essay on the new economic synthesis and financial...

84

THE CURRENT STA TE OF ECONOMIC SCIENCE

VOL. 3, PP. 1607-1635

ESSAY ON THE NEW ECONOMIC SYNTHESIS ANDFINANCIAL HEGEMONY: POLICY CONSEQUENCES

LUIS MATA MOLLEJAS

CENDES,Universidad Central de Venezuela,

Avenida Neverí, Edificio, Asovac, Colinas de Bello Monte (Venezuela)E-Mail: [email protected] .

Today, the broken flight of economic thought confronting to the great problems of ourtime leaves the economist disarmed, with his fragmentary knowledge, his segmentedattention, and a fascinating gap between a theoretical edifice in search of coherence anda world in search of solutions and replies.

Michel Beaud, Gilles DostalerLa pensée economique depuis Keynes

ABSTRACTIn today's world the past and the future make themselves felt in the form of financia!commitments, which reflect the relationships among the valuation of capital (stock market prices),the production of goods, the conditions on which financing is available for productive activity(credit), and the repayment ofthat financing with the proceeds ofsales.These interactions are marked by a financial hegemony, since the overall value of real transactions is greatly exceeded by that of financial ones, and the latter affect the level of the former.Hence, countries have experienced bank insolvencies and stock market crashes, and the "midsized" economies have been forced to make strenuous efforts (hard landing) with adverse effectson activities not linked to the outside world in order to keep in step with the financia) markets.This article reviews and summarizes the basic principies of a New Economic Synthesis (NES) inan attempt to explain the interaction between financial and real processes. And given the undesirable effects ofthe currently fashionable "adjustment" policies, it addresses the policy optionsfor dealing with contemporary econornic problems, contrasting them with those derived from theorthodox approach, through an assessment that reflects the concept offinancial hegemony.In this respect, it should be pointed out that orthodox -or adjustment of dernand- programs underconditions of stagnant or decreasing supply do not lead to an increase of well-being or theachievement of social equilibrium in Adam Smith's sense (Social Harmony), while the policiesassociated with the NES imply that the solution to unemployment and inflation lies in stimulatingcredit and discouraging adverse portfolio selection by managing interest rates. But that can onlybe done effectively under the demanding conditions of acceptance of the free internal circulationof international reserve currencies that perform the unit of account and medium of exchangefunctions,This explains the trend toward the creation of monetary areas or unions with central banks to actas coordinator - explicitly as in the case ofthe European Community or implicitly as in that oftheU.S. Federal Reserve and the Bank ofEngland when the gold standard was in effect.

Keywords: Financial Hegemony, Economic Policy, Inflation and Unemployment,Banking and Stock Market Crises

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Financial'Hegemony in International Trade

Exports of comrnodities (food, raw material s, fuels) represented about two thirdsof world trade volume in the late 19th and early 20th Centuries; trade in manufacturedgoods accounted for the remaining third. But the relationship between the two wasreversed in the 1945-1975 period, with manufactured goods amounting to two thirds ofworld trade and others to one third. That trend apparently explains the fact that 70% ofworld trade takes place among the industrial countries today'.

The most dramatic change worldwide, however, is the expansion of internationalfinancial transactions to a magnitude far exceeding that of merchandise trade. Mossé(1997 :77) points out that the value of all cross-border financial transactions was fourtimes higher than that of trade in real products in 1970, 40 times higher at the time of the1987 stock market crash, and over 100 times higher in the mid-1990s2

.

This trend is the outcome of the growing privatization of international assets (Elie,1970) and the resulting deregulation of international financial activity, against therecommendations ofthe Basel Comrnittee'; the leading industrial countries have not beenable to restore international monetary discipline since floating exchange rates became thenorm after the 1971 devaluation of the dollar, which marked the end of the BrettonWoods system",

The rapid increase in the importance of speculative financial activities largelydetermines the operation of a world economy, introducing a "Financial Hegemony'",which severely constrains the conduct of economic policy even in the most highlyindustrialized countries when internal processes are sought to be adapted to externa1influences. In other words, the adjustment policies favor, within each country, theinterests of the sectors associated with the outside (Roga1ski, 1996), in keeping with the"selective integration" practiced by the world markets. In response to any change in theinternational financial markets, the "midsize" economies must therefore make strenuousefforts (hard landing) with adverse effects on activities not linked to the outside wor1dand on employment, in order to keep in step with the financial markets, on the imp1icitassumption that the 1atter are efficient".

Hence, in this paper we will: 1) summarize the accepted basic principIes of a postKeynesian New Synthesis (NES)? in order to explain the interaction between financialand real processes through a dynamic general equilibrium reasoning, and 2) given theundesirable effects of the adjustment policy, assess the political dimension of thetheoretical arguments for dealing with contemporary economic prob1ems - growinzunemployment everywhere" and an inflationary trend in the industrializing countries.

2. Summary of the Evolution and Bases of the Macrotheories

The recurrent dissatisfaction with the dominant theoretical approaches underhistorical circumstances that appear to be repetitive has become so strong that we mightsay with Gonnard (1921 : Prologue) that over the course of time many accepted theorieshave been rectified, many indisputable economic laws have been questioned, and manyold ideas that had appeared obsolete have been applied anew. In other words, therestatement of theoretica1 syntheses to support policy trends has been a constamphenomenon, as the history of the discipline shows. Among the most intensely

ESSAy ON THE NEW ECONOMIC SYNTHESIS AND FINANCIAL HEGEMONY 1609

questioned -and questionable- of the theoretical subleties are those relating to thepresence ofmoney as a characteristic ofthe capitalist economy.

2.1. Interaction Between the Real and Monetary Spheres

As is well known, any country's national income can be analyzed from twostandpoints: that of spending, referring chiefly to consumption (C) and investment (1),and that of distribution of income, as between wages (W) and profits (B). Theproportions of income going into those four categories do not necessary balance out, andany differences may be offset by financial flows, ineluding the changes introduced bygovernment activity, even under conditions of "fiscal neutrality". It is thus elear that no"general equilibrium" can be analyzed unless it ineludes both financial and real aspects,because the distribution of income, its allocation to different forms of spending, and thechoice among financial assets are codetermined.

That codetennination or simultaneity is the essential feature of a comprehensiveview ofthe economy, and a consideration ofthe real factors plus sorne financial additivederived from separating the capital account balances of the different agents is nosubstitute, because that procedure would limit the recognition of the interaction amongthe agents in the different markets.

Neither can the comprehensive approach be limited to the conception that moneyinfluences the general price level but the monetary processes are unrelated to the realeconomy. It therefore makes sense to briefly review the options and conventional ideasthat have been used to integrate the two spheres, with emphasis on the characteristics ofmoney and its transformation.

2.2. A Succession ofTbeoretical Symbioses

The ideas on organization of the economy (property and justice) and trade(commerce and money) among the early thinkers in the ancient world and the MiddleAges were first given an academic formulation in the Salamanca School (15th and 16thCenturies). The concepts of supply and demand were introduced and a first approach to aquantitative theory of money? was put forward, resulting in the establishment of the basicconcepts (supply, demand, money, and prices) which interact according to the scarcityprincipie. Montchrestien coined the term "Economic Policy" to refer to these concepts in1650.

In the early 17th Century the mercantilists and physiocrats contributed essentialbuilding blocks to the construction ofthe VaIue-Work theory, with which the addition ofcosts principIe was introduced. These two sets of inputs made it possibIe to achieve thefirst theoretical grand synthesis at the end of the 18th Century; its most representativework is that of Adam Smith (1776) and its most complete elaboration is that of JohnStuart Mili (1848), in the middle ofthe following century'", The set ofwritings producedin that period, also including those of Say (1803), Ricardo (1817), and MaIthus (1798),characterized the "classical" period of economic thought, Marx (1859), to whom we areindebted for the term "classical", was among its critics. His work represents a synthesisof the scarcity principie, the addition of cost principIe, the physiocrats' economic circuitprinciple (Quesnay, 1758), and the conflict of interest principIe introduced by Ricardo.

1610 THE CURRENT STATE or ECONOMIC SCIENCE

The analyses offered by all the "liberal" classical writers and their "heterodox" critics allstressed the supply side and took a long-range perspective".

Separate mention should be given to the debate on the source of economic changelaunched in the British House of Commons" in 1810. Does change begin with thoseresponsible for the supply of money or does it stem from business activity and prices,with its effect on the demand for loans, and hence, on the supply of money? Thisconfrontation between what is known as the Currency PrincipIe and the BankingPrinciple is still of capital importance, even though it appeared to be resolved when theBank of England opted for the Currency Principle by adopting the gold standard andoffering unrestricted convertibility between gold and bank notes; this position wassupported by David Ricardo (1817:286). But shortly thereafter, without abandoning thegold standard the Bank of England moved to regulate interest rates, therebyacknowledging the importance ofthe Banking Principle".

Two new syntheses were introduced during the second half of the 19th Centuryand the first quarter of the 20th Century: one developed by the Cambridge School(Britain), which includes the partial equilibrium formulation (Marshall, 1890), and theother created on the European continent (the Vienna and Lausanne schools)", whichposited the marginal utility principle (Gossen, 1854) and culminated in the mathematicalformulation of general equilibrium (WaIras, 1874), making it the precursor ofmacroeconomics". These syntheses define in a very complete form the consumerprinciple and its generalization (maximization of gratification) to more than areformulation of the inherited basic concepts based on a ceteris paribus assumption(Marshall). Market equilibrium in the two basic mode1s -partial and general- is achievedby variations or adjustment of prices. The emphasis in this set of ideas is on the demandside and the short term, and it comprises what is known as neoclassical thought. Profitand scarcity share with cost in the determination of prices (according to the law ofdiminishing retums) 16.

