I very much appreciate Tom's acceptance of my noting Hume's analysis as 
preceding that of Henry Thornton's.  Perhaps I can persuade him a bit 
further away from his continued allegiance to Wicksell.

First, Wicksell (1906) did change his mind on the definition of the 
natural rate of interest in 1898 to be consistent with that of Smith's 
(adopted by Ricardo, J.S. Mill, and Alfred Marshall) thus: “The rate of 
interest at which /the demand for loan capital and the supply of savings 
exactly agree/, and which more or less corresponds to the expected yield 
on the newly created capital” (Wicksell 1906, 193; italics original). 
Now this comes awfully close to the classical definition, particularly 
if “capital” here means “loanable funds” rather than capital goods. 
Wicksell also writes, “the granting of credit or the transference of 
capital is itself frequently made in the form of money – which is also 
the way in which capital accumulations, or savings are made. Money is 
usually said to constitute a /means of saving /and of /transferring 
capital/ (loans),” and “Capital accumulation and transfer are always 
effected by means of money” (1906, 24; italics original). All this 
followed from the criticisms he got on his previous work.

Second, Wicksell was dealing with an economy in which money existed.  
The Bank of Sweden was responsible for issuing the currency.  And 
without money, the particular "commodity" designated as the measure of 
value, the price level is indeterminate.  We also can't tell the rate of 
inflation, in the absence of money, for a central bank to try to deal 
with it. Besides, the central bank is typically the initiator of 
inflation.  Why not prevent the problem rather than attempt to deal with 
it after it has begun?

Third, it may well be true that "Today, many analysts see 'the cashless 
economy' on the horizon," as Tom claims.  I think such analysts are 
engaged in a fruitless speculation.  There is always going to be some 
demand for money (cash).  Some people will always prefer the anonymity 
of cash transactions to electronic or other means of payment.  The 
conveniece of cash dealings in some circumstances, even if perfectly 
legal, is hard to replace. Trying giving your niece $10 with a credit or 
debit card.  Also imagine that the power goes out!  Besides, it's 
profitable for governments or an agency of theirs (the central bank) to 
print money (cash).  The U.S. Federal Reserve makes a profit from 
lending its printed money (at the Discount Window), and pays the 
Treasury the remainder after meeting its own operating expenses, doesn't it?

Finally, Tom says: "the natural rate is an unobservable variable 
impossible to target, the best one can do is to keep on adjusting the 
market rate in response to price-level movements until those movements 
cease and price stability prevails."  Two problems with this argument. 
First, without money (cash), we can't tell the price level, let alone 
its movement.  So Wicksell's groping for a price-level control mechanism 
in a pure credit economy is not really meaningful.  Secondly, we always 
can observe a rate of interest.  What we don't know is whether it is the 
natural rate or not.  As J.S. Mill (3: 648) so well explains, "there 
must be, as in other cases of value, some rate which (in the language of 
Adam Smith and Ricardo) may be called the natural rate; some rate about 
which the market rate oscillates, and to which it always tends to 
return. This rate partly depends on the amount of [“capital”] 
accumulation going on in the hands of persons who cannot themselves 
attend to the employment of their savings, and partly on the comparative 
taste existing in the community for the active pursuits of industry, or 
for the leisure, ease, and independence of an annuitant."  It is 
precisely because the central bankers don't know whether the observed 
market rate is the natural rate or not that they should refrain from 
attempting to influence it with their own credit injection or contration.

In another context, Adam Smith (/WN/, 1: 478) warns about the "folly and 
presumption" of those who would engage in the "dangerous" activity of 
interfering with individuals' savings and investment pursuits.  Would 
that central bankers understood Smith's message and left interest rates 
alone to coordinate the savings and investment activities of people.  
(These days the U.S. Federal Reserve persists on penalizing savers with 
negative real interest rates through its pursuit of a zero or near-zero 
Federal Funds Rate target with the so-called Quantitative Easing.) 
Somebody save us from people with such folly and presumption to know 
what the appropriate rate of interest is.  Did they ever read David 
Hume's "Of Interest" or David Ricardo's "The High Price of Bullion" 
especially at (3: 92)?

James Ahiakpor

Thomas Humphrey wrote:
> Good for James Ahiakpor for recognizing David Hume's contribution to 
> cumulative process analysis, which establishes Hume's chronological 
> precedence over Thornton in the history of the cumulative process 
> model. James is absolutely right on that.
>
> For Hume did indeed argue (1) that the equilibrium interest rate 
> (Wicksell's natural rate) is a real rather than a monetary phenomenon, 
> (2) that a one-time monetary injection may temporarily lower the 
> market rate of interest below that equilibrium level, (3) that the 
> same monetary injection will raise prices (and, for a while, real 
> activity, too), and (4) that the resulting price increases, via their 
> effect on loan demands, will reverse the fall in the market rate and 
> restore it to its initial equilibrium level, thereby ending the 
> cumulative process.
>
> More precisely, Hume noted that new money typically enters the 
> spending stream by way of loan. The resulting expansion of loan supply 
> relative to loan demand temporarily lowers the market rate below the 
> equilibrium rate with the gap between the two rates encouraging 
> borrowing and spending. The ensuing spending stimulus and price 
> inflation then raises the nominal value of real activity, 
> necessitating extra loans just to finance that real activity. The 
> demand for loans therefore rises, thus bidding the market rate back to 
> its equilibrium level.
>
> In short, Hume's name joins the long list of pre-Wicksell formulators 
> of the cumulative process model, which perhaps should be christened 
> Paul Samuelson style as the 
> Hume-Smith-Thornton-Ricardo-Marshall-Wicksell-Cassel model -- not 
> counting names undoubtedly overlooked.
>
> We can also agree with James's contention that many factors besides 
> monetary manipulation affect the market rate. For example, the market 
> rate can fall not only because of the temporary liquidity effect of a 
> monetary injection, but also because cyclical downturns depress the 
> real interest rate and the expected rate of inflation, the two 
> components of market rates identified by Irving Fisher. I don't think 
> Wicksell would deny that. Nor does it invalidate his monetary theory.
>
> James asks, "Of what use is a pure credit model when people are 
> anxious to deal with the problem of inflation?" The answer is that 
> pure credit models allow one to analyze how financial intermediation 
> attenuates the quantity-theory relationship between base or 
> high-powered money and the price level when modern payments mechanisms 
> evolve toward the cashless extreme. Today, many analysts see "the 
> cashless economy" on the horizon. Surely pure credit models are useful 
> in analyzing how such economies might behave.
>
> Again, James asks apropos Wicksell's feedback policy rule "Why not 
> focus on the price level (from an understanding of the quantity 
> theory) and leave interest rates alone." The answer, of course, is 
> that in the cashless pure credit economy base money ceases to exist 
> and cannot anchor the price level. Here another anchor is required. 
> One obvious candidate is the gap between natural and market rates of 
> interest. But (as Wicksell always insisted) because the natural rate 
> is an unobservable variable impossible to target, the best one can do 
> is to keep on adjusting the market rate in response to price-level 
> movements until those movements cease and price stability prevails.


-- 
James C.W. Ahiakpor, Ph.D.
Professor
Department of Economics
California State University, East Bay
Hayward, CA 94542

(510) 885-3137 Work
(510) 885-7175 Fax (Not Private)