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History of Political Economy 35.3 (2003) 491-519

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Keynes's Revindication of Classical Monetary Theory

Filippo Cesarano

John Maynard Keynes's insightful critique of the classical economists in his General Theory of Employment, Interest, and Money (1936) aimed at rebuilding economic analysis from its very foundations. Most, if not all, historians of economics agree that he succeeded, as they ascribe the discipline's only scientific revolution, in Thomas Kuhn's sense (1970), to the General Theory.1 Keynes's pathbreaking contribution held the stage for most of the twentieth century. It prompted the response of the monetarist counterrevolution (Johnson 1971), giving rise to a heated debate that is still going on, fueled by novel arguments, between new classicals and new Keynesians.

The propensity for radical innovation is not confined to Keynes's magnum opus but characterizes many of his writings and especially those regarding the international monetary system, a topic of foremost interest to him throughout his life. Keynes's unflagging quest for monetary reform is grounded in his theoretical work on money. Until the early thirties, it was based upon an elaboration of the classical model. Afterward, the General Theory provided an alternative model, leading to an [End Page 491] overall rethinking of international monetary arrangements. As one of the architects of the postwar monetary order, Keynes began to deal with this topic as early as the fall of 1940, producing the final draft of the plan that bears his name in April 1943.

The plan, which was the culmination of three decades of reflection on the international monetary system, was motivated by Keynes's rejection of the gold standard and eventually of classical monetary theory altogether. It is striking, therefore, that in his last published article, in 1946, Keynes revives classical monetary economics and, albeit not recanting the message of the General Theory, points out the mistake of neglecting the international adjustment mechanism based on the equilibrium hypothesis of classical economics. Written shortly before his death, this little-known paper on the issue of dollar scarcity can be viewed as his intellectual testament. Since the followers of Keynesian economics departed from the economics of Keynes in many respects (Leijonhufvud 1968), a reconsideration of his last essay is important in order to dispel further misinterpretations and give a more accurate assessment of his thought. After a reconstruction of his main contributions to monetary reform (section 1), the 1946 article is examined, showing Keynes's revindication of classical monetary theory (section 2).

1. Keynes on the International Monetary System

Keynes's concern for international monetary problems goes back to the very beginnings of his career. His first book, Indian Currency and Finance (1913), written in the heyday of the gold standard, supports the gold exchange standard. Although lacking originality from both a theoretical and an institutional viewpoint (Laidler 1991, 169–70), this work shows his unyielding effort to reform the monetary system. This is indeed a constant feature of Keynes's writings on the subject and is founded on a critique of the model of commodity money. Instead of having rigid rules shackling the economy's performance, monetary institutions should be molded with sufficient flexibility to allow the pursuit of domestic targets.2 [End Page 492]

After the First World War, the main objective of policymakers was to reestablish the gold standard. The Cunliffe Committee report ([1918] 1985, 175) contended that the return to gold would bring monetary stability, the prerequisite for economic stability, both to Britain and to the rest of the world. However, noted economists, among others Gustav Cassel and Irving Fisher, criticized the deflationary and redistributive impact of the restoration rule, which required going back to the original parity after a temporary suspension. This opened a crack in the edifice of the gold standard, since the rule was the keystone of the system's credibility.3 Besides providing the basis for economic policy discipline, the rule enhanced the adjustment mechanism insofar as, by virtually eliminating exchange rate risk, it fostered capital movements (Eichengreen 1996, 30–32). The search for an alternative monetary setup was also prompted by...


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