My Paper on the Monetary Theories of Ricardo and Thornton Is Now Available

I have just posted (on the Social Science Research Network) a revised version of a paper I presented last year in Tokyo at the Ricardo Society Conference on Money, Finance and Ricardo. The paper, “Monetary Disequilibrium and the Demand for Money in Ricardo and Thornton,” will be published next year by Routledge in a forthcoming volume edited by Susumu Takenaga, containing the papers presented at the conference. Here is the abstract of my paper.

This paper attempts to provide an account of the reasons for the differences between the theories of David Ricardo and Henry Thornton for the depreciation of sterling during the Napoleonic Wars. Ricardo held that only overissue by the Bank of England could cause depreciatiaon of sterling during the Restriction while Thornton believed that other causes, like a bad harvest, could also be responsible for declining value of sterling in terms of bullion. Ricardo thought that a strict application of the conditions of international commodity arbitrage under the gold standard showed that a bad harvest could not cause a depreciation of sterling, but, applying a barter model, he failed to consider the effect of a bad harvest on the demand for money. In contrast, Thornton’s anticipation of Wicksell’s natural-rate theory did not strictly adhere to the conditions of international commodity arbitrage assumed by Ricardo, allowing for the operation of a Humean price-specie-flow mechanism, but, like Ricardo, Thornton implicitly made the untenable assumption of an unchanging demand for money.

The paper is available for download at the Social Science Research Network website. Here’s a link

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2168012

Any comments or suggestions would be greatly appreciated.

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21 Responses to “My Paper on the Monetary Theories of Ricardo and Thornton Is Now Available”


  1. 1 Mike Sproul October 29, 2012 at 8:18 pm

    Hi David:

    My explanation for the inflation is that the B of E lost backing relative to the quantity of money issued. The threat from France would reduce the value of British government bonds. The B of E held a lot of those bonds, so as the bonds dropped, so did the B of E pounds those bonds were backing.

  2. 2 Ritwik October 30, 2012 at 3:32 am

    David

    Great paper! I’d disagree on the New View being Ricardian, insofar as I associate the New View with Jim Tobin. I think the Sumnerian viewpoint is actually Ricardian – note the stress on viewing money in terms of a commodity priceand stressing that irrespective of other developments, it is currency issue or the lack of it that determines the price level.

    The New View is Ricardian only to the extent that it claims that reflux mechanisms are available for competitive money supply and only monopoly money issuers matter, so that credit creation is endogenous and passively responds to the real sector. But in its focus on real sector demand itself being very sensitive to interest rates, it is in the tradition of Wicksell & Thornton.

    The Old View focuses on banks and financial intermediaries as the channels of monetary disequilibrium, but the monetarist conception of it has these banks responding passively to base money and focusing on the quantity, while the Schumpeter/Minsky endogenous money conception of it has banks and financial intermediaries themselves behaving as lead actors and focusing on interest rates. So again, it can be seen as Thorntonian or Ricardian, depending on whether you want to focus on the autonomy of financiers or on interest rates vs quantity of money.

  3. 3 Blue Aurora October 30, 2012 at 11:40 am

    While I’m not familiar with David Ricardo’s economics, or that of Henry Thornton, I thought your paper seemed solid. Is it going to be published in an academic journal, or somewhere else?

  4. 4 Frank Restly October 30, 2012 at 4:28 pm

    Ricardo:

    “In Ricardo’s account, the value of money can be said to be determined by the value of gold as a commodity, with a definite demand encompassing both monetary and non-monetary uses. Arbitrage between monetary and non-monetary uses equalizes the value of gold across all uses.”

    “Banks affect the value of money only insofar as they reduce the total demand for gold by allowing gold to be withdrawn from some monetary uses and to be devoted instead to non-monetary uses of lower value than was otherwise possible.”

    I still don’t understand how Ricardo infers that banks affect how gold is used – monetarily or non monetarily, unless banks were running a lending operation out the front and a jewelry store / dental clinic out the back.