Preceded by WickselI (1898), who recognized the importance of credit and of thedifferent rates of retum, Bemacer offered a strong critique of the quantitative theory ofmoney in 1922 and made statements regarding the flows of the economic circuit whichanticipated Keynes, with whom he contributed to the group of precursors of the liberalheterodoxy". Keynes consolidated this macroeconomic approach in 1936, by proposing:1) the interaction between income and expense flows through multipliers; 2) theadjustinent of markets through quantities on the assumption of rigid prices; and 3) thedependence of activity and employment on demand".

The first of those concepts implies a retum to the circulation or economic circuitparadigm used by Quesnay, Marx, and Bemacer. That led Poulon (1982) to concludethat, at bottom, Keynes relegates the general equilibrium of the markets to a secondarylevel of importance. But the presentation of Keynes' work by Hicks in 1937 revived theidea ofthe markets and tumed it into the "vulgata" ofthe Keynesian theory. This version,called Neoclassical Synthesis, subsequently revised by Modigliani (1944) and Pantinkin(1956), attempted to reinstate orthodox thought by reducing the Keynesian postulates,such as rigidity of salaries, to the specification of a variant or particular case - theKeynesian case. However, Keynes' ideas, combined with the contributions made by theeconomitricians, such as Frisch, helped underlie a political practice (sometimes describedas "interventionist") which stresses demand from the fiscal standpoint. This synthesis


was to prevail until the 1970s, when deficit spending therapy proved unable to solve thedominant problem of the last third of the 20th Century: intlation accompanied byunemployment and monetary disorder.

Critiques of all kinds, basically organized around the fragile connection withmicroeconomic theory to explain the absence of the continuous clearing of markets, andthe mathematization of the discipline, laid the groundwork for major revisions of the preexisting syntheses", and basically posited two contradictory approaches: that of rationalexpectations (Lucas and Sargent, 1981) by the Chicago School, which is complementedby Friedman's monetarism to comprise the New Classical Economics (NCE), and theapproach derived from revisions of Keynesian thought by neo and post-Keynesians,known as the New Keynesian Economics (NKE), which includes those who stressdynamic interpretations and a revision of the monetary concepts. The most importantfeatures ofthese approaches" are summarized in the following Synthesis Table 1:

For the best-known U.S.authors (Samuelson-Dombusch), by conserving themarket equilibrium paradigm and the assumption of profit maximization by each agentbased on his information (free of systematic errors), the rational expectations approach isa continuation of the main line of economic thought".

With its stress on basic adjustment through quatities, the intluence of thedistribution of income (wages-profits) on consumption and investment decisions, theinteraction between the ex ante rate of retum and financial altematives as an"objectivisable" component of investment programs, and institutional restrictions on thecredit market, the NKE school makes an eclectic set of critiques but does not pose asystematic challenge to the mainstream (Dombusch-Fisher, 1984:615). Post-Keynesianauthors such as Blanchard (1992) also hold that it provides outlines for theoriesbut doesnot pursue the opportunity to build them; this leaves open a space for the creation of aNew Economic Synthesis (NES) that ineludes the passage of time and the connectionbetween macro and microtheory as logical elements (inc1usion of real contemporaryconditions), as well as the existence of sticky prices, monetary endogeneity, and financialhegemony as a restriction on market equilibrium.

The ultimate aim is to modemize policy rules with which to reduce uncertainty(Abraham-Frois, 1993:177). It should be noted in this respect, together with Poulon, thatby stressing tlows (dynamic change phenomena) and identifying historically specificactors and institutional restrictions, the "circuit" approach makes it possible to drawtemporally valid conc1usions; in that sense it differs from the market equilibriumapproach, which seeks conc1usions with absolute and universal validation.

2.3. Incompatibility Between Markets and Circuits?

The macroeconomics of equilibrium or the market approach is essentialIy static,since it focuses on the conditions for supply and demand to equalize. This approach issimilar to the dynamic one when it introduces ex-ante and ex-post concepts to make thecausal sequence of events explicito The methodology is characterized by a comparison ofsuccessive states ofequilibrium (quasi-static analysis) and a prefiguration of"shadow" orunreal prices and planned quantities (Hicks, 1939).

The first difference is that the macroeconomics oftlows is essentialIy dynamic. Byfocusing on transformations of money as it passes from one actor to another, as a

1612 THE CURRENT STATE OF ECONOMIC SCIENCE

counterpart for the flows of goods and services or in search of remuneration even whenthere is no directly productive activity, it makes an explicit and necessary place for thepassage of time. The time of the flow is the time of the circuit (Poulon). On the otherhand, time disappears in the market or trade approach, which envisions change occurring.in an instant.

Synthesis Table No. 1. Principal Derivations OfKeynesian Thought

SCHOOL MAJOR AUTHORS CORE HYPOTHESIS REMARKS

a) Neoclassical Hicks, Hansen, IS-LM Model for Temporal Leading critics: Friedman,Synthesis Samuelson, Solow, General Equilibrium Lucas, and Sargent, of theOxford-American View Klein, Pantinkin, (I+C=Y), achieved by New Classical Economics

Modigliani, Blinder, adjustment of demandl (NCE) school. Natural rateTobin interdependence of prices. of unemployment and

rational expectations.b) Cambridge (Halo Harrod-Domar, Kaldor, There is a single rate which Leading critics: Hayeck,British) View, or long- Robinson, Pasinetti, permits self-sustained Robbins (London School).term study Kalecki, Kahn growth, but no guarantee Overinvestment theory.

that it will be attained(razor's edge).

New Keynesian Leijonhufuvud, Barro Fixed pricesl adjustment by Search for theEconomics (NKE): Grossman, Clower, quantities: "short" side of microeconomic bases ofa) Neo-Keynesian Benassy, Malinvaud demandoRationed markets. macroeconomics.View and DisequilibriumTheoristsb) Post-Keynesian Davidson, Minsky, LM-VV Model, for General New Economic SynthesisView and Circuit Barrere, Schmitt, Equilibrium with (NES): Study of economicTheorists Poulon, Parguez, unemployment: dynamics.

Sraffa, Aglietta, Lavoie, (I+C=W+8), attained by The adjustment oftheWaintraub, Gordon financial interrnediation. financial markets is

Endogenous money and instantaneoussticky prices theory. (preadjustment) but

provisional.

A second difference is the necessary presence of money in the macroeconomics ofcircuits approach, whi1e in the macroeconomics of markets approach money maydisappear or be concealed by trade relations or prices and may be introduced by creatingan ad-hoc market -the money market- or simply ignored as in the classical fiction of the"monetary veil".

We may then ask whether the market and circuit approaches are absolutelyincompatible or whether they are two sides of a single coin.

In OUT opinion, when the conditions considered by the different agents as "exante" to making a decision or determining a behavior are specified in the marketapproach, a "bridgehead" is established for bringing the circuit and market approachesinto compatibility. That bridge is comprised ofthe volume offlows in a given period, asa result of a prior decision. When the values of the behavioral functions are consideredfor periods tending toward zero, it becomes clear that the flows tend to disappear; thenthe existing conditions and prices of stocks influence the agents' behavior. That is to say,the ex-ante conditions ofthe markets for stocks (or financial markets) have an impact onthe ex-post results of the markets for flows (real markets). The mechanism emerging


from this hypothesis, called "post ergo ante hoc" is an essential component of the NewSynthesis (NES) and illustrates the need to explicitly incorporate the financial aspects.

3. The Need for Financial Considerations: From Walras to Keynes

In mainstream economic analysis, "equilibrium" is said to exist when the offeredamounts of any good (Xi) and the demand for it (Wi) are equal at a given price (Pi). Thedifference Pi(Xi-Wi) represents excess demand or supply. If the set of markets is inequilibrium we can write the following equation:

n

I Pi(Xi - Wi) = O

i = 1

This equation represents the general equilibrium concept, which was firstexpressed by lB. Say and formalized by L. Walras.

Though Walras' Law goes no further than to state that the sum of the surplusdemands (in value terms) is equal to the sum ofthe surplus supplies, that does not meanthat the demand for each good (i) is equal to its supply (i.e., that there is no excess supplyor demand). It does, however, imply that if (n-l) markets are in equilibrium, the last ofthem will also be in equilibrium. Among other important macroeconomic consequencesof Walras' Law is that all agents must accept a restriction of equality among the sourcesand uses ofresources (Poncet-Portait, 1981, P:19) 22, and that the demand for and supplyof each good depends on the prices and quantities of the other goods (Poncet-Portait, p.9).

