Abstract
Purpose
In terms of understanding the new issues emerging in the practice of monetary policies and how to evaluate the latest theories of monetary policy, this paper proposes referring to Das Kapital and developing a monetary policy theory grounded in Marxist political economy.
Design/methodology/approach
Based on the discussion of interest-bearing capital in Das Kapital and using a heterogeneous agent model, this paper tries to explain the determining mechanism of interest rate, leverage ratio, and asset price.
Findings
The research finds that if there are differences in the techniques possessed by capital, the resulting disparities in production efficiency will lead to differences in profit rates and further influence the functional choices of capital in the movement of social total capital. Thus, with the formation of lending relationships, interest rates, leverage ratios, and asset prices will be endogenously determined simultaneously. Moreover, as the degree of technological diffusion influences the industrial capitalists’ willingness to take loans as well as the level of profit rates, there may be counter-cyclical changes in the returns on productive investment and financial investment at different stages of the technology life cycle, contributing to diverting funds out of the real economy. Besides, this paper discusses the challenges, tools, and goals of monetary policy within the credit money system.
Originality/value
Clarify the intrinsic mechanism of the functional differentiation of capital determined by heterogeneous technologies and exogenous capital-labor relation and analyze the impact of capital differentiation on the economy.
Keywords
Citation
Qiao, X. (2024), "Interest-bearing capital and monetary policy: a heterogeneous agent Marxian model", China Political Economy, Vol. 7 No. 1, pp. 72-103. https://doi.org/10.1108/CPE-06-2024-041
Publisher
:Emerald Publishing Limited
Copyright © 2024, Xiaonan Qiao
License
Originally published in Simplified Chinese in China Review of Political Economy in 2022: Qiao, X. (2022), “From Interest-bearing Capital to Monetary Policy: A Heterogeneous Agent Model of Marxism Economics”, China Review of Political Economy, Vol.13 No.5, pp 133-165 DOI: 10.3969/j.issn.1674-7542.2022.05.007
1. Introduction
Following the outbreak of the global financial crisis triggered by the subprime mortgage crisis, the United States of America not only significantly lowered interest rates but also injected liquidity into the market through large-scale purchases of long-term Treasury bonds, agency debt and mortgage-backed securities (MBS), leading to a substantial expansion of the Federal Reserve’s balance sheet. Although there were once signs of interest rate hikes and balance sheet reductions subsequently, the COVID-19 pandemic and the twin pressures of combating the virus and reviving the economy led the US to double down on its easy money policy. This resulted in interest rates dropping to historical lows, liquidity shifting from acute shortage to extreme abundance and drastic fluctuations in the prices of financial assets. Afterward, in response to inflationary pressures, the Federal Reserve implemented consecutive interest rate hikes, maintaining high interest rates, which, in turn, led to rising debt costs and pressured asset prices. This sequence of events highlights that unconventional monetary policies have gradually become a conventional tool over the past decade. This has posed unprecedented challenges to mainstream macroeconomic theories, especially monetary policy theory. In this context, mainstream economics has undergone changes and adjustments, while a series of new monetary policy theories have emerged, making monetary policy theory a focal point of academic research.
In terms of understanding the new issues emerging in the practice of monetary policies and how to evaluate the latest theories of monetary policy, this paper proposes referring to Das Kapital and developing a monetary policy theory grounded in Marxist political economy. Specifically, this paper adopts a heterogeneous agent model based on Marxism to explore interest rates, leverage ratios and asset prices through Marx’s theory of interest-bearing capital. It seeks to address the following five key questions. First, when considering the aggregate capital of the society as a whole, how is the proportion of capital that should be allocated as industrial capital, engaging in production activities and value creation, as well as that of the capital to be loan capital detached from production activities and generating profit through the lending of capital, determined? In other words, how is the proportional relationship between industrial capital and loan capital established, and how is the supply and demand of loan capital determined? Second, since interest is a part of the average profit, what is the relationship between the interest rate, profit rate and wage rate, and how should the interest rate be determined? Third, how are the corporate and socially optimal leverage ratios determined? Are these two always aligned? Fourth, how are corporate asset prices determined, and how do changes in asset prices affect productive and financial investment? Fifth, what new insights will the above research findings bring to the theory of monetary policy?
