Don Patinkin (born 1922 in Chicago, died 1995 in Jerusalem) was the author of Money, Interest and Prices (1956), a book widely considered as the epitome if not the apex of the “neoclassical synthesis”.

He entered Chicago University in 1941 and was trained in the Marshallian tradition by the figures of the old Chicago School, Knight, Simons, Mint and Viner. However, he was also the student of Hurwicz, Lange and Marschak - mathematical economists and prominent members of the Cowles Commission.

As a fellow of this institution, in 1947, Patinkin completed a PhD thesis titled “On the consistency of economic models: a theory of involuntary unemployment”.

Patinkin emigrated to Israel in 1949 where he became a professor at the Hebrew University of Jerusalem. According to Barkai (1993: 3), he “single-handedly established economics as an academic discipline and, at the same time, showed how this discipline could be applied to the analysis of Israel’s pressing economic problems”. In 1956, with Simon Kuznets, he created what became the Maurice Falk Institute for Economic Research in Israel in order to provide Israeli economists with macroeconomic data. Patinkin was its research director from 1956 to 1972. He was deeply involved in the making of Israel’s economic policy until the 1970s, either directly or through his students, the “Patinkin boys”, serving in the administrations.

The Integration of Money into General Equilibrium Theory

Patinkin’s contribution to monetary theory came as a reaction to the works of Lange (1942, 1944) and Modigliani (1944), works actively discussed at the Cowles Commission.

Lange (1942) claimed that, in order to account for an overproduction crisis, general equilibrium theory had to incorporate money. Combining Walras’s and Say’s laws, Lange showed that the level of money prices was indeterminate in the classical theory of prices. The “traditional approach”, determining relative prices in the real sector and money prices by use of the cash balance equation, was no escape since the equation was inconsistent with Say’s law.

Both had to be abandoned in favour of a truly general equilibrium treatment of the issue, a move supposed to imply the rejection of money neutrality. In 1944, Modigliani challenged Lange’s conclusions and claimed that the hallmark of the classics was their view that “all the supply and demand functions [except the ones for money] must be homogeneous of zero degree, if people behave rationally” (1944: 46). Once Say’s law had been put aside, the traditional approach and money neutrality remained intact. The same year, Lange (1944) published an attempt to develop the depression theory hinted at in 1942 and, like Modigliani, he adopted the zero degree homogeneity postulate.

From Patinkin (1949: 1, 9), one can infer that Hurwicz discovered an inconsistency in Lange’s system of equations and that Haavelmo convinced Patinkin to work on the issue. Using the work of Hurwicz, Patinkin showed that the indeterminacy disclosed by Lange was a direct consequence of the assumption of zero degree homogeneity. Besides, this assumption was inconsistent with the Cantabrigian cash balance equation. The thrust of the argument was that if commodity excess demands were independent of the level of money prices, by virtue of Walras’s law, it should also be true of the real excess demand for money. The 1944 models of Lange and Modigliani were both inconsistent.

In his thesis and the two articles extracted from it, Patinkin (1948a, 1949) widened his critique to the monetary theories of the “classics” - mainly Cassel, Pareto and Walras. Inspired by Hicks (1935), Patinkin criticized Pareto and Walras for their supposed refusal to introduce money in agents’ utility functions. He showed that this approach was consistent only if the stock of money was nil and concluded that “any realistic attempt to describe this world must provide for the inclusion of money in the utility function” (Patinkin 1948a: 154).

Patinkin’s demonstration of the inconsistencies affecting the classics’ monetary theories left an open question: how could one solve the indeterminacy of money prices without violating the neutrality of money? The solution, introduced in the end of Patinkin’s 1949 article, was developed in Money, Interest and Prices.

To realize the “integration of monetary and value theory”, one had to take account of the real balance effect, “the sine qua none of monetary theory” (Patinkin, 1956: 22).

Patinkin started from the simplest framework to focus on the essential features of his theory. He analysed a pure exchange economy with goods and fiat money. The temporality of the economy was defined by the Hicksian week. Each Monday morning, agents were endowed with given quantities of goods “falling from heaven” and with cash balances carried over from the preceding week. Then they had to determine the quantities of goods they would sell and purchase and the money balances with which they would start the following week. A tatonnement process would take place and by the end of the day general equilibrium prices were determined and contracts were signed. At this stage, Patinkin assumed that contracts were placed in a common pool and randomly drawn from it in order to fix the day and the hour of their completion. As a result, agents had to face the risk of discrepancies between payments and receipts. In order to insure against the “embarrassment of default” they would keep some reserves of the medium of exchange. This narrative was not formalized but it vindicated the introduction of real balances in the utility function.

