A Sraffian interpretation of classical monetary controversies

This art icle was downloaded by: [ Germ án Feldm an] On: 18 Sept em ber 2013, At : 09: 45 Publisher: Rout ledge I nform a Lt d Regist ered in England and Wales Regist ered Num ber: 1072954 Regist ered office: Mort im er House, 37- 41 Mort im er St reet , London W1T 3JH, UK The European Journal of the History of Economic Thought Publicat ion det ails, including inst ruct ions f or aut hors and subscript ion inf ormat ion: ht t p: / / www. t andf online. com/ loi/ rej h20 A Sraffian interpretation of classical monetary controversies Germán D. Feldman Published online: 18 Sep 2013. To cite this article: Germán D. Feldman , The European Journal of t he Hist ory of Economic Thought (2013): A Sraf f ian int erpret at ion of classical monet ary cont roversies, The European Journal of t he Hist ory of Economic Thought To link to this article: ht t p: / / dx. doi. org/ 10. 1080/ 09672567. 2013. 792370 PLEASE SCROLL DOWN FOR ARTI CLE Taylor & Francis m akes every effort t o ensure t he accuracy of all t he inform at ion ( t he “ Cont ent ” ) cont ained in t he publicat ions on our plat form . However, Taylor & Francis, our agent s, and our licensors m ake no represent at ions or warrant ies what soever as t o t he accuracy, com plet eness, or suit abilit y for any purpose of t he Cont ent . Any opinions and views expressed in t his publicat ion are t he opinions and views of t he aut hors, and are not t he views of or endorsed by Taylor & Francis. The accuracy of t he Cont ent should not be relied upon and should be independent ly verified wit h prim ary sources of inform at ion. 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Introduction The first half of the nineteenth century was an extremely prolific period for the development of monetary and banking theory. Many controversial topics such as the difference between money and credit, the operational target of monetary policy, the endogenous vs. exogenous nature of money supply or the determinants of inflation can be traced to the bullionist controversy and the subsequent currency and banking school debates. The contributions of Viner (1937 [1960]), Wood (1939), Morgan (1943 [1965]) and Fetter (1965) are only some examples of the vast literature exploring different aspects of the classical monetary controversies. Most of these works offer a detailed description of each position, but do not provide an analytical structure that may allow for a better understanding of the agreements and disagreements among doctrines and the points of continuity with previous and subsequent theoretical developments. Moreover, a careful inspection of the above writings leaves the reader with the unsatisfactory impression that monetary and real problems are in essence disconnected phenomena. In effect, the marginalist tradition to which most of these authors belong conceives a long-period position as one in which relative prices and activity levels are determined independently of monetary factors. In contrast, I shall argue that the surplus approach as reconstructed by Sraffa (1960) and his followers represents a consistent alternative for reinterpreting these controversies treating the monetary and real spheres of the economy jointly, in that money neutrality, when is observed, is a result of the particular theory of distribution to be endorsed. Nevertheless, the openness of the classical system with regard to different distributive closures leaves room for accommodating theory to the case of money non-neutrality. Address for correspondence German D. Feldman, Faculty of Economics, University of Buenos Aires, Buenos Aires, Argentina; e-mail: feldmangerman@gmail.com Ó 2013 Taylor & Francis Downloaded by [Germán Feldman] at 09:45 18 September 2013 Germ a n D. Feldman The following propositions regarding value and distribution will be said to be shared by most participants in these controversies:1 there exist two notions of prices: market prices, which are affected by any sort of accidental forces, and normal or natural prices, which are only influenced by persistent forces. The main aim of price theory is to explain normal prices, which represent the ‘centre of gravitation’ of market prices and have average prices as empirical analogues. Natural prices equate costs of production, reflecting the dominant productive techniques and the exogenous real wage rate. In addition, prices and quantities are explained in two separate stages of analysis or two different parts of the theory: when determining relative prices and income distribution, the level and composition of final demand are treated as problem’s data. Early classical authors assumed Say’s Law2 (see Garegnani 1978–1979 (I), 338–41), leaving, thereby, the level of activity unspecified.3 A close connection to economic reality is one of the distinctive features of classical economics. In particular, the monetary thought of early classical authors was strongly encouraged by the developments of two historical times: the British ‘Restriction Period’ (1797–1821) and the postNapoleonic Wars gold standard. The Restriction Period was characterised by paper money replacing coined metals as the main circulating medium and a fast developing banking system, with the Bank of England as the main actor. The inconvertibility of bank notes into specie was declared in 1797 after a run upon the Bank. Over the following years, in conjunction with the Napoleonic Wars (1793–1815), inflation accelerated rapidly, but in contrast to the former ‘Price Revolution’ (c. 1520–c. 1650), the phenomenon was not generalised but affected exclusively to England, thus ruling out any explanation which could attempt to connect prices with the productivity of mines. Interestingly, inflation surged in combination with 1 It should be mentioned that classical authors writing after Ricardo tended to adopt a Smithian adding-up approach to distribution and prices (Bharadwaj 1989). However, as we shall see, to interpret the monetary thought of currency and banking, authors under a more consistent setting of an inverse relationship between the real wage and the rate of profits for a given technique would not alter their main conclusions. 2 It is certainly true that classical authors such as Malthus challenged the supposed impossibility of general gluts of commodities, but their line of reasoning implied that the capitalist system faced a problem of over-saving or over-accumulation, rather than a situation in which savings were not fully spent. Note as well that for classical economists, the equality between aggregate investment and savings did not imply the labour market clearing (Mongiovi 1990). 3 In contrast, modern classical authors employ the principle of effective demand endorsed by Keynes and Kalecki to explain production and employment. See, for example, Pasinetti (1974). 2 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies a persistent gap between the market price of gold and its mint price. This was the context for the ‘bullionist controversy’, in which the inflationarybias of the inconvertibility of bank notes occupied the focal point of debate. On the other hand, the resumption of cash payments in 1821 did not bring financial stability. The following decades witnessed waves of ‘overtrading’ and commercial crises. In this regard, the design of banking institutions compatible with a ‘sound’ convertibility regime was the main point of disagreement between the contenders of a new controversy, that one taking place between the currency and banking schools. The paper is structured as follows. First, I introduce the Sraffian ‘core’ of economic principles that early classical scholars should have agreed with. Then, I address the particularities of each doctrine and the theoretical roots of their divergences on policy grounds. Finally, I present the main conclusions of the study. 2. The classical approach to value and distribution under a gold standard regime Before stressing the differences among strands of the classical school, it is convenient to outline their common ground. As I shall argue, the theoretical roots of their opposite policy prescriptions about the adequate conduct of monetary policy did not reside in the theory of value and distribution or the determinants of accumulation and growth, but in the contrasting views on the short-period external adjustment and the nature of money supply under a credit-based monetary system. Therefore, contrary to the assessment of Schumpeter (1954, 696–7), disagreement between schools remains not only of practical importance, but also as regards analysis. Let us assume first an economy without commercial or financial relations with the rest of the world. There exists free capital and labour mobility across the different branches of production. Land is free and joint production is excluded. Wages are paid at the end of the period of production. There are n reproducible commodities, including a luxury article (‘gold’),4 which, apart from its uses in the arts, is employed as the general exchange medium and mean of payments. Constant returns to scale prevail in every sector.5 4 It is assumed that the economy is sufficiently productive so as to generate a surplus after normal reproduction. 