The structure of this paper is as follows: The current chapter introduces the research questions; Chapter 2 reviews the relevant literature and highlights the innovations of this study; Chapter 3 presents the model settings; Chapter 4 completes the model solving; Chapter 5 conducts numerical simulations; Chapter 6 discusses monetary policy in the context of the model and Chapter 7 concludes and suggests directions for future research.
2. Literature review
The new consensus monetary policy theory currently serves as the predominant theory, guiding monetary policies (McCallum, 2001; Walsh, 2003; Woodford, 2003; Gali, 2008). Theoretically, drawing from New Keynesian economics and combining with dynamic stochastic general equilibrium (DSGE) modeling methods, it forms a framework centered around the IS-PC-MP model [1]. Operationally, the intermediary targets of monetary policy have shifted from quantity-based to price-based tools, leading to the widespread adoption of the Taylor rule. The challenges posed by unconventional monetary policy practices to the existing theories have necessitated changes and adjustments within mainstream economics. The heterogeneous agent new Keynesian economics (HANK) has garnered significant attention (Ahn et al., 2018; Kaplan et al., 2018; Alves et al., 2020). Unlike the representative agent new Keynesian economics (RANK), HANK deviates from the homogeneous representative agent assumption. Instead, based on empirical evidence, it posits that differences in the amounts of liquid and illiquid assets held by households result in varying marginal propensities to consume (MPC). Consequently, different types of households respond differently to monetary policy. Therefore, the distribution of various households affects the overall efficacy of monetary policy.
Not only is mainstream economics adjusting its theories, but new monetary policy theories are also emerging, such as modern monetary theory (Wray, 1998, 2015; Mitchell et al., 2019) and the capital structure of nations (Bolton and Huang, 2017; Bolton, 2020). How to view and evaluate these new theories has also become a hot research topic in academia.
Additionally, with the normalization of unconventional monetary policies, the issues of debt and leverage induced by borrowing have garnered widespread attention. In response, Koo advocates examining the “Great Recession” from a debt minimization perspective (Koo, 2016, 2019). Dalio (2019), from an investor’s viewpoint, delves deeply into debt crises, emphasizing the changes in the debt cycle. Post-Keynesian economics specifically developed the stock flow consistent (SFC) model to analyze liquidity and debt defaults (Godley and Lavoie, 2007). There has been a marked divergence in the economic community’s understanding of leverage ratios for a long time. On the one hand, perspectives represented by the “financial deepening theory” support the notion that increasing leverage and expanding credit can promote economic growth (McKinnon, 1973; Shaw, 1973; Rajan and Zingales, 1998). On the other hand, views represented by the “debt-deflation theory” and the financial instability hypothesis argue that excessive leverage may lead to debt defaults and cause contractionary effects on corporate production and investment. These changes in corporate behaviors will be transmitted to the financial system and affect the credit behavior of financial intermediaries, which will be further amplified by the financial system and thus hinder economic growth (Fisher, 1993; Minsky, 1986; Bernanke et al., 1999). Recent studies suggest that the impact of changes in leverage ratios on economic growth or recession exhibits nonlinear characteristics and varies depending on the stage of development and the type of debt involved (Liu et al., 2018). It is evident that the determining mechanism of leverage ratios, i.e. the determinants of the supply and demand of loan capital, requires further investigation. Without a thorough understanding of these issues, it remains impossible to ascertain whether leverage levels are high or low. Thus, it is challenging to formulate deleveraging strategies and corresponding monetary policies.
