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    tym aegis Ie intrest rte Fall in relation ( {ssuming th ie abies, the co Rmmption 5008s Poy telcne bonds, Brevi so wit nase Bltnetworperod osu fe Pi a lovee densnd to Pieris isan inverse Pietoecs: the deena to {s the excess demands in the fet in this model. It therefc Boods markets, since @ ch Vor supply in’those markets the money and bond markets }model therefore contains nc price level is determinate in F 12, for a divergence in the lum, ‘ceteris paribus, causes FS create excess demands or i therefore create forces 10 Mhis occurs even though, as a Peal balances are identically Even when both money and Img issued only by firms and (Bt thelr effect on the house ta In that case, the alte of ageregate financial range invariant. A model of Haan’ St (1960) and is CHAPTER SIX THE PRE-KEYNESIAN QUANTITY THEORY TRADITION The crude version of the Quantity T 4 is nowadays often accepted as the Quantity Theory as it existed before Keynes. This is regrettable since the Crude Quantity Theory is a complete misrepresentation of the work of the Classical and Neoclassical economists. So total a mis. epresentation is it that we can even state that no Quantity Theorist ever put forward the unqualified Crude Quantity Theory. At most, in the rare cases where it was used, it was presented as an abstraction that summarized the simplified relation between money and prices when important complications are left in the background. The recl meat of the Quantity Theory tradition lay Precisely in the consideration that the Quantity Theorists gave to these complications. Moreover, the problem that Patinkin has formalized—the inconsistency between Say's Identity and the Crude Quantity Theory—cannot be said to have existed in general within the Classical Quantity Theory tradition. The Classical Quantity Theorists not only did not put forward the Crude Quantity Theory; they also did not generally advance the proposition that we have called Say's Identity (although some Neoclassical writers did suffer from confusion, in particular in their use of the Homogeneity Pos tulate), To understand the Quantity Theory tradition, we must go back to the sources and examine the literature of Classical and Neoclassical economics The difficulty of this exercise and the possibility of misinterpretation arise because of the imprecise and frequently self-contradictory manner in which the writers expressed their arguments. In consequence, an understanding of y employed in CI 92 QUANTITY THEORY TRADITION any particular quotation extracted from these writings requires careful con- sideration of the context from which the quotation is drawn. In this chapter we shall follow this procedure to examine whether any of the particular components of the Crude Quantity Theory—the hypotheses concerning M°, k, and y—do have a basis in the Quantity Theory tradition. In this way, we shall gain an overall picture of the nature of this tradition. In Section 6.1 we shall examine the idea that real income and output, are always at their full-employment level. Did the Quantity Theorists support the proposal that the aggregate demand for goods ensures that goods supplied with full employment of resources could always be sold? Did they support Say’s Identity, in other words? In Section 6.2 we shall consider whether the Quantity Theorists did maintain that k, the relationship between nominal income and the demand for nominal money balances, is constant. In Section 6.3 we shall discuss whether MS, the money supply, was regarded as being determined exogenously. Finally, in Section 6.4 we bring together the con- clusions of the preceding sections and consider the work of, Wicksell, the most sophisticated of Quantity Theorists. Before embarking on this survey, it should be remembered that, whereas in Chapters 4 and 5 we were concerned with an exchange economy where the goods in the model arrive from heaven, the Quantity Theorists were, in general, concerned with the real world where goods have to be produced, 6.1 SAY’S IDENTITY AND SAY’S LAW There is no doubt that the Classical economists with few exceptions adopted the law that is generally ascribed to Jean-Baptiste Say. His work was published at the beginning of the nineteenth century (although, as Sowell [1974] points out, versions of the law can be found in the works of earlier writers). The question we have to consider is: Precisely what was meant by Say's Law, for it was interpreted in different ways by different Quantity Theory writers? Specifically, we are concerned with whether Say's Law is to be interpreted as Say's Identity, the proposition employed in the preceding chapters. Recall that Say’s Identity can be expressed algebraically as 2 6) But what exactly does this expression imply? We can interpret it as a general statement saying that “the demand for goods equals the supply of goods," but such a statement is