The assumption that each agent determines his optimum level of real balances led Patinkin to supplement the Hicksian demand theory with the real balance effect. A modification of the price of a particular commodity triggered the traditional substitution and income effects but it also affected the real value of cash balances. In order to restore their optimum level, agents modify their expenditures on goods. Patinkin noted that money demand was also subject to this effect. A price level increase leads agents to demand more money. However, since the real value of their money holdings decreases, the budget constraint implies a reduction of this optimum level. The Cantabrigian assumption of a unit elasticity of money demand with respect to prices is false.

On this basis, Patinkin analysed the “determination of the price level” or the stability of general equilibrium in a money economy. Assuming that there was an equilibrium, Patinkin considered a situation in which real balances are higher than their equilibrium levels. In this case, there would be an excess demand on the goods market pressing prices upward. Real balances and demands for goods would decline until equilibrium is restored on the goods markets and, due to Walras’s law, also on the money market. Patinkin also showed that in the absence of distribution effects and money illusion, a doubling of the quantity of money would cause a proportionate increase of money prices without affecting real magnitudes. His approach was supposed to offer the “ultimate, rigorous validation of the classical quantity theory of money itself” (1956: 99). In chapter 8 of Money, Interest and Prices, Patinkin examined systematically how his new approach overcomes the limits and the errors involved in the older versions of monetary theory. In contrast with his earlier works he carefully distinguished the “classicals” from the various sorts of “neoclassicals” and documented all his claims with “notes and studies in the literature”.

Patinkin’s works on the integration of money had a deep influence on the debates of the 1950s and 1960s. Several economists opposed his rejection of the classical dichotomy. The contribution of Archibald and Lipsey (1958) marked the higher point of the resulting “Patinkin controversy” leading to a special issue of the Review of Economic Studies (1960). Patinkin’s indictment of the dichotomy was finally accepted, except in the case of an inside money economy (Modigliani, 1963). But deeper critiques were gradually formulated. Hahn (1965) showed that nothing in Patinkin’s models guarantees that the accounting price of money is strictly positive. The foundations for a monetary theory were still to be found. Different alternatives were offered over the years but none settled the issue.

Macroeconomics

“Macroeconomics” was the title of the second part of Money, Interest and Prices. There, Patinkin submitted the investment saving-liquidity preference money supply (IS-LM) framework to the discipline of the Walrasian method and used it to extend the neutrality results of the first part of the book to an economy with production.

Until the mid-1950s, the numerous versions of IS-LM had been plagued by confusions in the formulation of their equations and in the analysis of their properties. Despite its success, Modigliani’s 1944 model illustrates the issue (Rubin 2004). For instance, he made behaviour functions dependent on money instead of real income and the signification of the IS equation remained unclear. When he analysed the dynamics of his model, Modigliani actually presented IS as the long-run equilibrium condition for the money market. Some basic principles borrowed from the Walrasian methodology allowed Patinkin to formulate a superior version of IS-LM. The model was presented as a four-market system with three unknowns. Then Walras’s law and a set of simplifying assumptions related to the labour market was introduced to show how this four equation model could be reduced to the interaction between two different markets (preferably goods and bonds). Thanks to his tatonnement method Patinkin clarified the adjustment process leading to the equilibrium in his various versions of IS-LM. He also resolved a number of issues that would seem obvious afterwards. For instance, he showed that Keynes’s introduction of the rate of interest in the demand for money was not enough to discard the neutrality of money in a full employment model unless the speculative demand for money featured money illusion as it did in the General Theory (Keynes 1936). Incorporating the distinction of internal and external money developed by Gurley and Shaw (1960), Patinkin offered a detailed discussion of the introduction of a banking system in his model. Following Hicks (1939), he closed the long debate over the determination of the rate of interest stating that if the rate of interest is primarily related to the bonds market, it is generally determined, like all prices, by all the equations of the model.

He showed that the usual definition of the liquidity trap as the consequence of an “infinite demand for money” is mistaken for it implies the violation of the agents’ intertemporal budget constraints. All this explains why, in the 1960s, “at the London School of Economics and at MIT, the two essential books in macroeconomics were the General Theory and Money, Interest and Prices” (Fisher 1993: 25).