A second expression, which makes the presence of prototype markets explicit(Poncet-Portait:20) aUows an analysis of the interaction among the relevant conditions ofthe markets for goods (Y), money, (M), securities (V), and work (L). It can be written asfoUows:

p(yJ-r) + (M-M) + l/r (VU-V') + w(Ld-L') = 0 23

where (P), (r), and (w) are the relative prices and the superindices (d) and (s) representthe conditions of demand and supply. In other words, it is explicitly stated that generalequilibrium depends on the conditions prevailing in the goods market or the (IS) functionexpressing the supply and demand for monetary assets or the (LM) function for thesecurities markets or the (VV) function, and the interaction among them and the jobmarket (L), if we adapt the expression of Hicks (1937) 24. The "commissaire preseur"hypothesis (Leyjonhufuvud, 1968) is unnecessary.

In the Neoclassical Synthesis (Hicks-Keynes model), for the four-market systemto be in equilibrium it is enough for any three of them to be so; that aUows for theelimination of considerations on the securities market, which is assumed to be a merereflection of the money market or a complement to it for a given stock of fixed capital. Inthis version, which is supported by the marginalist microeconomic theory, it is stated thatcompanies will try to produce and seU until the particular w = P relationship is reached,wherein (P) is the price that can be eamed for the "Iast" unit produced and sold, and (w)is the wage rateo With joint consideration for the IS-LM (effective demand) set andproduction, Y = f(L,K), general equilibrium is reached in the short term or under the

1614 THE CURRENT ST ATE OF ECONOMIC SCIENCE

assumptions put forward by Marshall (1891) or invariance of fixed capital. Butaccep.ance ofthe equilibrium condition w = P opens up an important debate.

For sorne authors (classical and neoclassical), the levels ofP and w are determinedby the interplay of supply and demand on their respective markets; i.e., the conditionswhich affect the behavior of spending (Yd) playa role in the determination of P and it isstated that there will be no unemployment if (w) is an equilibrium (market clearing)price.

For others (more or less "pure" Keynesians), the level ofP is "predetermined" bycompanies to ensure a certain rate ofretum (b). That forces companies to negotiate withtheir employees to obtain a certain w rate, which is thus "predetermined" and a certainwage mass (W), for a given volume of capital", implying that there may be sorneunemployment (disequilibrium in the labor market) and the economy may fmd itself in"equilibrium" with subemployment".

Historically, then, two major options have been available for the study of generalequilibrium", and the issue would be resolved were it not for the complications arisingfrom the orthodox approach's inability to explain the crises whose persistence makesthem much more than "cyclical fluctuations" or passing disturbances -called"underconsumption" by the Marxists- and the Keynesian approach's need to explain theprocess whereby equality between saving and investment is established, postulatedtautologically by Keynes who considered it ex-post.

But in addition, to study change or perform a dynamic analysis it is necessary tolift the restriction posed by the fixed capital stock assumption and consider the effects ofunproductive saving (underconsumption). This leads us to a discussion of the nature ofmoney and its influence over changes in production. As noted aboye, this discussionbegan in the early 19th Century.

4. The Nature of Money and its Int1uence in Economic Dynamics

4.1. Definition and FunctionsThe capitalist economic system was bom in Westem civilization during the 13th

Century, following the Crusades (See, 1937:13). 11 is socially organized or grounded onfree enterprise, which implies that private agents seek to eam the highest possible profitwhile ensuring the continuity of the productive processes and fmding economic uses forthe surplus.

For centuries, this system has made use of various forms of money, as a way tofacilitate the process indicated above" and channel the interaction among sel1ers andbuyers, creditors and debtors, savers and investors. This essential "social arbitrage"function is by no means neutral, since it implies a question of politics, of exercise ofpower, which can benefit sorne and injure others (Aglietta, 1982). In addition, theexistence of diverse financial intermediaries, many of which are private (banks, savingsunions, etc.) implies the presence of a range of financial assets and liabilities which mayperform the functions attributed to money. Hence, the dividing line between what is andwhat is not to be designated as money is somewhat arbitrary, and the final criterion ofselection is that the instruments in question must have a high crosscutting elasticity,meaning that they are almost perfectly interchangeable.


To perfonn social arbitrage among contradictory interests, monetary instrumentshave historically been required to fulfill three basic functions: those of unit of account,medium of exchange, and reserve of value.

The unit of account function, which makes it possible to express the "valúes" ofdifferent kinds of merchandise, is fulfilled when a society, in the exercise of its identityand sovereignty, "coins" a monetary symbol, which then serves as a reference forvaluation purposes, to the exclusion of all others. Clearly, as a unit of account it cannothave a value of its own (Aglietta-Orlean, 1982:75). From this standpoint it is subjectiveand arbitrary to assign it a value such as "purchasing power", understood as the inversecalculation of sorne absolutely "conventional" choice of a given set of merchandise.When that occurs, a politicaI decision is ultimately being made :(Aglietta-Orlean,1982:83) 29.

When money operates as a facilitator of the circulation of goods, a numberless setofpurchase-sale (exchange) transactions ofmoney (D) for merchandise (M) and then formoney is simultaneously being perfonned. Expressed symbolically, the succession is: M,D, M. This simultaneity is easily related to the "monetary veil" and "monetary neutrality"concepts and to quantitative theory.

When private money was created by credit, interest appeared over the course oftime, adding value to previous capital (increasing it). As a result, money was given thefunction of creator and reserve of value. But when certain volumes of money areremoved from the spending stream (saving or hoarding), the circulation of goods isinterrupted or stopped. That shows that the fulfillment of the reserve function may beincompatible with that of the "médium of exchange" function and leads to the followingconclusions:l. The "neutrality" judgment conceals the basic social arbitrage function fulfilled by

money as a reserve of value.2. In general, when the "supply of money" declines, exchange and all processes are

hindered, meaning that a depression is provoked.3. If money is rejected, if the public does not want to hold it, the velocity of

circulation increases (rejection of money), more foreign exchange is purchased,and the attribution of value to merchandise is distorted, leading to inflation.\Ve can thus infer that inflation is not merely a simple "general increase of prices"

provoked by a "surplus" of money in circulation. Inflation reflects the rejection of moneyas a channel for social arbitrage and a satisfactory unit of reserve of value.

These considerations explain the difficulties faced by the monetary authorities intheir attempts to defend an exchange rate and apply a successful financial policy whentheir attention is focused on coined or public money and its relation to the real markets,while neglecting the importance ofprivate credit money. That in tum makes it necessaryto analyze the interactions between public money (exogenous) and private money(endogenous).

4.2. The Relations Between Public and Private Money: Interest RatesThe distinction between public and private money suggests the need to analyze

their interaction. The orthodox position (or first explanation) assumes that the supply ofpublic money, or monetary base, is independent of economic activity (monetary

1616 THE CURRENT STATE OF ECONOMIC SCIENCE

exogeneity theory) and that private money or credit is related to bank holdings (deposits)as affected by a multiplier mechanism",

The monetary endogeneity theory expresses the opposite point of view: the mainpurpose of the money issued by the central bank is to give the commercial banks thefunds they need to meet their reserve requirements, calculated as a portion ofthe depositsthey hold as a counterpart to initially granted credits (Lavoie, 1987). To that end thecentral bank sets a price, the interest rateo It is understood that the central bank will also .provide the refinancing needed to cope with "runs", or unforeseen removals of funds bydepositors (Arestis, 1988). From this standpoint, then, the money created by the centralbank depends on economic activity and cannot be the origin of inflation.

This conclusion does not mean that public money has no role in causing inflation;it is a condition which allows inflation to take place (Kanh, 1976; Moore, 1979; Lipietz,1982; Kaufman, 1988), but inflation's origin always lies in the real economy".

lt should also be stressed that the definition of the interest rate as the yield ofmoney "advanced" or lent over a term and with a guarantee (the unit yield of a"security", a capital) has important consequences. When the authorities issue securitiesthat are risk-free because they are guaranteed by the State, they are setting a marker ratewhich provides a point of reference for the financial intermediation process, andultimately, for reproductive or "real" investment.

Hence, the "ex-ante" comparison between risk-free yields and yields whichincorporate a calculated risk, or "financial preadjustment", is affected by fiscal action andthe monetary authorities. Since that preadjustment includes among the available options(altematives to real investment) "speculative" purchases of foreign exchange (reserve ofvalue), State actions which foster a preference for foreign currency over nationalcurrency impair the national currency as a unit of account and a medium of exchange.That is, they threaten the very currency that had been "coined" by the State and whichthe monetary authorities are presumably bound to defend. In other words, theyundermine the "sovereignty" or efficacy of the social arbitrage function for which theyare responsible.

Accordingly, every action taken by the central bank and the fiscal authorities is apolitical act which favors or injures the interests of certain economic actors: investors orsavers, debtors or creditors. In so doing it either stimulates economic growth or provokesa depression and unemployment. The foregoing leads us to the following conclusions:l. Public money can be used to facilitate exchange (basically small-scale

transactions) or can be kept as a reserve of value (retained funds) by the economicagents.

2. The reasons for that retention or demand for money (Md) may vary, and are to acertain extent related to: 1) the interest rate "r" which is charged for loans oreamed by "deposits" and 2) the possibility of purchasing securities and foreigncurrency.

3. AII credits and debts are money created by third parties, with varying degrees of"liquidity" and "reserve of value" capability, affected by the time periods forpayment of their return" and interest rates. Hence, control over credit money isrelated to that rate.

4. The interest rates associated with the different currencies affect the latter's relativeabundance and the exchange rate.