5 In order to simplify the analysis, it is convenient to consider the existence of mines of homogeneous productivity. Undoubtedly, this assumption does not reflect very well the actual conditions of gold production, which developed in a context of lands of different quality. In the latter case, the normal price of gold will be defined by the cost of production at the least fertile mine. 3 Germ a n D. Feldman Long-period prices are thus defined by the following ‘price ¼ costs’ conditions: Downloaded by [Germán Feldman] at 09:45 18 September 2013 p ¼ pAð1 þ r Þ þ lw; ð1Þ where A ¼ (n,n) semi-positive input-output matrix of capital input coefficients; l ¼ (1,n) positive row vector of labour input coefficients; p ¼ (1,n) row vector of nominal prices; w ¼ uniform wage rate; and r ¼ uniform rate of profit. System (1) has n equations and nþ2 unknowns (p, w, r). There are therefore two degrees of freedom, which are typically closed by choosing one num eraire and a specific theory of distribution. In particular, the above set of equations determines prices in terms of gold (pg) and the rate of profits once gold is set as the num eraire (pg ¼ 1) and the real wage is exogenously specified according to the following formula: w g ¼ p g cwT λ; ð2Þ where λ is the given real wage rate measured in terms of the basket of commodities consumed by workers (cw ), which allows covering their ‘subsistence’.6 Strictly speaking, there are two price systems: a ‘basic’ subsystem, which only contemplates those commodities which enter directly or indirectly in the production of all commodities, and the ‘actual’ system including nonbasic commodities, in this case the conditions of gold production. The productive techniques of basic commodities and the real wage in terms of 6 The condition of a given real wage is not well established by the literature analysing the debates between the currency and banking schools, especially in the case of Thomas Tooke, who was the main representative of the second strand of thought. As Smith (2002) argues, the various discussions of wages in Tooke’s writings show that he adhered to the general position among classical economists that the real wage was determined by social norms. It is precisely such a theory of the real wage, which together with Tooke’s position that the ‘average’ rate of interest was determined by politico-institutional factors regulating the supply of and demand for ‘monied capital’ (see Panico 1988) confirms his adherence to the adding-up value doctrine. However, it is equally true that Tooke did not consider money wages to be a major cause of price movements because he believed that their change occurred in response to and lagged well behind prior changes in the prices of ‘provisions’ (Smith 2002, 346). As shall be shown hereafter, the case of an endogenous real wage can be easily expressed by reversing the causality in Equation (2) (cf. Panico et al. 2012); The term ‘subsistence’ is not interpreted in the narrow sense of merely physiological needs, but as the income which allows the social reproduction of the labour force and the normal continuance of the productive process. 4 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies the consumption bundle (λ) are enough to determine relative prices and the rate of profits, while the conditions of gold production define money/ gold prices and the money/gold wage rate (p g ; w g ), which adjusts passively to allow labourers to consume the subsistence basket of commodities. Therefore, under a commodity standard there is no autonomy of the ‘monetary scale’ of the system from ‘real’ conditions. For the same reason, there is no room for a quantity-theoretic closure of the money price system.7 The ‘dual’ classical quantity system adopts the following ‘equilibrium’ conditions: ! rpAQ T T cp ; Q ¼ AQ þ AgQ þ lQ λcw þ ð1 sÞ ð3Þ pcpT where Q ¼ (n,1) vector of gross outputs; g ¼ (n,n) diagonal matrix of sectoral rates of investment; cp ¼ (1,n) basket of commodities consumed by capitalists; and s ¼ propensity to save out of profits. Notice that gross output is exhausted as replacement, net investment and private consumption. It is assumed that workers do not save out of wages and capitalists save (and invest) a given proportion s of their profits. Activity levels are normalised by setting the quantity of labour employed in the system equal to unity (lQ ¼ 1). Equation (3) corresponding to the gold sector, which as in the case of the other commodities reflects the equality between supply and effectual demand, can be formulated as follows:8 ð1=vÞp g Q ¼ G0 þ Qg Cg ; ð4Þ where G0 ¼ existing stock of gold; v ¼ ‘normal’ velocity of circulation; and Cg ¼ consumption of gold as a luxury article. 7 The kind of endogeneity implied here has nothing to do with the notion developed by neoclassical authors for open economies with fixed exchange rate regimes. As Lavoie (2001) correctly points out, while according to mainstream authors the endogeneity process is supply-led (that is, the money supply increases endogenously but independently of the demand for money), money endogeneity within the classical framework is demand-led (the money supply grows because more of it is being demanded by the various agents of the economy). 8 Gold output is not included into the level of transactions to be monetised because under a gold standard bullion is directly transformed into money without the need to enter in circulation as a commodity. 5 Downloaded by [Germán Feldman] at 09:45 18 September 2013 Germ a n D. Feldman Equation (4) states that the normal value of transactions performed must necessarily be sustained by an equivalent amount of circulating medium. Only if one is prepared to assume that the level of real transactions and the velocity of circulation are both given, will an exogenous increase in the money supply lead to a proportional rise of the general price level, as in the causal interpretation built around the ‘Quantity Theory of Money’. However, in the classical system causation runs from prices to the quantity of money, in what Marx (1976, 219–20) denominated the ‘law of money circulation’ (cf. Green 1992). In other words, the supply of gold, like any other commodity of the system, accommodates to its effectual demand, defined by the employment of gold as a medium of circulation and for non-pecuniary uses at its normal value, which is determined by the relative costs of production of gold vis-a-vis other commodities. It is certainly true that the durability of precious metals, and consequently, the small proportion that the annual supply and waste bear to the stock in use, the time which must elapse before new mines can be made productive, and the reluctance with which old ones are abandoned (derived from the existence of fixed capital in mine production, etc.), make the adaptation of gold supply to its effectual demand slow.9 Hence, the period of gravitation of market prices towards normal ones may be longer than in the case of other commodities. Nevertheless, as Robinson (1933) correctly asserts, ‘The stocks of gold are not inexhaustible, and sooner or later there must be some increase in the price of gold, and there will be some increase in new mining. In the long run the output of peas will fall and the output of gold [will] go up, just like the outputs of boots and of hats.’ As a consequence, if there is a growth of industry and commerce, ceteris paribus, the market value of gold will rise above its natural value (which is equivalent to the labour and expensing of mining and the risks attending to that branch of production) and thereby, the rate of profits on capitals invested in mines will be higher than the average rate of profits in the country. If the rise in output is perceived as transitory, it will only result in a temporary deviation of prices with respect to their trend. In contrast, if the change is of permanent nature, the extra-profits in gold mining will activate an inflow of capitals into that branch of production and a 9 It is this feature that made early marginalist authors treat the stock of precious metals as exogenously given and its relative price set directly by scarcity (see, for instance, Marshall 1887 or Hawtrey 1919). Interestingly, the post-Keynesian description of commodity money finds several coincidences with the marginalist position (cf. Moore 1988 and Rogers 1989). Moreover, one could argue that a general equilibrium system is perfectly compatibility with a cost of production approach to the value of gold, as Niehans (1978) confirms. 