, 177–9, 242 Shiller, R J 229–32 Shin, H S 221 Shleifer, A 229, 231–2 shocks concept of 236–7 equilibrium plus shocks dyad 246, 248 exogenous 15, 204, 206–7, 233, 236, 244 monetary 4, 9, 12, 35–6, 39–40, 71, 197, 211–12, 239 productivity 7, 143, 203–4, 206–7 real 9, 40, 193, 204–5, 207 technological 9, 21, 44, 202, 207, 242–3 Skidelsky, R 90 Snowdown, B 214 Solow, R M 14, 195, 204–6, 215, 234 Sonnenschein, H 144, 175 Sornette, D 229 Soskice, D 221–2, 233 speculation 4, 16, 53, 74, 78, 91, 120, 122–3, 127, 224, 226, 227 speculative financing 228 speculative motive 124, 166 Spence, M 216 Spiegel, M 179 Sprague, O M W 73 standard of value 16, 44, 70, 116, 122, 125, 244 statics 5, 43, 78, 145, 147, 150 distinction with dynamics 5, 78, 137–8, 141–2 steady state 22, 174, 176–7, 204, 236, 247–8 Stein, J C 223 Stiglitz, J E 215–18, 222–4, 237, 244 stock-flow analysis 90, 177 Stockholm School of Economics 103–4 Swedberg, R 42 tâtonnement 143, 147, 150–51 Taussig, F W 111 Taylor’s rule 184 Thakor, A V 216 Thirlwall, A P 122 Thomas, R 223–4 Thornton, H 4, Tichy, G 43–4 Tobin, J 11, 21, 89, 124, 126, 131, 141, 165–78, 182, 231, 242, 248 Tobin’s q see q variable Tooke, T Townsend, R M 219 Trabandt, M 216, 237 trade cycles 31–2, 40, 42, 62–6, 100 transactions costs 17, 170 transactions motive 30 transition periods 35–9, 78, 239 Trautwein, H 128, 131, 216, 219 Tsiang, S C 117–18 Turner, A 224 Tversky, A 232 uncertainty behavioural approach 232–3, 247, 249 demand for liquidity as defence from 92, 166, 240, 242 on future interest rates 120, 166–7 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ Index radical 17, 70, 144, 166, 170, 242, 244, 249 and risk of arbitrage 231–2 unit of account 13, 92, 122, 125, 146 Ushakov, A 144 Vane, H R 214 velocity of circulation 19, 25–7, 29, 31–2, 33, 39, 81, 84 vice of consolidation 163, 178 Viner, J 111 visible hand 3, 17, 72, 246 Wallace, N 202–3 Walras, L 5–6, 11–12, 21, 43, 141–5, 150–51, 153, 175, 187, 195–200, 204–5, 241–2, 245–6 Walras Law 40, 116–17, 120, 151–2 281 wealth effect 114, 131–8, 150, 152–4, 173 see also Pigou effect Weintraub, E R 143, 234 Weiss, A 217 Werner, R A 128, 223 Wicksell, K 5–7, 14, 24–32, 34, 39–40, 42, 44, 47, 64, 92, 127, 137, 142, 145, 187, 196, 224, 226, 239–40 Woodford, M 213–14, 216, 220, 224, 238 Wray, L R 226 Wright, R 13 Young, W 203 Zingales, L 179 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ ... ✐ ✐ ✐ ✐ ✐ 16 Banks and finance in modern macroeconomics Banks and specialized firms in financial markets emerged and acted as Schumpeterian entrepreneurs, introducing radical innovations They... the analysis of the way in which banks and financial markets have been conceptualized in mainstream economics, not only in Monetarism and New Classical macroeconomics, but also in Keynesian and. .. functioning or the maladjustment and crises of market economies have gone hand in hand with radical changes in the financial system Innovations in financial regulations and/ or in the functioning