To sum up, the orthodox school assumes that public money is a good with amarket, capable of influencing economic processes but independent of them(exogeneity), while the post-Keynesian school views money as merely a tool associatedwith bank financing of general economic activity (endogeneity), to which the Stateattributes exelusive use as a unit of account (Knapp, 1905; Lelart, 1964; Davidson,1994:104) though private parties may prefer to use any other currency on the basis ofinterest rate and exchange rate considerations.

4.3. Basic Elements ofthe Macroeconomic TheoriesAccording to the preceding discussion, the basic components or concepts of

economic theory lead us to Synthesis Table 2, where we find that:1. In relation to the four prototypical markets envisaged in the macroeconomic

theories (goods, securities, money, and labor), the pre-Keynesian models stressthree - merchandise (including both consumer and capital goods), money, andlabor; the Keynesian models, ineluding the neoelassical synthesis, specify four consumer goods, investment, money, and labor; and the post-Keynesian modelsposit at least five, reflecting sorne redefinitions implicit in the establishment ofthesets called monetary liabilities, bank assets and liabilities, and non-monetary assets(representing physical capital), while completing the interaction among all themarkets by considering those of consumer goods and labor.

2. Hicks' version of the Keynesian model, which focuses on the consumer goods,investment goods, and money markets, brings us to the IS/LM scheme and the 1 =

S condition, or its equivalent Y = C+I. The post-Keynesian model, by takingaccount of the differences between public money, unsecured money, andsecurities, makes it necessary to acknowledge interactions among the financialsubsets and interactions between the financial set and the real markets set. It positsas conditions for equilibrium that the supply of securities is equal to that ofloanable funds (VS = Vd) and that the total amount of spending (C+I) is equal tothe total amount of income (W+B). The following sections will focus on ananalysis ofthese interactions and their political consequences.

5. The New Synthesis (NES): General Hypotheses

5.1. Endogenous Money and Adjustment MechanismsAs shown aboye, though there are multiple schools of economic thought",

contemporary debate is polarized between the "orthodox view", which ineludes the "NewClassical Economics", and a New Synthesis (NES) which stems from a revisedKeynesianism and has been stimulated by (among other things) the dramatic failures ofliberal or monetarist attacks on the dominant problem of the final third of the 20thCentury: recession accompanied by inflation in a context of intemational monetarydisorder and recurrent financial crises, regardless of the degree of industrialization of thecountries affected.

As discussed aboye, orthodoxy assumes a core connection between the goodsmarket and the money market; the goods market is "cleared" by the variation of flexibleprices. Interest rates -flexible and determined on the money market- affect the productionof goods through investment. Finally, a flexible wage rate ensures reasonably

1618 THE CURRENT STATE üF ECüNüMIC SCIENCE

"competitive" prices for goods and a relatively satisfactory situation for a11 agents(equilibrium in Smith's sense) 34.

Synthesis Table 2. Basic Elements oC the Macroeconomic Theories

~PREKEYNES KEYNES POSTKEYNES

MARKETSMonetary Liabilities and

Money Money Money Foreign Exchange (eh)

Bank Assets andLiabilities(l/ra) (l/rf) and (l/rd)

Securities * Investment Non-Monetary Assets(l/e) (l/ri) Physical Capital

(l/q)Goods Merchandise Consumer Consumer Goods (P)

(P) Goods (P)Labol' Labor (w) Labor (w) Labor (w)Condition for P=w 1=8 Vd=VsEquilibrium MIP=kY C+I=Y C+I=W+B

P = Pnces of GoodsC = Consumptionra and rd = Bank Ratesy = National Incomek = Average period

between transactions

I = Investmente or q = Marginal EfficiencyB = Profit MassM = Money Massd=Demands = Supply

w= Wage RateW= Wage Massri = Rate of Yield

V = Bank and Non-Bank Assets

In the New Synthesis (NES), the endogenous money hypothesis posits that thesecurities market influences interest rates and the demand for foreign exchange affectsholdings of national currency, or "liquidity". The demand for goods produced andoffered at more or less "sticky" prices is affected by the salary mass and profitableplacements (including foreign exchange), and most of the adjustments in the goodsmarket are accomplished through quantities. The goods market will then be determinedby producers' rate of retum, and its comparison with the desired rate of retum and theyields available on the securities markets (credits, financial investments, public bonds,foreign exchange) will determine the future level of investment, and hence, that ofproduction and employment, as we11 as the future distribution of income. Behavioralfunctions for the different agents in the securities, money, goods, and factorial(employment and capital goods) markets are thus combined in a dynamic analysis (postergo ante hoc hypothesis) with financial restrictions affecting the different agents so as toarrive at changing (provisional) levels of"equilibrium" in said markets.

5.2. The Financial Preadjustment or the Economic Logic 01DynamicsAs said aboye, in formal terms the orthodox school fo11ows Walras' expression LPi

(Di-Si) = 0, which summarizes a model with flexible prices in a11 the markets, though


focusing on the relationship between the money and goods markets. The basicrelationship is expressed as follows:

P(Y" -Y')+(if -M') =0 (1)

wherein the securities market is a mere "mirror" of the money market and employrnent isa result or linear combination, which may therefore remain implicít".

The post-Keynesian version starts from a consideration of the set of prototypicalmarkets:

P(yd • Y') +W(Ld .l)+~(Vd -V')+(Ar -M")=Or

t+dt t+dt t+dt t s- dt

(2)

When a minimal temporal variation (dt--->O) is inc1uded, Expression [s] becomes:

Limp(yd -Y')+W(Ld -LI)+.!.(Vd _Vs)+(Md -MI) = Or (3)

dt~O t+dt t+dt t+dt t+dt

Since the goods and employment markets can be viewed as "flows", while thesecurities and money markets are stocks, Expression [3] is equivalent to:

.!.(Vd _ V·I) + (M d _ M S) = O

rt

(4)

when flow is nil"; that is interpreted as an instantaneous adjustment of the financialportfolios in response to exogenous variations of (r), and the securities market can bebroken down so as to specificalIy focus on the banking market", The instantaneousportfolio adjustment predetermines real investment (Financial Preadjustment), which isthe economic underpinning of the logic of dynamization or the post ergo ante hochypothesis. Hence, the explicit consideration of the financial markets and the post ergoante hoc hypothesis is a necessary and sufficient condition for determining thecumulative interaction or dynamic version of general equilibrium".

Finally, it should be stressed that if the premises of the orthodox view areaccepted, the interaction between the goods and money markets taken to the extremeallows for a single equation, such as the so-calIed "Saint Louis equation", while the NewSynthesis (NES) requires a set of financial markets which is formalized in a system ofdynamic equations. The behavioral functions adopted in each case and the accountingidentities and restrictions of specific equilibrium give the different mode1s their"specificity".

5.3. Relations Among PricesAs is welI known, there is no consensus explaining price behavior. The orthodox

school assumes that flexible prices c1earthe goods and labor markets, as a result ofwhichthey influence financial prices: interest rates and exchange rateo

ConsequentIy, to determine the exchange rate the orthodox approach resorts to the"purchasing power" of money concept (defined in practice as the inverse of "sorne"consumer prices (I/P). To this conventional result is added the nominal rate (m) at which

1620 THE CURREÑT STATE OF ECONOMIC SCIENCE

a lender agrees to provide capital to a borrower. The lender may consider the randomyield (q) that could be eamed by using the capital in production (real rate) to set the mrateo Hence, the nominal rate is conventional1y treated as the sum of a real rate (q) andthe expected increases of sorne prices (P). This is, m = q+P.

The results of the purchasing power (l/P) and nominal interest rate (m)calculations are therefore conventional, especial1y since they are intended to be anaverage of the behaviors and considerations of al1 lenders, borrowers, and consumers. Acorollary of this is that when the exchange rate (eh) is taken as a ratio of "purchasingpower parities", the result is equally conventional (i.e., arbitrary and subjective), as is thejudgment that the currency is over or undervalued. Consequently, in the struggle foreconomic surplus, the best informed or best educated agents can use their knowledge andpower to impose "conventions" favorable to themselves. The ad hoc convention isrevealed as a crack through with agents can elude economic logic (Aglietta-Orlean,1990).

The New Synthesis (NES) stresses that the prices of most goods (P) in theindustrialized economies are based on profit and cost; i.e., they reflect the influence 01financial prices, and are accordingly quite "sticky" in response to demand variations.This assumption finds a microeconomic justification in companies' goals of durabilityand profitability. Therefore, the wage rate (w) tends to be predetermined becausebusinesses control the movement of goods prices (P) and their profit rate over time"And as said aboye, the interest rate is influenced by the securities market.

Given that the "flexible" prices which c1ear the market are equilibrium prices, iíthe other markets are in equilibrium and this requirement is not satisfied the "clearing'price actually absorbs the disequilibria present in the other markets. From the NES'!standpoint, this gives rise to the fol1owing consequences:l. When the financial prices in their markets are adjusted (they are obliged) ex ante

to assimilate the disequilibrium in the real markets.2. The adjustment produced by variations of the real market prices will not reflect ¡

"true" equilibrium price, but rather a provisional price, reflecting the disequilibri:in the unemployment rate and in inventory buildup.

3. Deposit and lending rates (rd and ra, respectively) and the ovemight rate (u) wilfluctuate around the price of money set by the authorities (rt), while the exchangirate reflects the foreign exchange market, which in tum is influenced bintemational trade and capital flows". .