6 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies consequent expansion of production, until a uniform general rate of profits is finally re-established.10 The essential properties of the system remain unchanged in an economy whose frontiers are opened to international trade. It can perfectly happen that a country does not produce the commodity which is employed as the general circulating medium. Nevertheless, the necessary supplies can be obtained via foreign trade. It is in this context that the price-specie flow doctrine of Hume acquires relevance for the classical system.11 Let us suppose again that there is a relative scarcity of gold in the domestic economy resulting from an expansion of industry and commerce. Consequently, the gold price of commodities will be lowered, generating incentives to export local commodities and making the importation of bullion more profitable than before. As gold enters into domestic circulation, the price of commodities will be raised, until reaching the initial level defined by their costs of production. Therefore, in equilibrium, the purchasing power of gold must be necessarily the same across nations and the foreign trade of each country must be balanced. Every time a divergence takes place in a country, inter-country gold and commodity movements will be encouraged in response. In this respect, within a non-producing gold economy, supply shocks on the gold market will be connected with the state of the balance of trade. An excess of the value of exports over the value of imports, that is, an external trade surplus, will be equivalent to a positive supply shock, and conversely, an excess of imports over exports, or a trade deficit, will represent a negative supply disruption. 3. Coinage Thus far it has been assumed that the circulating medium of a country was exclusively ‘bullion’ or specie. Nevertheless, the actual money used in rising capitalist economies was coined metals and not gold in bars, while the 10 Strictly speaking, the actual adjustment was more complex and required the interaction between monetary and non-monetary uses of gold. The reader is referred to Senior (1829) for a detailed analysis. 11 Contrary to Rist’s (1938, 140) contention, Ricardo’s theory of the distribution of precious metals is more than just ‘a simple repetition of Hume’s theory’. I believe that much of the confusion arises from the perspective in which the analysis is developed. From the point of view of the individual open economy, money (gold) flows from countries where it is undervalued towards countries where it is overvalued, thus accommodating its supply to the value of aggregate transactions. Nevertheless, if we assume a closed economy or a shock affecting all countries in the same degree, it can be clearly identified the exogenous nature of money supply in Hume’s framework. In contrast, from a classical perspective the money stock is endogenous in a long period equilibrium. 7 Downloaded by [Germán Feldman] at 09:45 18 September 2013 Germ a n D. Feldman unit of account was not the ounce, but a unit defined by the State; in the case of Britain, the pound sterling (£). The mints were run as businesses by private entrepreneurs, but regulated by the government. Individuals could come to a counter at the mint and deliver their metal and they would be paid back, within a few weeks, in newly minted coins of the same metal they brought in. They always received back less fine metal than they brought in. Part of what was withheld by the mint paid for production costs – including a normal rate of profits – and was called brassage. The rest was sent to the sovereign as tax and was denominated seigniorage. Under this new setting the price system must also include the minting sector, with its respective cost-of-production equation:  T  pam ð1 þ r Þ þ lm w ð1 þ tm Þ ¼ pm ; ð5Þ   p ¼ pA þ qpm ð1 þ r Þ þ lw: ð10 Þ where pm ¼ nominal price of coins; am ¼ material input vector used in the production of coins; lm ¼ amount of labour used to produced one unit of coin; and tm ¼ seigniorage tax. The creation of money can therefore be separated in two stages: the production of gold as bullion and the transformation of bullion into coins. The seigniorage rate might be limited due to competition from alternative mints (including false coiners and foreign mints). However, if the domestic State alone coins, it can adjust the seigniorage rate within a wide range of values. Within this framework, seigniorage should not be interpreted as the profit made from money creation, but as an indirect tax imposed over a particular basic commodity. In effect, firms require a fraction q of coins per unit of output in order to pay for inputs and wages, and thus, the cost of obtaining coins must be included into normal costs of production:12 Equations (10 ), (2) and (5) determine nþ2 unknowns –p m ; w m ; r – when λ and tm are exogenously given and the coin is taken as the numeraire (pm ¼ 1). When coinage is gratuitous, that is, if the State absorbs the brassage and charges no seigniorage, the metallic content of the coin (amg ) defines its value in terms of bullion. Otherwise, the natural price of bullion will fall short of the natural price of money by the charge for coinage. 12 It is assumed that the producers must hold coins since the beginning of the production period. 8 A Sraffian interpretation of classical monetary controversies Downloaded by [Germán Feldman] at 09:45 18 September 2013 The government arbitrarily sets the gold content of a coin and the seigniorage rate (amg ,tm ), but the quantity of gold circulating as medium of payments is determined endogenously by the private sector, which decides the amount of bullion to be taken to the Mint and to be converted from coin to bullion taking into account the costs of minting and melting (viz. a process to transform coins into specie) and the price of gold in terms of coin (pgm ). Once the nominal or mint price of gold (pm£ ) is arbitrarily defined, the nominal scale of the system follows:   ½p m A þ qŠð1 þ r Þ þ lw m pm£ ¼ p g pgm pm£ ¼ p: ð6Þ System (6) reveals the existence of two sources of variability in money prices: (i) changes in the value of money in terms of the standard pg£ (¼ pgm pm£ ) or ‘monetary factors’ and (ii) changes in the conditions of production of gold vis-a-vis the other commodities p g , or ‘real factors’ (cf. Marcuzzo and Rosselli 1991, 41). From a classical perspective, sound economic policy could only prevent those price fluctuations arising from monetary factors; changes induced by real factors were considered as natural and inevitable (cf. Ricardo 2004 [1810–1811], 65). The quantity system (3) must now take account of the payments made to the Mint by those requiring this service and of the expenditure of the revenues of the State by administering the Mint:13 T Q ¼ AQ þ AgQ þ lQ λcw þ ! rpAQ T ~ cp þ s T G; pcpT ð30 Þ where s ¼ consumption bundle of the State; ~ ¼ level of public expenditure. G Note that gross output is now absorbed by investment, private consumption and public expenditure. The consumption of the State is financed through the tax imposed on money creation:   ~ pamT ð1 þ r Þ þ lm w tm qQ ¼ pðs T GÞ: ð7Þ For a given surplus, the addition of the State implies that a certain social class must face the burden of taxation. Assuming an exogenous real wage, 13 The equation in system (30 ) corresponding to the minting sector takes the following form: Qm ¼ qQ Q0 , with q ¼ qðp m ; vÞ. 9 Germ a n D. Feldman the capitalists will end-up paying the seigniorage rate and reducing, thereby, their expenditure. Indeed, we already know from Sraffa (1960) that ‘a tax on a basic product then will affect all prices and cause a fall in the rate of profits that corresponds to a given wage’. Downloaded by [Germán Feldman] at 09:45 18 September 2013 4. Paper money Let us move from a purely metallic base to a monetary circulation composed of both coined metals as well as paper money convertible into coin on demand, which is issued by a Bank with the monopoly of issue through mainly two channels: the purchases of bullion and the discount of commercial bills.14 Wages are entirely spent on consumption goods and workers have no access to financial markets, so the financial system only reflects transactions between ‘banks’ and ‘firms’. It is also assumed that capital is essentially circulating capital (i.e. funds for the payment of wages and raw materials), whose finance is based on the discount of commercial bills. Hence, the interest rate actually enters as a component of normal costs of production. According to Ricardo, a ‘perfect’ convertibility regime between paper money and coined precious metals would work exactly in the same way as a purely metallic circulation, the convertibility being an automatic principle of limitation to prevent the overissue of paper money. In effect, bank notes represented only a cheaper substitute for gold coins, but the overall amount of circulating medium would still be regulated by its effectual demand. Now, if the Bank were to issue promissory notes in excess of the requirements of demand, the paper would circulate domestically at a discount. With the possibility of charging a paper and a gold price of commodities prohibited by law, the value of the whole currency (that is, paper and gold coins together) would be reduced, and the market price of gold would rise above its mint price. As a consequence, the well-known Gresham’s Law would start to operate. There would be incentives to convert bank notes into gold to be melted and exported (i.e. to be employed as a commodity or world money and not as domestic money) and to import foreign commodities, which would be relatively cheaper. As the domestic currency 14 It is assumed that the government does not finance its deficit by loans from the Bank, thus eliminating the fiscal channel of monetary expansion. This assumption is a good approximation for the case of Britain during the nineteenth century. British wartime expenditures were mainly financed by raising taxes and issuing bonds (see White 1999). 