Law’s Macroeconomics and Monetary Economics
John Law brought remarkable modernity to his economic theorizing. In his first work, “Essay on a land bank”, he was the first writer to introduce supply and demand analysis to his theorizing, using it to solve the water/diamonds paradox of value.
He then progressed this analysis into monetary economics establishing the concept of the demand for money and arguing that prices would rise when the quantity of money expanded out of line with the demand for money. In explaining inflation in a demand for money/ supply of money framework, Law may be regarded as the first monetarist, long before Milton Friedman attempted to analyse the quantity theory of money in this format in 1956. Law’s vision, however, extended far beyond monetarism. By one deft change in a preposition he transformed the conceptualization of money from an intrinsically valuable medium of exchange “the value for which money is exchanged” to one that held that money did not need to be intrinsically valuable “the value by which goods are exchanged” (my italics) (Law, 1994: 55). In this way Law produced a new vista for the monetary economy, one that was not reliant on an intrinsically valuable commodity money. Law’s new conceptualization of money permitted the growth not only of paper money but also bank credit and a wide range of near money substitutes. His detractors from Cantillon to Marshall, all metallists at heart, did not grasp the extent to which Law had revolutionized his conceptualization of the monetary system to that which is used in the modern world.In Money and Trade Law continued to advance many of the arguments of the “Essay on a land bank” but the emphasis of his approach changed because he was addressing the problems of a stagnant Scottish economy facing considerable unemployment and underemployment. Law, building on the work of Sir William Petty, developed a circular flow of income analysis and then showed the importance that money had in transforming an economy from a primitive agricultural state to that of a broader economy, embracing manufacturing and other sectors. The title of his book said it all, Money and Trade. He saw money as driving trade, a synonym for economic activity. Unemployment and underemployment were signs that there was an insufficient amount of money in the economy. In a strong pre-Keynesian approach Law urged the authorities to expand the money supply and to reduce the rate of interest. For him the way to increase the money supply was to replace the gold and silver metallic system with a new paper credit system. Unlike most monetary theorists Law’s recommendations were soon to be implemented as monetary policy.