too general. It is the kind of statement that Quantity ‘Theorists frequently made, and its generality and vagueness have given rise to controversy over precisely what they meant. The interpretation of Say's Identity (Eq. 6.1) is more specific than that statement. First, because it is an identity, it says that the demand for goods always equals the supply of goods. THE PRE-KEYNESIAN QUANTY Therefore the quantity of goods produced and sup employment of labor and the means of production, ¢ for goods. Second, Say's Identity says that it is demand for goods that equals the planned supply demand over planned supply for goods as a whole i the supply of goods planned by producers is such th: employ all resources, buyers will choose to buy pr there is no reason why national production and the from it, y, should diverge from the full-employmer ositions of Say’s Identity combine, therefore, to income is always at the full-employment level, since of goods is always matched by demand. That is Say's Identity. Is that how the Quant Say’s Law? In order to consider this question, one Say’s Identity has several corollaries and that a Qua of any of these corollaries could potentially be inte Say’s Identity. One such is the idea that no one 1 instant. That this is a corollary of Say's Identity cam opposite, or what actually happens in capitalist, 0 real-life process of exchange of goods in such ecor GS -M—pG? ‘An individual exchanges (sells) goods for money transaction, exchanges money for (buys) goods. We planned supply and the purchase as planned dema the most important aspect of this process is th separated in time. Thus, the individual period of time; money is a temporary sequence, the individual's planned supply of individual's planned demand. At the in example, the person has a planned demand that is zero. But what about Surely, if the individual at the first individuals must plan to buy them?” other individuals may in thee tansaeti holding money, rather than at the poit possibility arises from the very individual's purchases and sales for the intervening period. The supply is mea {formulation of those eh entity equation referred 0 #1 5 Fraw Fany o! theses C0 Bee nhs & output TFincome and outP¥ Fprity Theorists SUPP Fes that 2oods supplied tid? Did they suppor [reonsider whether th [ship between nomi: Fis constant. I was regarded 3s bein Fring together the con work of Wicksell, t biking on this su 145 we were concerned Helarrive from heaven Hh the real world where f the pa few exceptions adopted & Say. His work was V (although, as Sowell im the works of earlier PLY what was meant by Eby different Quantity (hether Say's Law is oyed in the prec Aically as: interpret it Esupply of fatement Frese nae, Quant Petbretation of ‘Says Fine to of Say’s Pithestopiyorsana a QUANTITY THEORY TRADITION 93 herefo the quantity of goods produced and supplied, wh employment of labor and the means of production, always equals the demand there is full for goods. Second, Say’s Identity says that it is the planned, or ex ante demand for goods that equals the pl demand over planned supply for goods as a whole is zero. In other words, if the supply of goods planned by producers is such that its production will fully employ all resources, buyers will choose to buy precisely that output, Thus there is no reason why national production and the national income deri ie from the full-employment level. These two prop- ssitions of Say's Identity combine, therefore, to assert that real national income is always at the full-employment level, since the corresponding supply of goods is always matched by demand, ed supply:' the excess of planne from it, y, should diver That is Say's Identity. Is that how the Quantity Theorists interpreted Say's Law? In order to consider this question, one must first appreciate that Say's Identity has several corollaries anc that a Quantity Theorist’s sta of any of these corollaries could pot Say's Identity. One such is the idea that no one holds money even for an instant. That this is a corollary of Say's [entity can be seen by considering its, opposite, or what actually happens in capitalist, monetary economies. The real-life process of exchange of goods in such he form of: ntially be interpreted as a state sconomies takes PGS M pG? An individual exchanges (sells) goods for money and then, in a separate transaction, exchanges money for (buys) goods. We can interpret the sale as planned supply and the purchase as planned the most important aspect of this process is separated in time. Thus, the individual necessi period of time; money is a temporary abode of purchasi the individual's planned supply of goods does not always equal the individual's planned demand. At the instant of the first transaction, for example, the person has a planned sugply of goods that is positive and a demand, and for our purposes hat the two transact ly holds money for some power. In con- nd that