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Knut Wicksell

Johan Gustaf Knut Wicksell (December 20, 1851  – May 3, 1926) was a leading Swedish economist of 

the Stockholm school. His economic contributions would influence both

the Keynesian and  Austrian schools of economic thought.

Biography[edit source | editbeta] 

Wicksell was born in Stockholm, Sweden on December 20, 1851. His father was a relatively

successful businessman and real estate broker. He lost both his parents at a relatively young

age  – his mother died when he was only six years old, and his father died when he was fifteen.

His father's considerable estate allowed the now fatherless child to enroll at the University of 

Uppsala in 1869 to studymathematics and physics. He received his first degree in two years,

but continued in graduate studies until 1885 when he received his doctorate in mathematics. In

1887, Wicksell received a scholarship to study on the continent where he heard lectures by the

economist Carl Menger  in Vienna. In the following years, his interests began to shift toward the

social sciences, and in particular, economics.

 As a lecturer at Uppsala, Wicksell had attracted attention for his opinions about labor. At one

lecture, he condemned drunkenness and prostitution as alienating, degrading, and

impoverishing. Although he was sometimes identified as a socialist, his solution to the above

problem was decidedly Malthusian in advocating birth control  – a theory he would defend to the

end of his life. Although he had attracted some attention for his fiery ideas, his first work in

economics, Value, Capital and Rent, published in 1892, was largely unnoticed. In 1896, he

published Studies in the theory of Public Finance, applying the ideas

of  marginalism to progressive taxation, public goods, and other aspects of public policy,

attracting considerably more interest.

Wicksell married  Anna Bugge in 1887, although he found it difficult to support his family on his

irregular positions and publications. Economics in Sweden at the time was taught as part of the

law school and Wicksell was unable to gain a chair as a professor until he was awarded a law

degree. He returned to the University of Uppsala where he completed a four-year law degree in

two years, and subsequently became an associate professor at that university in 1899. The next

year, he became a full professor at Lund University, where he would undertake his most

influential work.

 After giving a lecture in 1908 satirizing the Immaculate Conception, Wicksell was deemed guilty

of  blasphemy and imprisoned for two months.[1]

 Eight years later, in 1916, Wicksell retired fromhis post at Lund and took a position at Stockholm advising the government on financial and

banking issues. In Stockholm, Wicksell associated himself with other future great economists of 

the so-called "Stockholm School," such as Bertil Ohlin, Gunnar Myrdal and Erik Lindahl. He also

taught a young Dag Hammarskjöld, the future Secretary-General of the United Nations. 

Wicksell died in 1926 while writing a final work on the theory of interest. Elements of his public

policy were taken strongly to heart by the Swedish government, including his price-level

targeting rule during the 1930s (Jonung 1979), and also his vision of a welfare state. Wicksell's

contributions to economics have been described by some economists, includinghistorian-of-

economics Mark Blaug, as fundamental to modern macroeconomics. Michael Woodford has

especially praised Wicksell's advocacy of using the interest rate to maintain price stability,noting that this was a remarkable insight at a time when most monetary policy was based on

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the gold standard (Woodford, 2003, p. 32). Woodford calls his own framework 'neo-Wicksellian',

and he titled his textbook on monetary policy in homage to Wicksell's work.

Theoretical contributions[edit source | editbeta] 

Wicksell was enamored with the theory of  Léon Walras (the Lausanne school), Eugen von

Böhm-Bawerk (the  Austrian school), and David Ricardo, and sought a synthesis of the three

theoretical visions of the economy. Wicksell's work on creating a synthetic economic theory

earned him a reputation as an "economist's economist." For instance, although the marginal

productivity theory  – the idea that payments to factors of production equilibrate to their marginal

productivity  – had been laid out by others such as John Bates Clark, Wicksell presented a far 

simpler and more robust demonstration of the principle, and much of the present conception of 

that theory stems from Wicksell's model. Wicksell's (1898, 1906) theory of the "cumulative

process" of inflation remains the first decisive swing at the idea of money as a "veil" as well

as Say's Law. 

Extending from Ricardo's investigation of income distribution, Wicksell concluded that even a

totally unfettered economy was not destined to equalize wealth as a number of Wicksell's

predecessors had predicted. Instead, Wicksell posited, wealth created by growth would be

distributed to those who had wealth in the first place. From this, and from theories

of  marginalism, Wicksell defended a place for government intervention to improve national

welfare. Wicksell influenced the field of constitutional political economy. His 1896 work on fiscal

theory Finanztheoretische Untersuchungen called attention to the significance of the rules within

which choices are made by political agents, and he recognized that efforts at reform must be

directed toward changes in the rules for making decisions rather than trying to influence the

behaviour of the actors.[2]

 

Wicksell's most influential contribution was his theory of interest, published in his 1898work, Interest and Prices. He made a key distinction between the natural rate of interest and the

money rate of interest. The money rate of interest, to Wicksell, was merely the interest rate seen

in the capital market; the natural rate of interest was the interest rate that was neutral to prices

in the real market, or rather, the interest rate at which supply and demand in the real market

was at equilibrium  – as though there were no need for capital markets. This theory was taken

after of the  Austrian School, which theorized that an economic boom happened when

the natural rate of interest was higher than the market rate.

