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, 1955), pp. 103-115 Published by: The University of Chicago Press Stable URL: http://www.jstor.org/stable/1827046 . Accessed: 29/07/2011 03:38

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JAMES TOBIN

theoreticalmodels just one tenablerate of growth. in As ofthebusiness cycleand of eco- acceleratormodels,growthis limited nomicgrowth typically other possess by theavailability factors of than two related characteristics: (1) they capital. But here these limitations do assumeproduction and theycan functions thatallow not operateso abruptly, for substitution no between by and factors, and be tempered monetary pricead(2) the variables are all real magni- justments that the acceleratormodels tudes; monetary and price phenomena ignore. have no significance. The cyclical behaviorof the model Because of these to characteristics, these modelspresenta is similar thenonlinear cyclicalprocrigid and angular pictureof the eco- esses of Kaldor, Goodwin, and Hicks.2 nomic process: straightand narrow But the cycle in the present modeldepathsfrom which slightest the way on theinflexdeviation pendsin an essential spellsdisaster, abruptand sharprever- ibilityof prices,moneywages, or the sals, intractable assets. ceilings and floors. The supplyof monetary modelsare highly the suggestive, their Furthermore, model to be debut representation the economy of arouses scribedhere does not restrict ecothe the suspicionthat they have left out nomic process to two possibilities, some essentialmechanisms adjust- steadygrowth cycles.An alternative or of line of development continuing ment. is unThe purposeof thispaper is to pre- deremployment "stagnation" during sent a simple aggregative investment increases the model that whichpositive allowsbothforsubstitution possibilities capital stock and possiblythe level of and for monetary effects. The growth real income. This outcome,like the in mechanism themodelis notradically cycle,dependson somekindof priceor different fromthe acceleratormecha- monetary inflexibility. nismthat plays the key role in other In Part I the structure the model of growth models.But it is unlikethe ac- willbe described, and in Part II some celerator in mechanism thatthere not of its implications be examined. is will

ONTEMPORARY 'I wish to acknowledge with gratitudehelpful discussionsof this subject with graduate students and colleagues at Yale University.In particular, Henry Bruton, Thomas F. Dernburg, William Fellner, Challis A. Hall, and Arthur Okun read the paper and made valuable comments.So did Robert M. Solow of M.I.T. But it is not their fault if I have failed to follow all their advice. The paper was writtenwhile I was holding a Social Science Research Council Faculty Fellowship.

2 N. Kaldor, "A Model of the Trade Cycle," Economic Journal, L (March, 1940), 78-92; R. Goodwin, "The NonlinearAccelerator and the Persistence of Business Cycles," Econometrica,XIX (January, 1951), 1-17, and "Econometrics in Business Cycle Analysis,"in A. H. Hansen, Business Cycles and National Income (New York: V. W. Norton & Co., 1951), chap. 22; J. R. Hicks, A Contribution the Theory of the Trade Cycle to (Oxford: OxfordUniversityPress, 1950).

Yale University

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JAMES TOBIN

I themarginal products homogeneous are functions degreezeroof thetwofacof whichthis blocks from The building are modelis constructed fourin num- tors; in other words, the marginal depend onlyon theproportions ber: (1) the saving function;(2) the products in whichthetwoinputsare beingused. function;(3) asset preferproduction conditions. The real wage of labor,w, is equated ences; and (4) labor-supply by competition themarginal to product of labor; and the rent,r, per unit of THE SAVING FUNCTION of of At any moment timeoutputis be- timeearnedby ownership any unit of capital is equated to the marginal ingproducedat a rate Y, consumption of at is occurring a rateC, and thecapital product capital: stock, K, is growingat the rate K, w =PN (K, N) (3) equal to Y-C. The saving function r =PK (K, A) (4) tells how output is divided between and consumption net investment: If labor and capital expand over time in proportion, thenoutputwill expand (I) K = S (IY) in the same proportion, and both the is This relationship assumedto hold in- realwageand therent capitalwillreof is That is, consumption main constant. capital expandsat a stantaneously. If adjusted withoutlag to the simulta- faster ratethanlabor,its rent mustfall, neous level of output; any outputnot and the real wage mustrise. is consumed an additionto the capital A production function withconstant or stock.Whether not it is a welcome returns scale,bothat any moment of to which de- timeand overtime, a convenient additionis anothermatter, is beof pends on the asset preferences the ginning In assumption. judgingthe apdiscussedbelow. community, of propriateness thiskindofproduction it Of thesavingfunction, is assumed function the model,it shouldbe reto and thatS(Y) is membered thatS'(Y) is positive that,if it ignorestechnical the improvement, the one hand, it igzero forsomepositiveY. Otherwise on is shapeof thesavingfunction not cru- nores limitations other of factors proof Variables other duction,"land," on the other.In the cial to the argument. than Y-for example, W, total real course of the argumentthe consethe quences of technological wealth-could be assumedto affect progresswill to propensity save withoutinvolving be briefly discussed. complications. morethaninessential

