Value and Capital

"Value and Capital", subtitled "An Inquiry Into Some Fundamental Principles of Economic Theory" was published in 1939 by J.R.Hicks. Hicks is credited as being the inventor of IS-LM. This was the first major economic work published after Keynes' "General Theory"

This was really a tough read - 3 months? And I got very little out of it - no mention of IS-LM. Rather it explores how to extend static models - taken at a given moment at time - to dynamic models, which include the time dimension, primarily in the form of agents' future expectations. This is used to build an Equilibrium Theory of the general economy.

We learn about resource classes, including money and securities, that are related in 1 of 2 ways: as being complementary, meaning that increased supply for 1 resource will drive increased demand for the other resource; or as being competitive or substitutes, where increased supply for 1 resource will drive decreased demand for the other resource.

On expectations, we learn that these can be elastic or inelastic. Elastic means that a price increase now implies price increases in the future; inelastic means that future prices don't depend on the current price change.

Similarly, the current supply of a commodity depends not so much upon what the current price is as upon what entrepreneurs have expected it to be in the past. It will be those past expectations, whether right or wrong, which mainly govern current output; the actual current price has a relatively small influence.

He notes that his models to not adequately take risk into account.

It is important to realize that the allowance for risk, the percentage by which the representative expected price falls short of or exceeds the most probable price, is not determined solely by the opinion of the planner about the degree of uncertainty. It is also influenced by his willingness to bear risks, by an element which in the last analysis depends upon his scale of preferences. An increased willingness to bear risks will therefore be represented in our analysis by a change in expected prices in favour of the planner.

Further (and this is the most serious weakness of our treatment), the willingness to bear any particular risk (to plan to buy or sell at any particular future date for which expected prices are uncertain, and to act on that plan) will be appreciably affected by the riskiness involved in the rest of the plan. I can do very little about this on present methods, though some consequences of the interrelations of risks will come to our notice now and then.

Money, money, money. Interesting how you can't seem to have an economic system without it.

Those kinds of securities which are money differ from those which are not money by the fact that they bear no interest; that is to say, their present value equals their face value, instead of falling below their face value, as is the case with bills. Looked at in this way, money appears simply as the most perfect type of security; other securities are less perfect, and command a lower price because of their imperfection. The rate of interest on these securities is a measure of their imperfection-of their imperfect 'moneyness'. The nature of money and the nature of interest are therefore very nearly the same problem.

This seems to ignore that securities can be offered, as they are now, at negative rates of return.

The definition of income:

Following out this idea, it would seem that we ought to define a man's income as the maximum value which he can consume during a week, and still expect to be as well off at the end of the week as he was at the beginning. Thus, when a person saves, he plans to be better off in the future; when he lives beyond his income, he plans to be worse off.

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This leads us to the definition of Income NO.2. We now define income as the maximum amount the individual can spend this week, and still expect to be able to spend the same amount in each ensuing week. So long as the rate of interest is not expected to change, this definition comes to the same thing as the first; but when the rate of interest is expected to change, they cease to be identical.

Interest changes are more complicated than price changes.

The reason why the theory of interest-changes is so much more difficult than the theory of price-changes is this. When we are dealing with prices it is possible to proceed directly to the most interesting case-the case of a change in prices which is expected to be permanent. (We saw why this is: a permanent change in prices is equivalent to a proportional change in current prices and price-expectations, so that we become entitled to use the static convention of treating commodities due to be bought or sold at different dates as the same commodity.) When we are dealing with interest rates, however, we cannot employ the same convenient simplification.

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Still, once the Austrian theory is put behind us, the only important thing which emerges is the general conclusion (which can be stated clearly enough for nearly all purposes without any of this rigmarole about average periods) that changes in the rate of interest affect the 'tilt' or crescendo of the production plan.

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This would make the net income effect work in the same direction as the total substitution effect, and reinforce the conclusion that, for the market as a whole, a rise in the rate of interest will reduce current expenditure, a fall in the rate of interest increase it.

Hicks definitely sounds a clear warning about the dangers of a liquidity trap, referencing Keynes.

This is all very well; but when we turn to the converse case of a
fall in prices, a new difficulty presents itself. It is now necessary for the rate of interest to fall, in order for equilibrium to be restored. If the rate of interest was reasonably high to begin with, it seems possible that this reaction may take place without difficulty. But if the rate of interest is very low to begin with, it may be impossible for it to fall farther - since, as we have seen, securities are inferior substitutes for money, and can never command a higher price than money. In this case, the system does not merely suffer from imperfect stability; it is absolutely unstable. Adequate control over the supply of money can always prevent prices rising indefinitely, but it cannot necessarily prevent them from falling indefinitely. Trade slumps are more dangerous (not merely more unpleasant) than trade booms.

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Taking all these things together, we may say that interest policy - which is monetary policy - gets very high marks as a means of checking booms, but very low marks as a means of checking slumps. It can set a point beyond which prices shall not rise; but it cannot ensure that they do rise to that point.

He also raised an issue that is still active in discussions today. In relating interest, inflation and employment, are changes dependent on the value of some quantity, or the rate of change in the value of that quantity?

Well so much for "Value and Capital". Next up, Marx, then a modern book on Behavioral Economics. But I have decided that I will start taking a vacation every summer from economic texts. So no economics until the Autumnal Equinox. I'm 2 months behind on the magazine stack, and have 20-something books to read in my iPad. Plus I have the latest Jared Diamond in hardback. Hopefully I can get caught up some by fall.