Simon Newcomb's and Irving Fisher's Quantity Theory, as we noted, relies entirely on the idea of a stable transactions demand for money. This requires that money is desired only for its medium of exchange function and this is institutionally imposed. An alteration on this point was brought in by several Cambridge economists in the earlier part of this century. In particular, A.C.Pigou (1917), Alfred Marshall (1923), D.H. Robertson (1922), John Maynard Keynes (1923), R.G. Hawtrey and Frederick Lavington (1921, 1922). These were the joint creators of what has since become known as the "Cambridge cash-balance" approach. The proposition they advance is that money is desired as a store of value. The Cambridge story, then, is fundamentally different from the Fisher story. In Fisher, money is desired by agents in some fixed amount solely because it happens to be the medium of exchange. As Fisher noted, money yields no gains to the holder. However, in the Cambridge story, this is not the case. Money does increase utility in a way: namely, by enabling the divorce of sale and purchase as well as a hedge against uncertainty. The first reason resembles that outlined by Adam Smith, W.S. Jevons (1875) and Carl Menger (1892) - where money is necessary to overcome transaction costs and coincidence of wants problems. As they note, in simultaneous, multilateral exchange with no transaction costs, the need for money by traders is not apparent. The advantage of money, in that it overcomes the need to obtain coincidence of wants; it implies that an agent can sell his good at one time for "money" and then extend his leisurely search for the best price, then trading his "money" for the goods he finally wishes to purchase. The Cambridge lesson is that the sale and purchase of commodities are not simultaneous and thus there is a need for a "temporary abode" of purchasing power, i.e. some temporary store of wealth. In particular, A.C. Pigou (1917) also allowed for money demand to involve a precautionary motive - with money holdings acting as a hedge against uncertain situations. As it is in its store-of-wealth and precautionary modes that money yields utility to the consumer, then it is demanded for itself in a way. How much of it is demanded depends partly on income and partly on other items, notably wealth and interest rates. The first part is obviously implied in transactions terms: the higher the volume of income, the greater the volume of purchases and sales, hence the greater the need for money as a temporary abode to overcome transactions costs. Thus, Cambridge theorists regarded real money demand as a function of real income, i.e.
where k is the famous "Cambridge constant". However, this is really misleading for the "constant" k is not constant at all. Rather, it relies on other components, such as interest (the opportunity cost of money) and wealth. We can compare this to Fisher's system by simply recognizing that real income (Y) and transactions (T) are, in equilibrium, identical. Of course there are transactions in wealth (e.g. the sale of existing assets such as a house) which do not count as part of income or output proper since they are only transferrals of ownership. The way around this is, as Pigou (1927) notes, is to recognize that, properly valued, the sale value of a home is really the discounted value of rents (which are income). Thus, the transactions in wealth represent transactions in discounted streams of income. Thus, we can claim that at least in some long-run, perfect world, T = Y . Therefore we can rewrite Fisher's equation as M/P = (1/V)Y, such that k = 1/V. Thus, in sum, one equation can be implied from the other. However, the theories are quite different. Firstly, money is here conceived in store-of-value, uncertain, utility-yielding terms. In Fisher, it was just the institutional medium-of-exchange that enabled transactions. Secondly, they advanced the possibility that k (and thus V) is not necessarily instutitionally fixed but rather changing. However, the dichotomy between the real and monetary sectors cannot really be said to have been broken down by this given the ambiguity as to what is contained in k - and their creators' reluctance to make much of this (see Patinkin, 1974). More than anything else, they considered the issue of uncertainty and confidence entering k and thus leading to real fluctuations - an idea which had already been contained in Marshall (1890: 591-2). However, this explanation lacked deterministic power for they placed forth no theory of expectation formation in such circumstances - and therefore, as a theory of fluctuations, it can be regarded (however stretched) as a short-run phenomena. But this is not very interesting. Indeed, had not Fisher's (1911) credit cycle and his "dance of the dollar" demonstrated the breakdown of the Quantity Theory in the face of short-run adjustment costs? Nonetheless, the main points of the Cambridge approach were two: (1) neutrality remains but dichotomy is doubtful; (2) money yields services and is demanded by choice. |
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