Thursday, January 17, 2013

Best buddies: Keynes & Hayek on moneyness

We are taught these days to view John Maynard Keynes and Friedrich Hayek as diametric opposites. This meme is encouraged by the Keynes vs Hayek rap videos, or Nicolas Wapshott's book Keynes and Hayek: the Clash that Defined Modern Economics.

But when it came to the idea of moneyness, both Keynes and Hayek were in agreement.

Wrote Hayek:
although we usually assume there is a sharp line of distinction between what is money and what is not—and the law generally tries to makes such a distinction—so far as the causal effects of monetary events are concerned, there is no such clear difference. What we find is rather a continuum in which objects of various degrees of liquidity, or with values which can fluctuate independently of each other, shade into each other in the degree to which they function as money.

I have always found it useful to explain to student that it has been rather a misfortune that we describe money by a noun, and that it would be more helpful for the explanation of monetary phenomena if 'money' were an adjective describing a property which different things could possess to varying degrees. -Denationalization of Money: The Argument Refined
Wrote Keynes:
As a footnote to the above, it may be worth emphasising what has been already stated above, namely, that “liquidity” and “carrying-costs” are both a matter of degree; and that it is only in having the former high relatively to the latter that the peculiarity of “money” consists....There is, clearly, no absolute standard of “liquidity” but merely a scale of liquidity — a varying premium of which account has to be taken. -The General Theory of Employment, Interest, and Money - Chapter 17
You may have noticed that the subtitle of my blog is inspired by the Hayek quote.

Neither Keynes nor Hayek consistently applied these insights. Rather, both tended to fall back into the noun form of money, or as Keynes called it, an absolute standard of liquidity, in which there are discrete buckets into which the economist must sort items as either money or non-money, or liquidity and non-liquidity. If they had consistently applied the idea of money as an adjective, or liquidity as a matter of degree, then Hayek would have called his book Denationalization of Moneyness, and Keynes would have called his The General Theory of Employment, Interest, and Liquidity!

That Keynes and Hayek mixed the two ways of conceptualizing monetary phenomenon isn't unusual. Most economists, living or dead, think almost entirely in terms of absolute liquidity while occasionally lapsing into a relative liquidity frame of mind.

If we were to take Hayek's advice and think purely in terms of moneyness, this is how it might look. Start with the idea that all wealth is capital, not just machines and buildings but land and human beings too. The anticipated stream of services these forms of capital will throw off as they move through time can be discounted back to the present and represented as some stock dollar amount. One of those services that capital throws off is its potential to be sold, or its moneyness/liquidity. After all, when the future is clouded, having a stock of easily saleable items can lull nagging feelings of doubt and uncertainty. Summing up the discounted flows of uncertainty-shielding services that arise from an item's anticipated liquidity/moneyness provides us with that item's liquidity premium. From there, these ideas might get some good insights into business cycles or new financial products. For now, though, we're still in a money world.


  1. JP,

    one one hand I agree and on the other I disagree. From the point of view of liquidity it makes sense to a wide number of media of exchange. For example, Keynesians like to make the argument that a depreciating "money" motivates people to spend. Once you consider the concept of liquidity, you'll realise that this is nonsense, because people who do not spend can simply buy other liquid goods that do not depreciate.

    But there are other factors and situations where the distinction matters. Not all liquid goods are used as a unit of account, and thus do not play a role in economic calculation. The Austrian Business Cycle Theory, for example, requires that money is distinct.

    1. Peter, while I agree that we need to think about the unit of account, I prefer to divorce the idea of unit of account from the concept of liquidity/moneyness so that both can be considered in isolation.

      This separation comes naturally. Many units of account have no associated media of exchange. Take the SDR, for instance, or the AMU (Asian Monetary Unit), the ACU, or the WAUA (West African Unit of Account). As far as I know no actual AMU and WAUA media of exchange exist - they're purely used as accounting units. All the world's prices could be posted in terms of WAUA, but we could settle every trade using non-WAUA (dollars and such).

    2. @Peter Surda, "people who do not spend can simply buy other liquid goods that do not depreciate" - I guess many people first do have to realize that. I am currently writing a Thesis on Cryptocurrencies and it looks like one of the factors to buy Crypto is that people want to put their money in a non depreciating asset(money storage) with easy access.

  2. Does public spending ever increase private sector growth?

    If you do this, if you look at the actual data, it is surprising see: Sydenhams Law of public expenditure and GDP growth

    Whether the public spending is for wars, economic intervention or welfare the answer is NO, furthermore the New Deal seems to have been a myth, there was a strong private sector recovery in the USA before the New Deal.