10 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies depreciated internally, the foreign exchange turned adverse and gold flowed out of the domestic circulation. However, such a situation could not last, because as soon as gold was drained from the coffers of the Bank and exported, the internal purchasing power of bullion would be raised (or equivalently, the gold price of commodities would be diminished), counterbalancing the initial incentives to import foreign commodities, closing thereby the gap between the market and the mint price of bullion. In the new equilibrium, the amount of circulating medium would be the same as before and the domestic general price level would go back to the initial point. Hence, the only effect of a sudden overissue of bank notes would be a drain of the gold in the coffers of the Bank proportional to the initial monetary expansion (Ricardo 2004 [1810–1811], 90). With inconvertible paper money, money prices lose the anchor previously represented under a commodity standard by the nominal price of gold. The absolute scale of the system (p; w) acquires autonomy from relative prices (p g ; w g ). Moreover, since paper had no intrinsic value attached and the money supply could be discretionarily expanded by issuing institutions,15 paper could be permanently depreciated in terms of all commodities including gold. In consequence, nominal prices would be determined, for a stable velocity, in proportion to the quantity of paper-money in circu£ lation M : £ M ¼ ð1=vÞpQ : ð!Þ ð8Þ Equation (8) sets the nominal scale of the system in line with the Quantity Theory, given the underlying relative prices and produced quantities. Money prices must be consistent with the ‘real’ equilibrium, through the adjustment of monetary cost equations, in particular via the full ‘indexation’ of the nominal wage rate: pcwT λ ¼ w: ð!Þ ð9Þ Under inconvertibility it is not possible to improve the competitiveness of domestic production in the world markets by altering the value of the local currency. The overissue of paper money would only depreciate the nominal exchange rate due to the augmentation of the domestic money 15 In The Price of Gold, Ricardo explicitly assumes that ‘Whilst the Bank is willing to lend, borrowers will always exist, so that there can be no limit to their overissues’ (Ricardo 2004 [1809], 17). 11 Germ a n D. Feldman price of bullion, but the real exchange rate, which reflected the ratio between the bullion price of commodities in the domestic and the world economy, would not be altered. Downloaded by [Germán Feldman] at 09:45 18 September 2013 5. The exchange rate and international gold flows: the first source of disagreement Ricardo held a very controversial view of the determinants of international gold flows. According to him, any external deficit and consequent gold drain would be caused exclusively by a monetary over-expansion: ‘[. . .] the temptation to export money in exchange for goods, or what is termed an unfavourable balance of trade, never arises but from a redundant currency’ (Ricardo 2004 [1810–1811], 59). Such a position contrasts especially with the doctrine of another referent of the time, Henry Thornton, who admitted to the possibility of gold outflows promoted by ‘real shocks’, such as ‘a war, scarcity, or any other extensive calamity’ (Thornton 1802, 118). Indeed, Thornton distinguished between temporary and permanent causes of gold drains; the real shocks were part of the former group of causes, while the redundancy of currency accounted for the latter group. To recognise the possibility of ‘real forces’ encouraging the exportation of gold introduces new principles for the conduct of monetary policy. In effect, the more adequate policy response to bullion drains would depend on the nature of the shock taking place: in the presence of monetary shocks, the Bank of England should contract its circulation in order to improve the foreign exchange, but in the case of real shocks, the best policy reaction would be to support domestic credit and face the gold drain with its bullion reserves. In this context, therefore, the extension of bank notes should be seen as a mean to preserve domestic financial stability from being disturbed until the balance of payments were adjusted through the price-specie flow mechanism, a process which was not instantaneous. As previously argued, Ricardo conceived of the positive gap between the market price of bullion and the mint parity as a measure of depreciation of domestic money due to the overissue of bank notes. He also suggested a second test for depreciation of the currency, namely, the deviation of the (nominal) exchange rate with regard to the par of exchange (Ricardo 1809, 18). By the time Ricardo wrote his monetary pamphlets, the international mercantile credit market had already been largely developed. Foreign bills of exchange represented an alternative mechanism to remit the payment of purchases in foreign markets. In effect, the domestic importer could, instead of directly sending bullion and paying the shipping costs, buy a bill of exchange drawn upon the foreign counterpart (brought by an exporter merchant), paying (1/E) units of foreign currency ($) for 1 unit 12 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies of domestic currency (£). The exchange rate (E) was determined by the supply and demand of bills of exchange arising from international transactions. Exports generated a supply of foreign bills of exchange in the domestic market, whereas imports engendered a demand for foreign bills of exchange. If the foreign trade were balanced, the supply and demand for foreign bills would be equal, and the exchange rate would be ‘at par’. The par of exchange (EP) was defined by the mint price of gold at home and abroad, assuming that both countries were on a gold standard and applied the same rate of seigniorage. In other words, the parity responded to the question: what amount of foreign currency contains the same quantity of pure gold as can be purchased by one unit of domestic currency in gold? Analytically, EP ¼ pm£ : pm$ ð10Þ The movements of the exchange rate reflected two different forces: the developments of the balance of payments, which defined the supply and demand for foreign bills in the domestic market and activated the gravitation of the exchange rate around the par, and the depreciation of the domestic currency, which moved the par of exchange itself. The former accounted for changes in the real exchange rate, while the latter implied variations in the nominal exchange (cf. Blake 1810, 8). The real exchange found an objective limit in the costs of remitting bullion, which defined the ‘specie points’: even if deviations of the exchange with respect to the par within such limits did not reverse the trade imbalance and, thereby, equilibrated the market for bills of exchange, once the exchange rate surpassed the export (import) specie point, at least the export (import) of bullion would become profitable. In contrast to the impact of the real exchange, monetary derangements operated, according to Blake, exclusively on the nominal exchange rate, leaving the ‘real side’ of the economy untouched (ibid., 47–8). Hence, a depreciation of an inconvertible currency altered the par of exchange itself, the new par being such an amount of a foreign metallic currency as the depreciated unit would buy at the market price of bullion. To sum up, the classical view of the exchange rate as exposed by Blake (op. cit., 87–8) can be reduced to the following ten propositions:16 16 Blake’s framework is general enough so as to include Ricardo and Thornton’s approaches as particular cases. For an antagonistic view of both classical scholars, see de Boyer des Roches (2007). 