This contribution, called the "cumulative process," implied that if the natural rate of interest

was not equal to the market rate, demand for investment and quantity of savings would not be

equal. If the market rate is beneath the natural rate, an economic expansion occurs, andprices, ceteris paribus, will rise. This gave an early theory of  endogenous money  – money

created by the internal workings of the economy, rather than external factors, and various

theories of endogenous money have since developed.[3]

 

Knut Wicksell's theory of the "cumulative process" of inflation remains the first decisive swing at

the idea of money as a "veil". Wicksell's process has its roots in that of  Henry Thornton . Recall

that the start of the Quantity Theory's mechanism is a helicopter drop of cash: an exogenous

increase in the supply of money. Wicksell's theory claims, indeed, that increases in the supply of 

money leads to rises in price levels, but the original increase is endogenous, created by the

relative conditions of the financial and real sectors. With the existence of credit money, Wicksell

argued, two interest rates prevail: the "natural" rate and the "money" rate. The natural rate is thereturn on capital  – or the real profit rate. It can be roughly considered to be equivalent to the

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marginal product of new capital. The money rate, in turn, is the loan rate, an entirely financial

construction. Credit, then, is perceived quite appropriately as "money". Banks provide credit,

after all, by creating deposits upon which borrowers can draw. Since deposits constitute part of 

real money balances, therefore the bank can, in essence, "create" money.

Wicksell's main thesis, that disequilibrium engendered by real changes leads endogenously to

an increase in the demand for money  – and, simultaneously, its supply as banks try to

accommodate it perfectly. Given full employment, (a constant Y) and payments structure

(constant V), then in terms of the equation of exchange, MV = PY, a rise in M leads only to a

rise in P. Thus, the story of the Quantity Theory of Money, the long-run relationship between

money and inflation, is kept in Wicksell. Primarily, Say's Law is violated and abandoned by the

wayside. Namely, when real aggregate supply does constrain, inflation results because capital

goods industries cannot meet new real demands for capital goods by entrepreneurs by

increasing capacity. They may try but this would involve making higher bids in the factor market

which itself is supply-constrained  – thus raising factor prices and hence the price of goods in

general. In short, inflation is a real phenomenon brought about by a rise in real aggregate

demand over and above real aggregate supply.

Finally,for Wicksell the endogenous creation of money, and how it leads to changes in the real

market (i.e. increase real aggregate demand) is fundamentally a breakdown of the Neoclassical

tradition of a dichotomy between monetary and real sectors. Money is not a "veil"  – agents do

react to it and this is not due to some irrational "money illusion". However, we should remind

ourselves that, for Wicksell, in the long run, the Quantity Theory still holds: money is still neutral

in the long run, although to do so, Knut Wicksell have broken the cherished Neoclassical

principles of dichotomy, money supply exogeneity and Say's Law.

(source:newschool.edu/~het/home.htm)

Parts of Wicksell´s ideas would be expanded upon by the  Austrian school, which used it to forma theory of the business cycle based on central bank policy  – changes in the level of money in

the economy would shift the market rate of exchange in some way relative to the natural rate,

and thus trigger a change in the relative proportion of the production of consumer goods to

investment, which would ultimately result in an economic correction, or recession, in which the

proportion of production of consumption goods to investment in the economy is pushed back

towards the level that the natural rate of interest would result in. The cumulative process was

the leading theory of the business cycle until John Maynard Keynes' The General Theory of 

Employment, Interest and Money . Wicksell's theory would be a strong influence in Keynes's

ideas of growth and recession, in Gunnar Myrdal's key concept Circular Cumulative

Causation and also in Joseph Schumpeter 's "creative destruction" theory of the business cycle.

Wicksell's main intellectual rival was the  American economist Irving Fisher , who espoused a

more succinct explanation of the quantity theory of money, resting it almost exclusively on long

run prices. Wicksell's theory was considerably more complicated, beginning with interest rates

in a system of changes in the real economy. Although both economists concluded from their 

theories that at the heart of the business cycle (and economic crisis) was government monetary

policy, their disagreement would not be solved in their lifetimes, and indeed, it was inherited by

the policy debates between the Keynesians and monetarists beginning a half-century later.

Wicksell also expressed his views on many social issues and was often a critic of the status

quo. He questioned the institutions of rank, marriage, the church, the monarchy, and the

military.[4]

 While Wicksell fought for a more equal distribution of wealth and income, he saw

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himself primarily as an educator of the public. He desired to influence more than just the field of 

monetary economics.