ASSET PREFERENCES

Only two stores of value, physical are The rateof output, dependsjoint- capital and currency, available to Y, of The ly on the stockof capital in existence, owners wealthin thiseconomy. on K, and the rate of inputof labor serv- ownrateof return capitalis its rent, r, equal to its marginal product.Curices,N: rencyis whollythe issue of the state (2) N) Y=P(K, and bearsan ownrateofinterest legally This rate established. is function assumedto and permanently The production It that will be assumedto be zero. The stock be linearhomogeneous. follows

THE PRODUCTION FUNCTION

105

of currency, is exogenously Ml, deter- existingcombination K and M/p of a of mined and can be variedonlyby budget represents situation portfolio baldeficits surpluses.The counterpart ance or imbalance?Portfolio or balance is of this"currency" themorecomplex assumedin thismodelto be defined in by is asset structure an actual economy thefollowing of functional relationship: not money by the usual definition, M (6) which includes bank deposits corre-=L(K, r, Y), to sponding privatedebts.It is, forthe Lr<O, L)> O. LKX>0, in United States, currency circulation for balances plus government debt plus the gold Requirements transactions of currency assumed,as is customare stock. If p is thepriceof goods in terms of ary, to depend on income; this is the the community's total real reason forthe appearanceof Y in the currency, function. Given theirreal wealth,W, wealthat any moment timeis of ownersof wealth will wish to hold a M (5) largeramountof capital,and a smaller 11=K+-. Up amount currency, higher rent of the the GivenK, M, and p, thecommunity may on capital,r. Giventherenton capital, be satisfied splitits wealthso thatit owners wealth to of willdesireto putsome holdsas capitalan amountequal to the part of any increment theirwealth of available stock,K, and as currency an intocapitaland somepart intocurrenamountequal to the existing real sup- cy. It is possiblethatthereare levelsof ply, Mip. Such a situation will be re- r (e.g., negative rates) so low thatportferred as "portfolio to balance." foliobalance requiresall wealthto be Portfolio balance is assumed to be in the form currency thatthere of and the necessaryand sufficient condition is some level of r above whichwealth forpricestability - 0). If, instead, owners (k wouldwishto holdno currency. ownersof wealthdesire to hold more But the main argument followin to goods and less currency, theyattempt Part II concernsrangesof r between to buy goodswithcurrency. Prices are, 7 thoseextremes. bid up (p > 0). If theydesireto shift The assumption about portfolio balin the otherdirection, theyattempt to ance has nowbeenstated, and thereadsell goods forcurrency < 0). These er whois moreinterested learning (p in its price changes may, in turn,be asso- consequencesthan its derivationcan ciated withchangesin outputand em- proceedto the next section.But since ployment;but that depends on other this is the one of the four building on partsof themodel,in particular the blocksofthemodelthatintroduces posof conditions labor supply. sibly unconventional and unfamiliar whether an materialinto the structure, requires What, then,determines it and defense. 3This is the same concept developed in con- some discussion nection with discussionsof the "Pigou effect";see The theory portfolio of balance imand Full EmployHerbertStein,"Price Flexibility plicitin mostconventional aggregative ment: Comment," American Economic Review, XXXIX (June, 1949), 725-26, and Don Patinkin, economic theories investment of implies "Price Flexibilityand Full Employment: Reply," that rates of return all assets must on Economic Review, XXXIX (June,1949), American be equal. Appliedto the two assets of 726-28.