13 Downloaded by [Germán Feldman] at 09:45 18 September 2013 Germ a n D. Feldman (i) The real exchange depends upon the proportion between the foreign payments which a country has to make, and the payments it has to receive. (ii) The nominal exchange depends upon the comparative value of currencies. (iii) The real exchange has an immediate effect upon the exports and imports. (iv) The nominal exchange, whether favourable or unfavourable, has no effect whatever upon exports and imports. (v) An unfavourable real exchange, if its rate be sufficiently high, will cause an export of bullion (once the exchange reaches the export specie point). (vi) An unfavourable nominal exchange, whatever be its rate, will not necessarily lead to any export of bullion, but will immediately cause a drain upon the Bank, of the conversion of coin into bullion. (vii) When the market price of bullion exceeds the mint price, in consequence of its export from an unfavourable real exchange, the currency is not depreciated, for it bears the same relative value to all other commodities; it is the real price of bullion that is raised, from a temporary scarcity. (viii) When there is an excess of the market price of bullion above the mint price, together with an unfavourable nominal exchange, the real price of bullion is not altered, for it bears the same relative value to all other commodities; it is the currency that is depreciated, from a temporary abundance. (ix) The real exchange cannot be permanently favourable or unfavourable, whatever be the state of the currency. (x) The nominal exchange may continue for any length of time favourable or unfavourable, provided the value of currency continues to be depreciated. The previous observations have several implications. Statement (vii) justifies Thornton’s explanation of the high price of bullion and the drain of gold during the Restriction Period driven by external trade deficits. The causation implied by Thornton, which would be later supported by the banking school, goes from the balance of foreign payments to the real exchange rate via the price of bills, which raises the demand for bullion in the domestic market and, thereby, the market price of gold. Following this reasoning, it could not be asserted generally that a positive gap between the market and mint price of gold unequivocally signals a depreciated currency as a result of the 14 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies overissue of paper money. Points (iv) and (vi) would be soon criticised by Ricardo, who distinguished between the case in which only inconvertible paper money circulated and a mixed currency (i.e. a situation in which gold is still obtainable at its mint price). The latter case includes both convertibility and inconvertibility with residual coins in circulation. In fact, under a mixed circulation an excess supply of money would force not only a nominal depreciation, but also a real one, thereby creating incentives to export bullion provided that the gain more than compensated the costs of shipping. However, there is a second channel through which a depreciation of the domestic currency may influence the real sector, overlooked in the preceding model due to the fundamental assumption regarding the exogenous distributive variable. Since early classical authors assumed a given real wage rate, nominal remunerations adjusted at the same rate that the price of commodities. Thus, they ruled out the potential ‘real’ effect of nominal depreciations connected with a reduction in the labour cost of domestic production. In contrast, still within the classical framework, altering the distributive closure towards an exogenous determination of the rate of profits could allow lowering the real wage permanently by manipulating the exchange rate. 6. Money creation and banking principles: a second source of controversy Despite the resumption of convertibility in the year 1821, macroeconomic fluctuations were not diminished. A succession of commercial crises and gold drains that threatened to exhaust the gold reserves of the Bank of England, recurring about every 10 years, led scholars to explore in depth the problems of the British financial architecture. The advocates of the currency school17 concentrated on how the Bank of England and country banks could introduce distortions which prevented the natural and automatic adjustment of a fully convertible paper-based monetary system. As during the former bullionist controversy, Ricardo’s ideas played a significant role: in his Plan for the Establishment of a National Bank, which was published in 1824 shortly after his death, Ricardo emphasised that the Bank of England conducted two entirely different businesses, which might just as well be handled by two separate agencies: the issue of paper money to replace metallic currency and the 17 The most prominent supporters of this doctrine were Samuel Lloyd Jones (later Lord Overstone) and Richard Torrens. Other members of the group were G. W. Norman, Thomas Joplin and James Pennington. 15 Downloaded by [Germán Feldman] at 09:45 18 September 2013 Germ a n D. Feldman granting of loans. Ricardo recommended that the right to issue notes should be transferred from the Bank of England to a national bank, viz. a note-issuing authority under the direction of five permanently appointed government commissioners, whose only function would be to keep the price of gold stable by the purchase and sale of gold against notes. This idea of separating note issue from the remaining banking functions was taken over a little later by the so-called currency principle.18 The supporters of the currency principle did not introduce any profound change to the bullionist view of the theoretical working of a convertibility system, but they believed that the actual workings of the banking system may deeply affect the ‘automatic adjustment’ of the economy. In effect, bullionist authors had treated the overissue of bank notes as a sudden and temporary phenomenon. Instead, Overstone and Torrens conceived of the overissue of bank notes as a systematic procedure followed by the Bank of England, which could increase the pressure and inconvenience of the natural absorption of shocks and even potentially lead to the abandonment of cash payments. The Peel’s Act of 1844 aimed precisely at regulating the British banking system in order to avoid such distortions. It closely reflected the position of the currency school, according to which one expected that a currency consisting of both convertible notes and gold coins or a fully paper system backed on gold would function exactly like a purely metallic currency. The Banking Act included several measures, among which the separation of the issuing and banking functions of the Bank in two independent bodies was undoubtedly the main institutional change, intended to impose 18 Rist makes a major contribution to the general confusion about Ricardo’s standpoint. For him, the Ricardian theory of money is the quantity theory of money par excellence (Rist 1966 [1938], 173). Also, he regards the National Bank plan as the basis for the Reform of 1844 (Rist 1966 [1938]). However, Ricardo never advocated proportionality between bullion reserves and money creation. ‘The issuers of paper money should regulate their issues solely by the price of bullion, and never by the quantity of their paper in circulation. The quantity can never be too great nor too little, while it preserves the same value as the standard’ (Ricardo 1816, 64). Furthermore, his National Bank’s plan could be interpreted in terms of how to distribute the seigniorage from money creation so as to favour the general public and not a private institution such as the Bank of England. ‘. . .that the commerce of the country would not be in the least impeded by depriving the Bank of England of the power of issuing paper money, provided an amount of such money, equal to the Bank circulation, was issued by Government: and that the sole effect of depriving the Bank of this privilege, would be to transfer the profit which accrues from the interest of the money so issued from the Bank, to Government’ (Ricardo 1824, 281). 16 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies quantitative limits to the banking system’s capacity of issuing notes. The issue department of the Bank would just behave as a ‘Mint’, receiving bullion by the public and converting it into coin, for subsequently throwing the money again in the form of paper to the circulation of the country. Thus, the idealised description of a paper-based circulating system acting as a mere less expensive substitute of precious metals seemed to be realised. According to the currency school, a ‘sound’ currency respects the premise that gold movements should be entirely reflected on domestic circulation, and the capacity to expand credit (that is, to increase the stock of securities of the Bank) should be limited by its ability to obtain new deposits. Before the Banking Act of 1844, the Bank of England used to violate such a rule, because every time a gold drain took place, instead of leaving the pressure act on circulation, it sustained the former level of circulation by extending the discount of commercial bills. In contrast to the unified system, with the separation of departments the Bank would have two independent balance sheets: one for the department of issue, and another for the department of banking. Thus, with the complete division of functions, the issue of bank notes would be exclusively connected with the movements of bullion. On the other hand, the department of banking would limit its discount of bills of exchange to the extent