Knut Wicksell - Interest And Prices

INTEREST AND PRICES

(Geldzins und Gterpreise)

A STUDY OF THE CAUSES

REGULATING THE VALUE OF MONEY

By

KNUT WICKSELL

Translated from the German by

R. F. KAHN

With an Introduction by

PROFESSOR BERTIL OHLIN

COPYRIGHT

PRINTED IN GREAT BRITAIN

BY R. & R. CLARK, LIMITED, EDINBURGH

TRANSLATORS NOTE

I HAVE to express my sincere thanks to Miss Anna Schwarzschild, who read a portion of the manuscript with great care, and to Dr. Eduard Rosenbaum, who helped me out of many difficulties. The Appendix consists of Wicksells last published article, translated from the original Swedish by Mrs H. Norbcrg.

Wicksells Geldzins und Gterpreise was published at Jena by Gustav Fischer in 1898. Such footnotes as I have found it necessary to insert are enclosed in square brackets.

R. F. K.

CONTENTS

To judge the character and importance of Knut Wicksells monetary doctrines, it is necessary to view them against the background of the monetary controversy of the late nineties. For some decades the organisation of an international gold standard had been the outstanding problem. Hardly had this organisation won its victory in the seventies, when its position was threatened by the continued fall in wholesale prices. A violent propaganda for bimetallism set in almost everywhere. The character, working, advantages, and disadvantages of this system naturally became the central topic of discussion in the monetary field. The old debate between the currency and the banking schools had died out and the latter undoubtedly held the field. The quantity theory of money was discredited, even in the Anglo-Saxon countries. Most writers agreed that if credits were granted on adequate security in accordance with sound banking principles, the supply of means of payment could not exceed the requirements of the market. There was no discussion in that connection of the level of bank rate.

Two things seem to have caused Wicksell to adopt an entirely different attitude to monetary problems. First of all, he was a close student and admirer of the English classical school of economists, above all of Ricardo. To Wicksells mathematical mind the quantity theory of money, as presented by Ricardo, made a much stronger appeal than the vague generalisations of the current banking discussions, which side-stepped the question Why do prices rise or fall? that Wicksell at an early stage came to regard as the main problem of monetary theory. The stress which the Ricardian school placed on the influence of discount policy on the quantity of money and on prices seemed to Wicksell entirely justified. On the other hand, he could not get round the fact that the rate of interest, as pointed out by Tooke, had on the whole been low during times of falling prices and high during times of rising prices, whereas the Ricardian doctrine seemed to suggest the opposite. The solution of this difficulty Wicksell found through his study and amplification of Bhm-Bawerks theory of interest. Must not the natural rate of interest, governed by the marginal productivity of capital, i.e. of the roundabout methods of production which would exist if money were not used, have some connection with the rate of interest as it actually appears on the capital market? There was only one possible answer. But what was this connection? These two rates of interest, the natural rate and the money rate which is quoted on the market, tend, of course, to coincide. If the former differs from the latter, money can no longer be said to be neutral, and monetary consequences in the shape of changes in prices are bound to ensue. If the money rate were kept below the natural rate prices would rise, if above they would fall.

Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory.

Wicksells opinion of the character of the business cycle is perhaps most clearly presented in his paper The Riddle of Crises.rocking-horse. Wicksell undoubtedly inclined towards the latter view, while maintaining that intelligent credit policyat least under most conditionscould prevent the rocking tendency from growing violent.

As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.

Davidson retorted that this might happen, but he denied that it must happen. He was inclined rather to maintain that when the natural rate of interest, as a result of technical progress, tended to rise above the money rate, a fall in commodity prices would have a counteracting effect and, by keeping the natural rate down, would prevent any discrepancy from emerging.

In his rejoinder Wicksell admitted that this case required more attention than he had so far given to it. Davidsons reasoning depended, however, on the tacit assumption that the supply of real capital has been increased in the same proportion as productivity. Davidson is obviously of the opinion that money wages remain unaltered; thus if commodity prices have fallen, real wages would have been subject to an increase, but how can they be raised without an increased supply of real capital? Although it was possible that prices might temporarily fall, a tendency for a cumulative rise in prices would set in unless the money rate was raised.

This discussion, although a little confused, is particularly interesting because it touched upon a line of reasoning which, had it been followed up, must have led to a reconsideration and revision of the fundamental concept of the natural or real rate of interest. The outcome, as Wicksell pointed out, obviously depended on what business men believed about the future course of prices; it would influence their demand for credit as well as for wages and raw materials. The assertion that business calculations are as a rule made on the basis of current prices would not have withstood much criticism. A discussion of what determines anticipations about the future would have been inevitable and the treatment of the factors which govern the volume of investment would, to some extent at least, have escaped from the domination of the curious concept of the natural rate of interest.

The chief reason why Wicksell changed his views so little was undoubtedly that the criticism which his theory met did not go down to fundamentals.about the reliability of the explanation of war-time inflation which he, like all other Swedish economists, had presented and defended.

Let me record very briefly the modifications and changes in Wicksells theory, as indicated by himself. In the preface to the first Swedish edition of his Lectures, II: On Money and Credit, 1906, we read: Beside the somewhat too vague and abstract concept natural rate of interest I have defined the more concrete concept normal rate of interest, i.e. the rate at which the demand for new capital is exactly covered by simultaneous savings.... Here I have on the whole tried more than formerly to deal with the problem of changes in the general commodity price level in terms of a simple and easily comprehensible formula of supply and demand for commodities and services.