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The Quantity Theory and the Income Expenditure Theory in an Open Economy: Canada, 1926–1958*

Published online by Cambridge University Press:  07 November 2014

George Macesich
George Macesich*
Affiliation:
Florida State University
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Post-war balance of payments problems are partly the results of policy applications of the “modern view” of the balancing mechanism of international trade theory. Derived from the Keynesian income-expenditure theory of income determination, the “modern view” relegates the role of the stock of money to a secondary place in determining national income. It asserts that control of the stock of money through monetary policy is incapable of significantly, or dependably, influencing the circular flow of income and thereby the balance of payments. One reason for this view is the conviction that monetary velocity behaves in an erratic and unpredictable manner. In contrast, pre-Keynesian theory attributed a central role to the stock of money, and so to monetary policy, in the balancing mechanism of international trade. It contained an explicit acceptance of the quantity theory of money which argues, among other things, that monetary velocity does behave in a predictable manner.

The usefulness of the modern view of the balancing mechanism of international trade turns partly on the relative stability and behaviour of monetary velocity on the one hand and of the Keynesian investment multiplier on the other. In all countries, but particularly in those that are sensitive to external disturbances, the balancing mechanism of international trade is an issue of vital concern for public policy. The purpose of this paper is to examine the relative stability and behaviour of monetary velocity and of the investment multiplier in an open economy that is subject to external disturbances and in which international trade plays a relatively important role in aggregate output and income. The article deals with the Canadian economy during the period 1926–58.

Type
Articles
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 30 , Issue 3 , August 1964 , pp. 368 - 390
Copyright
Copyright © Canadian Political Science Association 1964

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Footnotes

*

I wish to thank the Research Council, Florida State University, for a grant and the Computing Center of Florida State University for making available machine time which partly made this study possible. I am indebted to Marshall R. Colberg, Richard G. Cornell, and Fred S. Jaap, for useful comments and suggestions, and I owe a special debt of gratitude to Milton Friedman and David Meiselman.

References

1 See for example, Metzler, Lloyd A., “The Theory of International Trade,” Ellis, Howard S., ed., A Survey of Contemporary Economics (Homewood, Ill., 1949), vol. I, 212.Google Scholar For a useful summary see Harry Johnson, G., “Monetary Theory and Policy,” American Economic Review, 06, 1962, 335–84.Google Scholar

2 See for example, G. Rosenbluth, “Changing Structural Factors in Canada's Cyclical Sensitivity, 1903–54,” this Journal, Feb., 1958, 21–44; Marcus, Edward, “Cyclical Turning Points: Canada 1927–39,” American Economic Review, 09, 1954, 572–85.Google Scholar

3 Metzler, , “Theory of International Trade,” 212.Google Scholar

4 Friedman, Milton and Becker, G. S., “A Statistical Illusion in Judging Keynesian Models,” Journal of Political Economy, 02, 1957, 65–75.Google Scholar

5 Milton Friedman and David Meiselman, The Relative Stability of Monetary Velocity and Investment Multiplier in the United States, 1897–1958, forthcoming publication of the Commission on Money and Credit.

6 George Macesich, “The Rate of Change in the Money Stock as a Leading Canadian Indicator,” this Journal, Aug., 1962, 424–30.

7 Friedman, Milton, A Program for Monetary Stability (New York, 1960), 87.Google Scholar

8 In this writer's opinion the recent crises owe their origin more to the uncertainty generated by the pronouncements of political persons than they do to strictly economic factors.

9 McIvor, R. Craig, Canadian Monetary, Banking and Fiscal Development (Toronto, 1958), 123 Google Scholar (cited hereafter as CMBFD). Continued expansion of the money stock implied the expansion of notes and deposits by chartered banks. The failure on the part of these banks to contract their operations and so preserve external balance was the result of the operation of the Finance Act. Under its provisions chartered banks were able to replenish their reserves by pledging securities with the Minister of Finance and receiving in exchange Dominion notes convertible into gold. The gold drain was, in effect, transferred from the banks to the government. Following a heavy gold drain at the end of 1928 the Department of Finance ceased to convert Dominion notes into gold in early 1929 and Canada chose to depart de facto from the gold standard rather than to undertake the adjustments required by that standard.

10 For a detailed analysis of this period see Knox, F. A., Dominion Monetary Policy, 1929–34 (Ottawa, 1939)Google Scholar and McIvor, CMBFD.

11 McIvor, , CMBFD, 133.Google Scholar

12 Dominion Bureau of Statistics, National Accounts Income and Expenditure, 1926–56 (Ottawa, 1958), 19.Google Scholar

13 McIvor, , CMBFD, 134.Google Scholar For a discussion and analysis of events leading to the establishment during this period of the Bank of Canada see, for example, Plumptre, A. F. W., Central Banking in the British Dominions (Toronto, 1940)Google Scholar and Neufeld, E. P., Bank of Canada Operations, 1935–54 (Toronto, 1955).Google Scholar

14 Marcus, , “Cyclical Turning Points,” 581.Google Scholar

15 McIvor, , CMBFD, 182 Google Scholar and R. Craig McIvor, “Canadian War-Time Fiscal Policy, 1939–45,” this Journal, Feb., 1948, 62–93.

16 Rasminsky, Louis, “Foreign Exchange Control in Canada: Purposes and Methods,” Parkinson, J. F., ed., Canadian War Economics (Toronto, 1941), 1–16.Google Scholar

17 McIvor, , CMBFD, 171.Google Scholar

18 For a discussion of the “free” Canadian exchange rate see Harry C. Eastman, “Aspects of Speculation in the Canadian Market for Foreign Exchange,” this Journal, Aug., 1958, 355–73; Harry C. Eastman and Stefan Stykolt, “Exchange Stabilization in Canada, 1950–54,” ibid., May, 1956, 221–33; and Paul Wonnacott, “Exchange Stabilization in Canada, 1950-54: A Comment,” and Harry C. Eastman and Stefan Stykolt, “Exchange Stabilization Once Again,” ibid., May, 1958, 262–66.

19 Friedman and Meiselman, The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897–1958.

20 All estimates except the money supply are taken from National Accounts Income and Expenditure, 1926-56 for the period 1926-56; and from the Canadian Statistical Review, 1959 Supplement (Ottawa, 1960)Google Scholar for annual and quarterly estimates for the period 1957–58. Quarterly estimates for the period 1947–52 are from National Accounts Income and Expenditure by Quarters 1947–52 (Ottawa, 1953)Google Scholar; for the period 1953-55 quarterly estimates are from Canadian Statistical Review, 1955 Supplement; and for 1955–58 they are from the Canadian Statistical Review, 1959 Supplement.

The money supply estimates are from an unpublished manuscript by George Macesich.

The annual figures are centred means of end of month figures. Quarterly figures are centred means of end of month figures. The concept is the sum of currency, bank notes, and all chartered bank deposits in public hands.