that it obtained new deposits of bank notes, through which it built it contingent reserves. The Bank would lend the money left after preserving the amount of notes considered as appropriate to meet the demand of depositors. Therefore, under the new system, the Bank reserve acted as an intermediary target indicating when issues should be restrained. If, for instance, a gold drain took place, the holders of bank notes would go directly to the department of issue to convert their paper into bullion. In that event, the variation of bullion would impact directly on internal circulation, thus preserving Hume’s adjustment mechanism. Now, for those individuals who had to make external payments but performed them through drafts on their bank accounts, the pressure would be felt on deposits. They would ask for their notes in the department of banking, in order to exchange them later for bullion in the department of issue. The department of banking would face the call with its reserve, but, in contrast to the unified system, it had no power to create new reserves at will. In order to re-establish the optimal reserve-todeposits ratio, this department would have to sell their securities and refuse to give new discounts. Therefore, during the process of adjustment to a gold efflux the Bank contracted its circulation of bank notes, allowing for an appreciation of gold in terms of commodities that would stop the drain (see Overstone 1858, 124). 17 Downloaded by [Germán Feldman] at 09:45 18 September 2013 Germ a n D. Feldman In similar lines, the currency school characterised the commercial crises experienced under the unified banking system (those occurred in 1783, 1787, 1825 and 1836–1837) as resulting from the overissue of bank notes: ‘in every one of them the non-diminution of the paper money as the bullion went out, was the immediate and intimate cause of those crises’ (Overstone 1858, 156). The currency proponents did not deny the chance of commercial crises under a sound convertibility system, because they recognised crises were inherent to the capitalistic system of production. Indeed, the British economy suffered disruptive episodes under the new financial structure, for instance, during the panic of 1847. However, for these authors the only crises in which the Bank could take corrective measures were those which had been generated by its unsound behaviour. Interestingly, during the panic of 1847 the British government restored confidence augmenting the Bank reserves with purely bank paper. This measure, like similar ones applied in 1857 and 1866, reveals a stylised fact of the dynamics of commercial crises: the end of the downward cycle was in general accompanied by a monetary expansion, although a contraction of circulation was the expected action according to monetary rules. While the banking school would argue that these facts revealed the inadequacies of Peel’s Act and the relevance of ‘lender of last resort’ functions played by the Bank of England, Torrens offered an alternative view. The author distinguished between two kinds of gold drains: external drains, which were those motivated by an adverse foreign exchange, and internal drains, which were caused by panic and alarm among the public. In the latter case, confidence was shaken and people ‘flied to quality’: gold was preferred to paper, and sovereigns were held rather than the notes of the Bank of England. Within an internal drain, the function of the Bank as a lender of last resort would be strongly desirable: ‘These are the only circumstances under which it can be necessary that the Bank should exercise its vaunted function of sustaining commercial credit’ (Torrens 1837, 43). In such a critical context, the Bank was exposed to two opposite dangers and it could not avoid the one, without approaching the other. ‘If they do not contract their issues, their treasure may be exhausted by the continual action of the foreign exchange; and if they do not increase their issues, their coffers may be emptied by the immediate action of a domestic panic. Of the two dangers, that of having their coffers emptied by domestic panic, is the most serious and the most pressing; and therefore, in an emergency leaving only a choice of evils, the Bank directors are justified in disregarding the principle of regulating their issues by the foreign exchanges, and in making such advances as may be necessary to restore commercial credit’ (ibid., 42–3). However, if the internal drain was a result of the previous mismanagement of the Bank in administering an external drain, then it would not be a justification to defend the Bank’s policy. Indeed, the suspension of the Peel’s 18 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies Act during the post 1844 crises was usually interpreted as the recourse to ‘escape clauses’ from the rule under extraordinary real shocks.19 In contrast, the banking school presented a defence of the unified structure that characterised to the Bank of England until the mid-1840s. Its monetary thought, reflected mainly in the works of Thomas Tooke and John Fullarton,20 was highly innovative in several fields such as the nature of money supply within a credit economy, the goals and instruments of monetary policy and the adjustments of the economy to external imbalances. Tooke defined the ‘banking principle’ as the guard by regulation against two evils: the suspension of cash payments and the insolvency of the banks. He emphasised that the currency school added a new dimension: ‘. . .it is not sufficient that the Bank notes should be at all times strictly convertible into coin, and that the banks, whether issuing or not issuing, should be solvent; they consider that a purely metallic circulation (excepting only as regards the convenience and economy of paper), is the type of a perfect currency, and contend that the only sound principle of a mixed currency is that by which the bank notes in circulation should be made to conform to the gold, into which they are convertible, not only in value, but in amount’ (Tooke 1844, 1–2; emphasis added). The endogenous nature of money supply under a credit-based system was one of the pillars of the banking school’s theoretical apparatus. In effect, these scholars differentiated between a compulsory paper money issued by the government (including advances by the banks to the government in the form of notes) and bank notes issued by credit institutions due to the discount of commercial bills; ‘government paper is ‘paid away’ , and is ‘ not returnable to the issuer’ , whereas the bank notes are only lent, and are returnable to the issuers’ (Fullarton 1845, 66, italics in the original). Only regarding the former would all the features of the ‘inconvertibility paper system’ postulated by the bullionist and currency authors apply (cf. Tooke 1844, 69–70). On the contrary, no overissue of bank notes lent to the industry could take place because there were alternative channels through which notes in 19 For instance, Schumpeter believes that the suspensions of Peel’s Act during times of internal panic ‘were really, though not officially, part and parcel of his scheme’ (1954, 696). 20 Among the advocates of the banking school one could also include the young John Stuart Mill. Some elements of their doctrine are also contained in the works of James Steuart and Attwood. The position of the banking school received approving comments by Marx and Keynes, who lamented that the currency school’s position ‘conquered England as completely as the Holy Inquisition conquered Spain’ (Keynes 1936, 32). 19 Downloaded by [Germán Feldman] at 09:45 18 September 2013 Germ a n D. Feldman excess could be returned to the Bank. This is the renowned ‘law of reflux’, which states that the supply of credit accommodates endogenously to the requirements of the demand for credit (cf. Fullarton 1845, 64). Furthermore, the banking school emphasised the narrow definition of ‘circulating medium’ employed by the currency school. Not only did coins and bank notes perform the role of ‘money’, being the medium of exchange and payments, but several other credit instruments such as bills of exchanges, cheques or even simple book credit could equally carry out such a function (ibid., 31–2). If the Bank of England took all its notes from circulation (assuming that it would have such a power), the vacuum would not be covered with coin, but ‘most probably would be supplied by cheques and bills of exchange and settlements’ (Tooke 1844, 21). Under the conditions that gave ground to the existence of credit, that is, a certain level of confidence among the public, the amount of ‘potential currency’ did not limit to the availability of bullion or the issue of bank notes. There was therefore no mechanical connection between the value of transactions and the natural quantity of coin in the economy, even under a purely metallic circulation, as long as credit existed. A demand shock on the gold market would not necessarily lead to an importation of bullion from other countries, if the new transactions were