4. The financial preadjustment will favor the relations between nominal rates (mand future flows in accordance with the risks and other characteristics of tludifferent financial instruments.

5. The contrast between the desired or ex ante yield ofphysical capital (q) and the e:post yield actual1y obtained, with interest rates and exchange rate variations, tumuncertainty into risk and becomes the objective basis (financial preadjustrnent) foeconomic change or dynamics.

6. When normal transactions take place in any economy, in at least two "currencies-the one issued by the country and a foreign currency, used as a medium oexchange and reserve of value- one market must be viewed as a "mirror" of thother, as a result of which the financial preadjustment [4] can be written afol1ows:

ESSAy ON THE NEW ECONOMIC SYNTHESIS AND FINANCIAL HEGEMONY

!(Vd _V") + eh($d$"') = Or

1621

(5)

This expression makes the importance of variations of (r) and (eh) 41, and of theirclear.interaction", explicit, when any external interest rate (rx) is considered.

5.4. The Fundamental Scheme for a Dynamic ModelThe idea that general equilibrium of markets requires an equivalence between the

uses and sources of funds among the agents for an "average" contemporary economy isexpressed in Synthesis Table 3. Six typical agents are specified in the table: families,companies, government, financial authorities, banks, and the rest of the world. Theyinteract in six markets: goods, bank instruments (credits and deposits), domesticsecurities (stocks and non-bank bonds), public or circulating money, foreign exchange,and foreign securities (foreign debt). It should be noted that:l. This scheme omits explicit consideration of bank credit to foreigners, since it

assumes that the national currency is not an "international reserve" currency. Theimplicit consideration of the labor market -assuming that the wage mass W is aresult associated with investment and credit- is justified under the hypothesis of aperfectly elastic supply at an institutionaIly predetermined salary level and ademand dependent on the expected yield (q) related to productivity",

2. Though the scheme makes explicit reference to the primary capital market, itshould be c1ear that this market is relatively narrow in industrializing countries,since few companies list their stocks on the exchange. Hence, most capitaltransactions are made in public securities, which gives special importance to fiscalconditioning factors.

3. Since the general equilibrium of the markets (with consideration for budgetaryrestrictions) requires the sum of aIl surpluses and deficits to cancel each other out,it becomes obvious that the adjustments under the post ergo ante hoc hypothesiswill come in the quantities when prices are predetermined. Hence, the prices ofgoods will be preconditioned by the sum of costs and the wage rate by the profitrate; bank credit will be governed by the central bank's rediscount rate; nonbanksecurities will generally retlect the yields of fixed-income bonds; foreign securitieswill be oriented by the international interest rate and the supply of and demand forforeign exchange will determine the exchange rate", thereby converted to themarket with adjustment ofprices, above al! in contemporary economies.

4. The exchange rate's instantaneous adjustment makes the foreign exchange marketa "combination" of the others by absorbing the disequilibrium of the marketscharacterized by sticky prices or influenced by institutional factors; hence, explicitconsideration of the foreign exchange market makes it possible to omit argumentsreferring to any other market when analyzing the circumstances affecting thegeneral equilibrium, since under Walras' equation it is enough to study (n-I)markets. It will then become possible to eliminate analyses of the labor market bydeeming it implicit, as is usually done in general equilibrium studies throughmonetary values and is shown in Synthesis Table 3.


5. The omission of arguments on the labor market is offset by consideration of theidentities which reflect the influence of the distribution of income (B+W) andspending (C+I). Thus, based on the flows indicated in the table, budgetaryrestrictions, identities, and equilibrium conditions, models can be built withdifferent degrees of detail by making the specific hypotheses of the behavioralequations patent",

6. The Explanatory Logie of the "NE8" and its Consequenees for Eeonomie Polieyin a Midsize Economy

From the economic policy standpoint, it should be stressed that, as a result of theinteraction between financial conditions on the "margin" or the interaction betweeninterest rates and profits, the "stickiness" of goods prices is intrinsic to contemporarycapitalism; said "stickiness" should be understood as resistance to price reductions whendemand falls, due to the requirement for maintaining a positive financial flOW 46

•

Another point which is of key importance for economic policy should also bestressed. While orthodox economics considers the level of employment as a final result,the New Synthesis (NES) focuses on its dynamic influence on the relationship betweenprofit and wages (distribution of income). This is because the level of employment andthe wage rate dynamically influence the behavior of consumption, while the contrastbetween expected profits and profits actually earned dynamically influences investmentand its financing.

Thus, the most important aspects of the "orthodox" stabilization programs stemfrom the specific assumptions of the monetarist approach, which reflect the generalhypothesis that prices on the real markets vary to the point needed to clear the markets(equilibrium price). That is, specifically considering that:1. Internal prices (Pi) are determined by the dynamics of internal overall demand,

related to the expansion of the monetary mass, which in turn is intluenced by thevolume ofpublic deficit".

2. The comparison with the purchasing power of foreign exchange (purchasingpower parity) determines the exchange rate (eh). Its consideration, together withexternal interest rates, makes it possible to indicate the level of internal interestrates (the "covered arbitrage" rule).

3. The joint consideration of the interest rate and the internal rate of return (marginalefficacy) makes it possible to determine the volume of investment. Finally, theentire aggregate demand, including trade in goods and services with the outsideworld, makes it possible to determine the national income.In contrast, a policy reflecting the New Synthesis (NES), based on the "financial

preadjustment" and endogenous money general hypotheses, specifically posits that:1. Institutional conditions, including the rediscount rate (rf) and the financing of the

fiscal deficit at rate rg (exogenous) will affect the level ofthe lending rate (ra) andthe latter will influence the volume of private credit, which is the key to thevolume ofreproductive investment".

Synthesis Table 3. Principal Flows In A Contemporary Economy I

~Families Companies Banks Public Central Rest of Equilibrium Equilibrium Variable to Be

Markets Treasury Bank World ofFlows ofStocks Determined

Goods (p) - M(.) CPR(.)+J y JCPR (.) J * G * - +G+X-M- * (1) (2)

X Y=ONonmonetary BFD-Vd+a Vs-Vd-assets (ri) BT Vs * ABT * * AFs+AF o_ * aBT (3)

BFD(.) AF,(.)=AF d +aBT-Vd (.) aBT=O

Bank Assets and DPs (.) DPo - CR-CRI- DPs-DPo CR(4)Liabilities CRO (.) CRI(.) CR BBT * * CRIO-(ra,rd) BBT=OForeign Debt * xCRI(.) * XBTd(.) DE xCRI+xBT- * Saldo: DE(rx) DE=OForeign $d $s $o-$s- VOD * saldo 00Exchange (eh) ch (5) (a)Monetary BMP(.) BMB(. BMA * RFd-RFs-O BMA-BMB+ BMA (6)Liabilities ) RFs BMP(ennmerate RFd(.)Them)Aetors' J-AF- CR+B G BMA-R X-M+budgetary * CRI+CRlx+ MP=D T=aBT+ F DE=BERestriccions Vs P+RF BBT+xBT +BE

(b)NOTA: (a) 00 IS directly determined and rt codctermines BE, which IS instanly reflected m ch.

(b) The accounting restriccion includcs lB and RB, resulting in: CR+BMP+lB=DP+RF+RB.The symbol (.) denotes bchavioral functions. .The superirnposcd symbol (-) indicates predetermination.

:cmCJ

~Oz-<

1 The variables indicated in the flow table are"J: Investment CRO:Crcdit ro familiesVüD: Forcign exchange flows CRI:Credit to companiesG: Public spending D8T: Bank credit to governmcntOD: Foreign reserves xCRl: External credit lo companiesM:Gold and foreignexchange imports xBT: Extemal credit lo governmentX: Exports BMP:Monetary base held by public

Y: Gross domestic product BMB:Monetary base held by ba- ·{S

aST: Publics bonds hcíd by familiesAF:Self-financmg by companiesDE:Foreign debt [flow)RF:Central Bank credit to banksVd: Corporate securities held by familiesRF:Central Bank credit to banks

BE:Exogenous baseVs:Securities offered by companiesT:Fiscal revenuesBMA:Monetary base issued by authoritiesBFD: Families'securities holdingsDP:Deposits from 'he public held by banks

1624 THE CURRENT STATE or ECüNüMIC SCIENCE

The difference between internal and external interest rates, plus the country risk position,will influence the capital account balance, which together with the trade balancedetermines the exchange rate when there are no restrictions on currency conversion.2. The vaiue of inputs, which is related to the exchange rate (eh) and capital costs

(ra), and the predetermined profit rate (q) exert an "ex ante" and simultaneousinfluence on prices (Pi) and the wage rate (the addition of costs principie), whichwill have an impact on the level of employment and the volume of the wage mass(W).

3. The volume of overall consumption (C), under the influence ofthe wage mass (W)and profitable placements (Vd), plus the volume of investment (i), will determinethe national income. It can be modified by the results of international traderelations and variation of inventory, which adjusts the previously estimatedmacroeconomic results, including the effective profit rate and its reflection instock yields (rp) in "ex post" fashion.To sum up, under orthodox policy the key public economic policy variables are

the volume of fiscal deficit (BT), the monetary base (BMA) or the anchoring of theexchange rate (eh) and the wage rate (flexible); under the policy suggested by the NES,on the other hand, the key variables are the different interest rates (ri), the exchange rate(eh), the profit rate (q), and the volume of credit (CR). The sequence and dynamic amongprices is Pi -> eh -> ri under orthodox policy, and ri -> eh -> P under post-Keynesianpolicy". Synthesis Table 4 illustrates the foregoing.