The paper attempts to analyze the above questions based on Marxist political economy. The third volume of Das Kapital investigates the overall process of capitalist production, which requires a deeper analysis of other types of capital beyond industrial capital. Consequently, in Part V, Marx creatively introduces the idea that profit can be divided into interest and entrepreneurial income. This notion not only lays the groundwork for analyzing loans, banks and credit but also forms the theoretical basis for understanding interest-bearing capital. His core ideas can be summarized as follows: First, the use value of capital is to generate surplus value. Capitalists who own the capital may transfer this use value to other industrial capitalists, thereby earning interest for themselves. In this instance, their capital is transformed into loan capital, achieving a separation between the ownership and the use of capital. Second, the interest earned by loan capital is a portion of the industrial capital’s profit, representing a profit division with loan capital. Third, the determination of the interest rate is contingent and influenced by the supply and demand of loan capital, with no natural interest rate.
As Engels (2004) noted, “The greatest difficulty was presented by Part V, which dealt with the most complicated subject in the entire volume.” Although Marx’s significant discourse elucidates the relationship between loan capital and industrial capital, as well as the essence of interest, it fails to provide a definitive model for determining the interest rate. This omission leads to various uncertainties and theoretical divergences. Firstly, since interest is a part of profit, in what proportion should loan capital and industrial capital divide profits? Secondly, in the process of this allocation, what is the relationship between the rates of interest, profit and wages? How is the asset price determined? Furthermore, if the interest rate determination is subject to the contingencies arising from the supply and demand of loan capital, what factors influence this supply and demand? Moreover, what are the distinctions between the supply and demand of monetary capital emphasized in Marxist political economy and those in Western economics? Only by scientifically addressing these questions can we possibly distinguish the mainstream economic theories on monetary policy, as well as the modern monetary theory and state capital structure theory widely discussed, and this further establishes a Marxist political-economic theoretical framework that gives guidance on monetary policy practice based on a process of critique and absorption.
Several studies have explored issues such as interest-bearing capital, interest rates and leverage ratios from the perspective of Marxist political economy. While many of these analyses are grounded in the theories of capital circulation or social reproduction, differences in analytical perspectives and the introduction of factors such as banking, credit creation and economic cycles have complicated the discourse. As a result, these complexities have exacerbated theoretical divergences, and a comprehensive consensus has yet to be achieved (Panico, 1980, 1984; Chiodi and Messori, 1984; Fine, 1985; Lianos, 1987; Dymski, 1990; Lapavitsas, 1997; Cipolla, 1997; Hein, 2009; Saros, 2013; Park, 2020, 2021).
This paper’s innovation lies in developing a heterogeneous agent model based on Marx’s theory of interest-bearing capital, as discussed in Das Kapital. The study most closely aligned with my approach is the research of Park (2020, 2021). Specifically, both Park and I explore the divergence between industrial and loan capital from the perspective of technological heterogeneity. However, several crucial differences distinguish this paper from Park’s. First, concerning productivity, Park’s study posits that the capital-labor ratio (i.e. capital intensity) determines labor productivity (LP), while this paper adopts the analytical framework of Okishio, Roemer and Hahnel, providing a more comprehensive examination of technology through three dimensions: the technical composition of capital (the organic composition of capital), its impact on total labor productivity (TLP) and its effect on the profit rate (Okishio, 1961; Roemer, 1981; Hahnel, 2017). Second, regarding production relations, Park assumed the wage rate to be a function of the average social productive efficiency. In contrast, the wage rate is treated as an exogenous variable determined by the capital–labor relation in this paper. Third, regarding the profit rate, Park defines it as the remainder of sales revenue minus wage payments divided by the capital stock. This definition does not conform to Marx’s concept of the profit rate, as articulated in Das Kapital. In contrast, this paper strictly adheres to Marx’s definition of the average profit rate. In conclusion, while this paper shares a similar conceptual framework with Park’s research, the model utilized in this study extends the heterogeneous capital and representative technical models proposed by Qiao and Wang (2021) as well as Qiao and Li (2021). This paper employs a dual approach: firstly, it investigates the divergence of various forms of capital and the determining mechanism of interest rates, leverage ratios and asset prices within a unified framework that considers the dynamics of social total capital and the overall production process; secondly, it extends this theoretical framework to an examination of monetary policy from the perspectives of policy challenges, policy instruments and policy goals, offering several insights that deviate significantly from the new consensus theories prevalent in mainstream economics.