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JAMES TOBIN

monetaryassets. He interest-bearing was able to showthat,givenuncertainin ty or lack of unanimity theexpectathe of tions wealth owners, rateofinterbalance beportfolio est thatpreserves tweencash and "bonds" is not indeof of pendent thesupplies thetwokinds ofassets.But he didnotapplythesame to reasoning the muchmoreimportant physicalgoods or capiof currencyis, therefore, se/p. Simi- choicebetween and tal, on the one hand, and monetary of owners wealthhave a firm larly, of unanimousview of the rate at which assets,on the other.His theory inwealthwillgrowifit is heldas physical vestmentwas orthodoxin requiring efficiency the between marginal mar- equality capital.This rateis re,theexpected whichmay or may notbe the of capitaland therateofinterest. ket rent, behind the portThe assumptions of sameas r. Owners wealthwillchoose equation in the present wealth folio-balance makestheir which thatportfolio grow at the fastestrate. If - jbe/pwere model, equation (6), may be briefly of to exceedre, theywould desireto hold stated.Each owner wealthentertains values of both numerous and no capital; if re were as possibilities all currency than- kelp, theywoulddesire re and - #e/p, and to each possiblepair ,greater The a to hold all capital and no currency. of valueshe attaches probability. value of re, thatis, the mean Onlyifthetworatesare equal willthey expected probability distribution, of of its marginal be satisfied holdpositiveamounts to value both assets; and, indeed,in that case, is assumedto be r. The expected willnotcarewhatthemixofassets of - 5e/p is assumed to be zero. In they the of otherand less precisewords, owner On is in theirportfolios. thistheory the on the relativesupplies ofwealthexpects balanceneither asset preferences Whatever rent of capital nor the price level to of the assets do not matter. balance requires change.But he is not sure.The disperthe supplies, portfolio and on sionsofpossiblerents pricechanges ratesof return thattherealexpected values and below theirexpected if the assets be equal. In particular, above twoassets. the requires constitute risksof the re r and ke 0, equilibrium asOwnersof wealth,it is further thatr _ 0. in sumed,dislikerisk. Of two portfolios thistheory Keynesdepartedfrom value of rate of of withthesame expected explanation his liquidity-preference the one will prefer an return, investor the choice betweencash balances and with the lower dispersionof rate of IAn individual may be assumedto knowthe of The principle "not putting courseof pricesp(t) up to the present return.5 historical of course prices all your eggs in one basket" explains a (fort to) and to expect future the mythicaleconomyof this paper, Owners wouldgo as follows: thistheory of wealth have a firm,certain,and of unanimousexpectation the rate of pricechange, 5e.This may or may not be the same as the actual rateof price of changejp at thesame moment time.' The rate at whicha unit of wealthis if to expected grow it is heldin theform

course the -to). Presumably expected p,(t) (for startsat the same priceat whichthe historical is courseends (p[to]=pj[to1). But there no reawiththesameslopewith start son thatone should to whichthe otherends: p'(to), referred in the the textas k,is not necessarily same as pe'(to), to referred in thetextas

6 Risk aversion in this sense may be deduced from the assumption of generallydecliningmarginal utility of income. Here, however, it is not necessaryto go into the question of the usefulness of the concept of cardinal utility in explaining behavior under uncertainty.

107

whya risk-avoiding is investor may well ductivity higherthe more capitalhold a diversified portfolio even when intensive the combination. Suppose theexpected returns all theassetsin thereis a unique relationbetweenthe of it are notidentical. thepresent For pur- supplyof labor and the real wage. An pose it explains whyan owner wealth equilibriumlabor-capitalcombination of willhold currency excessof transac- is one thatdemands in laborin an amount tions requirements, even when its ex- equal to the supplyforthcoming the at pectedreturn zero and the expected real wage corresponding thatcombiis to return capitalis positive. also ex- nation.The equilibrium on It absoluteprice plains why,given the risksassociated level is then determined the portby with the two assets, an investormay folio-balance equation. Given the rent desire to have more of his wealth in and amountof capital in the equiliband the supply of capital the largeris r. The higherthe rium combination prospectiveyield of a portfolio, balance mustbe obthe currency, portfolio greater the inducement acceptthe tainedby a pricelevelthatprovides is to the additionalrisks of heavierconcentra- appropriate amountof real wealth in liquid form. tionon themoreremunerative asset.6