    Thorton:

    “Thornton’s analysis is less straightforward than Ricardo’s. By increasing the quantity of money in the short term, banks can raise prices under a gold standard even without causing a reduction in the monetary demand for gold.”

    So Thorton is saying that the price level can rise without a reduction in liquidity preference. Certainly possible if productivity falls. Of course the banks might be lending to the crown to pay some soldiers to burn some fields. And when the owner of said fields cannot pay taxes to the crown, the fields become owned by the crown who uses them to pay off the loan to the bank.

  5. 5 JP Koning October 30, 2012 at 6:27 pm

    Excellent. I’ve added it to my reading list.

    Incidentally, where do you stand between Sumner and Rowe?

  6. 6 David Glasner November 5, 2012 at 9:35 am

    Mike, Have you actually studied the contemporaneous B of E balance sheets? On the other hand, couldn’t the higher yield on bonds simply reflect an inflation premium or uncertainty about whether convertibility would be restored at the original gold parity?

    Ritwik, Thanks so much. I actually agree with your point about Sumner, Tobin and Ricardo. Tobin was not a consistent Ricardian. His Keynesianism led him it seems to me into a muddle about how the price level is determined, and that’s why the significance of the New View was greatly misunderstood at the time, with all the participants seemingly under the misimpression that the New View was a theory explaining why monetary policy is ineffective rather than a theory explaining that the transmission mechanism was different from the one adopted in the Old View. I also agree that the Old View/New View dispute does not consistently track the differences between Ricardo and Thornton. Thornton has a foot in both camps.

    Blue Aurora, Thanks. It will be published in a forthcoming (2013?) volume containing all the papers presented at the Ricardo Society conference. The publisher is Routledge.

    Frank, Do you understand how an ethanol mandate affects the amount of corn available for food even though gasoline refiners are not in the food business? If banks add to their holdings of gold, the additional gold in their vaults has to come from some other source. There are economic incentives operating to induce gold to be withdrawn from non-monetary banks attempt to increase their holdings of gold.

    About Thornton, he is assuming that the quantity theory operates even under a gold standard so that if banks increase the quantity of money, there will be some tendency for prices to rise because with a constant demand for money, each unit of money will have to be worth slightly less.

    JP, Thanks. I have to catch up on their posts, and when I do, I will see if I have anything to add. So stay tuned.

  7. 7 Frank Restly November 6, 2012 at 10:23 am

    David,

    “Frank, Do you understand how an ethanol mandate affects the amount of corn available for food even though gasoline refiners are not in the food business?”

    Yes I understand very well how a mandate works. In this context it is a legal requirement that gasoline refiners must include a certain percentage of ethanol in the blends of gasoline that they sell to the market. And so it creates a demand pull for corn based ethanol.

    “If banks add to their holdings of gold, the additional gold in their vaults has to come from some other source.”

    And it can come from either monetary gold or nonmonetary gold. What you seem to insist is that just by purchasing gold out of the market, somehow banks affect the distribution of how gold is used.

    What you are missing is the “legal requirement” of a mandate. What is the legal mandate that says banks had to purchase monetary gold or banks had to purchase nonmonetary gold? If you had said that a government required all taxes to be paid in gold and that payment must be in gold coins of uniform weight and bearing the seal of said government, then you have truly shifted the distribution of gold from nonmonetary to monetary uses.

  8. 8 Forex Mentor Pro November 6, 2012 at 4:54 pm

    Anytime any currency is taken off the gold standard, that is the start of the collapse of any empire. America took the world currency off gold standard in 1971. Sadly, look at where we are heading now….

  9. 9 Mike Sproul November 7, 2012 at 10:22 am

    David:

    Nope, the B of E’s old balance sheet was too confusing. Maybe JP Koning could apply his wizardry to it.

    In any case, it clearly makes sense that a war would depress a country’s bonds, and as those bonds fell, the money backed by those bonds would also fall.