3. Model specification
3.1 Divergence of the functions of capital
How to differentiate between industrial capital and loan capital regarding the function in an economy? This paper employs a model of heterogeneous agent Marxian (HAM) economics to investigate this issue. Analogous to HANK, the term HAM can describe a mathematical political economy model that incorporates heterogeneous agents. However, unlike HANK, which is grounded in new Keynesian economics, HAM is theoretically based on political economy. The concept of heterogeneous agents has already been included in Das Kapital. However, it has long been inadequately reflected in the formal modeling of mathematical political economy. For instance, when discussing the “law of value,” Marx emphasizes that the value of a commodity is determined by socially necessary labor time, which reflects the average level of production efficiency across society. Individual labor times among different producers may diverge from this average, signifying differences in productivity due to the technical disparities among different capitalists. Furthermore, the productivity difference resulting from technological heterogeneity may cause a portion of capital to detach from production activities and become loan capital under certain conditions, earning interest income.
Assume a closed economy with a single production sector without foreign trade and cross-border investment and that
If capital is invested in the production sector and the total amount of capital invested is denoted as
Capitalists utilize
As indicated in Equation (1), the ROE is influenced by three factors: profit rate
Assume the proportions of industrial and loan capital in the social total capital are denoted as
The fundamental principles of Marxist political economy indicate that the profit rate is primarily influenced by production technology and wages in kind. The former reflects the level of production efficiency, which signifies the level of productive forces, while the latter represents how newly increased value is distributed, illustrating the capital–labor relation. When capital is heterogeneous, the proportions of capital employing high-efficiency and low-efficiency production technologies in the total industrial capital invested in the production sector determine the overall productivity level of society, thereby influencing the profit rate. Moreover, the above proportions are related to the amount of capital converted into loan capital, detaching from the production activities. Therefore, if
3.2 Heterogeneous technology of heterogeneous capital
Regarding the settings for heterogeneous technology, this paper builds upon the assumptions made by Qiao and Wang (2021), as detailed in equations (3) through (7).
Equation (3) illustrates the determination of the value contained in a unit of commodity, denoted as
Equation (4) outlines the calculation method for TLP. Given that the value embodies the labor time consumed in producing a unit of commodity, its reciprocal can denote the quantity of commodities produced per unit of labor time. The term “total labor productivity” is employed because the labor time considered herein encompasses both the embodied labor time
Equation (6) outlines the determination of production price
Based on Equation (6), Equation (7) further specifies the conditions necessary to evaluate the impact of technical change on the profit rate. When analyzing technical change, it is crucial to consider its effect on the profit rate, besides the technical composition of capital and production efficiency. Under the assumption of constant wages in kind and production prices, Okishio (1961) and Roemer (1981) argued that rational capital would opt for technologies that increase the profit rate rather than those that decrease it, namely, to judge the feasibility of technology based on the principle of cost savings. Let
By this point, the settings for technical change include its effects on the technical composition of capital, the TLP and the profit rate. Given that Marx, drawing from the materialist conception of history, emphasized technical change that enhances production efficiency through “machine replacing human labor,” and this type of technical change leads to a rise in the organic composition of capital and a decline in the average rate of profit, such technical change is referred to as “Marx-biased technical change” (MBTC), which is also a central focus of this paper.
