Money beyond time and space


It’s kind of a cheap shot (but still endlessly amusing) to attack neoclassical economics for a lack of realism in the assumptions of the models at its core. Neoclassicals are generally well-aware of their absurdity. Anyway, much of the neoclassical economics of the last two or three decades is empiricist to a fault, its problem being a lack of theory rather than an excess of it. The spine of general equilibrium theory has been replaced by an exoskeleton of econometrics.

But the fact remains that when neoclassicals turn to theory they tend to take physics as the guide, rather than the social sciences, and the consequences can be hilarious.

Lately I’ve been working on the theoretical section of my thesis, and have had to hit the books again to improve my sense of neoclassical takes on money, to contrast them with those of the Marxian and post-Keynesian theory that is my natural home. I picked up C. A. E. Goodhart’s Money, Information and Uncertainty as a textbook with a good reputation. (I have the 1st edition from 1975; the 1989 second edition is still in print.)

I don’t want to cast aspersions on Goodhart himself; it’s generally a good textbook, mainly because Goodhart has years of practical experience as a central banker and thus has a particularly sharp sense of the distance between monetary theory and real-world money. But respectability demands his engagement with the mainstream theorists. The first chapter of his book reviews the literature on how theorists have tried to explain money by first asking the the obvious question – would omniscient beings beyond time and space need money to organise their economy? And then moving on to the trickier problem of omniscient beings who are not beyond time:

In fact, a medium of exchange will be desirable in any economy with a time dimension. Because of differences between people in tastes, endowments, etc., exchanges will occur. Because of the existence of time, these deals will not all take the form of contemporaneous exchanges of goods or services, i.e. barter. So the process of exchange must involve the extension of credits and debits, i.e. there will be a medium of exchange through which current goods will be exchanged for future claims to payment. But in a world of certainty, without transaction costs, there is no reason why the ultimate payment need be made in the form of a specialised means of payment. Person A could sell goods to person B at time 1, confident in the knowledge that his claim on goods in return will be met by a transfer from person C at time t + n, while B may extinguish his debt by selling services at some other time to some other person.

In such a world of certainty the whole time path of the economy is effectively determined at the outset with both present and all future markets cleared at known relative prices. No one can default on an obligation, or purchase goods and services which over the course of time exceed the value of the goods and services which he can proffer in return, through the employment of his initial endowment of physical and human capital (plus transfer payments). Under these circumstances everyone knows to whom to send his products and where to pick up his own consumable goods in return. [p. ?]

(I’ve excised the footnotes replete with references to the vast literature where the specifics of this wacky dimension are considered in so much detail.) 

It is fairly obvious that without uncertainty there would be no need for money. But this is a trivial fact, not an interesting one. The fact only became interesting because it had to be pointed out that under the assumptions of the earlier neoclassical models, the existence of money did seem a puzzle. (This was one of Keynes’ main points.)

This does not mean that uncertainty ‘explains’ actual real world money. This is like arguing that the proper way to investigate the airline industry is to first consider whether such an industry would exist in a world without gravity, and then reach the conclusion that the airline industry is explained by the fact that we live in a world with gravity.

Instead a real explanation for money is going to be partly historical and partly functional, and actually quite messy. But the neoclassicals don’t like messy:

Despite its patent unreality, the abandonment of a certainty, or a certainty-equivalent, economy as the main paradigm of the system causes serious difficulty for economic analysis. Most of the studies of market behaviour, of price determination, or equilibrium, of Pareto optimal conditions, have been undertaken within the context of a system which can be collapsed into one period, in an important sense in a timeless system. The rigorous analysis of an economy in which market decisions under incomplete information take place in sequence – described as a ‘sequence economy’ in the growing literature – is only now beginning and is proving to be rather complex. [p. ?]

Published in: on 26 May, 2007 at 12:44 pm  Leave a Comment  

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