performed by bills of exchange. Similarly, supply shocks on the gold market, that is, those disruptions connected with the state of the balance of trade, would not affect the state of domestic circulation as long as they acted entirely on bullion reserves. In order to fully appreciate the role of the latter, we must come again to the description of a gold-money economy without a banking system. Under such a framework, it was implicitly assumed that the only reason for holding money was the ‘transactions’ motive: gold was employed in the form of coin as the general medium of circulation. However, there was another motive for demanding money: the ‘speculative’ motive, which resulted from the role of money as a reserve of value. Hoarding provides another tool to absorb shocks in the gold market; short run fluctuations in the supply for gold (for instance, due to a current account surplus) do not necessarily translate to internal circulation, thus leaving the price of commodities unchanged (see Fullarton 1845, 71). The amount hoarded ‘is not governed by the state of prices, but by the market-rate of interest’ (see Fullarton 1845, 71). That is, the public made a portfolio choice on the allocation of surplus money. Furthermore, in advanced economies exhibiting high levels of industry and commerce and a developed banking system, those hoards were not in the hands of the public but deposited in banks. That was the case of the British economy and the Bank of England (ibid., 72). Hence, the Bank of England guaranteed the stability of the market price of gold by absorbing any sudden supply of gold which importers brought 20 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies to the domestic market.21 ‘Thus England holds out to the bullionmerchant a never-failing market for his gold; in England there is never any abatement of the demand for it; and the Bank of England naturally becomes a sort of general receptacle for the surplus produce of the gold mines in every quarter of the globe’ (ibid., 77). The hoarding mechanism operated in equal form under a paper regime. Though the purchases of bullion by the Bank injected bank notes into the economy, thus expanding for a moment the money supply, they did not stay in domestic circulation if they were not demanded for transactions. The holders of paper money would offer them in the market for discounting bills, thus enlarging the supply of credit. In other words, the monetary expansion would not lead to an excess of demand in the market for commodities, but rather in the market for bonds. The result would be a lowering of the market rate of interest, unless the Bank decided to sell part of its stock of securities to stabilise the rate (see Fullarton 1845, 78–9). In either case, the Bank had no power to add to the circulation. The only thing it could do was to influence the rate of interest, deciding whether it remained unchanged or not. 7. Inconvertible paper money revisited The arguments offered by the banking school proved that the money supply cannot be considered exogenous so long as money enters the economy via the provision of credit, that is, as a debt, being either convertible to gold or not (overissues of paper money may actually arise, for Ponzi finance schemes or other types of speculative movements may be developed, but they should not be viewed as persistent phenomena, that is, as being normal in a long period position). The operation of the ‘law of reflux’ ensures that in a normal position, the quantity of money in 21 There is no doubt that temporary monetary shocks in either direction could be met through the hoards, but the adjustment under permanent shocks is asymmetric in nature. While a rising supply of bullion can be absorbed increasing the bullion reserves indefinitely, a prolonged or structural gold drain may exhaust the bullion reserves, finally impacting on domestic circulation and relative prices. In that case, the central bank will eventually run out of reserves and will be forced to adjust through currency devaluation, rising interest rates or imposing controls to capital flows. As Wicksell points out, ‘the existence of large stocks of coin is no guarantee of the stability of monetary values. They do indeed tend to act as shock absorbers to the changes which occasional disturbances in the volume of production or of industrial consumption would otherwise cause; but accumulated stocks are quite powerless against persistent and radical changes in those spheres, such as the discovery of great new goldfields, or the exhaustion of existing ones’ (Wicksell 1935, 125). 21 Germ a n D. Feldman circulation responds to the requirements of trade, ruling out any possible divergence between supply of and demand for money. Analytically, M£ will be established by the modified version of (8): Downloaded by [Germán Feldman] at 09:45 18 September 2013 pQ ¼ M£ v: ð!Þ ð80 Þ The question arises as to how then the nominal scale of the system is determined. The counting of equations and unknowns rapidly reveals that nominal variables will result underdetermined once the condition of money supply endogeneity is imposed. The structure of relative prices and income distribution is left untouched, but an additional variable is added, so money prices will ‘hang in the air’. It should be stressed that such indeterminacy has no connection with the so-called ‘real-bills fallacy’, which emphasises the price-money-price feedback that renders the real bills mechanism dynamically unstable.22 For within the endogenous money doctrine of classical authors, the price level is treated as given, determined by forces beyond the money stock itself. A plausible solution to the indeterminacy problem resides in the fundamental role that the persistence of nominal wages exerts in the determination of money prices under an inconvertibility regime, a function emphasised by Keynes (1936, 304) and incorporated to the classical framework in Panico’s (1988) and Pivetti’s (1991) models of normal income distribution. Formally speaking, we move from a classical price system in which one commodity (gold) is employed as the numeraire to a ‘labour standard’ (cf. Hicks 1955), in which prices are expressed in terms of labour commanded: p w ¼ p w A ð1 þ r Þ þ l  ð11Þ with A ¼ A þ qabT and l  ¼ l þ qlb :23 The nominal wage rate is taken as given (w ¼ w), set by institutional and political conditions such as the action of labour unions, and the rate of profits is arbitrarily fixed by the central bank through the persistent manipulation of the interest rate (r ¼ aðiÞ, with a0 > 0). Finally, the real 22 For a critical analysis of the real-bills doctrine as a rule for money creation, see Mints (1945). 23 The subscript b denotes the loan industry, q being in this context the loan input vector per unit of gross output of commodities. It should be stressed the underlying symmetry between the seigniorage rate and the minting industry in a gold standard system with the rate of interest and the loan sector in a credit-based monetary regime. 22 A Sraffian interpretation of classical monetary controversies wage is determined endogenously over the range above subsistence: 1 ¼ p w cwT λ: ð12Þ As expression (13) below reveals, money prices now depend positively on the nominal wage rate for a given rate of profits and increase with the rate of profits, given the nominal wage:24 Downloaded by [Germán Feldman] at 09:45 18 September 2013 p w ðr Þw £ ¼ p: ð13Þ Note also that under a labour standard, as opposed to a gold standard regime, it is not possible to decompose price changes into those induced by ‘real’ and ‘nominal’ factors. As has already been pointed out, prices relative to labour commanded can be influenced by monetary policy via the link interest rate – normal rate of profits and economic policy in general can attempt to contain nominal values through the control of wage inflation. Likewise, structural factors affect relative prices not only directly – especially through differential rates of productivity growth – but also indirectly, since, for instance, the level of unemployment, which is partially 24 There exist some difficulties in applying the monetary theory of distribution to the gold standard period. First, one should justify that workers participated in the surplus, which is doubtful given historical and institutional conditions (for instance, the inexistence of labour unions, etc.). But most importantly, Tooke’s view of money prices as depending positively on the level of the rate of interest faces a logical problem when applied to a commodity-standard framework. In effect, under a gold standard the general price level is fully determined once relative prices and the nominal price of gold are specified and, hence, a change in costs of production may result in fluctuations of relative prices, but there is no reason to suppose that the price of commodities in terms of gold will rise on average. Put differently, Tooke’s approach would force us to admit that prices of commodities do not reflect the ratios of their cost of production to that of gold, unless very arbitrary assumptions as to the technical conditions of production of commodities vis-a-vis those of gold are made [a point made by Pivetti (1998, 49) himself, though the author considers that his approach can be applied to commodity standard systems]. It is not possible for the money wage to be advanced and the real wage to be accommodated through changes in the average price of commodities going in the direction of variations in the rate of interest, because there is no reason to assume that all money prices will increase pushed by raising interest costs. Those commodities with a capital composition above gold will go up in price and those with a capital composition below gold will go down. The case of a fiat money regime is different because the adjustment of relative prices can take place with a general rise of money prices, each commodity rising at a different rate depending on relative capital and labour requirements. 