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The Second End of Laissez-Faire -- Bootstrapping Nature of Money and Inherent Instability of Capitalism

Listed author(s):
  • Katsuhito Iwai

    (Faculty of Economics, University of Tokyo)

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    "Globalization" can be interpreted as a grand experiment of the laissez-faire doctrine of neoclassical economics that the wider and the deeper markets cover the capitalist economy, the more efficient and the more stable it would become. The "once a hundred years" global economic crisis of 2007-9 stands as a testament to the grand failure of this grand experiment. Following the lead of Wicksell and Keynes, this article argues that capitalist economy is subject to an inevitable trade-off between efficiency and stability because of its essentially "speculative" nature. First, while financial markets need, for their risk-diversifying function, the participation of a large number of risk-taking professional speculators, competition among professionals can be likened to Keynesian beauty-contest that constantly exposes financial markets to risks of bubble and bust. Second and more fundamentally, it is the very use of "money," which is the ultimate source of efficiency for capitalist economy, which is also its ultimate source of instability. To hold money is the purest form of Keynesian beauty contest, because we accept money only because we expect everybody else accepts it as money. When there emerges a speculative bubble on money, it plunges the real economy into depression, and when there emerges a speculative bust on money, it eventually leads to hyperinflation. Indeed, Wicksellian theory of cumulative process shows that any disturbance in monetary equilibrium triggers a disequilibrium process that drives all the nominal prices cumulatively away from it. Keynesian principle of effective demand then demonstrates that it is the stickiness of nominal wage that saves capitalist economy from its inherent instability, albeit at the expense of full employment. This article also contends that in the current global crisis such monetary instability has manifested itself in the form of the collapse of liquidity in the financial markets as well as in the form of the loss of confidence on dollar as the global capitalism's key currency.

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    Paper provided by Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo in its series CARF F-Series with number CARF-F-160.

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    Length: 61 pages
    Date of creation: Aug 2009
    Date of revision: Oct 2009
    Handle: RePEc:cfi:fseres:cf160
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    1. George A. Akerlof, 2009. "How Human Psychology Drives the Economy and Why It Matters," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 91(5), pages 1175-1175.
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