3.3 Differentiated profit rates and the functions of capital
Based on the above discussion of heterogeneous technologies, this paper delves into the relationship between technological differences and profit rate disparities, as seen in Equations (8) through (17). To examine the coexistence of high-efficiency and low-efficiency capital, as well as the gradual diffusion of technology, assume the proportions of capital with high-efficiency technology and low-efficiency technology are
Given the coexistence of capital with high-efficiency and low-efficiency technologies, it suggests that no single technology can capture the overall productivity level of the economy. Therefore, it is necessary to introduce a representative technology
According to Marx (2004, p. 52), socially necessary labor time refers to the time required to produce a particular use value under normal production conditions and with the average degree of skill and intensity prevalent within society. According to this definition, the socially necessary labor time
Equation (13) shows that even if the two types of capital possessing different technologies do not engage in commodity exchange, high-efficiency capital can still transfer a portion of value from low-efficiency capital. This transfer arises because the law of value dictates that commodities should be exchanged based on socially necessary labor time, where individual values cannot serve as the standard of commodity exchange. Comparing
Given the differences between
The above analysis demonstrates that heterogeneous technologies lead to differentiated profit rates, which may drive the capital to be allocated for different functions. In other words, given the current degree of technological diffusion, which capital will serve as industrial capital and which will function as loan capital, as well as the proportions of them within the total capital, are the questions that must be addressed through the differentiated profit rates determined by the heterogeneous technologies. Since the leverage ratio essentially represents the proportional relationship between industrial capital and loan capital, discussing the determining mechanism of leverage ratios is necessary to examine the divergence of capital’s functions.
4. Model solving
4.1 Determination of the interest rate
The heterogeneity in technology leads to differences in profit rates between high-efficiency and low-efficiency capital. Therefore, analyzing which type of capital determines the interest rate is necessary.
In the case of
Proof: First, determine the relationship between
Then, determine the relationship of size between
Finally, determine the value of
Four inferences can be derived as follows based on
Inference 1: High-efficiency capital invested in industrial capital yields an interest premium, i.e.
Inference 2: The interest premium yield by high-efficiency capital invested in industrial capital implies that the ratio between the cost of high-efficiency technology and that of low-efficiency technology is less than the ratio between their TLP, i.e.
Proof: Equation (18) can be derived from Equations (16) and (17), along with Proposition 1, as well as defining
Since
Inference 3: In terms of MBTC, the ratio between the cost of high-efficiency technology and that of low-efficiency capital is less than the ratio between their TLP, suggesting
Proof: Given that the technology
The significance of Inference 3 lies in synthesizing various discussions in Marxist political economy regarding technical change with the determinants of leverage ratios and the proportional relationship between industrial capital and loan capital within a unified theoretical framework.
As previously mentioned, the increase in the proportion of capital possessing high-efficiency production technology can be regarded as the extent of technological diffusion. During the proof of Proposition 1, it has been established that
Inference 4: As the degree of technological diffusion increases, the upper limit of leverage for high-efficiency capital invested in industrial capital gradually decreases, i.e.
It is important to note that both
4.2 Determination of the leverage ratio
Since the relationship between the proportions of industrial capital and loan capital and the leverage ratio has been defined in the model settings, the determining mechanism of the leverage ratio is akin to the decision mechanism of the abovementioned proportion. As the heterogeneity of capital manifests in the form of technological differences rather than differences in own capital, the profit of the capital can then be represented as
The solution to the above optimization problem can define the proportions of industrial capital and loan capital and the leverage ratio.
The determining mechanism of the proportion of industrial capital in social total capital, denoted as
Proof: Define the partial derivative of the ROE for the proportion of industrial capital within the social total capital as Equation (20).
Next, discuss each of these three effects in detail.
According to Equation (16), the profit rate effect can be expressed as Equation (21).
Given that
Following the preceding definition, the interest rate spread effect can be expressed as Equation (22).
Given that
The leverage effect can be expressed as Equation (23).
Given that
Therefore, the determination of the optimal leverage ratio is influenced by the above three effects, leading to a range of possibilities and indeterminacy.
Regarding capital, according to Proposition 2, the leverage ratio that can achieve the maximum profit rate, i.e. the maximum ROE, is not definitively established. The optimal leverage ratio can be further examined from a societal standpoint. If the social objective is defined as maximizing the material output, it stands to reason that limited embodied labor and living labor should be allocated to highly productive producers. Therefore, output maximization and efficiency optimization can be achieved by only allowing high-efficiency capital investment in industrial capital and allowing low-efficiency capital to exit the production field and lend self-owned capital to high-efficiency capital to complete production. Consequently, by comparing the optimal capital leverage ratio with the socially optimal leverage ratio, Inference 5 can be drawn.
