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Monetary Reform

John Maynard Keynes, A Tract on Monetary Reform (London: Macmillan, 1924)


Brad DeLong

Associate Professor of Economics University of California at Berkeley
Berkeley, CA 94720
(510) 643-4027 phone
(510) 642-6615 fax

This may well be Keynes's best book. It is certainly the best monetarist economics book ever written.

What do I mean by monetarist? Consider the book's preface, where Keynes writes:

[The economy] cannot work properly if the money... assume[d] as a stable measuring rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer--all proceed, in large measure, from the instability of the standard of value.
It is often supposed that the costs of production are threefold... labor, enterprise, and accumulation. But there is a fourth cost, namely, risk; and the reward of risk-bearing is one of the heaviest, and perhaps the most avoidable, burden on production....[T]he adoption by this country and the world at large of sound monetary principles, would diminish the wastes of Risk, which consume at present too much of our estate.

The belief that monetary instability--inflation and deflation--is the principal, or at least a principal, cause of other economic evils; the hope that sound monetary principles can be identified and, when identified, would greatly diminish uncertainty and risk; the focus on the job of the public sector being to provide the private economy with a stable measuring-rod and a stable environment--all these are core ideas of whatever we choose to call monetarism. Keynes believed these ideas very, very strongly in the mid-1920s. And his Tract on Monetary Reform is a review of economic theory and a look at the economic problems of post-WWI Europe through this set of monetarist spectacles.

The first chapter--"The Consequences to Society of Changes in the Value of Money"--may still be the best summary of the many and varied effects of deflation and inflation--on the distribution of income, on economic activity, on attitudes toward risk and reward--ever written. From our present-day standpoint, it could use a little more focus on the differing effects of "anticipated" and "unanticipated" inflation and deflation. But a great deal is packed into a short space.

The second chapter--"Public Finance and Changes in the Value of Money"--may also be the best of its class. It provides an extremely lucid introduction to the idea of the "inflation tax"--that inflation is most importantly seen as a way for governments to levy a hidden tax on holdings of real money balances, and that governments almost inevitably find themselves resorting to this tax, whether by accident or by design.

The third chapter--"The Theory of Money and the Foreign Exchanges" is in its firsts part a rapid introduction to the so-called "Quantity Theory of Money". It contains what must be Keynes's most famous line--in the long run we are all dead--which is embedded in the following discussion:

It would follow... that an arbitrary doubling of [the money stock], since this in itself is assumed not to affect [the velocity of money or the real volume of transactions] ... must have the effect of raising [the price level] to double what it would have been otherwise. The Quantity Theory is often stated in this, or a similar, form.

Now "in the long run" this is probably true. If, after the American Civil War, the American dollar had been stabilized... ten per cent below its present value ... [the money stock] and [the price level] would now be just ten per cent greater than they actually are.... But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the strom is long past the ocean is flat again.

In actual experience, a change in [the money stock] is liable to have a reaction both on [the velocity of money] and on [the real volume of transactions]...

The second part of the chapter is a rapid introduction to exchange-rate determination--the purchasing-power-parity theory of exchange rate movements, and why there might be substantial and persistent deviations from what purchasing-power-parity would suggest.

Chapter four--"Alternative Aims in Monetary Policy"--sees Keynes shift from analyst to advocate: he comes down, in the context of Western Europe in the 1920s, on the side of devaluation to bring official currency values in line with relative national price levels rather than of deflation to force national price levels into consistency with pre-WWI exchange rate parities. He argues that when you are forced to choose between maintaining a stable exchange rate and maintaining a stable internal price level, choose the second. For avoiding fluctuations in your internal price level avoids a host of evils:

We see, therefore, that rising prices and falling prices each have their characteristic disadvantage.... Inflation is unjust and Deflation is inexpedient.... [I]t is not necessary that we should weigh one evil against the other. It is easier to agree that both are evisl to be shunned. The Individualistic Capitalism of today, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient--perhaps cannot survive--without one...

He argues against return to the gold standard, on the grounds that modern central banks can do a better job of maintaining price stability if they are not tied to gold. Keynes's arguments in chapter four look very good: current opinion among economic historians, exemplified by Barry Eichengreen's Golden Fetters: The Gold Standard and the Great Depression, is that attachment to gold did a large part of the work in preventing central banks from stemming the Great Depression of the 1930s.

The last chapter contains Keynes's "Positive Suggestions for the Future Regulation of Money". Keynes's suggested policies are the same as Irving Fisher, or indeed as Milton Friedman: spend money to construct a good price index, and then tune monetary policy so as to stabilize internal prices. As Keynes wrote in his preface:

We leave Saving to the private investor.... We leave the responsibility for setting Production in motion to the business man.... [T]hese arrangements, being in accord with human nature, have great advantages. But they cannot work properly if the [value of] money, which the assume as a stable measuring-rod, is undependable...

The implicit point of view is that if the value of money is dependable then leaving saving to the private investors and investment to business will work well. The magnitude of the Great Depression of the 1930s would destroy Keynes's faith in the proposition that stable internal prices implied a well-functioning macroeconomy and small business cycles. But from our perspective today--in which the Great Depression is seen as a unique disaster brought on by an unprecedented collapse in financial intermediation and in world trade, rather than as the largest species of the genus of business cycles--it is far from clear that Keynes of 1936 is to be preferred to Keynes of 1924.

Besides, Keynes of 1924 writes better: his prose is clearer, less academic, less formal; his argument is more straightforward, linear, easier to follow; his style is as witty.


Created 2/'21/1996
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Associate Professor of Economics Brad DeLong, 601 Evans
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