Since the explanatory differences between these theories are quite significant, theyalso have different potential objectives and policy instrumentation.

Orthodoxy focuses on bringing inflation under control, in association with theachievement of a stable exchange rate in the long term, to which end it stresses a foreignreserve buildup. Hence, devaluation is recommended in the short run, and in the long runit is desirable for countries to specialize in "competitive production". This policy arguesfor an opening to the outside world (even if that means making wages flexible) andwould make employment depend on a multiplier of export activity, which is subject tothe risks of changing international conditions".

The policy suggested by the NES, on the other hand, puts the highest priority onensuring sustained employment for workers and the creation of favorable interna'conditions for investment and production, even if only for the domestic market. Wagereductions are undesirable because they depress consumption and do not causeemployment to expand; in addition, it can be posited that the work force is nohomogeneous and a part of it subsists at an inhumanly low level. Hence, the opening tethe outside world must be evaluated from the standpoint of employment". In othewords, from the standpoint of the NES, the best policy for a "midsize" country includes é

negotiated opening designed to complement production in the respective countries, suclthat the set of "partners" achieves a level of employment higher than each one woukhave had in the absence of integration".

The New Synthesis, then, does not accept the orthodox assumption that monetarpolicy has no impact on overall supply, which reacts to specific policies (industrialagricultural, etc.) designed to improve their "efficiency". On the contrary, the neoliberapolicy of indiscriminate opening is held to constrain the efficiency of specific action


seeking to foster autonomous development, since"smaIl" countries with open economiesare more strongly affected by international trends because they are "price takers",

Its concern to restrict overaIl demand leads neoliberal policy to caIl for higherinterest rates as a way to hold back consumption, and indirectly, imports; at the sametime it seeks to increase capital inflow. Then, it is necessary to reduce the money supplyin order to moderate inflation, which implies raising interest rates and accepting theresuIting risk of recession (contraction of credit, investment, and income) or takingrecession as a necessary price for combating inflation",

The NES would suggest an opposite interest rate policy. Rates should be broughtdown to provide an incentive for investment and employment; imports may increasewhen production expands. The exchange rate's variation wiII then depend on the trend inthe trade balance, the spreads between internal and external interest rates, and "countryrisk",

Synthesis Table 4. Assumptions for Economic Policy

Orthodox Synthesis New Synthesis

'-- ---; '"'''''''r'ca

' ''

wVd

IBMB

BMP- BMA.......I---- DiJ K(e},

BT,rg } l---. C --1.~ I lri J ,

RF(rb) J y~i -.Co j

IH~~rW}eh

CCNered ArtitragelDlscoont

P+fX+rac=~1.K(e)l-' I

Px

+~]...BMf Pi- PPC- eh - M

Purchasing I IPower Pailt.y .-

Y

P-' eh -. ri ri-' eh~ P

Key Policy Variables:VoIumeof

G,T,BMa, y tasa de W late

Key Policy Variables:VoIume of CR, y tasas ri,ch,b tate


To sum up, orthodox policy toward the domestic market is deficient andcounterproductive in attacking the contemporary dilemma of inflation-recessionunemployrnent":1. It ignores the fact that the economic agents take ex ante account of an optimization

criterion which predetermines changes in the distribution of financial stocks andthe volumes of real tlows, as a result of which the orthodox policy provokes a"depressing" process that expresses itself in the following phases:• When the authorities induce an interest rate increase to restrict credit, remove

money from circulation, and finance part of the deficit through securitiesissues, they bring about a contraction of the set of profitable reproductiveinvestments; this reduces the growth of income or provokes a recession if theeconomy is stagnating at the time the policy is adopted.

• When companies and banks attempt a "forward escape" (loans at ratesexceeding physical yields), the recession is reinforced by a downward spiralthat culminates in the outbreak offinancial bubbles and bank insolvencies".

2. It ignores the fact that the real markets' adjustments are "temporary", sinceinventory buildup and unemployment show that the prices which "olear" them arenot necessarily equilibrium prices.

3. It ignores the fact that devaluations, and tloating exchange rate systems in general,at a time of growing worldwide mobility of financial capital (financialglobalization) cause internal capitalization (accumulation) to be intermittent andthreatened by adverse portfolio selection.As a result of all this, the purchasing power parity rules for the exchange rate" and

interest rates do not lead to the expected long-term equilibrium of assets". On thecontrary, the attempt to lower intlation by raising financial costs and depressing theeconorriy sets the stage for banking crises and persistent intlation and unemployment inthe less-developed countries, while in the industrialized countries the crisis takes theform ofrising levels ofopen unemployment.

Finally, when the importance of the "financial preadjustment" identified by theNew Synthesis (NES) is explicitly recognized, we can say that:l. The fight against intlation and unemployment requires a stimulus to production by

facilitating credit and discouraging adverse portfolio selection.2. Regarding credit there is a question as to whether policy action is more effective

when it operates on the magnitudes of tlows or on interest rates. When operatingon the former, policy may resort to actions such as control of the volume ofrediscount or the volume of credit".

3. In relation to the exchange rate, by recognizing that speculative capital moves fora variety of reasons and interest rate policy cannot effectively cope with thosemovements without constraining domestic production, the NES charges theauthorities with preventing speculative crises against the national currency byadopting a Currency Board system if foreign: trade is strong enough to maintain apositive trade balance".

4. The foregoing is strengthened by the observation that circulating currency plays asmaller and smalIer role in all countries (due to the expanding use of credit (virtualmoney) which has its physical manifestation in the so-called "plastic money" orbank credit cards. Hence, the most important function of public money at the

ESSAy ON THE NEW ECONOMIC SYNTHESIS AND fINANCIAL HEGEMONY 1627

present time is to serve as a unit of account, and a stable link to the intemationaIreserve currencies and their acceptance as a medium of exchange suffices to thatend.

7. Conclusions: Keynes' Defeat and Victory

As is made c1ear in the preceding analysis, the change in the use of money in allits forms of expression is an important indicator of the capitalist system's evolution overtime.

By the second decade of the 20th Century the development of commercialbanking, the major expansion of credit that accompanied it, and the growth ofintemational trade led to the beginning of the replacement of the gold standard (anapplication of the currency principIe) by the gold exchange standard. Hence, thetheoretical explanation based on the relationship expressed in the quantitative equationbecame insufficient and its policy application corollaries became questionable. In twokey periods (1920-1936 and 1945-1960), authors such as Bemacer (Spain), Keynes(Cambridge), Triffin (Yale), Heilperin (Geneva), and Rueff (Paris) wamed of theconsequen ces ofthe changes taking place in the monetary system and made contributionsofvarying importance to theory and policy application.

As long as the Anglo-Saxon countries accumulated trade surpluses and kept theircurrencies (sterling and the U.S. dollar) convertible, those currencies were universalIyaccepted and the related financial systems could offer relatively low interest rates,allowing for a sustained economic expansion which made those countries the leaders ofthe capitalist world.

But the difference in productivity levels among Europe, Japan, and the UnitedStates became evídent in the 1960s, while other events such as rising external militaryspending by the United States sparked a large-scale migration of capital. In technicalterms, it could be said that the subsequent credit pyramids began to create a doublecharge on the stock of gold hcld by the United States, which forced that country toabandon free convertibility between the dollar and gold in 1971 and to accept the end ofthe Bretton Woods arrangement in 1976 (Jamaica meeting); had it not done so, the U.S.financial system would have collapsed. .

The subsequent generalization of free currency flotation (intemational monetarydisorder) forced each country's internal monetary policy (especially interest ratemanagement) to adapt to speculative currency movements. That had a negative impact ongrowth, since the use ofhigh interest rates to defend the exchange rate depressed nationaleconomies. As shown aboye, general equilibrium in the capitalist countries depends onthe financial pre-adjustment, as a result ofwhich the basic prices for economic policy arethe exchange rate and interest rates.

The policy consequence of this is that the basic rule of orthodox economics adjustment of demand- is applicable or effective only when the balance of paymentsdeficit stems from the trade balance (overheating of the economy), but not when it is anoutcome of intensifying financial speculation.

How can speculation be eliminated when migration of financial capital isunrestricted?

1628 THE CURRENT STATEor ECONOMIC SCIENCE

We conclude our theoretical analysis with the observation that in contemporaryeconomies public money (monetary base) is used chiefly as a unit of account, defined bysocial convention, and its volume largely depends on the coverage of credit (endogenousmoneyj'", Economic logic and historical experience show that speculation woulddisappear if the capitalist world were to accept a single standard or universal currencysuch as the Keynesian "bancor". Under that condition, the normative remnants of thecurrency principle would be eliminated and the elements of the banking principie wouldbe solely applicable in the sphere of internal monetary policy. This would yield the dualadvantage of following the economic policy of a country that served as a point ofreference (the average yield of total capital) while ensuring the freedom of circulationthat is required by international capital today.

