Money: Lectures on the Basis of General Equilibrium Theory and the Economics of Institutions

406 Pages·1989·6.88 MB·English

by  Professor Dr. Rudolf Richter (auth.)

Rudolf Richter
o n e y
Lectures on the Basis of General Equilibrium
Theory and the Economics of Institutions
Translated from the German by
Wolfgang F. Stolper
With 38 Figures
Springer-Verlag Berlin Heidelberg New York
London Paris Tokyo Hong Kong
Professor Dr. Rudolf Richter
Department of Economics
Universitat des Saarlandes
6600 Saarbrucken 11, FRO
Translator:
Wolfgang F. Stolper
Professor Emeritus
Department of Economics
University of Michigan
Ann Arbor
Michigan, USA
ISBN-13 :978-3-642-74039-8 e-ISBN-13: 978-3-642-74037-4
DOl: 10.1007/978-3-642-74037-4
Library of Congress Cataloging-in-Publication Data
Richter, Rudolf, 1926-
[Geldtheorie. English)
Money: lectures on the basis of general equilibrium theory and the economics of institutions /
Rudolf Richter: translated from the German by Wolfgang F. Stolper.
p. em.
Translation of: Geldtheorie.
Bibliography: p.
Includes indexes.
ISBN-!3:978-3-642-74039-8 (U.S.)
1. Money. 2. Equilibrium (Economics) I. Title.
HG22I.G41313 1988
332.4--dc 19
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To my wife
Introductory Remarks
Nowadays every exposition of the problems of the money
economy should really begin with a theory of price and
distribution.
1. A. Schumpeter (1917118, 631;
English translation 1956, 150)
Economics comes closer to being a 'science of contract' than
a 'science of choice'.
1. M. Buchanan (1975, 229)
The theory of money is the theory of exchange involving the use of money.
Both exchange and the use of money are social phenomena. Both can only
be explained within the framework of a social model. For exchange con
sidered in isolation there exists such a model: the theory of general
equilibrium. As far as the use of money is considered matters are
somewhat more complicated. Nevertheless, the theory of general
equilibrium is in the process of being supplemented by a theory of ex
change by means of money. At the same time, the institutional basis of a
money economy, i.e. the economics of institutions, is once again being
stressed. However, a systematic joint analysis of both is still missing. This
book, too, will not succeed in presenting a complete synthesis. We will,
however, try to direct the attention of the reader in this direction.
Neoclassical equilibrium analysis will be understood as the ideal result of
a specific institutional framework, as a system of consistent contracts bet
ween individuals which are carried out exactly. How these contracts are
reached will not be analyzed. A stationary equilibrium model will serve as
a reference system. Deviations from stationary equilibrium are interpreted
as the result of slack within the institutional framework. A description or
explanation of the process of adaptation to equilibrium is not of interest
in this context.
No analysis of market processes will be given. The analysis of evolu
tionary processes is confined to the evolution of currency orders where
"order" is defined as a system of social norms or rules. Monetary theory
is understood as a theory of the currency order. This approach permits not
only clearer access to problems of monetary theory, it also gives a total
view of monetary theory that is otherwise impossible.
The book consists of two parts. Part I presents, in elementary form
and tailored to our purposes, the basic skeleton of the theory in so far as
it is relevant to our subsequent considerations: general equilibrium theory
and the economic theory of institutions. In Part II we develop monetary
theory on the basis of these fundamental considerations.
Part I consists of three chapters. Chapter 1 presents the general theory
of competitive equilibrium for one period. The chapter limits itself to ex
change or purchase transactions where both sides of the exchange occur
simultaneously. The second chapter deals with the theory of general
equilibrium over several periods. Loans in kind and forward purchases are
now possible. A model of stationary equilibrium and the theory of
VIII Introductory Remarks
overlapping generations are presented. The overlapping generations
model will later be used as the basic model of monetary theory. Chapter
3 deals with the economic theory of institutions in general, not merely with
the theory of the institution of money. The concepts of "property rights"
and of "transaction costs" will be introduced. The model of a transactions
firm will be described which will be used later to explain the holding of
cash balances and the theory of the banking firm. We finally deal with the
theory of the market as an institution and, in this context, the concept of
a market community.
Part II consists of Chapters 4 to 8. Chapter 4 presents approaches to
the economic explanation of the institution of money. In the older
literature this was called the analysis of the "nature of money", a term
which we also will use. We introduce the concepts of a "currency com
munity" and of an "elementary currency order". The core of this chapter
is the description and economic explanation of the regulatory objects of
an elementary currency order. Chapter 5 deals first with the concept of
"payment" applied to exchange by means of money. Next we describe an
economy without transaction costs. In such an economy the holding of
cash balances does not pay even if exchange involves the use of money.
Money is "qualitatively" perfectly neutral; that is, it makes no difference
whether exchange involves the use of money or not, whether we deal with
money purchases or barter transactions, whether loans are made in kind
or involve money, or which currency is used in accounting. The conditions
of arbitrage equilibria, which playa pervasive role in neoclassical theory,
are described; the significance of the arbitrage logic is illustrated.
