THE ROLE OF THE GOLD STANDARD IN KEYNESIAN MONETARY THEORY

I. INTRODUCTION The primary motivation for this paper was provided by ambiguities within the General Theory regarding the efficacy of monetary policy remedies to a depression. I will argue that rather than being a "fixed-price" or "depression" model, the General Theory is best thought of as a "gold standard" model. Thus, I show that Keynes's statements on monetary policy ineffectiveness implicitly assumed the existence of a monetary system with some linkage to gold and that some of the General Theory's most distinctive features make more sense if viewed from that perspective. This hypothesis may appear surprising in light of the popular perception that in the General Theory Keynes tried to move away from the open-economy, international gold standard framework employed in the Treatise on Money. I will argue that he failed to do this. Even if Keynes did not explicitly regard the General Theory as a gold standard model, during the 1930s he began to view the economic problems that we associate with the gold standard (monetary policy ineffectiveness, occasional episodes of deflation, and so on) as being inherently characteristic of a modern capitalist economy. Ironically, Keynes made this change just as many countries were beginning to deemphasize the role of gold. Keynes is regarded as one of the most severe critics of an international gold standard with rigid parities. Thus, it is odd that he would develop a monetary ineffectiveness proposition that has little or no applicability to a country operating under a fiat money regime. An essential part of my argument will be to show that Keynes viewed a pure fiat regime as being both highly unlikely and highly undesirable. An important implication of this paper is that the gradual replacement of the gold standard by fiat money regimes should have led modern Keynesian economists to move away from some of the most distinctive features of 1930s Keynesianism (such as monetary policy ineffectiveness, deficit spending, the paradox of thrift, and protectionism.) I will show that the recent metamorphosis of New Keynesian macroeconomics represents a natural response of economists to a radically altered monetary environment. II. KEYNES'S VIEWS ON MONETARY POLICY To better understand the role played by the gold standard in Keynes's work, it will be helpful to start with the "monetary ineffectiveness proposition." In current usage, this phrase generally refers to the New Classical view that money has no impact on real output. In contrast, most would interpret the pessimistic views expressed by Keynes during the 1930s as reflecting a belief that monetary expansion might be incapable of increasing nominal output. Because Keynes clearly did not believe that an expansionary monetary policy would reduce real output, this interpretation suggests that Keynes viewed the ineffectiveness proposition as also applying to the price level. Unfortunately, there is great uncertainty as to how pessimistic Keynes actually was regarding the effectiveness of monetary policy. The 31 December 1933 issue of the New York Times [Times, p. 2XX] published a long letter by Keynes in which he evaluated the first year of the New Deal. After a lengthy critique of the National Recovery Act, Keynes turned his attention to Roosevelt's gold-buying program:(1) "The other set of fallacies . . . arises out of a crude economic doctrine commonly known as the quantity theory of money. Rising output and rising incomes will suffer a setback sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt." This is a clear example of what is often referred to as the "pushing on a string" view of monetary policy ineffectiveness. But notice how Keynes subtly shifts his argument in the very next paragraph, as he turns from money's effect on real output to its effect on prices: "It is an even more foolish application of the same ideas to believe that there is a mathematical relation between the price of gold and the price of other things. …