A sole universal currency, or a least a reduction of the number of currencies to ahandful of regional ones defined by groups of countries whose foreign trade amongthemselves predominates over their trade with other parts of the world, would lower thecost of intercurrency transactions by reducing the risk of speculation and the uncertaintywhich proliferate under the floating exchange rate system, but would also require theexistence of a single authority or "coordinating central bank". That in tum wouldundermine the local authorities' autonomy, but the change would be more apparent thanreal because the under the gold standard regime the national monetary authorites took theBank of England as an implicit intemational authority and the U.S. Federal Reserveplayed much the same role during the period ofthe Bretton Woods Agreement.

The recent creation and acceptance of the Euro as the reference currency for theEuropean Union members can then be visualized from two angles. First, as theintroduction of a new standard parallel to the U.S. dollar for use in international trade;and second, as a way to reduce speculation among the European currencies, takingadvantage of the fact that the volume of trade among the signatories to the MaastrichtAgreement is larger than their trade with the United States or Japan.

With the single European currency and European Central Bank (Keynes' revenge)in place, the member countries will have a reference interest rate that will allow thenational credit systems to operate in accordance with their own needs. Clearly, this willlead to mergers among private banks ofthe member countries.

In any case, our final conclusion is that, under the conditions of financialglobalization, a medium-scale country -even one with a trade surplus- can only apply acredit policy tailored to its own needs when it accepts a stable parity between the nationalcurrency and an international reserve currency and guarantees that linkage by allowingunrestricted circulation of the latter. Not doing so exposes it to the risks and rigors offinancial speculation, including capital flight associated with the search for economicefficiency in its own banking system, and no volume of reserves will suffice to controlthat speculation, since the banks can finance foreign currency purchases with their legalreserves, while the financial and foreign exchange authorities are powerless to preventit?'. This phenomenon leads to a steady deterioration of the national currency's exchangerateo

ESSA y ON THE NEW ECONOMIC SYNTHESIS AND FINANCIAL HEGEMONY 1629

The universality of this process has recently been iIIustrated by the unexpectedcrisis of the "Asian Tigers" which saw their banking systems colIapse when Japan foundit impossible to maintain low interest rates and provide credit to the local banks, afterwhich they had to bear the brunt of capital flight and devaluation of their currencies.

Endnotes

l. It can also be stated that Latin American exports continue to be largelyconcentrated in commodities or products with little va1ue added. That results inlarge trade deficits due to the Se1ective World-Market Orientation policy whichhas opened up countries' internal markets to imports before those countries canexpand their export capacity, two thirds of which continues to be represented byraw materials and other commodities.

2. Ferrer (1995) has also pointed out that only 5% of the trillion U.S. doJlars thatmove on the foreign exchange markets every day represents payments for factorsand real commercial transactions. The other 95% consists of capital movements,chiefly short-term ones.

3. A committee of banking regulators from the 10 most highly industrializedcountries (Group of Ten), which has issued minimum capital recommendations(standards) for internationaJly operating banks; those standards focus on risk toassets and tracking of capital movements.

4. FormalIy, the fundamental change carne at the 1976 Jamaica meeting.5. The importance of financial interaction has begun to be recognized by Latin

American authors, as evidenced by the coining of the expression "FinancialHegemony" by the distinguished Argentine economist Aldo Ferrer (1995).

6. The assumption of financial market efficiency can be rebutted by recognition thatcapital market speculation reflects not only indicators of productive enterprises'performance but also the influence of extra-economic factors (Blanchard et al.,1993).

7. New Economic Synthesis or (NES).8. Mossé (1997:62) points out, on the basis of OECD statistics, that there were

approximately 10 milJion unemployed in the member countries in the early 1970s;by 1993 the figure had risen to 33 million, and to it should be added the roughly15 milJion people c1assified by the OECD analysts as "dropouts", making for atotal of 50 million unemployed.

9. Among others, Martin de Azpi1cueta(1556), and "paraIJel" writers in France (JeanBodin, 1568). Prior to that, Oresme (1366), Bishop of Lisieux was a precursor towhat carne to be known as Gresham's Law in his work De Origine, Natura etMutationibus Monetarum.

10. Phases of the development of a scientific approach to economics can be identified.A prescientific stage would run from ancient Greece and Rome as far as theSalamanca School. It was foJlowed by three successive scientific stages: first, thatof the physiocrats and c1assical economists up to 1870; second, includingmarginalism and mathematization of equilibrium; and third from Keynes (1936) tothe present, since in Kuhn's sense there have been three different paradigms: thelabor vaJue theory, marginalism, and Keynesianism.

1630 THE CURRENT STATE üFEcüNüMIC SCIENCE

11. The extremes come together in the person of those who follow the deductivemethod of mathematics, those who apply inductive logic in a more or lessempirical fashion (as in the so-called physical sciences), and those who eling tohistoricism. For the latter, economics can do no more than describe observedcases.

12. Select Committee on the High Price ofGold Bullion (Galbraith, 1975:50).13. The Bank ofEngland abandoned the gold standard in September 1931.14. As is well known, marginalism made it possible to resolve Smith's paradox (the

different values attributed to water and diamonds): marginal utility variesinversely with quantity. Hence, the low price ofuseful but abundant goods and thehigh price commanded by scarce goods even if they are doubtful utility. Themarginality principIe also shows that the prices of services for productive factors(costs) are related to marginal productivities, which generalizes the traditional ideaof labor value. Note as well that the Vienna School thinkers (from Menger toHayeck) adopt an individualism so extreme as to reject macroeconomics outright,focus on the psychological dimension of behavior, and take an extreme a-prioriapproach.

15. Note the concem for "mathematically" demonstrating the existence of anequilibrium point; without it, even if the analysis were economically coherent thetheoretical apparatus would be too fragile. Wald (1936) achieved that goal, basinghimself on the works of Cassel (1918) and others.

16. The microeconomic critiques were made by Sraffa (1926) and Chamberlin (1933).17. This group also ineludes Myrdal (1931) and Kalecki (1935), though for sorne

analysts the latter is quite close to Marxist heterodoxy. Bemacer, for his part, wasamong the first to point out the lack of coherence in Keynes' "General Theory",which tautologically postulates the saving-investrnent equality when in previouswork he had come across unproductive saving.

18. The introduction of multipliers as ratios among the macromagnitudes was aconceptual innovation which, together with the negation of the automatic trendtoward full employment and the key role of expectations in determininginvestrnent, can be accepted as a substantive change of paradigm or a scientificrevolution in Kuhn's sense.

19. Other approaches arising between 1920 and 1940 inelude the "Socialist EconomicOptimum" (Lange, 1936) in relation to the compatibility of socialist planning andgeneral equilibrium, and Hayeck's opposition (1939) based on imperfectinformation and absence of incentives. Both conserve the general equilibrium asthe point of reference. Special mention should go to Von Neumann (1936), whoproposed a balanced growth model based on general equilibrium and asserted thatthe interest rate is equal to the growth rate at the equilibrium point (Zylberberg,1989:22).

20. A recent neariy exhaustive study of this issue was made by M. Beaud and G.Dostaller (1993). It contains sorne differences from Blaug's work in the same vein(1985).

21. The NEC complements the rational expectations approach (Lucas) withFriedman's natural rate of unemployrnent concept. But there is no empiricalevidence that any stable natural rate exists, and far less that all the predictive


variables can be probabalized to calculate mathematical expectations thatempirically support the rational expectations approach.

22. This presentation is consistent with Allais' version (1981:p. 335). For Allais,general equilibrium will be achieved when there is no possibility of any furtherexchange which appears to be advantageous. He also considers the Arrow-Debreuversion (1959) to be unrealistic in spite of its mathematical rigor, and insufficientto demonstrate the stability of equilibrium (Boncoeur-Thoument, 1992:p. 191).

23. This expression presents ajuxtaposition of"flows" (labor and goods markets) andstock markets (money and securities). But that does not pose a serious problem,since identity may arise in terms offlows when an initial stock is made explicit:

p(yd_ys) + w(Ld_LS) + [(Md_Mo)-(MS-Mo)] - 1/r [(yd_yo)_(Ys_yo)] = O

Another possible presentation is

1/r (Vs-Vd) = p(yd_ys) + w(Ld_LS) + [(Md_Mo)-(MS-Mo)]

according to which the net supply of securities is equal to loanable funds (PoncetPortait:p. 21).

24. The graphic representation of the IS and LM curves expresses equilibrium in themarkets and reflects the equality of saving and investment (sensitive to fiscalpolicy) and the equality of demand for monetary liquidity and the money supply(sensitive to monetary policy).

25. A volume of employment which correlates with a stock of capital is assumed.26. A complement to the neoclassical model is provided by Phillips' concept (1958) of

a diminishing relationship between the unemployment rate and the rate ofvariation of nominal wages. Hence, inflation will be close to full employment. Theneo-Keynesians, for their part, stress the idea that in the absence of equilibriumprices the interaction among the markets leads to rationing (Malinvaud, 1980).

27. Complementary hypotheses such as nullity ofthe interest rate make the LM curvevertical, which brings us back to the c1assical model; if LM is horizontal (theliquidity trap), fiscal policy will be the only efficient response. The bibliographywith intermediate models is quite extensive. Poncet-Portait's work (1981) and thatof Anisi (1988) strike us as complete.

28. Not all societies have used a general medium of exchange. One example was theAztec society, which at the time ofthe conquest (according to a well-known letterfrom Hemán Cortéz to Charles Y) had a market larger than those ofthe Europeancities. Transactions were made without money, following a system of rulessupported by strict controls.