is zero. But what about aggregate planned demand and supply Surely, if the individual at the first irstant plans to supply goods, other individuals must plan to buy them? \t true. At that first instant, the other individuals may in their transactions be at the point, M, where they are holding money, rather than at the point where they choose to buy goods. This possibility arises from the very fact that in a monetary economy, each individual's purchases and sales are separated in time and each holds money for the intervening period. The length of time for which a person holds money is the subject of personal choice: one may, for example, choose to sell goods This is n "in the exchange economy con Identity equation he concent of planned plans. Therefore, in. the a the Say's there re 94 QUANTITY THEORY TRADITION ‘and build up a hoard of money over a substantial period, rather than use the proceeds to buy goods. It follows that in a monetary economy, the existence of money holdings for a period of time (however short) ensures that there i no guarantee that aggregate planned demand always, at every instant, equals planned supply. For the two to be always equal, as Say’s Identity states, money must never be held even for an instant. Therefore, a corollary or statement of Say’s Identity could take the form: “Money is never ckosen to be held for an instant.” Another corollary of Say’s Identity would be the statement: “There is never a general glut of unsold goods.” Goods willingly produced, desired supply, are always willingly bought, since they equal planned demand, Underlying this idea there may be an idea of the direction of causation. Common to many interpretations of Say's Identity is the idea that causality runs from supply to demand: planned supply instantly creates an exactly equal planned demand—indeed, Say himself saw causality in this way. This, then, implies a strong statement of the neutrality of money: “Since planned demand for goods always equals and is determined by planned supply, an ‘exogenots change in the supply of money cannot affect for an instant the real demands and supplies of goods." ‘Now, having established these versions, implications, and corollaries of Say’s Identity, we can consider whether the Classical and Neoslassical Quantity Theorists included it as a component of their theories. Statements of Say’s Identity Jean-Baptiste Say himself certainly appears to have done so. As well as being an original thinker in his own right, he was a popularizer cf Adam ‘Smith's general propositions. In combining these two functions, he also saw his task as systematizing the ideas advanced by Smith, setting out the basic propositions that must lie at their foundation, and criticizing what he con- sidered to be errors in Smith's work. Like Smith, Say was an apologist for the new economic system, capitalism, which was in its infancy at tre time, although, again like Smith, he had a social conscience and was a critic of some of the social conditions that accompanied the development of capi- talism. As an apologist, Say was concerned to demonstrate that capitalism had limitless possibilities of expansion if only the barriers to trade were eli- minated. In the process, he wrote his Treatise of Political Economy, first published in 1803, which became a best-seller and went through many Note that such a statement implies an assumption that the supply of money cannot directly affect the supply of goods. It can affect supply only if itis able fist to affect demand (and this is precluded by Say’s Identity). This assumption that money does not directly affect supply is Permmon in the Quantity Theory tradition (which, 2s we shall se, is not based on Say's Identity Ss expresied here), It also common in modern Keynesian and monetary theory, THE PRE-KEYNESIAN QUANTITY TE editions.’ The book contained proposition that has be ‘aw of markets” and made it especially clear in its sec editions. This is now known as Say's Law and some Say's Identity If we examine an English translation we find a clea Identity See. | eer, ea Parievancte eae We must, however, ask whether Say was st proposition or merely as a polemical point. home, in his role as an apologist, the idea that itless, since the expansion of produetio be halted in the long run by an oversupply of the affirmative, for the passage quoted preceded by the much weaker sta with a view to hoard or bury it, the purchase of some kind” (emphasis add that in a monetary economy there purchase, and the emphasis on the in the previous quotation is merely ‘Since we can find no other ‘emphasize the immediacy of th we must conclude that the int second paragraph of this Quantity Theorist. They’ el explained in Chapter 1) tin ‘money allows a real sep: ‘An explicit statement Although he who sels he sells: and he doet commodity when he 2 Separated, it may inclination to sell i ination to deter ther than use the sures that there is ery instant, equals s Identity. states, e, a corollary oF ever chosen to produced, desired planned demand. tion of causation idea that exactly his way. This, Since planned aned supply, an n instant the real izing what he con- aan apologist for the fancy at the time, ind was a critic of Yelopment of ment of capi $ that capital capitalism had {leat Econom Fent throug first THE PRE-KEYNESIAN QUANTITY THEORY TRADITION 95. tions. The book contained a proposition that has been translated as the n its second and subsequent law of markets” and made it especially editions. This is now known as Say’s Law and s ied as Say's Identity If we examine an English translation,‘ we find a clear statement of Say’s Identity has put the finishing hand (0 his p le should diminish in his h sin the purchase of We must, ho’ ask whether Say was sating this as a strict theoretical proposition or merely as a polemical point. Was it put forward only to drive home, in his role as an apologist, the idea that the opportunities for capitalism are limitless, since the expansion of production that capitalism entails cannot be halted in the Io ly of goods? The answer must be in he affirmative, for the passage quoted here is (as Patinkin notes) imme: preceded by the much weaker statement tha: “even when money is ob with a view to hoard or bury it, the ultimate object is always to employ it in a purchase of some kind” (emphasis added). Cearly, therefore, Say understood that in a monetary economy there is a break in time b chase, and the emphasis on the immediate link between p evious quotation is merely polemi Since we can find no other quotations from the Quantity Theorists that emphasize the immediacy of the disbursement of money received from sales, we must conclude that the interpretation of Say’s Identity, presented in the graph of this section, is too extreme to be attributed to any recognized, at least implicitly, that (as ween sale and chase and sale second para Quantity Theorist. They explained in Chapter 1) tim money allows a real separation in time of purchases and sales. An explicit statement of this was made by John Stuart Mill (1844): is of the essence for the existence of money; Although he who sels, really sells ony to buy. he need not buy at the same moment wi he sels: and he does not therefore necessarily 10d 10 the inimediate demand for one mmodity when he adds to the supply of snatver. The buying and selling being. 96 QUANTITY THEORY TRADITION But we can modify the concept of time that we have employed so far to arrive at a version of Say’s Identity that is formally unchanged. That is, we can arbitrarily divide time into discrete periods, a short run, and « long run which is a succession of such short runs. We can then state Say’s Mentity as the proposition that the planned supply of goods over the short-run period (a flow concept) is identically equal to the planned demand over that period, Money is held between the transactions occurring within the period but not from one short-run period to the next;’ individuals are eager to spend money balances within some such period, and they want to do it as quickly as possible, so the period. is as short as possible. This seems to be Patinkin's interpretation of Say’s Identity, since he quotes as examples of it passages that make no mention of immediate disbursement of money or syn- chronization of planned purchases and sales at every instant Quotations from Classical economists that appear to support Say's Iden- tity in this modified form are legion. For example, they are to be found in the writings of James Mill. In his Commerce Defended (1808), he proviced a more explicit statement of the law than Say had offered at that time, and in his Elements of Political Economy (1821), we find: ‘When a man produces a greater quantity of any commodity than he desires for himself, i can only be on one account; namely that he desires some other commodity And: No man wants money but in order to lay i ou, ether in articles of productive or articles of ‘unproductive constimption. We can also find in Ricardo’s writings statements of Say’s Law in the form of an identity—or, as Ricardo called it, “Mr. Mill's theory.” They are found not so much in Ricardo’s great Principles of Political Economy and Taxation (1817), where the main reference is a laudatory remark in the preface, but in his correspondence with, and comments on, Malthus. For example, Ricardo writes: Whoever is possessed of a commodity is necessarily a demander, ether he wishes to consume the commodity himself, and then ao purchaser is wanted: or he wisnes {0 sell it tnd purchase some other thing withthe money. Similarly, McCulloch, a rather crude defender of Ricardo's system of thought, argued (1844): It is... the acquisition of [other goods) ..and not of money, that isthe end which every ‘man bas in view who certes anything to market This concept of time is clearly analogous