Financial Markets, Money and the Real World

276 Pages·2002·1.22 MB·English

by  Paul Davidson

Financial Markets, Money and the
Real World
To Louise
In grateful appreciation of a wonderfully productive relationship
formorethan a half-century
Financial Markets,
Money and the Real
World
Paul Davidson
Editor of the Journal of Post Keynesian Economics and
Professor Emeritus at the University of Tennessee,USA
Edward Elgar
Cheltenham,UK • Northampton,MA,USA
© Paul Davidson 2002
©
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
Glensanda House
Montpellier Parade
Cheltenham
Glos GL50 1UA
UK
Edward Elgar Publishing,Inc.
136 West Street
Suite 202
Northampton
Massachusetts 01060
USA
A catalogue record for this book
is available from the British Library
Library ofCongress Cataloguing in Publication Data
Davidson,Paul,1930–
Financial markets,money,and the real world / Paul Davidson.
p. cm.
Includes index.
1.Capital market. 2.International finance. 3.Liquidity (Economist).
4.Money. I.Title
HG4523.D38 2002
332–dc21 2002019549
ISBN1 84064 740 X
Printed and bound in Great Britain by Biddles Ltd,www.biddles.co.uk
Contents
List of figures and tables ix
1. Keynes,you should be alive today! 1
1.1 Postwar economic performance
1.2 Keynes’s revolution
1.3 The academic resurrection of classical economics
1.4 Differing views on the role of financial markets
1.5 Five key points
1.6 Keynes,the poet of money
1.7 A brief outline of this monograph
2. Keynes’s principle of effective demand 17
2.1 Is lack of competition the fundamental cause of
unemployment? Liquidity versus Say’s Law
2.2 Say’s Law
2.3 Classification and the principle of effective demand
2.4 Why flexible wages do not assure full employment
2.5 Some further clarifications
Appendix 2A1 A simple illustration of the principle of
effectivedemand
Appendix 2A2 Deriving Keynes’s aggregate supply and
demandanalysis from Marshallian micro
demand and supplyfunctions
3. Uncertainty and reality in economic models 39
3.1 A parable:the fable of the P’s,or what mortals these
P’s fool!
3.2 Axioms and model building
3.3 Classical axioms and money’s elasticity properties
3.4 Two concepts of economic reality
3.5 A brief excursion into the history of economic
thought
3.6 Uncertainty and ergodic stochastic processes
3.7 Immutable versus transmutable theories of reality
3.8 Uncertainty and ‘irrational’behavior
v
vi Contents
3.9 Crucial decisions and Schumpeterian entrepreneurs
Appendix 3A Are probabilities knowable but unknown
becauseof limited human computing power?
4. Investment:illiquid real capital versus liquid assets 70
4.1 Two types of investment
4.2 Markets,contracts,liquidity and chartalist money
4.3 Financing and funding assets:why money matters
4.4 Asset position taking and liquidity
4.5 Real capital,savings,time preference and liquidity
preference
4.6 Attributes of all durables
5. Why liquidity preference? 87
5.1 The four motives for holding money
5.2 The demand for the medium of contractual settlement
5.3 The demand for a liquid time machine
5.4 Bulls versus bears
5.5 The finance motive and endogenous money
5.6 The finance motive,finance and funding
5.7 Endogenous versus exogenous money
6. Financial markets,liquidity and fast exits 104
6.1 The double-edged sword of financial markets
6.2 Market liquidity,fast exits and funding investments
6.3 The market for securities
6.4 The different role of banks and nonbank financial
intermediaries
6.5 Bank loans and money-market financial intermediaries
6.6 Conclusion
7. Planned investment,planned savings,liquidity and economic
growth 120
7.1 Harrod’s actual,warranted and natural rates of
growth
7.2 Planned savings and the supply of financial assets
7.3 Ownership and liquidity
7.4 External funding and savers’‘nonspeculative’demand
forsecurities
7.5 Actual growth when new issues exceed the nonspeculative
demand for securities
7.6 The contractionary case with a bull market
Contents vii
7.7 Economic growth,liquidity and funding ‘other’
spendingsectors
7.8 Some conclusions
8. Complicating the picture:money and international liquidity 136
8.1 Open versus closed and unionized versus non-
unionizedmonetary systems
8.2 Aggregate accounting as a basis for the closed–open
dichotomy
8.3 The accounting value of exports and imports and
transferpricing
8.4 The balance of payments accounting statement
8.5 Measuring the degree of openness
8.6 The UMS–NUMS classification
8.7 Exchange uncertainty
8.8 Was the gold standard a UMS?
9. Trade imbalances and international payments 150
9.1 Classical real adjustment processes
9.2 Trade adjustments,payments adjustments and the
Marshall–Lerner condition
9.3 Income effects and payments imbalances
9.4 Thirlwall’s Law:extending Harrod’s trade multiplier
analysis
9.5 The demand for money – domestic or international
9.6 The need for reserves
10. International liquidity and exchange rate stability 169
10.1 The facts versus the theory of flexible exchange rates
10.2 Fixed versus flexible exchange rates and asset holdings
10.3 The efficient market hypothesis again
10.4 Who should ‘make’the exchange rate market?
11. If markets are efficient why has there been so much volatility
infinancial markets? 180
11.1 Efficiency versus liquidity
11.2 Taxing volatility:theory versus the facts
11.3 Ergodicity,efficient markets and noise traders
11.4 Summers,Tobin and super-efficient markets
11.5 Keynes,speculation and liquid financial markets
11.6 Keynes,liquid financial markets and the empirical
findings
viii Contents
11.7 Ergodicity,efficient markets and the empirical findings
11.8 Are real capital allocation decisions efficient?
11.9 Speculative whirlpools and bandwagons
11.10 A policy implication:buffering conventional wisdom
12. Exchange rates and the Tobin tax 200
12.1 Is social control of exchange markets bad?
12.2 Capital uncertainty,speculative flows and the Tobin tax
13. The plumbers’solution to destabilizing international capital
flows 213
13.1 Capital movements
13.2 Flexible exchange rates and export-led growth
13.3 Explaining the facts
13.4 A lesson from the gold standard era
13.5 Plumbing solutions to end financial market volatility
13.6 The Bretton Woods experience and the Marshall Plan
14. The architectural solution:reforming the world’s money 231
14.1 Reforming the international payments system
14.2 Alternative financial architectural proposals
14.3 Criticism of Williamson’s FEER proposal
14.4 Criticism of McKinnon’s PPP proposal
14.5 A comparison of the three architectural proposals
14.6 What if?
14.7 Conclusion
15. The economy and the twenty-first century 253
15.1 The positive role of government
Index 257
Figures and tables
FIGURES
2.1 Say’s Law version of aggregate supply and demand 22
2.2 A general theory of aggregate supply and demand 22
2.3 Flexible wage rate and aggregate supply and demand 26
2A1.1 Illustration of the principle of effective demand 29
4.1 Two-step decisions about the use of current income 81
5.1 The speculative demand for money 94
TABLES
1.1 Real GDP (annualized growth rate) 2
3.1 Concepts of external economic reality 54
8.1 A classification of economic systems by trading patterns and
monetary systems 136
8.2 A balance of payments statement 141
9.1 USinternational payments balances 156
ix