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Direct reversal of cause and effect from the relation maintained by the quantity theory has been rather widely recognized in monetary literature for various particular situations.
But a much more categoric assertion of this reversal seems to
inhere in the description of economic equilibrium emanating
from Keynes and his followers. Marginal efficiency of capital
in comparison with interest determines investment, which in
turn through the multiplier controls the level of employment
or output. Prices are established without direct reference to
the effective quantity of money (MV) by the cost functions
of individual goods. Volume of output multiplied by prices
gives the money requirement for the active circulation; and
the residual money becomes the supply available for reserves,
with which the liquidity demand function equates to set the
rate of interest.
The foregoing representation of the r6le of money in the
Keynes analysis will later be shown to be an over-statement
of Keynes' real position on the part of Mr. Harrod'; but it
has the merit of setting in bold relief an important line of
causation in that theory. I do not hold that an appeal to
1. R. F. Harrod, "Mr. Keynes and the Conventional Theory," Econometrica, vol. 5, no. 1 (January, 1937), pp. 74-86.
431
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432
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433
434
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435
436
given commodity through all the entrepreneur stages (average number=L), encompasses all the income-expenditure
periods (average length=i), it "overlaps" the time-dimension of all working balances (iL=m); the monetary requirement reaches its minimum, circuit velocity its maximum, and
overlapping is perfect (g= 1). At the other extreme, the
average payment interval (v) encompasses the average timedimension (i) of working balances of only one entrepreneur
stage (v=i, vL=iL); the monetary requirement reaches its
maximum, circuit velocity its minimum, and overlapping is
zero (g=0). The general expression for limiting and inter7
mediate values of overlapping can be written: g = vvL-m
8. Op.cit., p. 233.
9. Throughout all illustrations on my interpretation any time
absorbedin the process of making payment is included in the income-
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437
ceeds comes before the time at which his obligations fall due,
each person needs to carry the funds only a fraction of a day.
The total time through which funds are carried in all three
stages does not exceed the payment interval. The (average)
income-expenditure period (i) of 1/3 day, multiplied by the
(average) number of stages in the production-consumption
circle (i) or 3, equals the (maximum) payment interval (m),
one day;' that is, iL = m, and overlapping is perfect or g= 1.
Case I:B, which I have added to Angell's, reveals that
individual income-expenditure periods may differ in length
without impairing g =1, if their average (i) remains the same
so that iL still equals m; and that the number of stages can
increase compatibly with perfect overlapping, provided that
i is correspondingly shortened to maintain iL=m. In Case
II, to return to Angell's illustrations, a situation of g= 1 can
be imagined aside from the simplifying assumptions of Case
I, that the amount of payments at every transfer of money
was everywhere the same, and that all payment intervals
were the same, "maximum" having no particular significance. In Case JJ2 each consumer-laborer pays 1/7 of his
weekly wage daily to the middleman, who pays over these
receipts without delay to the producer, and the latter pays
the accumulated receipts of seven days to the consumerlaborer on week-ends. As Angell explains, the respective
income-expenditure periods are now 3.5, 0, and 3.5 days in
expenditureperiod of the person who continues to own the money until
the moment of legal transfer of ownership. Angell's assumption of
instantaneoustransfernot only lends his analysis an avoidable tinge of
unreality,but it fails to give the propersubordinationin a generaltheory
of velocity to such technical details as the speed of trains, the rapidity
of bank-clearings,etc. The Cambridgecash-balancedevice accomplishes
this subordination,as I do, by looking to the transfer of ownership of
funds, which is instantaneous.
Value added by manufactureis introduced by Angell later in Case
V, but nothing in the nature of perfect overlappingprecludesits inclusion here also.
1. In Case I:A, since all income-expenditureperiods are alike and
payment intervals are also, the terms "average" and "maximum"
have no particularsignificance.
2. Ibid., pp. 235-236.
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438
DAY
CONSUMERS
fL N:FC6R~TrloN_
MIDDLEMEN
CASE I :A
CASE i:B
PRODUCERS
'
8 DAYS
CON SUMERS
CASE 11
<
-- -
--
-a
DAYS -
~~~~PRODUCERS
-->
~~~CASIEm-_3
The lapse of time is representedhorizontally to the right; an act of
payment and its direction, by a heavy vertical arrow; the movement of
money from consumersto most remote producersby progressfrom top
to bottom of the chart; size of real balance-holdings,by the vertical, and
duration of balance-holding,by the horizontal dimensions of enclosed
areas.
' The interpretation of Case Ilrequires special reference to page 471.
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-I D
SAYAS
439
I DAY
INCONSUMERSU
/ U/
/
i
PRODUCERSP
NX
~~CASE
2
Z
ZPROD
ER
-C
CASEY*
In Case IV the two 'strands" of money before integration are distinguished as
plain and cross-hatched areas. The one "strand" or sequence of balances after integration is identified by double lines.
5 In Case V payments are actually traced through for only one sequence of balances;
to complete the picture of payments for the whole period, such a sequence would have
to be represented as beginning on each day.