In his introduction of Money, Interest and Prices, Patinkin presented “the theory of a monetary economy with involuntary unemployment” as the “second major theme” of his book (1956: 2-3). This issue was actually the starting point of his PhD dissertation in 1946. Lange presented Keynes’s concept of involuntary unemployment as the consequence of a horizontal supply curve for labour. For Patinkin, since this assumption implied labour market clearing, the position of workers could hardly be called involuntary. Involuntary unemployment could only arise when workers were “off their supply curve”. Patinkin developed this line of thought in the second part of his thesis, giving rise later to the disequilibrium theories of the 1970s (Rubin 2012). Within a framework supposed to derive from a Walrasian model, he tried to account for the possibility of an unemployment equilibrium with price and wage flexibility. He argued that, in a disequilibrium context, agents were faced with “additional restraints” so that the choice theoretic basis of the general equilibrium models had to be modified. He identified correctly the additional constraint of unemployed workers as the level of employment and came very close to Clower’s dual decision concept. Yet, Patinkin did not see how to give an operational content to his intuition. His reasoning suffered from a partial equilibrium perspective and, ironically, his model left the interest rate and the price level indeterminate. These problems forced him to revise his position.

From 1948 on, Patinkin claimed that Keynesian economics were about unemployment disequilibrium. This position was supported by chapter 13 of Money, Interest and Prices, the beginning of the history of disequilibrium economics and the result of a long process of elaboration (see Boianovsky 2006). In this chapter, Patinkin applied the concept of “spillover effect” in a Keynesian context and finally captured the operational intuition missed in his thesis. He submitted his four-market system to an aggregate demand decline and assumed that the adjustment process was slow. Faced with a sales constraint on the market for goods, firms would have to revise their demand for labour whatever the real wage level. This in turn would create an excess supply of labour and involuntary unemployment. Analysing different scenarios on the basis of the relative adjustment speeds of wages and prices, Patinkin’s claimed that unemployment could appear even if the real wage is still at its market clearing level. Chapter 13 was a decisive source of inspiration for Clower (1965) (Rubin 2005). The concept of spillover was taken up by Barro and Grossman (1971) and played a crucial role in the literature on disequilibrium that developed in the 1970s. Patinkin’s involuntary unemployment theory was far from being conclusive. In a famous footnote, he admitted the inconsistency of an analysis combining the assumption of a sales constraint with perfect competition and hoped that someone would find a consistent way of modelling the behaviour of firms in disequilibrium.

Patinkin’s approach supported a new definition of the frontier between the classics and Keynes. A chapter 19 Keynesian, Patinkin always claimed that involuntary unemployment was not a consequence of wage rigidity. According to him, both the classics and Keynes admitted that even though prices and wages were flexible their adjustments were not instantaneous. Assuming the same speeds of adjustment for wages, prices and the rate of interest, they differ in their evaluation of the elasticity of aggregate demand with respect to the rate of interest and the price level. For the classics, this elasticity is high. As a result, a small price decline would restore equilibrium on goods’ markets in a short time. For the Keynesians, the elasticity is low and, even if the real balance effect pushes the system back towards full employment, this process is a “long, drawn out one” (Patinkin 1956: 216). A market economy left on its own is prone to chronic disequilibrium and unemployment. The length of time of the adjustment process is enough to vindicate the use of public expenditure to maintain full employment. The debate between the two camps was a matter of “empirical considerations” (ibid.: 237) and the Keynesian stance was freed from its dependence on extreme theoretical scenarios like the liquidity trap.

Patinkin as a Historian of Economic Thought

As already noted above, Patinkin’s commitment to history of economic thought was a distinctive characteristic of Money, Interest and Prices. His “Notes on the literature” with the studies on Fisher, Walras or Wicksell were a remarkable contribution to the history of the quantity theory. In the 1970s, Patinkin devoted his research to the history of the Keynesian revolution in the 1930s. Since his days as a student, he had tried to find out the nature of Keynesian economics. Patinkin pursued this quest on the basis of the newly published volumes of Keynes’s collected writings (Backhouse 2002). In 1976 he published Keynes’ Monetary Thought, a book that examines the development of Keynes’s ideas from the Tract to the General Theory. Patinkin argued that Keynes’s central message in 1936 is the theory of effective demand. For him, Keynes’s book is the “first practical application of the Walrasian theory of general equilibrium” and the General Theory is a “dynamic theory of unemployment disequilibrium”. In his Anticipations of the General Theory? (1982) Patinkin argued that the Keynesian revolution was not a case of multiple discoveries. All these works were condensed in Patinkin’s entry on Keynes’s for the New Palgrave Dictionary of Economics (Patinkin 1991). Another important contribution to the field was Patinkin’s study on the Chicago tradition (1981). The fierce polemic it triggered with Friedman stimulated a whole stream of research.

Goulven Rubin

Don Patinkin (born 1922 in Chicago, died 1995 in Jerusalem) was the author of Money, Interest and Prices (1956), a book widely considered as the epitome if not the apex of the “neoclassical synthesis”.

More on the topic Don Patinkin (born 1922 in Chicago, died 1995 in Jerusalem) was the author of Money, Interest and Prices (1956), a book widely considered as the epitome if not the apex of the “neoclassical synthesis”.: