11 - Monetary theory in the neo-classical era

Summary

Although the later classical theorists, such as J. S. Mill, had been aware that theories formulated in real/physical terms could not be applied to the complex system of credit prevailing in the leading commercialised countries, they settled rather readily for the relatively simple monetarist doctrines they had inherited from Ricardo. Nor were their immediate successors among the neo-classical theorists much inclined to explore the links between the supply of money and the level of output to which Thornton had drawn attention at the beginning of the nineteenth century. The main reason for this blind spot was no doubt the fact that economic policy problems originating in the financial sector did not present themselves in such an urgent and acute form as they had in the early years of the nineteenth century or as they were to do in the twentieth century inter-war period. Whatever the reason, the Ricardian example of separating the problems of price determination into two separate compartments of analysis was carried over into the neo-classical paradigm. The structure of relative prices was explained in real, micro, terms – as dependent on marginal cost and/or utility – essentially in terms applicable to a competitive barter economy in long-term equilibrium. The absolute price of each commodity or the general level of prices, was given a monetary, macro, explanation dependent on a short-term fixed relationship between the stock of money and the stock of commodities.