  10. 10 JP Koning November 7, 2012 at 5:16 pm

    The BoE’s balance sheet? That’s like 320 years worth of data. Maybe one day…

  11. 11 Mike Sproul November 7, 2012 at 9:37 pm

    JP:

    No, just the data from 1797 to 1821 would be more than enough.

  12. 12 JP Koning November 9, 2012 at 8:38 am

    Mike, if you find the data I’ll do it :)

    David, I got around to reading your paper. Very interesting, I learnt a lot. I don’t have much expertise on Ricardo so I don’t have anything helpful to say on that front.

    You wrote that the Wicksell/Thornton natural rate model doesn’t have an equation for the demand for money. I remember reading Wicksell and he very explicitly set out the various motives for money’s “interval of rest”. He posited a transaction motive, a precautionary motive, and a place to put one’s money in between transactions in capital. So was Wicksell assuming that money adjusts passively to whatever quantity of money is supplied (your “alternate interpretation” on page 15)? Does this assume constant velocity?

    “Finally, equation (5) says that if banks set their lending rate below the natural rate, the pressure of excess demand eventually forces banks to raise the lending rate to match the natural rate, thus, restoring an equilibrium with a stable price level and no excess demand.”

    What do you mean by the pressures of excess demand? Why does this force banks to increase rates? I remember that Wicksell said that reserves flowing out of the banks would eventually force banks to raise lending rates back up.

  13. 13 David Glasner November 10, 2012 at 8:51 pm

    Frank, My question was not so much about how the mandate works as about the effect of the demand increase that the mandate causes.

    Central banks, under the gold standard, did sometimes go into the market and physically acquire gold, but most of the time, banks were acquiring gold because people were bringing gold to the central bank and exchanging it for coins or banknotes or deposits at the bank. Suppose that all the gold brought to banks was previously used for monetary purposes, so the central bank is not directly withdrawing any gold from non-monetary uses. Still, by withdrawing monetary gold from circulation, the central bank will have reduced the amount of monetary gold available. Presumably, the demand for monetary gold has not changed, so the public will try to increase their holdings of monetary gold in the aggregate. But they cannot do except by themselves purchasing gold now used in non-monetary uses or by spending less on real goods and services. Reduced spending on real goods and services will cause the prices of real goods and services to fall while the price of gold is fixed. The relative price of gold devoted to non-monetary uses having risen, some owners of non-monetary gold will forego those uses or find substitutes for gold with which to replace the gold they had been using.

    Forex Mentor Pro, The world has done rather well since the gold standard was abandoned at the depth of the Great Depression. From 1944 to 1971 there was a pseudo gold standard which was nothing more than an elaborate system for fixing the dollar price of gold while other currencies were tied to the dollar at fixed, but adjustable, exchange rates.

    Mike, Agreed, but there could still have been a lot of equity on the B of E balance sheet so that the reduced value of the assets did not have to cause depreciation of the liabilities.

    JP, I am sure that Wicksell had an understanding of the demand for money as a medium of exchange and a store of value, but that understanding did not inform his treatment of the natural rate/market rate mechanism, and it is not to be found in the canonical version of the natural rate/market rate model as written down by Laidler and then by Thomas Humphrey whose version I cribbed.

    I don’t know exactly what Wicksell was assuming about the demand for money, but you can sensibly attribute to him the assumption of a passive adjustment to the quantity of money supplied which, I think, is equivalent to constant velocity. By pressure of excess demand I mean excess demand is forcing up prices, and as prices rise interest rates go up.

  14. 14 Frank Restly November 11, 2012 at 8:13 am

    David,

    “Central banks, under the gold standard, did sometimes go into the market and physically acquire gold, but most of the time, banks were acquiring gold because people were bringing gold to the central bank and exchanging it for coins or banknotes or deposits at the bank.”

    And so who was insane – the central bank of France or the people who were exchanging their gold holdings for banknotes and deposits?

