The Foundations of Monetary Theory

To the pure theorist, at the present juncture the most interesting and challenging aspect of money is that it can find no place in an Arrow-Debreu economy. This circumstance should also be of considerable significance to macroeconomists, but it rarely is. Much of current macroeconomics is written as if the ‘real’ economy could be looked at as an equilibrium of an Arrow-Debreu economy. It is true that these economists have given the economy a sequential characterisation, but they believe that the postulate of rational expectations renders this inessential: the underlying economy could just as well be that described by Debreu. In this, I believe, they are not only careless (since the matter is never given proof) but also mistaken. It is one of my central concerns in what follows to argue this. Indeed, I shall wish to maintain the view that from our present standpoint Keynes’s theory, and in particular his monetary theory, is best understood as a denial of the realism and relevance of Arrow-Debreu equilibrium. Of course, Keynes did not and could not have put it in this way and in any case, while he had a poet’s insight, he lacked the seriousness and care of a theoretician.