Chapter 6 introduces transaction costs and their effects. We develop a sta
tionary overlapping generations model in which the holding of cash
balances is worthwhile because the exchange of cash for interest-bearing
assets and vice versa involves cost. The quantity theory of money applies:
the amount of money and the prices of goods are related in a strictly pro
portional manner. Money is "quantitatively" neutral. Chapter 7 deals
with problems of the various institutional solutions to the problem of
safeguarding the value of money on the basis of the overlapping genem
tions model which has been developed in the preceding chapter. The two
basic types of a currency order, the commodity standard and the paper
standard, are discussed, both for the case of a single country (i.e. on a "na
tional" basis) and for the case of two countries (i.e. on an "international"
basis). Freely fluctuating exchange rates are discussed in this context, as
are the arguments for and against the commodity and the paper standard.
Chapter 8 discusses financial intermediaries, particularly banks, using the
concept of a "transactions firm" which was introduced in Chapter 3. We
return to the problem of how to safeguard the value of money and discuss
the problems of public regulation of the central bank and the commercial
banks.
The book has grown out of a series of lectures which the author gave
during the past fifteen years and which he continuously revised. It is a mix
ture of monograph and textbook. Its centml idea is the importance of the
Introductory Remarks IX
currency order. The currency order determines the why and how of the use
of money. The individuals who negotiate purchase or loan agreements
orient themselves on such an order. It is the currency order which is the
basis of the trust in a currency which in turn is the precondition for the pro
per functioning of money. It has been our intention to interpret the theory
of money as the theory of a currency order. We have done so on the simple
assumptions of a stationary overlapping generations model whose
primary function has been to help organize our thoughts. We deviate from
this model in our interpretations whenever this seems appropriate. We have
not tried to formulate an exact model for the economic analysis of institu
tions as applied to money.
The theory of money is such a vast subject matter that it is impossible
to discuss all of the relevant literature even when limiting oneself to a par
ticular point of view. On the other hand, an intensive and extensive study
of the literature is essential for an understanding of the theoretical topics
which we treat. To help the student, we have appended to each chapter sug
gestions for further reading together with brief comments.
The English version is a translation of the first German edition which
went to the printer in January 1987 and which appeared during the sum
mer of 1987. The references to the literature have been extended for the
English reader, and a few important later contributions have been incor
porated. Tables and Charts were updated to 1987 inclusive. Several
paragraphs were revised and it is hoped, improved, among them in par
ticular the end of Chapter 6. Two errors were corrected: an unjust criticism
of Patinkin in Appendix 3 to Chapter 6 which was pointed out to me by
U. Schlieper and a wrong subscript in equation (3) of Appendix 1 to
Chapter 8 which was discovered by one of my students. This correction
made the results of equation (8-3) more complicated and also affected the
arguments in Sections 8.2 and 8.4. All told, the English translation may
be considered a revised and enlarged second edition of the German book.
My debts of gratitude are extensive. My first debt is to the University
of the Saarland for maintaining good working conditions despite difficult
budgetary problems. The University of Michigan extended two invitations
for longer periods as guest professor which were most stimulating and
helpful. My thanks are also due to the Deutsche Forschungsgemeinschaft
and the Wissenschaftliche Gesellschaft des Saarlandes for financial help
with two shorter visits to the USA. To the same foundations, the Fritz
Thyssen Stiftung and the Kultusminister of the Saarland go my thanks for
providing the major part of the costs of the international seminars on the
New Institutional Economics organized by Eirik G. Furubotn and myself
which gave me insights into new and interesting directions of research. Mr.
Hans Gliem, President of the Landeszentralbank flir das Saarland, and
Mr. Herbert Weber, Chairman of the executive board of the Landesbank
Saar, Girozentrale, provided contacts with actual practice.
Numerous discussions with colleagues of the Faculty of Law and
Economics of the University of the Saarland stimulated the work on the
manuscript. The discussion of early versions of Chapters 3 and 4 in a
x Introductory Remarks
working group on law and economics with Georg Rees, Dieter Schmidt
chen and Dietrich Schultz should be specially mentioned. It was a
beautiful experience. Elke Schafer-Jackel read and criticised in particular
early versions of Chapters 2 and 6. Wolfgang Stutzel helped with questions
and answers to Chapter 5. My former assistant Peter Dittus discussed with
me the various drafts of the last three chapters and the whole conception
of the book.
I am greatly obliged to Emil Baltensperger, Eva Bossmann, Ekkehard
Schlicht and Ulrich Schlieper for critically reading the final version of the
manuscript. Individual parts of the manuscript were presented and
discussed at Washington University St. Louis, Texas A&M University, Col
lege Station, the University of Texas at Arlington and several times at the
University of Michigan, Ann Arbor. In this connection lowe particular
thanks to Eirik G. Furubotn, Douglas C. North, Steven Wiggins, Aquiles
Almansi, David Aschauer and Jeffrey Miron for their critical comments.
