Uncertainty In Rosensteinrodans Monetary Theory

In recent literature there seems to exist a fair amount of agreement among writers that uncertainty has to be regarded as the major determinant of movements in the size of cash-balances, i.e. as the main cause of liquidity-preference. At closer inspection, however, this apparent harmony emerges as somewhat problematical, because different writers give this word a different meaning. In the following we shall confine ourselves to the examination of two examples of monetary theories in both of which the leading role is assigned to uncertainty, and we shall find that in each case the word has a different meaning.

Afterwards we shall make use of the result of our critical examination of these theories in order to find that meaning of 'uncertainty' which will enable us to regard it as the cause of liquidity-preference.

In a study on 'The Co-ordination of the General Theories of Money and Price'1 Dr Rosenstein-Rodan uses the word uncertainty 'in its original meaning of doubt, of a vague and dumb feeling of not knowing'.2 This 'vague and dumb feeling' is, however, according to him, of causal significance for the existence and magnitude of cash-balances. This result is obtained by means of contrasting our world of frictions and unforeseen changes to a frictionless world of perfect foresight. 'In an economy without frictions, where everybody foresaw with perfect certainty his tastes, income, future prices, and therefore the dates as well as the size of his purchases, nobody would keep a cash-balance' (271). Hence, 'Money (as cash-balances) exists only and in so far as general foresight is not certain, it is the function of the individual's feeling of uncertainty, a means of meeting it, a good satisfying the want for certainty' (272).

This statement, however, is later on qualified in a footnote, where we read that The function of uncertainty about income and prices will be naturally a function of many variables' (p. 272, footnote 3);3 i.e. translated from the language of functional into that of causal-genetic analysis, uncertainty is but one of many causes of liquidity-preference. Moreover, the statement about the functional relationship between uncertainty and cash-balances has to be read in the context of Dr Rosenstein's discussion, in an earlier part of his article, of the store-of-value-function of money (266-7). Here we are told that money, although being the only good capable of fulfilling the functions of unit of account and medium of exchange, is 'only one of many goods fulfilling what one may call a cash-balance-function'. And, significantly enough, the author adds that, even where money is established as the standard of deferred payment, it will not be the only store of value.

The conclusion which we have to draw from Dr Rosenstein's argument thus appears to be this: There exists a certain functional relationship between uncertainty and the demand for cash-balances. Yet, neither of the exact form of this relationship nor of the other variables and their relative significance have we the slightest knowledge. We are left much in the position of King Crasus, who asked the Oracle of Delphi about his chances in the war he was going to wage on his neighbour and received the reply that he would destroy a great empire.

If a causal-genetic investigation like ours is to be conducted on Dr Rosenstein's line of approach, two main questions have to be answered. First: Can increased uncertainty not be accompanied by a diminution in the demand for money, viz. a 'flight from the currency'? Secondly: Are we not familiar with examples of cash-balances held not because of uncertainty but because of the (subjective) certainty of their owners that prices will fall? If in both cases the answer is in the affirmative, this would mean that it is impossible to assign to uncertainty in this sense the role of a cause of liquidity-preference.

In both respects the lesson of experience seems to be clear. Uncertainty may result in an increased demand for cash-balances. But if at the same time the future of the currency is deemed to be in danger, we know by manifold experience that people will feel induced to exchange their cash for highly illiquid goods like furs, jewels, and furniture.4 Uncertainty may generally induce people to restrict the volume of their current liabilities. But if it also affects the future value of money: people may even borrow for buying commodities of the kind mentioned. When will they act in this, when in that manner? We do not know; our functional relationship does not provide us with a satisfactory criterion.

While our conclusion is thus of little, if any, help to the monetary theorist and, of course, entirely useless for purposes of monetary policy, it would be unfair to blame Dr Rosenstein for it. For the task he had set himself was to co-ordinate the general theories of money and of price, and since he endeavours to do it on the Lausanne model, he is entitled to confine himself to inserting a new set of variables into a system of simultaneous equations. As in this system all quantities are interdependent, it is sufficient to show that any variation in uncertainty must have some repercussion on some other magnitudes in order to make the system work and safeguard it, on its own level of abstraction, against theoretical objections. That this type of functional analysis does not solve the problems we have set out to solve is no argument against it; that it 'does not tell us anything about the real World', is a true, but by no means a novel gravamen. Slightly varying Professor Ricci's comment on Pareto one feels tempted to say that, while adding with great architectural skill to the beauty of the famous castle that was erected on the shores of the Lake of Geneva, Dr Rosenstein has still left the housing problem unsolved.

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