29. As Aglietta remarks, it is truly arbitrary to try to compare the "purchasing powers"oftwo currencies and attribute them to "economic technique" factors, when in factthey reflect the particular political circumstances of each society. The dangerinherent in such comparisons is that, depending on the author making them andthe circumstances of the case, they can lead to the disqualification of the currency("coinage") as a social reference in a given country.

30. As is well known, this theory is based on the fact that depositors do notsimultaneously withdraw all the funds "on deposit", but only a fraction of them.Hence, the banks can lend out a significant portion thereof. Since the "loaned"


portion will be deposited again, and a fraction of it will be subject to withdrawal,the remainder will once again be available to be lent out, and this succession ofpotential credits forms a convergent series. The sum of that series of credits caneasily be calculated on the basis of the coefficient of retention, which is given bythe public's habits and legal regulations.

31. Summarizing for illustrative purposes, inflation arises in' the income redistributionprocess according to the Cambridge (England) School (see, for example,Robinson, 1960:271). According to the Marxists, price increases are necessary toremunerate overaccumulation (Bourges, 1978:60). The circuit theorists attributeinflation to the action needed to prevent business failures (Kauffman, 1988:60). Inour view, inflation is a consequence of underinvestment for directIy reproductivepurposes.

32. ConsequentIy, contemporary financial systems have at least three kinds ofinstruments: coined money (money issued by the authorities), credit money (creditoriginating in banking operations), and securities or credits (obligations amongnon-bank private parties).

33. At present, according to Femández Díaz (1994), as many as 17 distinct "schools"can be identified, but they can be grouped into five major currents of thought:Microeconomic neoclassicists with distorted Keynesianism. Modem monetarists.Post-Keynesians. Marxists and radicals. Institutionalists.As mentioned aboye, the New Synthesis (NES) rests basically on postKeynesianism, and its formalization in general equilibrium models requires arelatively small number of equations.

34. Equilibrium as social harmony based on the search for private profit through thedivision oflabor (specialization).

35. The strictly neoclassical system considers :

(yd_ yS)+ l/p(Md_MS)

where the price ofmoney is expressed as its purchasing power (l/p).36. It is sufficient to state that the goods market is one of flows and the explicit

inclusion of the labor market is unnecessary since the nth market must be inequilibrium if n-I markets ensure the presence of general equilibrium.

37. The post-Keynesian system visualizes an equivalence among the followingelements:

l/r(yd_ys); l/ra (CRd_CRS); (Md_MS)

where CRs and CRd are the supply and demand for bank loans.38. The cumulative interaction, as a result of the financial preadjustment, can be

positive (stimulating investment and increase the real magnitudes) or negative(depressing investment and reducing those magnitudes).

39. The foregoing is equivalent to saying that the explicit equations for prices (marketclearing by flexible prices) can advantageously be replaced by a subsystem ofequations which makes the changes in indebtedness and profit explicit, and relatesthe latter to the market's expansion, which in tum is related to the distribution ofincome. These elements are very difficult to reflect in the explicit price equations,which conceal variations in the rate of profit.


40. Hence, the purchasing power concept is insignificant compared with theimportance of tlows calculated on the basis of nominal rates.

41. The foreign exchange market is adjusted by prices in the short term if the centralbank refrains from intervening.

42. In our view the post-Keynesian system would inelude the following elements:

lIr (yd_ys); lira (CRd_CRS); eh ($d_$s).

43. According to Lago (1993), the foregoing assumptions retain their validity for"small" economies in course of industrialization, since there is a dual skills marketin those economies: a modern sector with salaries determined by collectivebargaining, and a traditional sector retlecting a social minimum wage determinedwith State participation. Oversupply of labor is assumed in the traditional sector,so all pressure to raise the minimum wage will be frustrated unless it is supportedby the State. The modern sector, on the other hand, may be characterized byexcess demand for labor, but even under those circumstances the level ofemployment will be constrained by the level of capitalization and associated creditrequirements.

44. The validity of Walras' law or Say's principie stems directly from the sum ofrestrictions, and does not depend on prices' being the sole mechanism forbudgetary allocation of resources or on the economic agents' optimizing objectivefunctions (Lago, 1993, p. 9, eiting Clower).

45. The presentation ofa particular "model" would go beyond the scope of this artiele,which attempts only to review the different behavioral theories. An example ofthat work is provided in Mata (1994).

46. Another factor to be considered is that the quantities of the different markets aremutually conditioned.

47. Foxley (1986) points out the existence of a somewhat different "monetaryapproach" related to the balance of payments. Here, internal prices depend oninternational prices, the political variant involves anchoring the exchange rate (ifthe foreign reserves are large enough to make that possible), and there is no needto be concerned about the growth of the money supply. Credit restrictions areassumed to drive up the interest rate and attract capital from abroad, while tariffreductions will help lower internal prices.

48. Note that the levels of credit and ra, plus the rules of institutional proportions, willrequire a counterpart of deposits DP and a management of rd to achieve it. Thisleads to BMB, which makes BMA the variable to be adjusted. That is opposed toorthodox reasoning, which treats BMA as an exogenóus variable.

49. Note a) that the "intermediate" position in the dynamic sequence ofthe exchangerate (eh) can cause actions on the exchange rate based on differing conceptions tocoincide, depending on the particular circumstances; and b) that the rate of profitis the key policy variable for the private sector. Hence, when heterodox programsseek to incorporate social consensus-building measures, they must deal with thosemeasures' impact on private interests, an extremely sensitive issue. Note as wellthat the sequence in Foxley's version would be ch~Pi-Hi.

50. The operating assumptions of orthodox theory are:


i) the external deficit stems from excess demand, basicalIy originating ingovernment spending.

ii) Commercial and financial opening to the outside world, lifting of pricecontrols, and wage flexibility wi1l bring relative prices into line withinternationallevels.

iii) Financial opening to the outside work facilitates the financing of moderateexternal deficits.

iv) Economic growth and growth of employment are associated with thegrowth of competitive exports.

v) Interest rates at international and "positive" levels ensure sufficient saving.51. The point is not that the NES favors a closed economy; it is to determine the

expansion of internal employment produced by interaction with the outside worldwhen the economy is opened up to imports and wages are made more flexible, ineach particular case.

52. We stress that the concern for production for the internal market and for anegotiated opening to the outside world in the course of economic integrationprocesses encounters associable policy proposals in René Vi1lareal's work (19761997), defined by that author as "neo-structuralist",

53. A restrictive monetary policy implies control of internal financial flows, whichshould lead to a stabilization of the monetary aggregates, accompanied by fiscalausterity. In particular, the monetary restriction limits the expansion of internalcredit, while seeking to stimulate saving by ensuring "positive" interest rates forremuneration of saving. The outcome wi1l be a trend toward bank insolvency.

54. The achievements in bringing down inflation have come at the cost of risingunemployment, and led the national economies down the inefficient path of "stopand-go economics".

55. To i1lustratethe fact that financial crises have broken out everywhere, we mentionthe 1987 stock market crash (New York, Tokyo, and the leading Europeanexchanges) and the crises of 1994 (Mexico, Venezuela), 1995 (Poland), 1996(Czechoslovakia), 1997 (Thailand, Malaysia, and other Southeast Asian countries.

56. As is welI known, the theoretical foundation ofneoliberal exchange rate policy isthe Monetary Theory of the Balance of Payments. According to this approach,equilibrium in external payments depends on an equilibrium between the supply ofand demand for internal money. Hence, the response is to reduce internal credit,and then to focus attention on the real exchange rate, which wi1l be in equilibriumwhen the country achieves the same rate of inflation as its principal "customers"and "vendors" in international trade. A major assumption of this theory is that adevaluation has no impact on the differences in internal relative prices, but rather,affects the general price level. The position we have taken is exactIy opposite tothis one. In our view, equilibrium of external payments affects internal demandthrough public money, so the point is to watch the movement of the nominalexchange rate and the factors which influence it.

57. It is also important to note that the short-term correction achieved by reducingdemand is limited by the unreal assumption of price flexibility. In fact, prices incontemporary economies depend on the desired or planned rate of profit and costsincurred.

ESSA y ON THE NEW ECONOMIC SYNTHESIS AND FINANCIAL HEGEMONY 1635

58. An empirical examination of this issue leads to a review of the analytical pathsfollowed by B. Friedman and Kuttner (1992) and by P. Wang and Ch. Yip (1992),as well as the policy followed by France in the 1980s.

59. This conditioning effect leads to a specification of the diagnosis in each concretecase. To that end we believe it is useful to complement our conclusions with thetheoretical approach of the 'savings-investment', 'foreign exchange', and'absorption' gaps, which allow us to overcome the false conflict betweensubstitution of imports and promotion of exports. A precise and detailed treatmentof this approach, though putting forward different proposals for exchange ratemanagement, is found in the study done by René Villarreel (1997) for the Mexicancase.

60. A consequence of public money's endogenity is an increase of bank system risk,since bank clearance's large share of GDP (2 days and a half days in Switzer1andand Japan, 3 to 4 days in the United States and Germany: Crocrocket 1994) makesit difficult to exclude large institutions from the clearing system, even when theyare illiquid. This fact poses a serious difficulty for the authorities.

61. The El Nacional newspaper of Caracas reported this action in 1998 (p. E-l); therewere even negative compensations in spite of penalties at rates going as high as60%.

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