to the market day in Hicks's (1967) monetary model, discussed in Chapter I. x THE PRE-KEYNESIAN QUANTITY Finally, we have the well-known statement of John S ciples of Political Economy (1848): All sellers are inevitably... buyers. Could we suddenly double country, we should double the supply of commodities in ever: the same stroke, double the purchasing power. Everybody wou well as supply; everybody would be able to buy twice as mus have twice as much to offer in exchange Say and Ricardo in Context Although we can find these, and more, statements by that appear to support Say’s Identity, reading them in that these writers most certainly did not support the p of the context is the intellectual climate at the time th wrote. They were engaged in a fierce battle with those of Keynes in a sense, who argued that a general glut Chalmers, Sismondi, and others emphasized that sup ‘own demand, that a general overproduction of goods inadequate aggregate demand for goods as a whole, at will depress production. One way to clarify the debate and the followers of Say’s Law emphasized that thy determine aggregate output, whereas Malthus and the» emphasized demand as the determining factor. noted, argued that crises, slumps, and une general, however, followers of Say's Law location of resources—too few being used i demand and too many being used in sectors ‘general glut theorists argued that crises general, It would be untrue to say, however» followers of Say’s Law denied the existe ‘each of the writers we have quoted. AS himself admitted the possibility of the general glut theorists, Say eve cession” to their views in preparing edition, we find him arguing that t and that recognition of this is political economy” rather than ® Ricardo, too, recounizs His difference with the get fact that he worked at a level the long-run potential fOr have believed that in the the long run, the limits which depends on the be Patinki' "seems 10 Bibb eramles or i rss ERement of 0 Fevers stant i Pi ete snort say's ten. Piya tobe four inte Brite, ne povided» more Vleet at tat tine, a in hs k [foi than he desires for hms bom otter commodity Finartctes of productive or HS0f Say’s Law in the form of [Stheory.” They are found not litical Economy and Taxation Wtemark in the preface, but in Malthus. For example, Ricardo BE demande, either he wis Het it wanted; or he wishes PERicatdo's system of thought PIR eta is the end wich PR Heke 557 sone x TRADITION 97 Finally, we have the well-known statement of John Stuart Mill in his Prin ciples of Political Economy (1848): ime stoke, double the purchssig power, Everybody would brn Say and Ricardo in Context Although we can find these, and more, statements by Classical economists that appear t Say’s Identity, reading them in their context indicates that these writers most certainly did not support the proposition. One aspect of the context is the intell wrote. They were engaged in a fier of Keynes in a sense, who argued that tual cimate at the time that the Classical writers attle with those writers, the precursors Ithus c its eral glut was possible. M Chalmers, Sismondi, and others emphasized that supply own demand, that a g inadequate a eral overproduction of goods is possible because of regate demand for goods as a whole, and that such a situ will depress production. One way to clarify the debate is to si and the followers of Say’s Law emphasized that the conditions of supply determine aggregate output, whereas Malthus and the “general glut” theorists emphasized demand as the determining factor. Neither side, it should be noted, argued that crises, slumps, and unemployment are impossible. In general, however, followers misallocation of resources—t demand and too many being used in s of Say’s Law argued that they stem from a 10 few being used in sectors where there is high rs with low d feneral glut theorists argued that crises reffect an inadequacy of demand in general It would be untrue to say, however, that in the followers of Say's Law denied the existe: each of the writers we have quoted. As S himself admitted the possibility of general gluts. In his correspondence with he general glut theorists, Say eventually revealed that he had made a “con. sion" to their views in preparing the fifth edition of his Trea edition, we find him arguing that there are limits to production in t and that recognition of this is necessary when “we are studying pra political economy” rather than “abstract Ricardo, too, recognizes the possibility of general gl His difference with the general glut theorists appears to stem partly from th fact that he worked at a level of abstraction where he fixed his eyes firmly on the long-run potential for capitalist accumulation and growth. He appears to have believed that in the short rua, supply may be limited by demand, but in the long run, the limits to production are determined by the rate of profit which depends on the distribution of national income among workers’ wages, mand—whereas the uurse of this debate, the .