Disconnect Of Monetary And Price Theory In Neoclassical Economics

Friedrich Hayek, John Maynard Keynes, and Gunnar Myrdal found themselves in the 1930s addressing the same problem in price theory. I refer not to the practical difficulty in accounting for the Great Depression, but the lack of integration between monetary theory and the theory of value and distribution:

Here's Hayek:

"What I complain of is not only that this theory [Fisher's monetarism] in its various forms has unduly usurped the central place in monetary theory, but that the point of view from which it springs is a positive hindrance to further progress. Not the least harmful effect of this particular theory is the present isolation of the theory of money from the main body of general economic theory.

For so long as we use different methods for the explanation of values as they are supposed to exist irrespective of any influence of money, and for the influence of money on prices, it can never be otherwise." (Hayek 1935, p. 2-3)

Here's Keynes:

"So long as economists are concerned with what is called the Theory of Value, they have been accustomed to teach that prices are governed by the conditions of supply and demand; and, in particular, changes in marginal cost and the elasticity of short-period supply have played a prominent part. But when they pass in volume II, or more often in a separate treatise, to the Theory of Money and Prices, we hear no more of these homely but intelligible concepts and move into a world where prices are governed by the quantity of money, by its income-velocity, by the velocity of circulation relative to the volume of transactions, by hoarding, by forced saving, by inflation and deflation et hoc genus omne; and little or no attempt is made to relate these vague phrases to our former notions of the elasticities of supply and demand. If we reflect on what we are being taught and try to rationalize it, in the simpler discussions it seems that the elasticity of supply must have become zero and demand proportional to the quantity of money; whilst in the more sophisticated we are lost in a haze where nothing is clear and everything is possible. We have all of us become used to finding ourselves sometimes on the one side of the moon and sometimes on the other, without knowing what route or journey connects them, related, apparently, after the fashion of our waking and our dreaming lives.

One of the objects of the foregoing chapters has been to escape from this double life and to bring the theory of prices as a whole back to close contact with the theory of value. The division of Economics between the Theory of Value and Distribution on the one hand and the Theory of Money on the other hand is, I think, a false division..." (Keynes 1936, p. 292-293)

And here's Myrdal:

"It is a peculiarity of all systematic treatises on orthodox economic theory that there is no inner connexion and integration of monetary theory with the central theory of prices. Usually the monetary theory is only a rather loose appendix to the theory of price formation. The central economic problems - according to the classical theory, those of production, of barter-exchange and of distribution - are treated, without exception, as problems of exchange value, or, in other words as problems of relative prices. Obviously, by regarding the central economic problems in this way one entirely detaches their fundamental treatment from any monetary considerations." (Myrdal 1939, p. 10)

I put the above quotes into my latest iteration of this paper.

I think that, despite later work by, for example, Don Patinkin or Eugene Fama or with models of overlapping generations, mainstream economists still fail to satisfactorily integrate monetary and price theory. I an influenced in this view by a Frank Hahn paper and comments of various Post Keynesians, such as Paul Davidson.

References

• Hahn, F. H. (1965). "On Some Problems of Proving the Existence of an Equilibrium in a Monetary Economy" in The Theory of Interest Rates (Ed. by F. H. Hahn and F. Brechling), Macmillan.
• Hayek, F. A. (1935). Prices And Production, Second Edition, London: George Routledge and Sons.
• Keynes, J. M. (1936). The General Theory of Employment Interest and Money, New York: Harcourt, Brace and Co.
• Myrdal, G. (1939). Monetary Equilibrium, New York: Sentry Press.