Fundamental Re-Examination of Keynesian Economics and Monetarism as Portfolio Adjustment Theories: Towards the Fundamental Reformation of Modern Macroeconomics

Abstract

The quantity theory of money is a theory that the quantity of money matters in income creation. Curiously, this theory may be developed in two mutually exclusive manners. One is by thinking that the quantity of money that matters in income creation is the quantity of money “in” circulation because the primary role of money is the role of a “means of exchange.” The other is by thinking that the quantity of money that matters in this sense is the quantity of money “out of” circulation because the primary role of money is the role of a “means of hoarding,” or an “asset.” Keynesian economics (both old and new) and monetarism have evolved from the latter standpoint as portfolio adjustment theories. Moreover, though in general not properly understood, post-war mainstream macroeconomics has always been such portfolio adjustment theories. To tell whether money is really primarily a means of hoarding as literally all current mainstream macroeconomists firmly believe, this paper re-examines the trend of liquidity preference in the inter-war two decades which saw the Great Depression, and also that in the last two decades which saw the Great Recession. In each case, the result is unambiguously in favor of the idea that money is primarily a “means of exchange.” The quantity of money that matters in income creation is the quantity of money “in” circulation, not that out of circulation. Modern macroeconomics must be fundamentally reformed accordingly.