bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

164 MONETARY ECONOMICS
interest rate elasticity of the demand for money was not higher at lower rates
of interest would cast serious doubt on the existence of a liquidity trap. This
appears to be the case. Studies of the demand for money in the 1930s, when
interest rates were low, do not show a higher interest elasticity of the
demand for money than in other periods. In addition, regressions incorporating
data from the 1930s predicted the velocity of money in later decades
accurately. The absence of a liquidity trap, however, does not refute the
possibility of instability — the possibility that the speculative demand curve
moves unpredictably.
Nonetheless, most economists who see themselves as true adherents to
the Keynesian tradition (Post Keynesian rather than New Keynesian or neo-
Keynesian) are likely to follow the endogenous money path (despite
Keynes’s acceptance of an exogenous money supply) and/or to concentrate
on the finance motive for holding money. The finance motive, which did
not figure in Keynes’s General Theory, has been ignored entirely by mainstream
economists. We mention it briefly in Section 5.4. It is defined by
Wray (1990 p.120) as ‘a propensity to hoard cash in preparation for funding
an investment project’. Keynes thought investment was highly unstable
because investment decisions depended on the price ratio between capital
assets and current output together with financial market conditions and were
made under conditions of uncertainty. He saw the markets for capital assets
and current output as separate and prices in the two markets as influenced
by different factors. Shocks in financial markets could produce large and
rapid changes in expectations regarding the future. The combination of
these elements meant that investment was subject to rapid and unpredictable
change. Clearly then, the finance motive could provide a source of instability
in the demand for money function. There have been no attempts to
test for the existence or nature of the finance motive.
Minsky (1978, 1986) developed a theory of financial fragility, which
grew out of Keynes’s views regarding investment decisions and theories of
endogenous money. According to Minsky, instability derives from waves of
credit expansion and deflation. In booms, firms make more use of debt
financing; both households and firms reduce their holdings of cash and liquid
assets relative to debt. Banks increase their loans. This credit expansion
increases the money value of assets and this, in turn, justifies further borrowing.
The debt/real assets ratio continues to rise. However, this cannot
continue forever. At some point the boom falters. This leads to crisis, credit
contraction and collapse. In a world like this, there is no room for a stable
demand for money function or exogenous money. Minsky claimed evidence
for his hypothesis in the 1987 stock market crashes (Minsky, 1991).