Essay on the Classical and Modern Economists’ Views on Money

Money and Classical Views:

In classical economic analysis, money was presumed to have an insignificant place since it was deemed to have no causative role to play in the economy.

The classicists held that money is essentially “colourless” and adjusts itself to economic activity rather than the reverse. To them, money was useful only as a technical device which overcame the difficulties of barter in effecting exchanges; but it did not affect the economy in any other way and was insignificant in so far as the real process of production was concerned.

In the classical view, thus, the factors determining the volume of production, the kinds and quantities of goods and services produced and consumed, the market value of different types of goods and services, and the distribution of wealth and income in the community would normally be the same in a money economy as an efficient barter economy.

According to them, money by itself was barren a passive element. Money was considered to be only a Lubricating to smoothen the exchange process involved in the real phenomena of production and distribution.

Apart from facilitating exchanges, it has least effect on the operation of an economy in any way. Metaphorically, therefore, “Money is the garment draped round the body of economic life” or “Money is the veil behind which the action of real economic forces is concealed.”

Behind the “veil of money”, supply creates its own demand Say’s law of markets working as smoothly as it would in a moneyless barter economy. Accordingly, money only changes the mode of exchanging things from one another without making any difference to the essential character of real transactions.

It is in connection with the exchanging phenomena in a money economy that the monetary facts and happenings come into being, together with the real facts and happenings.

Take the real facts and happenings away, and the monetary facts and happenings necessarily vanish with them; but take money away and real facts and happenings will remain as they are. In this sense, money clearly is a veil.

The Veil of Money:

This “veil attitude” of classical economists may further be elucidated as follows: Money is just a convenient means of payment. It simply facilitates the process of exchange a part of economic activity.

But it cannot determine the level of economic activity. Money helps to convey goods and services to the consumers; but it is not a determinant of the volume of these goods and services.

Further, the values in exchange of these commodities in real terms remain unaltered by money itself. Thus, money is a veil which the economist must pierce through to have a look at what is real, i.e. the production and consumption of goods and services.

It is necessary that economists must go behind money prices and look at the changes in the volume of output and in “real” incomes. Though money is a very important device for exchange, it is not really money which people want; it is what they can buy with the money.

In short, money was an insignificant thing for the classical economists of the nineteenth century. In their opinion, monetary disorders were an exception rather than the rule; they rarely occurred and the resulting disturbances were insignificant since they would correct themselves.

Treating money as a veil, classical economists set out their economic analysis in real terms only and propounded that supply creates its own demand; when a producer produces a commodity he creates a demand for other commodities, which he would purchase with his own commodity.

Since the classicists dealt mainly with the long- period analysis, they underestimated the effects of money. They argued that in the long run the supply of money tends to adjust itself to the demand for money. By devoting attention to the long run with the assumption of full employment, they could analyse the operation of exchange economy in terms of barter.

Thus, in examining the working of the economic system, the classical economists looked beyond the veil of money. They made their abstractions from money and examined economic life as though money did not exist.

They held that the prices expressed in terms of money represent, ideally, the exchange ratio between real goods and services expressed in absolute terms.

Consequently, the role of money in classical economics is just to determine the level of absolute prices. Classical monetary theory, then, explains only the changes in the general level of absolute prices but not their effects.

Money and Modern Views:

In modern economics, money is assigned an active and important role. Modern economic theorists discard the classical assumption that the role of money is passive and monetary disturbances are infrequent and insignificant and can be easily ignored in the long run.

To modern economists, a leading function of money lies in its power and duty to regulate the general economic activity, contribute to wealth and welfare and accomplish general socio-economic reforms.

Modern monetary theory is, thus, a branch of economics that seeks to discover and explain how the use of money in its various capacities affects production, distribution and consumption the three inter-related facets of economic activity.

In recent times, there has been a growing concern about the short-run operations of the economy under less than full employment conditions. Modern economists seem to follow Keynes who remarks that in the long run we are all dead; thus, modern theories are mainly concerned with short-term analysis.

It has been realised that, in the short-period, money can be powerful and may promote or hinder economic activities. The monetary changes bring about changes in the working of economic forces.

Money and monetary policy have significant effects upon the total volume of investment, employment, output, the distribution of wealth and income among the people in a community and, thus, upon the kinds of and quantities of various goods produced and on consumption.