Inference 5: The maximum social total material output or the optimal production efficiency is achieved when
The above propositions indicate the potential conflict between the goals of capital and those of society, which originates from the fact that capital’s purpose is to pursue profits.
4.3 Determination of the asset price
The determination of asset prices for production enterprises is related to arbitrage mechanisms. Whether capital is converted into loan capital or used to purchase and hold assets, the yield rate should be equal. Let
The asset price of a production enterprise can be determined by dividing its ROE by the interest rate, i.e.
Proof: When
Since this paper employs a single-sector model for analysis and standardizes the production price to 1, the changes in asset prices lead to relative changes between asset prices and commodity prices. Therefore, Inference 6 can be derived.
Inference 6: Changes in asset prices will lead to changes in the relative prices between assets and commodities.
Marx (2004, p. 142) proposed that “the quantity of money functioning as the circulating medium is equal to the sum of the prices of the commodities divided by the number of moves made by coins of the same denomination.” Two significant changes have occurred compared to the context in which this formula was initially applied. The first is that the credit money system supplanted the previous money system based on precious metals; the second is that the expanding financial assets have an increasingly significant impact on economic operations. Since it is difficult to separate the money serving as the medium of circulation for goods from that used for the circulation of assets, the formula can be modified to incorporate financial assets as “(the sum of the prices of commodities + the sum of the prices of assets)/the number of moves made by coins of the same denomination = the quantity of money functioning as the circulating medium.” Therefore, assuming that the amount of money supply, the number of money circulation, the quantity of goods and the quantity of assets remain unchanged, changes in the relative prices of goods and assets will lead to changes in the allocation proportion of circulating money. This is the key to understanding the coexistence of goods deflation and asset price inflation.
The nature of the assets is unique, and the returns associated with them can be categorized into two types. The first type of return comes from holding the asset after purchasing it and receiving dividends from the asset. The following discussion introduces the concept of time periods, denoted by subscripts. For example, if an asset is purchased in period t1 and held until period t2, the dividends received can be determined by the ROE (
Inference 7: Changes in production technology and the capital–labor relation will lead to changes in ROE and asset prices, ultimately influencing investment choices. Moreover, the decision mechanism of such investment choices is a significant cause of diverting funds out of the real economy.
The following text will discuss the impact of the technological diffusion cycle on investment choices through simulation analysis and define the relationship between “diverting funds out of the real economy” and technological diffusion.
5. Simulation analysis
5.1 Simulation analysis approach and parameter settings
Based on the theoretical analysis presented in the preceding section, this section focuses on two key aspects utilizing a numerical simulation method. Given that the leverage ratio is related to
In terms of parameter settings, the parameters for both types of technologies are first set, as shown in Table 1. In this setting, since
Next, the wage in kind is set, i.e. determining its range and economic implications based on technological settings. The setting of the wage in kind
The range of wages in kind should be
Finally, the proportion of high-efficiency capital is set. When there are heterogeneous capitalists, it is evident that
5.2 Three numerical examples of optimal capital leverage ratio and their economic interpretations
Proposition 2 has demonstrated that the optimal capital leverage ratio is indeterminate due to the differing effects of the profit rate effect, interest rate spread effect and leverage effect when leverage increases. In this section, with the previous parameters set and assuming
The first scenario illustrates a situation where
The second scenario illustrates the situation where
The third scenario illustrates a situation where
The above three numerical examples reflect that a company’s willingness to leverage is mainly influenced by technology, the degree of technology diffusion and the capital-labor relation, and it does not necessarily always need loans. The underlying theoretical mechanism is that capital with high-efficiency technology will choose the optimal leverage ratio based on its ROE. The leverage ratio determines the proportional relationship between industrial capital and loan capital. In some situations, it may be more beneficial to the ROE to leave some low-efficiency capital in the production sector rather than converting it into loan capital through leverage. This reflects the influence of the law of value on the profit rate of heterogeneous capital under the condition that the socially necessary labor time determines the quantity of commodity value. These findings provide theoretical insights into many significant issues. For example, can monetary-credit expansion solve the problem of low social demand for loans? Additionally, this demonstrates the different understanding of this issue in Marxist political economy compared to other theories.