My friend Wolfgang F. Stolper translated the manuscript from the
German, not without frequent substantive objections and proposals for
improvement. Occasionally, I have even listened to him - after lengthy and
animated discussions. His openness to arguments, patience and labor in
tensity deserve many thanks.
My assistants and selected graduate students helped in many ways
both with the preliminaries and the final version of the German and Eng
lish manuscripts. Frank Diener made the calculations and the computer
plotted figures and drew the graphs. Ralf Maurer compiled and improved
the German manuscript including the list of references. With great pa
tience and perseverance Barbara Thimm-Maldener typed the German ver
sion and Eva Schneider and Detlef Karges typed the English version.
Claudia Korf and Thomas Busch made the index, provided the English
references and helped with the final proofs of both versions. David An
drews helped with the editing of the English translation and Joan Kmenta
with editorial advice.
To my wife my thanks are due for her patience, moral support and help
with the final work on the manuscript. The English version was finished
in March 1988.
Rudolf Richter
Contents
Part I. Theoretical Foundations: An Elementary Overview .....
Chapter I. General Equilibrium Theory: An Outline . . . . . . . . . . . 3
1.1 General Equilibrium Theory Without Production . . . . . 3
1.2 General Equilibrium Theory With Production . . . . . . . . 9
1.3 The Purchasing Power of Money: Definition. . . . . . . . . 15
1.4 The Determination of the Purchasing Power of
Money. ... . .. . .... . ... . .... .... .... . .... ... ... . . 17
1.4.1 The Case of a Commodity Standard: The Pure Gold
Coin Standard ................................... 18
1.4.2 The Case of a Paper Standard: A Pure Paper
Circulation ...................................... 18
1.5 The Classical Dichotomy and the Patinkin
Controversy ..................................... 20
Appendix to Chapter 1 ................................. 25
1. The Determination of the Optimal Consumption Plan
of a Household .................................. 25
2. The Determination of the Optimal Production Plan
of a Firm..... .... ... . .... . .... ... .... . ....... .. 27
3. Walras's Law With Any Number of Households and
Firms. ... .... . .... ....... . .... . ....... .... ... . .. 28
Suggested Readings to Chapter 1 ......................... 28
1. Theory of General Equilibrium . . . . . . . . . . . . . . . . . . . . . 28
2. The Purchasing Power of Money ..... . . . . . . . . . . . . . . 29
3. Determination of the Purchasing Power of Money . . . . 29
Chapter 2. Capital Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
2.1 The General Approach .. . . . . . . . . . . . . . . . . . . . . . . . . . . 32
2.2 A Simple Robinson Economy . . . . . . . . . . . . . . . . . . . . . . 33
2.3 Two Present and Two Future Goods: Does "the" Real
Rate of Interest Exist? ............................ 43
2.4 The Robinson Economy in Stationary Equilibrium . . . . 45
2.5 The Young and the Old Robinsons: The Stationary
Theory of Overlapping Generations . . . . . . . . . . . . . . . . . 50
2.5.1 An Overlapping Generations Model Without Production 50
2.5.2 An Overlapping Generations Model With Production. 55
XII Contents
Appendix to Chapter 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
The Stationary Rate of Interest May be Different
from Zero ....................................... 59
Suggested Readings to Chapter 2 . . . . . . . . . . . . . . . . . . . . . . . . . 63
1. The Robinson Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
2. The General Case ................................ 63
3. The Optimal Capital Stock of an Economy . . . . . . . . . . 63
4. Two Approaches to Capital Theory ................. 63
5. General Discussion of Capital and Interest Theory. . . . 64
6. The Model of Overlapping Generations ............. 64
Chapter 3. The Economics of Institutions . . . . . . . . . . . . . . . . . . . . 65
3.1 Topics of Modern Institutional Economics .. . . . . . . . . . 65
3.2 What are Transaction Costs? ....................... 69
3.3 Transaction Costs in General Equilibrium Theory:
A Simple Example ............................... 73
3.4 Why Economic Institutions? ....................... 81
3.4.1 The Market as an Institution: Auction Markets or
Direct Negotiations? ............................. . 82
3.4.2 Why Do Firms Exist? ............................ . 84
3.4.3 Why Relational Contracts? ....................... . 85
3.4.4 Why Public Regulation? .......................... . 86
3.5 General Equilibrium and Institutional Economics:
Some Conceptual Considerations .................. . 89
Appendix to Chapter 3 ................................. 92
Utility Maximization of the Household Including
Transaction Costs ................................ 92
Suggested Readings to Chapter 3 ......................... 94
1. Property Rights and Transaction Costs in General . . . . . 94
2. Transaction Costs in General Equilibrium Theory . . . . . 94
3. Why Economic Institutions? ....................... 95
a) Auction Markets or Direct Negotiations? ......... 95
b) Why Do Firms Exist? .......................... 95
c) Why Relational Contracts? ..................... 95
d) Internalization of External Effects ...... . . . . . . . . . 95
e) Why Public Regulation? ........................ 96
4. On the Economic Theory of Institutions . . . . . . . . . . . . . 96