LABOR SUPPLY BALANCED GROWTH

Proportional growthof capital, income,and employment accordimplies, ing to the assumed productionfunction,constancy capital rent,r, and of the real wage,w. Maintenance portof foliobalance requires, an therefore, increasein M/p. Giventhesupply curof rency, pricelevelmustfallcontinuthe ously over time. Balanced growthreII quiresan expanding laborsupply, availSTATIONARY EQUILIBRIUM able at the same real wage and at an money wage. The modelwouldbe of littleinterest everdecreasing if its position stationary of equilibrium GROWTH WITH CAPITAL DEEPENING were inevitably and rapidly attained, In thismodel, unlike thoseofHarrod, but, forthe sake of completeness, this Hicks, and others,failureof the labor positionwill be describedfirst. There to for are any number combinations la- supply growat theratenecessary of of balanced growthdoes not mean that bor and capital that can produce the at a slowerrate is possible.If zero-saving level of output. To each growth the real wage mustrise in orderto incombinationcorrespondsa marginal duce additionallabor supply,the rent productivity labor,to whichthe real of of capitalmust, is true,fallas capital it wagemustbe equal; thismarginal pro- grows. Portfolio balancerequires, there' There is an "incomeeffect" working the fore, in thata givenincrement capital of opposite direction. portfolio-balance The function, be accompanied a greater by price deequation(6), assumesthe substitution effect to be dominant. cline than in the case of balanced

The behaviorof the model depends in a crucialway on assumptions regardingthe relations the supplyof labor of to the real wage, to the moneywage, and to time. willbe convenient, It therealternative fore,to introduce assumptionsin the courseof the argument of Part II.

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JAMES TOBIN

growth. But thereis some rateof price MONETARY EXPANSION AS AN ALTERdeclinethatwillpreserve portfolio balNATIVE TO PRICE DEFLATION ance, even in the extreme case of comGrowth withcontinuous price deflapletely inelastic labor supply.Although tionstrains assumption thatwealth the the rate of price declineper increment owners expect,on balance, the price of capitalis greater less elasticthe level to remainconstant.The process the supplyof laborwithrespect the real itselfwould teach them that the exto wageand withrespect time, time pectedvalue of the real return curthe to on rate of price declineis not necessarily rency positive, is and it wouldperhaps faster.The growth income,saving, also reducetheirestimates the disof of and capitalis slowerwhenlabor is less persion possiblereturns currency. on of elastic,and it takes longerto achieve This lessonwould increasethe relative thesame increment capital. of attractiveness currency a storeof of as value and thusforce everfaster an rate TECHNOLOGICAL PROGRESS AND ofpricedecline. PRICE DEFLATION An alternative price deflation to is The preceding argument assumed expansion thesupplyof currency. has of As an unchanging production function with notedabove, monetary expansioncanconstant returns scale. In comparison not,in thismodel,be accomplished to by withthatcase, technological is progress monetarypolicy in the conventional to deflationary the extentthat a more sense but mustbe the resultof deficit rapidgrowth income of augments trans- financing.7 Assumethatthegovernment actionsrequirements currency. for But deficitM takes the formof transfer technological inprogress offsetting payments. has Then equation (1) mustbe flationary to effects the extentthat it changedto read: raisesthemarginal of productivity capM M ital corresponding given inputs of to k=S(Y+-J. (7) P P/ capital and labor. Conceivablytechnical improvement keep the renton The normalresultis thatconsumption can and a capital risingeven thoughits amount willbe a larger investmentsmaller relativeto the supply of labor is in- share of a given level of real income. This rise might is even be suffi- Thus, the greater M, the slowerwill creasing. cientto keep the demandforreal cur- be therateof capitalexpansion. the At rencybalances fromrising, spite of same timethe growth the currency in of the growth the capital stock and of supply meetsgrowing of retransactions transactions At requirements. theother quirements and satisfies the desire of it extreme, is possibleto imaginetech- wealth owners to balance increased nological progress that failsto raise or holdingsof capital, possibly yielding even lowersthe marginalproductivitylowerrents, withenlargedholdingsof ofcapitalcorresponding giveninputs liquid wealth. to ofthetwofactors. of Progress thiskind 7The implicationsof the approach of this paper containsnothing counteract de- concerningthe effectsof conventional monetary to the of flationary pressures a growing capital policy are left for discussion elsewhere. Clearly stock, decliningcapital rent, and in- such a discussionrequiresthe introductionof additional types of assets, including bank deposits transactions creasing needs. and privatedebts.