An increase in the amount of money may lead to greater employment; if the increase is excessive, it may lead to rising prices which may alter the distribution of income in the society and may affect the volume of output perhaps favourably at first and adversely after a time.

Further, money is regarded as a liquid asset so that it may be hoarded as a form of wealth. Hoarding and dishoarding of money can have serious effects upon the working of an economic system.

In so far as the business cycle arises from a divergence between decisions to save and decisions to invest, it is a monetary phenomenon, which is unknown in a barter economy.

Thus, monetary facts and happenings are very important to economic life. The institution of money is an extremely valuable social instrument, making a large contribution to economic welfare.

In the absence of money, many of the transactions of modern economy and especially credit transactions would not be worth making and as a direct consequence, the division of labour would be hampered and lesser amount of goods and services would be produced.

Thus, the real income would not only be allocated less satisfactorily from the standpoint of economic welfare, but it would also contain a smaller amount of money, if not of all sorts of goods. Obviously then, money is not merely a veil or a garment.

Money is a key by means of which the production energies that would otherwise be latent can be released. Though money itself creates nothing, it vehemently influences creation.

Chandler aptly writes: “Money is sterile in that by itself it can produce nothing useful, but it has a very high indirect productivity owing to its ability to facilitate exchange and sepcialisation.”

Money does not remain merely a technical device of exchange. It affects the operative forces of the economy. However, all such effects are not always helpful. Modern economists rightly contend that money often gets “out of order” sometimes in one way and sometimes in another, which considerably changes the mode of capitalist economy.

In fact, the starting point of modern monetary theory is that the flow of money and the money economy are inherently unstable. Keynesian analysis, which we will study later, contends that the instability of a modern capitalist economy arises primarily because of the role played by money through the medium of prices.

The flow of money is inherently unstable and it will not manage itself in the best interest of the economy. Here intelligent and progressive application of the monetary system tends to result in a fuller utilisation of natural resources, and in a higher standard of living.

On the other hand, a too narrow and rigid application of the monetary system is apt to hinder economic progress. The misuse of the facilities provided by the monetary system is apt to lead to grave setbacks and let loose destructive forces in the economy.

Money is not an unmixed blessing. If an economy is entirely left at the disposal of money, or money is misused, it will lead to wide fluctuations in economic performances and breed serious evils as stated below:

(i)It leads to concentration of wealth in the hands of few and gives a monopolistic advantage to its possessor so that he could exploit the other sections in the community;

(ii) It widens the inequalities of income in the society and creates class conflicts between the “haves” and the “have-nots.”

(iii) Instability in its value causes many hardships to some sections in the society at different times. The changes in its value are reflected by the changes in the general price level, indicating inflationary and deflationary situations.

Inflation or deflation distorts the existing pattern of distribution of income and wealth in the society. The instability in the value of money or the changes in prices naturally affect the accumulation of capital and economic activities.

(iv) Moral and ethical values of life may be sacrificed at the altar of money; democratic and political institutions and organisations may become money- minded.

Some control over money is, therefore, quite inevitable. To quote Robertson once again: “Money, which is a source of so many blessings to mankind, becomes also, unless we can control it, a source of peril and confusion.”

Money, thus, is to be deliberately managed with a view to assisting in the achievement of certain definite economic and social objectives. Money is to be regulated in such a way as to ensure that variations in money supply occur in accordance with the needs of the society.

A wise monetary policy, therefore, is essential for the efficient working of the economic machinery.

Nevertheless, the significance of money and monetary policy should not be over emphasized. The size of the national income depends upon the economic real resources rather than upon the money supply.

Money supply cannot make up for any deficiency or scarcity in the factors of production. Monetary policy can be used to maintain the rate of production near the potential productive capacity of the economy although it is not necessarily a determinant of the potential capacity itself.

In technical jargon, money supply or monetary policy can help to uplift the actual production curve up to the production possibility frontier of a country but it cannot by itself increase the potentiality of the production possibility frontier itself.

Moreover, monetary analysis cannot help in explaining everything that happens in the economic arena. We may, thus, conclude with Prof. Robertson that “it is necessary for the economics student to try from the start to pierce the monetary veil in which most business transactions are shrouded to see what is happening in terms of real goods and resources; indeed so far as possible he must penetrate further, and to see what is happening in terms of real sacrifices and satisfactions.

But, having done this, he must return and examine the effects exercised upon the creation and distribution of real economic welfare by the twin facts that we do use the mechanism of money and that we have learnt so imperfectly to control it.”