picture via bluemountain.com

James Tobin’s papers are very interesting. I have a special liking for him even though he sometimes said strange things and used a lot of neoclassical analysis. His asset allocation theory is one of the most interesting things in monetary economics.

I came across this paper from his book Essays In Economics – Vol 1: Macroeconomics titled Money And Income: Post Hoc Ergo Propter Hoc? (also available here if you neither have the book nor jstor access).

The paper is also noted and analysed in Louis-Philippe Rochon’s book Credit, Money, and Production: An Alternative Post-Keynesian Approach (p 124 – )

In this paper Tobin takes Milton Friedman to task by constructing what he calls an “ultra-Keynesian” model which he describes as

In the ultra-Keynesian model, changes in the money supply are a passive response to income changes generated, via the multiplier mechanism, by autonomous investment and government expenditure.

(note: multiplier as in expenditure multiplier and not “money multiplier”).

For some strange reason Tobin says he doesn’t believe in this model but shows how Friedman’s empirical findings (the latter’s assertion that “changes in the supply of money are the principal cause of changes in money income Y”) are all wrong especially his assertion about leads and lags. This was also noted by Nicholas Kaldor in his 1970 article The New Monetarism reprinted in his Collected Essays, Vol 6 as Chapter 1.

… Suppose the initiating change is a decision of some firms to increase their inventories, financed by borrowing. The first impact is to cause some other firms whose sales have increased unexpectedly to incur some involuntary disinvestment. It is only when that is made good by increased orders that productive activity is expanded; any such expansion will cause higher wage outlays which in turn may involve further borrowing. The ultimate effects on income involve further changes in productive activity arising from the expenditure generated by additional incomes. There is every reason to supposing, therefore, that the rise in the “money supply” should precede the rise in income – irrespective of whether the money-increase was a cause or an effect.

So much for the various tests using Econometrics by Friedman – these don’t prove anything.

Again in his 1980 paper Monetarism and UK Monetary Policy, Kaldor states:

… the change in the money supply may be the consequence, not the cause, of the change in the money incomes (and prices), and that the mere existence of time-lag – that changes in the money supply precede changes in money incomes, is not in itself sufficient to settle the question of causality – one cannot rule out the possibility of an event A which occurred subsequent to B being nevertheless the cause of B (the simplest analogy is the rumblings of a volcano which frequently precede an eruption).

Back to Tobin. He says the following from what his “ultra-Keynesian” model:

… The main point of the exercise can be made by assuming that the monetary authority provides the bank reserves as necessary to keep r constant… The monetary authority responds to the “needs of trade”. With the help of the monetary authority, banks are able and willing to meet the fluctuating need of their borrowing customers for credit and of their depositors of money.

… The financial operations of the government and the banks are as follows: The government and the monetary authority divided the increase in debt … between “high-powered money” and bonds in such a manner as to keep the interest rate on target… the monetary authority provides enough new high-powered money to meet increased reserve requirements and any new demand for excess reserves. The remainder of the increase in public debt … takes form of bonds and is just enough to satisfy the demands of the banks and the public.

An important observation made by Tobin is that because the stock of money rises following a fiscal expansion due to a rise in income, an ultra-Keynesian

… would not even be surprised if some observers of the accelerated pace of monetary expansion in the wake of a tax cut conclude that monetary rather than fiscal policy caused the boom.

Tobin shows how “every single piece of observed evidence that Friedman reports on timing is consistent with the timing implications of the ultra-Keynesian model”.

This is quite important. Somehow most observers cannot understand the role of fiscal policy and there is almost total attention given to “what the Federal Reserve is doing or going to do” by economic commentators and “experts” of Wall Street with most comments on fiscal policy being that fiscal deficit should be somehow reduced. “We are all Keynesians now” is quite misleading because most economic commentators are heavily distorted by the quantity theory of money even though sometimes they claim to not believe in Monetarism.

Anyway, have a look at Tobin’s paper Money And Income: Post Hoc Ergo Propter Hoc?