¢ of general gluts. Consider in turn ywell (1974) demonstrates, even Say uantities ts in the short run 98 QUANTITY THEORY TRADITION landlords’ rent, and capitalists’ profits. As he said in a letter (1966, Vol. 7) to his adversary Malthus: It appears to me that one gre cause of our difference in opinion, on th subjects which we have so often discussed, i that you always have in your mind the immediate and temporary effects of particular changes—whereas I put these immediate and temporary effects quite side, and fix my whole attention on the permanent state of things wtich will result from them Similarly, in Ricardo's notes to James Mill, dated December 18, 1821 (1966, Vol. 9}, there is a clear distinction between the possibility of a general glut in the short run and its impossibility in the long run: If every man was intent on saving, more food and necessaries... would be produced than could be consumed. The supply above the demand would produce sucha glu, that with the increased quantity you could command no more Isbour than before [that i, prices of goods ‘would fal, So a fall in the absolute price level comes through a short-run excess supply in the goods markets (as is the case with Patinkin’s real balance effect). But matters are different in Ricardo’s long run. For the fall in the prices of goods involves an increase in real wages, a redistribution to workers, as a result of, which “all motive to save would cease,” the excess supply would be eradi cated, and, moreover, it would not have permanently hindered accumulation because the rise in real wages evokes an increased labor supply, which lowers real wages to their initial level. Ricardo, like most Classical writers, is not always consistent. We can, therefore, find places where he denies the possibility of a general glut in the short run, but even there he does not support the Say's Identity proposition that supply creates its own demand. Instead, in such places he argues that in the short run, supply is determined by demand and a fall in demand can push supply below the full-employment level. But he contends that supply falls instantaneously in response to this decrease in demand, so that excess supply is immediately eradicated. For example, in a letter to Malthus dated July 9, 1821 (1966, Vol. 9), Ricardo wrote: If you had said “after arriving at «certain limit there will inthe actual czcumstances be 90 use to try to produce more-—the end cannot be accomplished, and if it could, instead of ‘more, less would belong to the class which provided the capital.” I shoald have agreed with ‘But it is clear that a difference between concentrating onthe short run snd on the long run is not the sole souree of the difference between Ricardo and Malthus, since Malthus wrote, in his Definitions in Political Economy: “The question of 2 glut is exchsively whether it may be ‘general, as well as particular, and not whether it may be permanent as well as temporary.” Malthus, unlike Ricardo, clearly considered that long-run stagnation, with excess supply of goods arising from inadequate demand, wat possible. The important point that te passtge suezest, however is that Ricardo thought excess supply. a general glut, t0 be possible in the short run, . THE PRE-KEYNESIAN Qué Ricardo followed this with an emphasis on the j because a limit on demand immediately ensures that demand and supply remain in balance: acknowledge there may not be adequate motives for not be produced, but T eannot allow... that with these be produced” Finally, and in the same vein, we find in Ricard ‘a Low Price of Corn on the Profits of Stock” (I: the effects of a government's restricting exp Ricardo recognized that a fall in demand cau: wrote: “No interruption could be given tot] without the most extensively ruinous commer the fall in supply is preceded by a short-run exc ‘The immense capital which would be employed or suddenly, and under such cicumstances without iat orn in their markets, which would affect their whole Caleulation... would occasion a scene of wide spread From our consideration of Say and Ricardo quite wrong to suppose that they believed it Jong-run proposition that enabled them to is distribution, prices, and values, that determine | as a short-run proposition cannot be pinned ont for Keynes, who was primarily (but not who analysis, to write (1936): “From the time of economists have taught that supply creates its + McCulloch, Mill, and Marshall Moreover, it is not only Say and Ricardo are qualified so as to make them read like context. We have quoted McCulloch a5 Identity, but that statement is imi clear that he is thinking of the Tong possible: "although Sowell (1974) interprets tlt that demand influences suppl is the motives for production #8 motive to he profit and showed Bom

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