    “Suppose that all the gold brought to banks was previously used for monetary purposes, so the central bank is not directly withdrawing any gold from non-monetary uses. Still, by withdrawing monetary gold from circulation, the central bank will have reduced the amount of monetary gold available. Presumably, the demand for monetary gold has not changed, so the public will try to increase their holdings of monetary gold in the aggregate.”

    You are contradicting yourself here. In one sentence you say that people are willing to accept bank notes as a money substitute in exchange for gold. In another you say that the public (people) will try to increase their holdings of monetary gold, that the demand for monetary gold has not changed. Either the demand for monetary gold has decreased (people exchange monetary gold for monetary banknotes) or it has not. Which is it?

    What you are lacking here is an enterprise where monetary gold and money issued by a bank are not treated equally. You have already established that the general public views them equally – people exchange their monetary gold holdings for banknotes. Who is your enterprise that does not treat them equally?

  15. 15 David Glasner November 11, 2012 at 12:26 pm

    Frank, You asked:

    “[W]ho was insane – the central bank of France or the people who were exchanging their gold holdings for banknotes and deposits?

    That’s easy. The Bank of France was insane, because it was their policy that induced the inflow of gold into the central bank, because that was the only way they could get the banknotes they demanded. The policy was implemented by a combination of gold reserve requirements and the redemption of foreign exchange (i.e., obligations issued by the US and the UK) thereby requiring gold to be shipped to France to discharge those obligations.

    You said:

    “You are contradicting yourself here. In one sentence you say that people are willing to accept bank notes as a money substitute in exchange for gold. In another you say that the public (people) will try to increase their holdings of monetary gold, that the demand for monetary gold has not changed. Either the demand for monetary gold has decreased (people exchange monetary gold for monetary banknotes) or it has not. Which is it?”

    Yes, people are willing to accept banknotes as a substitute in exchange for gold because the issuer is guaranteeing with sufficient credibility to make them instantly convertible into one another at a fixed exchange rate. That doesn’t mean that people are indifferent between holding their cash solely in fold coin and bullion or solely in banknotes. It just means that after accepting banknotes, they will later exchange the banknotes into gold.

    “What you are lacking here is an enterprise where monetary gold and money issued by a bank are not treated equally. You have already established that the general public views them equally – people exchange their monetary gold holdings for banknotes. Who is your enterprise that does not treat them equally?”

    There is a difference between viewing two things as equally valuable and viewing them as equally useful in all applications. I don’t distinguish between the value of a $10 in currency and $10 in deposits, but I generally try to minimize the amount of currency on my person at any time.

  16. 16 Frank Restly November 11, 2012 at 3:13 pm

    David,

    “Yes, people are willing to accept banknotes as a substitute in exchange for gold because the issuer is guaranteeing with sufficient credibility to make them instantly convertible into one another at a fixed exchange rate. That doesn’t mean that people are indifferent between holding their cash solely in fold coin and bullion or solely in banknotes. It just means that after accepting banknotes, they will later exchange the banknotes into gold.”

    And so the demand for monetary gold falls as people exchange gold for banknotes and rises as people exchange banknotes for gold.

    “But they cannot do that except by themselves purchasing gold now used in non-monetary uses or by spending less on real goods and services.”

    They most certainly can do that as long as the value of the banknotes issued is the same as the value of the monetary gold held by banks based upon the agreed exchange rate. This can become a problem when a bank lends out its banknotes. You are missing credit expansion and fractional reserve lending in this analysis.

    “There is a difference between viewing two things as equally valuable and viewing them as equally useful in all applications.”

    Under what application are banknotes and monetary gold not equally useful ?

    “I don’t distinguish between the value of a $10 in currency and $10 in deposits.”

    But we are not talking about depositing gold in a safety deposit box here. We are talking about an exchange of banknotes for gold.

  17. 17 Mike Sproul November 12, 2012 at 11:05 am

    David:

    Good point. Given a cushion of positive equity, a loss of assets does not have to mean the Bank’s money loses value. In fact, since the bank’s money is a senior claim against the bank’s assets, the Bank’s equity can even go into the negative range and the bank’s money can still hold its value.