23 Germ a n D. Feldman determined by technical features, conditions workers claims for higher wages. Downloaded by [Germán Feldman] at 09:45 18 September 2013 8. Concluding remarks The classical price system is open to alternative distributive closures. The particular theory of distribution to be endorsed has direct consequences on the neutrality of money. The theoretical framework of early classical authors, in which the real wage was regarded as given by subsistence, renders money neutral, thus having no effect on the equilibrium vector of relative prices and resource allocation. But the classical approach is flexible enough so as to allow for the determination of the rate of profits by the rate of interest set in financial markets, imposing a direct influence of monetary policy on normal distribution and relative prices. All early classical authors agreed that under a metallic standard the money supply was endogenous in a long period position. The divisions arose when dealing with paper money systems. The branch led by Ricardo regarded money supply as exogenous under a paper standard, independently of the institutional framework regulating money creation, while banking authors also viewed money as endogenous under a credit-based regime, accepting the validity of the Quantity Theory only in the case of paper money issued by the State. In this regard, though the money supply may be consistently conceived as exogenous in the case of an inconvertible paper money issued by the government, its exclusive impact on nominal prices rests on the acceptance of Say’s Law, or the existence of supply constraints for the expansion of aggregate production. For the very same reason, moving towards a determination of production through the principle of effective demand would not threaten the consistency of the classical ‘core’, which only requires to take quantities as given, leaving room for a separate stage in which production can be explained. The divergent policy prescriptions of currency and banking schools emerged from different opinions with regard to the short-period external adjustment and the nature of money supply under a credit-based monetary system. For currency authors, a trade deficit would not result in gold drains unless money was overissued. It was therefore an excessive money supply the main threat to convertibility. Speculation and instability in domestic financial markets were also promoted by mismanagements of the monetary authority. On the contrary, banking scholars believed that the external sector, at least in the short run, adjusted via international gold flows. Hence, an adverse balance of payments could threaten convertibility and its adjustment could disturb domestic credit conditions. 24 Downloaded by [Germán Feldman] at 09:45 18 September 2013 A Sraffian interpretation of classical monetary controversies The former debates resulted in very different insights on the way a central bank should conduct its policies. Two goals of monetary policy were advanced by classical authors: to preserve the stability of the value of the currency, through the maintenance of convertibility between paper money and gold at a fixed exchange rate,25 and to guarantee financial stability, through the Bank’s role as a lender of last resort. ‘Real’ goals such as full employment or economic growth were excluded due to their adherence to Say’s Law. As to the question of whether these policy goals were mutually compatible, the currency proponents believed that both problems could be simultaneously addressed with a strict rule for money creation: to assimilate the functioning of a paper money economy to a purely metallic circulation where the amount of money in circulation follows the pace of the balance of payments, through the implementation of a ‘currency board’. From this perspective, the central bank’s role as a lender of last resort should be eliminated, on the belief that ‘The only disturbances in the money market, which the directors of the Bank of England have any power to correct, are those which their own mismanagement of the currency creates’ (Torrens 1837, 44). In contrast, for the banking school the central bank should smooth the short-term fluctuations in the sphere of circulation through the administration of its foreign exchange reserves; the impact of gold inflows and outflows could be absorbed by the bullion in the coffers of the Bank, without affecting internal circulation and domestic economic activity or prices. Moreover, the monetary authority should attempt to counterbalance shocks on the public confidence which tend to constrain credit supply. In order to pursue such functions, the division of the Bank’s departments, far from helping, contributed to increase the fragility of the system. With the banking reform, the Bank did not gain anything and lost the control of the rate of interest, another key policy instrument. Moreover, when Peel’s Act forced the banking department of the Bank of England to behave as a standard commercial bank, it eliminated the countercyclical logic of the Bank’s credit policy. Finally, it is difficult to decide which side of this dispute emerged as the winner on policy grounds. After all, as Hicks (1967, 167–8) expresses, though the Bank Charter of 1844 de jure represented the victory of the currency school standpoint, the contemporary growth of central banks 25 Strictly speaking, the objective of early central banks was not to ensure the stability of the purchasing power of the currency in terms of ‘commodities’, but in terms of the precious metal employed as the standard. Only if the value of precious metals in terms of commodities, which was beyond policy control, remained stable, would the maintenance of a fixed parity with gold or silver and the stability of the general price level be one and the same thing. 25 Germ a n D. Feldman around Europe and the de facto administration of Britain’s monetary policy by the banking department of the Bank of England implied the triumph of the banking school position. Moreover, the proliferation of cheques as means of payments after the Bank reform confirmed that money supply responded endogenously to the system’s demand for liquidity. Downloaded by [Germán Feldman] at 09:45 18 September 2013 Acknowledgements A preliminary version of this paper was presented at the 15th Conference of the European Society for the History of Economic Thought -ESHET-, Istanbul, 19–21 May 2011. I am grateful to Bertram Schefold, Maria Cristina Marcuzzo, Carlo Panico and two anonymous referees for helpful comments and suggestions. The usual disclaimer applies. References Bharadwaj, K. (1989). Ricardian theory and Ricardianism. In Themes in Value and Distribution, 41–76. London: Unwin Hyman. Blake, W. (1810). Observations on the Principles Which Regulate the Course of Exchange. London: Edmund Lloyd. de Boyer des Roches, J. (2007). Cause and effect in the gold points mechanism: A criticism of Ricardo’s criticism of thornton. 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Bordo (Ed.), The Gold Standard and Related Regimes: Collected Essays. Cambridge: Cambridge University Press. Wicksell, K. (1978 [1935]). Lectures on Political Economy. Vol. II. New Jersey: Augustus M. Kelley. Wood, E. (1939). English Theories of Central Banking Control, 1819–1858. Cambridge: Harvard University Press. Downloaded by [Germán Feldman] at 09:45 18 September 2013 Abstract The aim of this paper is to explore the contrasting views of inflation, exchange rate misalignments and determinants of gold flows held by different branches of the classical school during the first half of the nineteenth century. The properties of money neutrality and money endogeneity within the classical system are studied by reinterpreting these controversies through the analytical framework of the surplus approach as reconstructed by Sraffa [Production of Commodities by Means of Commodities. Cambridge: Cambridge University Press, 1960] and his followers. Keywords Banking school, classical economics, currency principle, gold standard, law of reflux JEL Classifications: B12, E31, E42 28