Joseph Schumpeter’s mid-twentieth-century identification of the differences between ‘real’ and ‘monetary’ analysis and his summary of the latter’s assumptions has never been bettered:
Real analysis proceeds from the principle that all essential phenomena of economic life are capable of being described in terms of goods and services, of decisions about them, and of relations between them. Money enters into the picture only in the modest role of a technical device … in order to facilitate transactions…. [S]o long as it functions normally, it does not affect the economic process, which behaves in the same way as it would in a barter economy: this is essentially what the concept of Neutral Money implies. Thus, money has been called a ‘garb’ or ‘veil’ over the things that really matter…. Not only can it be discarded whenever we are analyzing the fundamental features of the economic process but it must be discarded just as a veil must be drawn aside if we are to see the face behind it. Accordingly, money prices must give way to the ratios between the commodities that are the really important thing ‘behind’ money prices. (Schumpeter 1994 [1954], 277, original emphasis)
This view remains at the core of modern mainstream macroeconomics, which argues that money does not influence ‘real’ factors in the long run: that is, productive forces – especially advances in material technology – are ultimately the source of economic value. Therefore, ‘[f]or many purposes … monetary neutrality is approximately correct’ (Mankiw and Taylor, 2008, 126, which is a representative text). However, there is an alternative view: ‘monetary analysis’ follows a view of money which prevailed in the practical world of business before the classical economists’ theoretical intervention (Hodgson, 2015). Here money is money-capital – a dynamic independent economic force. Money is not merely Hume’s ‘oil’ for economic ‘wheels’; it is, rather, the ‘social technology’ without which the ‘classical’ economists’ physical capital cannot be set in motion and developed. This distinction, between ‘real’ analysis and ‘monetary’ analysis, is known as the ‘Classical Dichotomy’.
Money itself cannot create value; but in capitalism the wheels are not set in motion and production is not consumed without the necessary prior creation of money for investment, production, and consumption (see Smithin, 1918). In the ‘classical’ view, the ‘real’ economy is in fact an ‘unreal’ model of a pure exchange, or market, economy in which money is the medium for the exchange of commodities: that is, Commodity–Money–Commodity (C–M–C). Here, money enables individuals to gain utility: that is, satisfaction from the commodity. In ‘real-world’ capitalism, money is the goal of production – the realization of money-profit from the employment of money-capital and wage-labour: that is, Money (capital)–Commodity–Money (profit) (M–C–M). As Marx and Keynes stressed, depressions and unemployment are not caused by the failure of ‘real’ productive forces. These can lie idle for want of money for investment and consumption not only in the immediate short term but also in the long run. And as Keynes scathingly remarked, the ‘long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again’ (Keynes, 1971 [1923], 65, original emphasis).
For economic orthodoxy, the proponents of monetary analysis were ‘cranks’ who were banished to an academic and intellectual ‘underground’ (Keynes, 1973 [1936], 3, 32, 355; Goodhart, 2009). But, for Keynes, they were ‘brave heretics’ whose analysis was revived and greatly elaborated in his The General Theory of Employment, Interest and Money (1936). A late nineteenth-century American ‘crank’, Alexander Del Mar – unknown to Keynes – has only recently come to light (Zarlenga, 2002). He anticipated Keynes’s general position on monetary theory and policy:
Money is a Measure … the Unit of money is All Money within a given legal jurisdiction…. The wheels of Industry are at this moment clogged, and what clogs them is that materialistic conception which mistakes a piece of metal for the measure of an ideal relation, a measure that resides not at all in the metal, but in the numerical relation of the piece to the set of pieces to which it is legally related, whether of metal, or paper, or both combined. (Del Mar, 1901, 8)
Keynes sought theoretically to convince his ‘classical’ orthodox mentors and colleagues that government expenditure, financed by money created in advance of tax revenue, could solve chronic unemployment in the 1930s. Money created by government spending would increase production and employment, which, in turn, would increase ‘effective aggregate demand’: that is, real ‘purchasing power’. As opposed to the subjective ‘wants’ and ‘preferences’ of orthodox economic theory, demand created by expenditure was both ‘effective’ and ‘aggregate’, inaugurating a positive cycle of growth and tax revenue to fund the original deficit. For a while during and after the Second World War, Keynesian versions of ‘monetary analysis’ gained acceptance in theory and policy. However, as we shall see, the 1970s crises were held to have discredited Keynesian economics, leading to a revival of the old orthodoxy of ‘neutral’ money and the ‘real’ economy.
The two kinds of economic analysis and their respective theories of money lie behind arguably this most contested question in the governance of capitalism. On the one hand, mainstream economics believes that the supply of money may have a short-run positive effect, but cannot and therefore should not exceed the economy’s productive capacity in the long run. Only ‘real’ forces of production – technology, labour – create new value, and their input cannot be increased simply by injections of money. Consequently, if monetary expansion runs ahead of these ‘real’ forces, inflation inevitably follows. On the other hand, the broadly Keynesian and heterodox tradition continues to argue that money is the vital productive resource – a ‘social technology’ – that can be used to create non-inflationary economic growth and employment.
However, it is of the utmost importance that the theoretical dispute is not seen exclusively as an ‘academic’ question; theories of money are also ideological. Our understanding of money’s nature – what it is and how it is produced – is intimately bound up with conflict over who should control its creation and, by implication, how it is used. Insisting that money is nothing more than a ‘neutral’ element in the economy implies that it can be safely removed from politics. If money were merely a passive instrument for measuring pre-existing values of commodities and enabling their exchange, then disputes over its use would be misguided. All we need to do is ensure that there is enough money for it to fulfil its functions and ensure the smooth operation of the economic system – which is precisely how the money question is most frequently posed. The retired Governor of the Bank of England, Mervyn King, wrote in his recent memoirs that “[in essence] … the role of a central bank is extremely simple: to ensure that the right amount of money is created in both good and bad times” (King, 2017, xxi). The quantity of money should be calibrated to enable the consumption of what has been produced. Too little money will depress activity as goods cannot be bought; and too much money will do no more than inflate prices.
Here we encounter another of money’s many puzzles. From a theoretical standpoint, it might be a simple matter to supply the right amount of money, but in practice it is not. We shall see that the experiment with ‘monetarist’ policy to control the money supply in the 1980s was beset by two related problems (see chapter