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Keynes’s Theory in the Era of Global Finance
Jan Kregel
Keynes Seminar UAM Xochimilco Mexico City,October 16-17

Which Era of Globalisation?
• International Financial Flows and international market integration at the end of the 19th century was as great as it is in the end of the 20th century • Keynes early experience as an economist was formed in this earlier period of globalisation •Early work – Indian Currency and Finance, all dealt with the problems of the breakdown of this period of financial globalisation and the Gold Standard

Tract on Monetary Reform, Treatise on Money

And the General Theory?
• The General Theory is usually considered to: – Refer to a closed economy – Presume fixed exchange rates – Ignore international aspects • International capital flows •international trade flows

Indications from Keynes’s

Treatise on Money
• In The Treatise on Money Volume II – the Applied Theory of Money Keynes makes a detailed analysis of the impact of an international system with global financial flows under an international standard such as the Gold Standard • Definition of Financial Globalisation– Uniform rates of interest in all countries – Loss of policyautonomy

National Policy Autonomy
• In Chapter 36 of the Treatise Keynes gives a very clear assessment of the impact of international finance on domestic economic conditions in the chapter entitled “National Policy Autonomy” • It deals with the potential policy conflict between international investment flows under an international monetary standard such as the gold standard, and the need tooffset the impact on the economy of the cyclical behaviour of domestic investment decisions. • Today we would talk of national “policy space” for developing countries

National Policy Autonomy
• A single international monetary standard requires the Central Bank to relinquish control over domestic interest rates • This implies a uniform rate of interest across countries. • Any attempt to useinterest rates to offset domestic fluctuations in investment would then create interest rate differentials and international capital flows that would eventually undermine the country’s commitment to the international standard. • To resolve this policy conflict Keynes suggests the control of net capital flows -- the foreign capital balance. • His analysis assumed the (often criticized) assumptionthat the commercial balance is slow to adjust to changes in relative prices (leading to Ohlin’s accusation that Keynes ignored the impact of changes in the level of income and the multiplier effect), compared to the response of international capital flows to international interest rate differentials

Long-term Capital Flow Controls
• Keynes recommends formal controls over long term capitalflows. • He notes that most countries have always had registration requirements for capital issues in their own markets and that these could be expanded internationally. • He also suggests a tax on purchase of foreign securities not listed in the UK market of 10 per cent.

Short-term Capital Flow Controls
• To influence short-term flows
– he recommends a dual rate structure that differentiatesbetween financial flows and trade finance, given preference to the later. – He also recommends a more flexible exchange rate structure through variation in the rates at which the Central Bank’s bid and offer rates within the gold points – He also recommends the active use of intervention in the forward market, a suggestion that was first made in the Tract, to set short-term interest rates onshort term capital transactions.

• He concludes that Central Banks should use bank rate, the forward rate and flexibility in its bid and offer rates to influence short-term flows.

The Ideal International Financial System
• However, he also notes that an ideal system would be one in which all countries set similar gold points for exchange of their currency with an external asset issued by a...
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