109

That thereis a timepath of M commaybe seen patiblewithpricestability consethe by considering inflationary quencesof largevalues of M. There is a presumably value of M large enough to so thatthe desireof the community save at the disposable income level by Y + M/p wouldbe satisfied saving Then thecapitalstock at therateRI/p. would remain constant,its marginal and wouldstayconstant, transproduct actions requirementswould remain unchanged. Portfolio balance could at onlyby inflation thenbe maintained bethesame rateas R/M. Somewhere tween thisvalue of Alland zero thereis of supply a rateof growth thecurrency withpricestability. compatible

WAGE INFLEXIBILITY AS AN OBSTACLE TO GROWTH

of N, because the marginal productof labor declineswithemployment witha given capital stock. This relation is shownin Figure 1 as curveLMB. The levelof employment is themaximum Nf laborsupplythatcan be inducedat the givenmoney wage.At thatlevel of employment money the wagebecomesflexibleupward. themoney If wageis raised or lowered, LMB curvewillshift the up or downproportionately. the capital If stockis expanded, LAMBcurvewill the shift downward, because an addition to capital will raise the marginal product of labor at any levelof employment.

LMS Pf PB LM P

Po~~~~~~~~~~~~~~~~~~~'

PB

Po

I If the currencysupply grows too that the slowly, necessity pricedeflation -probably an ever fasterprice deflacastsconsidergrowth tion-accompany Fic-. 1A.-Stable FIG. 1B.-Unstable able doubt on the viability of the above. This described processes growth The secondrelation between same the limits twovariables, and N. is the"portfolio the doubtarisesfrom institutional p of on downwardflexibility prices, in balance" relationPB, also shown in character- Figure 1. As the name indicates,it wage rates, money particular The purpose shotvs any level of employment istic of actual economies. for the is sections price levekrequired for portfolio of thisand thetwo following balto analyze the behaviorof the system ance between givenstockof capital the whenmoney wageratesare inflexible. K and thegivensupplyof currency AM. to For this analysisit is convenient Its slopemaybe either positive negaor between tive. The marginal work with two relationships productivity the of of the price level, p, and employment given stock of capital, and hence the assume a rentof capital,is greater higher labor, AT.Both relationships the the K. The first, volume of employment. constantcapital stock, Currencyis called the "labor market balance" thusa relatively attractive less asset at gives forany level of higher (LMB) relation, levels of employment; faras so employment, thepricelevel,p, that this effect concerned, pricelevel N, is the of equates the marginalproductivity mustbe higher higher at levels of emin laborto therealwage. Giventhemoney ployment order to reduce the real The transactions for wage,thisp is higher largervalues s apply of currency.

NNd No Nf N- Nd No N1

d PB

1 10

JAME'S TOBIN

relation demandforcurrency the (Fig. 1B), capital expansionincreases of to levelof real income in works, however, both No and Po. The PB curve shifts the opposite direction.Whatever its more than the LMB curve,and their slope, the PB curve will, for obvious intersection The movesnortheast. qualireasons,shiftupwardif currency of sup- tativeeffect capital expansionmay ply M is expanded,and downward be depictedgraphically imagining if by capital expands. the PB curveto shiftdownward while It is notpossibleto establish priori the LMB curve stays put. The same a which curve, LMB or PB, has the argument showsthatcapitalaccumulagreater slope. The two possibilities are tion moves a point like (pf, Nf) or in shown Figures1A and 1B. In Figure (Pd, Nd) in Figure 1B downward, while 1A the LMB curve has the greater capital decumulation movesit upward. slope; bothcurvesare drawn withposi- When the intersection (Po, No) is a tive slopes, but the PB curve could stablepoint(Fig. 1A), theargument of equally well have a negativeslope. In the Appendix indicatesthatcapital exFigure1B thePB curvehas thegreater pansionnecessarily lowersPo but may slope. As indicatedby the arrows,the either increaseor decreaseNo; the inintersection No) is a stable short- tersection moveeither may southeast or (po, runequilibrium Figure1A butan un- southwest. is, in other words,not in It stable one in Figure 1B. This follows possibleto say whichcurveshifts more fromthe assumptionthat 5 will be as a consequence a givenchangein of positive,zero, or negative,depending thecapitalstock. permit on whether consideration of wealthownersregardtheir These results the questionwhether growth with full currencyholdings as too large, just of with right,or too small.' In Figure 1B employment laboris compatible on wage rate.Except (pf, Nf) is a stable short-runequilib- a floor themoney laborsupplygrowsas rium.And theremaybe another stable in thecase where intersection Nd) . Here Ndwouldbe rapidlyas capital or morerapidly,the (Pd, a levelof employment low and, cor- growthprocess brings about an inso amount respondingly, real wage so highthat creaseoftherealwage.A certain a ofpricedeflation therefore is compatible the rigidity the moneywage breaks of withrigidity the moneywage. But, of down. according the results to in reported the Capital expansion shifts both the previous paragraph, certainly theunin LMB and the PB curve downward. stable case and possiblyin the stable How does capital expansionaffect the case, too,theamountof pricedeflation point (po, No)? The following results neededto maintain portfolio balance is are provedin theAppendix:Whenthe too muchto enable employment be to intersection No) is an unstable point maintained a rigid (po, at money wage.Cap8 Employmenthas been assumed always to be ital growth shiftsthe PB curve down at the point where the marginal product of labor more than the LMB curve. However, equals the real wage. But the conclusionson the stabilityof (po, No) in the two parts of Figure 1 it is also possiblein thestablecase that would not be altered if it were assumed instead theLMB curveshifts morethanthePB that N is positive,zero, or negativedependingon curve, so that employment could be whether the marginal product of labor exceeds, equals, or is less than the real wage. maintainedand even increasedwhile

