THE ATTACK ON SAY'S LAW AND THE INTERPRETATION OF MONEY

Keynes saw clearly that the mainstay of orthodox confidence in the self-adjusting properties of a market system to a full employment equilibrium was the neo-classical version of Say's Law and he made this strand of theory a primary target of criticism.

Subsequent re-interpretations of Say's Law (and particularly the version implicit in latter-day neo-classical thought) could be translated into the proposition that all income would be spent. In other words, there would be no important leakages from the income stream in the form of hoarding. In standard neo-classical reasoning this conclusion was held to be a self-evident truth. It was not, of course, denied that an occasional miser might mar the image. But this type of behaviour could be dismissed as irrational and likely to be so rare that, for all practical purposes, it could be ignored. After all, who in his right mind would accumulate idle funds in substantial volume when, by lending them, he could add to his income? Consumption expenditure was the main object of economic activity. Rational economic agents could only be induced to restrain their consumption - i.e. to save part of their income - when offered a reward in the form of a rate of interest for so doing.

Around these postulates the whole structure of neoclassical thinking about saving and investment in the aggregate had been built. The community was expected to respond positively to higher rewards for saving; an increase in the rate of interest would swell the volume of loanable funds. Borrowers, on the other hand, would adjust the quantity of loanable funds for which they were prepared to pay as the rate of interest changed; at low rates of interest the quantity of loanable funds demanded would be augmented and at higher rates, curtailed.

This line of argument was further reinforced by the standard neo-classical interpretation of the role of money. In this view the primary function of money was as a medium of exchange. It was sought for the command over goods and services that it provided. But money per se was sterile and lacking in intrinsic value. This perspective, of course, was both consistent and closely inter-related with the judgement that hoarding was irrational. Money was economically interesting only as it was spent and circulated throughout the system. Indeed, this presupposition underlay the various versions of the quantity theory of money worked out by neo-classical economists.

Keynes's assault on the Say's Law tradition centred on this analysis of money. He set about the task by reversing the perspective from which money was viewed. Whereas neo­classical writers looked first at money in motion - i.e. when spent - Keynes chose to analyse money as it was held. The primary question to be answered was: how and for what reasons is the community induced to hold the stock of money that exists at a given moment? Obviously the community required some minimum stock of money to lubricate the wheels of commerce and to provide a reserve against contingencies. These motives for holding money were thoroughly compatible with neo-classical thinking. But Keynes insisted that there was also another reason for holding cash - the speculative motive for liquidity. This concept was essential to the opening of space for the analytical innovations of the General Theory.

Why should anyone wish to hold money in excess of the amounts required for transactions and precautionary purposes when he sacrificed thereby an income he might have gained as a lender? Keynes's reply rested on the inverse relationship between interest rates and the capital values of paper assets.

For purposes of argument, let us assume that a 3 per cent consol has been issued at a par value of £100; i.e. the holder is assured of £3 per year. Let it further be assumed that, subsequently, the rate of interest on new debt of comparable quality rises to 6 per cent. The holder of the 3 per cent consol, should he wish to sell, would be exposed to a considerable

capital loss. At interest rates now prevailing those seeking an assured income of £3 per year could obtain it by placing £50 and would not be prepared to pay more for the consol originally valued at £100. Actual - as opposed to hypothetical - market situations are, of course, less tidy because of the variety of paper assets of widely differing quality available as alternatives to holding cash. Nevertheless, there will still be a tendency for interest rates and capital values on interest-bearing assets to move in opposite directions. Rising interest rates will be associated with capital losses to the holders of old issues, while falling interest rates will bring windfall gains. In the light of this relationship Keynes argued that there might be circumstances in which it would be prudent to hoard as a hedge against risks of capital loss. Indeed the speculative motive for liquidity might be forceful when the rate of interest was already low (and the sacrifice of income through hoarding was not great) and when it was thought that rates of interest in the future would probably move up (and expose the owners of debt instruments to substantial capital losses).

When this consideration was taken into account, money could no longer be interpreted exclusively as a medium of exchange. Instead it also performed an important function as a store of value. This insight undercut the line of reasoning upon which Say's Law had rested. Hoarding could no longer be ruled out by assumption, nor treated as an irrational activity. Once this link in the neo-classical analytical chain had been broken, confidence in the self­adjusting properties of the economy to a full-employment level of equilibrium could no longer be sustained. On the contrary, an underemployed economy might tend to get stuck at a level of income well below its potential if part of its income stream leaked into the build-up of idle hoards.

In developing this view of money Keynes found intellectual companions among mercantilist writers of the seventeenth and eighteenth centuries. He was prepared to argue that the mercantilist tradition contained clearer insights into the nature of money than those offered by the teachings of the classical and neo-classical schools. In doing this he associated himself with doctrines that had been viewed as heresy for more than a century and a half.

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