2
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440
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441
second time. Transactions velocity (V) divided by the average number of stages (L) equals circular velocity (C), or
V=C; and
equals also
V-'=
V C
present abstraction of idle balances. But the average incomeexpenditure period (i) is the reciprocal of transactions velocity
1
1
i.L
1
(V), or i= -. Substituting i for-in- = -, we obtain- =iL.
V Vd
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442
dNI'
443
444
N-
the cir-
9= vL
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445
446
QUARTERLYJOURNALOF ECONOMICS
447
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448
449
g= 0
or
=vL-
vL- m
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450
451
tom nearly as venerable the Fisher analysis refers to transactions. Students approaching these two formulations for
the first time are prone to conclude that they deal with
distinct phenomena, and no less eminent an economist than
Keynes lends his support to the idea that the Cambridge
equations naturally "lead up to" one kind of price index, the
Fisher equations to another.2 But there is no inherent reason
why the "money-at-rest" viewpoint should be associated
with income while the "money-in-motion" view should
necessarily be conjoined with transactions; and Robertson
has, amongst others, performed a substantial service in
demonstrating the substitutability of one set of symbols for
the other in dealing with either income or transactions.3
The traditional reference in the Cambridge analysis of the
real-balance factor k to real incomes is beset with three serious
causes of misunderstanding, which sometimes impede the
attempt to translate this mode of statement into the Fisher
terminology. For one thing, a state of fog prevails as to
whether k refers to something exclusively pertaining to the
consumers' monetary economy, or whether it includes the
monetary facts in producers' and consumers' spheres alike.
Now there can be no doubt that the latter is the true character of the monetary member of the equation, but with equal
force the formulation of the theory seems to involve the
former alternative. Formulae embodying kcare widely used
as general equations of exchange and not as expressions of
the state of affairs in the consumers' sphere alone. Robertson's four formulae setting forth Fisher and Cambridge
methods of dealing with incomes and with transactions
include the same money stock held by the same people,
simply because the former includes all4the money, the latter
all the people. Keynes' dissatisfaction with his earlier quantity equation in the Tract on Monetary Reform was precisely
because its reference to consumption units (kcas a ratio to
2. J. M. Keynes, A Treatise on Money (New York, 1930), vol. I,
p. 238.
3. D. H. Robertson, Money (New York, 1929), p. 195.
4. "All" may be interpretedto include hoards, altho in this Section
we are concernedwith working balances primarily.
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452
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453
-,
where P
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454
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455
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456
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457
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458
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459
460
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461
Both the "velocity" of money and the amount of "transactions" of goods are hybrids. For, on the one hand, velocity
is a weighted average of velocity of working balances and
zero velocity of idle balances; and on the other hand, transactions is the product of multiplying quantity of goods by
number of turnovers or stages. This has long been recognized.
But it is not always recognized (1) that mechanical connections obtaining between T and 'v (in the Fisher equation)
are limited to relations between turnover and velocity (or
size) of working balances, with the absolute exclusion of the
3. J. M. Keynes, "Mr. Keynes' Theory of Money: A Rejoinder,"
Economic Journal,vol. 41, pp. 413-419.
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462
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463
rate of physical transfer is uniquely established by the absolute length of income-expenditure periods and payment
intervals, by degree of overlapping, and by the number of
productive stages. Concerning this rate of physical transfer
there need be no mystery: it is the rate at which dollars, if
they circulate at all, must move; for working balances, rate of
physical transfer and velocity in this category coincide. For
idle balances, rate of physical transfer and velocity again
coincide, but ex definitions at zero. In a literal sense, given
the determinants of working balances, nothing can happen to
the physical transfer rates. If money does not rest in idle
balances, it circulates at a predetermined rate; and whether
velocity rises or falls depends upon whether less or more finds
its way into idle balances, Whatever controls this division
controls velocity, since it controls the weights assigned to
zero rate of idle balances and the "predetermined" rate
analyzed in Sections I-III.7
According to the quantity theory of money this division
is accomplished by a subjective calculus on the part of the
money holder. The flow of utilities from holding real wealth
in money form against contingencies - it might be against
a tempting opportunity to invest - is weighed against the
flow of consumption utilities on the one hand and the utility
yield of investment on the other. For this three-fold calculus,
the x-axis of utility curves might be taken as dollars, so far
larly within the conventional maximum "charging" period. If this
choice should enable and induce the receiver of the sums in turn to pay
obligations sooner, velocity in general may rise. Conventional "due
dates" throughout the system serve at every step, however, to obliterate the effects of individual choices earlierin the productiveseries.
7. Representationsof this fact by symbols differ. If k, C, and V are
taken in connectionwith all the money in the hands of the public, a shift
from idle to workingbalanceswill show up in changesin the magnitudes
of k, C, and V themselves and not in M; but if k, C, and V are taken in
connection with working balances only, a shift from idle to working
balances increasesM, leaving k, C, and V constant. Both theoretically
and practically the former practice seems superior: M can then be
regarded as controlled by the monetary authority, while the velocity
magnitudes rest partly on payment customs and partly on subjective
elements; further, statistical information is more readily and directly
available for velocity variations than for division of money into two
categories.
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464
as concerns the atomistic individual's own influence on velocity: purchasing power of money would be a parametric function; but since even the individual cannot assume the total
supply of money as given by the banking system to be conuse Marshall's
stant, he must think in real terms -to
illustration, in wheat. Marginal utilities of real values
devoted to consumption, investment, and reserves are equalized by letting money go into any one of the three where the
margin is temporarily too high, by taking it away from a
use where the margin is too low. Money in idle reserves is
brought to the desired margin by letting some go into, or by
withdrawing some from, working balances sufficiently to
raise or lower prices sufficiently to make the money in idle
reserves give the requisite real-value provision against contingencies. Mr. Harrod errs when he states that the quantity
theory provides no determinate division of the money stock
between working and idle balances.
Before we proceed to inquire how the real-balance analysis
misleads Mr. Harrod, as indeed it misleads Professor Angell,
we should point out for later reference two correlates of the
foregoing "pure" quantity-theory causation. (1) An increment to M would, ceteris paribus, be divided between idle
and working balances proportionally to their existing or
equilibrium magnitudes; i.e., the Multiplier, as Angell,
Knight and Robertson have said, would be circular velocity.8
(2) The utility of idle balances or "liquidity preference"
would determine price levels, not interest rates.
This exposition of the real balances version of the quantity
theory is purposely "crude and common";9 for, with the
emphasis put upon the division of money stock, the quantity
theory of real balances undoubtedly makes working balances
8. J. W. Angell, "The General Dynamics of Money," Journal of
Political Economy, vol. 45 (June, 1937), pp. 337-8; 341-2; F. H. Knight,
"Unemployment: and Mr. Keynes's Revolution in Economic Theory,"
Canadian Journal of Economics and Political Science (February, 1937),
p. 110; D. H. Robertson, "Saving and Hoarding," Economic Journal,
vol. 43 (September,1933), pp. 409-410.
9. To employ the flatteringphraseby which Mr. Harroddescribeshis
own passages designedfor his inept, uninitiated readers.
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465
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466
467
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468
CL*'I
i'-
,
LI
Lesslfull Iemployment
than
forkXYZ forlXYz'
mploymentf-'4
MP oyment
0%
100%/
100%1
0/
< 100%1
1. The slope of YZ and Y'Z' indicates direct and proportional variation of prices with money times circular velocity. Full employment
for XY'Z' lies farther to the right than for XYZ because part of the
money is "wasted" in raising prices; but the absolute magnitude of
employment and output is identical for XYZ and XY'Z'.
2. The slope of X"Y" indicates that at first the increase of money
goes preponderately into extending employment, but later into raising
prices. Whether the downward price-production function in depression
exactly corresponds with X"Y" read upward is immaterial for present
purposes. Y"Z" indicates pure inflation, as in YZ and Y'Z'.
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469
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470
471
sented as exercising a causal influence upon the rate of interest," it has "as its permanent r6le, a share in the determination not of the rate of interest at all but of the price-level."'
There is no more momentous issue in contemporary economic
theory and policy.
HOWARD S. ELLIS.
UNIVERSITY OF MICHIGAN
A NOTE ON CASE II
My graphic illustration of this arrangementof payments (p. 438) as
well as the textual description (p. 440) suppresseda certain complication in order to simplify the argument at an introductorystage. But it
is necessary to recognize that, however characteristicof important real
situations the scheme of Case II may be, the perfect overlappingwhich
Angell attributes to payments as he describesthem here cannot in fact
be achieved. Incomeexp-enditureperiods are given as 3.5, 0, and 3.5
days in length, whereas literally they are 3.5, 0, and 3.0 days for consumers, middlemen, and producers respectively; the average is 2 1/6
days, and i L = 6 and not 7 as would be necessaryfor g = 1.
At the end of the seventh day, the consumers'expenditurewas, quite
as on previous days, transferred instantaneously from consumers to
middlemenand from the latter to producers. But unlike previous days,
the seventh witnessed an instantaneous transfer of this money back to
consumers as laborers. What Angell ignores, in calling this a case of
perfect overlapping,is the possibility (as Case V, q.v.) of reducing the
"necessary money" - in this case by 1/7 - through the simple offsetting of debit and credit to consumer-laborersat the end of the seventh
day. Preciseanalysis of Case II reveals, therefore,that a certainfraction
of the total money used to obtain the value of g as equal to 1 actually
belongs to idle instead of workingbalances. Any illustration embodying
consumerand producerincome-expenditureperiods of finite length will
be embarrassedby a certain amount of balances which are really idle,
just as in Angell's case, provided the general scheme of Case II be
maintained.
Nevertheless, actual situations may approachthe complete elimination of idle balances and the attainment of perfect overlappingwithout
departing from the general scheme of receipts and disbursements of
Case II. As consumer disbursements are made progressively more
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472
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