A I)YNAM\IIC A(;(GREA(-FI

MOI)lL

111

the money wage remains rigid and reached at which the wage rate bedownward in Fig. 2). de- comesflexible (Nd pricesfall.But eventhispossibility The permanence this"floor"equiof pends on the assumptionthat wealth dependsupon the savingfuncownersbalance theirportfolios the librium on expectation thatthe pricelevel will re- tion. If positivesaving occurs at the main the same. As noted above, it is levelsofincome produced laborsupby onlyrealistic expectthata processof ply Nd, capitalexpansion continue; to will deflation would itselfteach ownersof and so also will price and wage deflawealthto expectprice deflation thenderather tion.Increase of employment than price stability. of Such expectations pendson thewillingness labor to acwould inevitably enhancethe rela- cept additionalemployment the low at so severe tive attractiveness currency an levelto which has unemployment of as wage. Willingness asset that the process could not con- driventhe money to tinuewithout reduction themoney- accept additionalemployment this a at of money wage maybe encouraged the wagerate. by

WAGE INFLEXIBILITY AND

Po Pf ,LMB

CYCLICAL

FLUCTUATIONS

R

It is the situation depictedin Figure 1B thatgives rise to the possibility of a cycle formally similar to those of Kaldor, Goodwin, and Hicks. Suppose theeconomy at point(pf,Nf). Capital is will expansion sooneror latercause this point coincide to with(po, No) at a point 1i(. 2 like R in Figure 2. This day will be hastened any inflation themoney- increasein the real wage due to conin by wage floor fosteredby full employ- tinued A capitalaccumulation. sufficient ment; it may be that,once havingen- lowering the money-wage of rate dejoyedthemoney wage corresponding manded for increased employment to (pf,Nf) in Figure1B, laborwillnotac- would result in a situationlike that cept any lowermoney wage. Once R is represented pointS in Figure3, and by reached,any further capital expansion fullemployment could be restored. will require a price decline that will the Alternatively, "floor"maycorrepush the real wage of labor,giventhat spond to a level of incomeat which the moneywage cannotfall,above its thereis negativesaving. The gradual marginal productivity. Employerswill attrition the capital stockwill then of thereforecontract employment. But move the PB curve up relativeto the this does not obviate the necessity of LMB curve. capitalbecomes As scarcer, pricedeflation. Indeed,it aggravates it, itsmarginal product rises; and forboth because the reduction employmentreasons its attractiveness of relative to lowers the marginal productivity of that of currencyincreases.Whatever capital. Balance cannot be restored happens to the money-wage termson bothin thelabor market and in wealth whichlabor will accept additionalemholdings untila level of employment ployment, decumulation capital is the of

I PdK f PB' N LMB Td 1

t4N

112

JAMES TOBIN

are increasing, because the timerateof pricedeflation becomestoo fastin relaOnce S is reached, contraction reduc- tionto thislag. Likewise, of any further can tionin the money wage,or any further employment be stoppedand even demands decumulation capital,willlead to an reversedwhen money-wage of of expansion employment. increas- have had time to catch up withwhat But to ingemployment enhances rela- has been happening the price level. only the In thisdiscussion the floorit has of tiveattractiveness the existing of stock of capital,causingthepricelevelto rise been assumed that the rate of capital is by and employment be still further to in- decumulation controlled the saving function. An interesting question creased. As Figure 3 shows,the only arises when the saving function indistopping pointis (pt, Nf). Once Nf is cates dissavingat a rate higherthan reached, money the wage becomesflex- that at which the capital stock can ible upwardand follows pricelevel the physically decumulate.In the models of Goodwin Hicks,in fact, floor and the is thelevelofincome which at dissaving equals the maximum possible rate of capitaldecumulation. A physical limit therateofcapital on decumulation cannotreallybe handled withinthe framework an aggregaof tive model that takes accountof only one industry, commodity, one one and pricelevel. Such a modelassumesthat theoutput theeconomy essentially of is Fic. 3 homogeneous and can equally well be consumed accumulated productive or in upward until portfolio balance is re- stocks, from whichit can be withdrawn storedat the price level pf. The cycle at will.If capital goodsand consumers' thenrepeatsitself. goodsare regarded less thanperfect as The floorin this model is provided substitutes, is necessaryto imagine it by a levelof employment low,and a that they have different so price levels. real wage correspondingly high,that Encountering Goodwin-Hicksfloor so a money-wage rates become flexible wouldthenmeanthatthetwopricelevdownward. The breakdown money- els diverge.At any lower level of inof wage rigidity may also be interpretedcome the community would be unable as a function time; as Leontiefhas to consume capitalat therate at which of suggested, the money-wage rigidity not it wishedto dissave.Consequently, may woulddissavefrom holdits reflect any persistent "moneyillusion" community This would stop the on thepartofworkers their and organi- ings of currency. fall in the price level of consumption zationsbut only a lag in theirperceptionof thepricelevel to use in reckon- 9W. Leontief, "Postulates: Keynes' General ing theirreal wage.' Troubleoccursat Theoryand the Classicists,"in S. E. Harris (ed.), The New Economics (New York: A. A. Knopf, fullemployment, whenreal wages 1947), chap. xix. even willeventually lead to a position like S

in Figure 3.

LMB Ps Pt PB p LM8 N-* NoNd Nf

113

goods and make the Goodwin-Hicks SUMMARY flooran equilibrium level of employ- The simple aggregative model that mentand income.The price of.capital has been presentedhere differs from goodswouldcontinue fall as owners others to usedin discussions growth of and capital cycles in two main respects. of wealthattempted convert to The prointo eithercurrencyor consumption. duction function allowsforsubstitution This fall in the value of capital goods between capitaland labor.The willingbalance-even ness of thecommunity holdphysical would restoreportfolio to though consumers' goods pricesceased capital depends on its rate of return ratesremained and on the value of the liquid wealth to fall and money-wage rigid-by making capital a smaller held by the community. These two aswealth. sumptions proportion the community's of providea link,generally abWith the model thus amended,the sentin other models, between world the physicallimiton capital decumulation of real magnitudes and the world of a provides floor thatwillstopand even- moneyand prices. This link provides even if the the modelwithsome adjustment tuallyreverse contraction a mechBut money-wage is intractable. the anisms ignoredin other growthand rate neednotproceedto thisex- cycle models. The followingconclucontraction floor treme,if the wage-flexibility de- sions result: scribedabove occurs at a higherlevel 1. Growth possibleat a greatvais and of employment output. rietyof rates and is not necessarily whenthelabor supplygrows precluded WAGE INFLEXIBILITY slowlyor remains constant. AND STAGNATION 2. The course of the price level as arises from The cyclejust described capital growsdependson (a) the acin thesituation depicted Figure1B. But rate of expansionof the companying the situation Figure 1A, wherethe of labor force,(b) the rate at whichthe greater LIMB curvehas an algebraically slope thanthe PB curveand the inter- supply of currencyis augmentedby and deficits, (c) therateof section(po,No) is a stable equilibrium, government technological progress.The firsttwo In also is a possibility. thiscase the inTechnotersection may moveto the leftas the factorsare both inflationary. In of stockincreases. Growth cap- logical progresshas mixed effects. capital expansion and of ital is accompanied reduction em- theabsenceof monetary by progress, price deflation so ployment, long as the money-wage technological of maintained. This process may is a necessaryconcomitant growth rate is even whenthe labor supplyis increasend in a stationary position equilibrium in if it entailssuch a reduction output ing just as rapidlyas capital. In these to therefore, growthwith (or, if wealthis relevant the saving circumstances, employment cannot such an increasein wealth) stableor increasing function, if rate as to reducesaving to zero. But it is continue the money-range is indownward. also possiblethat a processwithposi- flexible 3. Given wage inflexibility, sysof the tive saving,growth capital, and intem may alternatebetweenhigh and will continue creasingunemployment low levels of employment concurand, indefinitely.

114

JAMES TOBIN

rently, betweenperiodsof price infla- occurring the same time. Whether at tion and deflation. The ceilingto this the systembehaves in this manneror cyclicalprocessis provided inelasti- with cyclical fluctuations by depends on cityof thelabor supply. The floor may the relationbetweenthe conditions of be providedeitherby the breakdown portfolio balance and the rate of reof therigidmoney wage or by physical turnon captial.The greater shift the in limitson the rate of consumption portfolios of that ownersof wealthwish the capital. Alternatively, systemmay to make when the rate of returnon "stagnate" at less than full employ- capital changes,the more likely it is ment, quite conceivablywith capital that the systemwill have a cyclical growthand reductionof employmentsolution.

APPENDIX The equation of the labor-market-bal-aPo (M) aK 'Po/ ance curve,forgivenK, is

PPN (K, N) =wo (1)

aK

YPK -

(6)

= - PoLK-POLrPKK-POL

dp

)

LMB

- LKPNN

p2PNN Wo

(2)

DD

KL,r

PNNPKKLr y - PNXPKL

Y),

~~~~~~~~(7)

Since PNN < 0, thisslope is positive. The equation of the portfolio-balance curve,forgivenK and M, is ak

M=pL

=

+ PNKPNL

(WD LK+WOLrPKK 5

- MPNK

+ WOL YK),

(8)

(K, r, Y)

N]).

(3)

where

D =

(dp d TP'B

M

pM

WOLTPK,\--MPN

N + WOLYPN

(9)

(LrPKN+L

yPN).

(4)

Since Lr.< 0, PKN > 0, and Ly > 0, this slope may be either positiveor negative. The point (po, No) is determined the by intersection (1) and (3). The problem of is to findthe changesin Po and No associatedwithan increasein K. ly, Differentiating and (3) with re(1) spectto K gives

O9K 4-P

From (2), (4), and (9), it can be concluded that D will be positive,zero, or negative according theslopeof theLMB as curveis greater than,equal to, or less than the slope of the PB curve.In the stable case (Fig. 1A), D is positive.In the unstablecase (Fig. 1B), D is negative. The production function assumed to is be homogeneous degree of one. ConsequentPNN+PKK=P.

apo(WO)+ a No (POPNN)

K(5) POPNKR

PNNN+PKNK

PNKN+PKKK

= O,

=

(1 0) (11)

A DYNAMIC

MODEL (;GGRE(G'ATINTE

115

Opo _-

,OK

D (t N

+PNKCPNLY

P(PL

s(2)

- PNNPKLY)

Since PNN is negative, this derivative has the oppositesign of D. Consequently, in the stable case it is negative,and in the unstablecase it is positive. Using (9), (10), and (11) in (8) gives da0N 1 (AT =K D(K D-WOLK-woLY

Y),

(13)

where LK and LY are positive. Conseawo aOpf ==pflvset, _ (wo quently,if D is negative-the unstable But if D case-No//oK mustbe positive. is positive-the stable case-the derivaaf (M) = _ pfLI(1 tivemayhave either sign. &K \~pjf -P A pointlike (pf,Nf) represents interthe PfLrPKK-PfL YPK. Therefore:

aWo -= -WoLK-WOLPKK-WOLYPK A9K M/Pf

curve (3) sectionof the portfolio-balance witha vertical curve. labor-market-balance To findout whether can employment be it maintained Nf whenK is increased, is at necessaryonly to find8wol/K for fixed Nf from(1) and (3). If thisawolaK is negative, of thenmaintenance employment is not consistent of withmaintenance portfloor foliobalance unless the money-wage is w(,is lowered.If the derivative zero or positive,then employment can be maintainedor indeedincreased even though the rate remainsfixed or rises. money-wage Differentiating and (3) with respect (1) to K, forfixed gives: N, (14)

(15)

+ MPNK.

(16)

(awo

( aN N

o

/ocons.

(17)

From the conclusionspreviouslyreached negative.But when D is positive (stable withthe aid of (13), it follows that,when case), dwo0/K may have either sign. D is negative(unstablecase), OWO/lK is

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