    But the reverse is also true. The Bank might have enough assets to maintain convertibility at 1 pound=.25 oz of gold, but if the Bank chooses to maintain convertibility at .20 oz., then that is what the pound will be worth, regardless of the Bank’s cushion of equity. And ‘convertibility’ doesn’t have to be GOLD convertibility. It can be bond convertibility, loan repayment convertibility, etc, and the result is the same.

    This is where the backing theory and the quantity theory look uncomfortably similar. For example, if the Bank has plenty of assets, but nevertheless lets the pound lose 25% of its value, then people will want to hold 25% more of the Bank’s money, in order to maintain their real balances. If the Bank accommodates this money demand then it will issue 25% more money, and the quantity theory will appear to show a close correlation between the money supply and the price level. (Except that prices will change before the money supply changes. This is what Thomas Tooke observed in the 1800′s, and also what Sargent observed in his “Four big inflations” paper.)

  18. 18 David Glasner November 14, 2012 at 8:23 pm

    Frank, You said:
    “And so the demand for monetary gold falls as people exchange gold for banknotes and rises as people exchange banknotes for gold.”

    Sorry, but that’s not how I (along with most economists think about the demand for money). What makes money money is that you will accept it even though you have no demand for it, because you know someone will accept when you want to get rid of it. So the demand for money refers not to the amount of money you happen to have in your bank account at a particular moment of time, a magnitude that fluctuates daily for most people on a daily basis. Instead it refers to an average amount of cash you want to hold over long a relevant period of time even though the amount in your bank balance may not, at any particular moment, correspond to that desired amount.

    My point about the Bank of France was that they were restricting the amount of banknotes that they were creating so that people who wanted additional banknotes could increase their holdings of cash only by reducing their expenditures which meant that they were reducing imports and increasing exports causing an inflow of foreign cash or gold which could be used to obtain banknotes.

    You asked:

    “Under what application are banknotes and monetary gold not equally useful?” You can take a banknote to the Apple store and buy an ipod. You could not take a bar of gold bullion to the Apple store and walk out of the Apple store having bought anything.

    Mike,

    Right. I think that we are pretty much on the same page.

  19. 19 Frank Restly November 16, 2012 at 6:18 pm

    David,

    “So the demand for money refers not to the amount of money you happen to have in your bank account at a particular moment of time, a magnitude that fluctuates daily for most people on a daily basis. Instead it refers to an average amount of cash you want to hold over long a relevant period of time even though the amount in your bank balance may not, at any particular moment, correspond to that desired amount.”

    I thought we were talking specifically about the demand for monetary gold as opposed to the general demand for money. From your original paragraph:

    “Suppose that all the gold brought to banks was previously used for monetary purposes, so the central bank is not directly withdrawing any gold from non-monetary uses. Still, by withdrawing monetary gold from circulation, the central bank will have reduced the amount of monetary gold available. Presumably, the demand for monetary gold has not changed, so the public will try to increase their holdings of monetary gold in the aggregate. But they cannot do that themselves except by purchasing gold now used in non-monetary uses or by spending less on real goods and services.

    Were you talking about the demand for money in general here or the demand for monetary gold in particular? If the central bank sells banknotes for monetary gold and the public is willing to accept banknotes for monetary gold then by definition the demand for monetary gold has fallen and the demand for banknotes has risen. The demand for money in aggregate (banknotes + monetary gold) has not changed and so the public does not have to spend less on real goods and services.

    “You can take a banknote to the Apple store and buy an ipod. You could not take a bar of gold bullion to the Apple store and walk out of the Apple store having bought anything.”

    That is because gold is no longer accepted as a medium of exchange today. I thought we were referring to a period in time when it was. So let me rephrase – during the early 20th century when gold was used as a medium of exchange – under what application are banknotes and monetary gold not equally useful?


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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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