5.3 Numerical examples of technological diffusion and asset price changes
In the HAM economics model, technological diffusion refers to the progressive increase of capital possessing high-efficiency technologies in the aggregate capital. For technological diffusion, the proportion of high-efficiency capital falls within a range of [0,1]. Periods in which the proportion of capital with high-efficiency capital is comparatively lower can be defined as the “early stage.” In comparison, those with a higher proportion can be regarded as the “late stage.” For comparing the impact of technological diffusion in the early stage and late stage on asset prices, the paper assumes that all other conditions remain unchanged and only observes the scenarios in which the proportion of capital with high-efficiency technology,
Continuing with the settings provided in Tables 1 and 2, and given specified values of
For instance, when
6. Extended discussion
6.1 From capital lending to credit creation in the banking system
The model above discusses the divergence of capital possessing different production technologies with various efficiencies and the establishment of lending relationships. This kind of lending relationship can be characterized by three features. (1) The “capital” that is lent refers to physical capital rather than monetary capital. (2) The lending relationship is established directly between industrial capital as the borrower and loan capital as the lender, without involving commercial banks. (3) Since repayment of principal and interest can only be implemented after the completion of value realization of the produced goods, the essence of the lending relationship is that loan capital provides credit to the industrial capital. The underlying logic is that loan capital transfers its right to use its physical capital to the industrial capital, facilitating the concentration of means of production and labor and expanding the production of industrial capital while providing credit.
Marx emphasized the unity of productive capital, commodity capital and monetary capital in the capital circulation cycle. However, following the collapse of the Bretton Woods system and the decoupling of gold from the US$, the international monetary system was transformed into a pure credit system. Monetary capital may then solely engage in a profit-seeking cycle, separate from productive and commodity capital. Therefore, compared to the abovementioned model, there are three significant changes in the real world. First, the advent of the credit monetary system causes the borrowing and lending of monetary capital to replace the borrowing and lending of physical capital. Second, due to restrictions by factors such as information, it often becomes difficult for industrial capital and loan capital to directly complete capital borrowing, resulting in the increasingly significant role of the banking system. Thirdly, because of these two changes, both the method of credit provision and the organization of production have undergone fundamental changes, which will be further discussed in this section from Marx’s perspectives on credit.
According to Marx, credit is a debt-and-claim relationship that originates from borrowing activity, which typically manifests in commercial and bank credit. The paper first examines commercial credit, a claim-and-debt relationship between the producers of goods and distributors. Under normal circumstances, producers sell their goods to distributors, who would, in turn, sell them to those in need and need to offer monetary payment to the producers. At this point, “Money serves here, by and large, merely as a means of payment, i.e., commodities are not sold for money, but for a written promise to pay for them at a certain date” (Marx, 2004, p. 450). With the expansion and development of the credit system, distributors no longer have to pay producers in cash but instead provide promissory notes for future payments. “[…] we may put all these promissory notes under the general head of bills of exchange. Such bills of exchange, in turn, circulate as the means of payment until the day they fall due, and they form the actual commercial money. Inasmuch as they ultimately neutralize one another through the balancing of claims and debts, they act absolutely as money, although there is no eventual transformation into actual money.” (Marx, 2004, p. 450) Therefore, in this regard, credit money can be viewed as a tool created by the credit system for its functioning.
Bank credit is then examined. The emergence of commercial credit is undeniably intertwined with the turnover and circulation of commodity capital. The credit system can expand into bank credit to overcome the commercial credit limitations in the borrowing scope, scale and direction. Generally, monetary and commodity operations go hand in hand, and the management of interest-bearing capital and money capital develops as a unique function of monetary operation, laying the groundwork for forming bank credit. Therefore, banks are positioned as “the general managers of monetary capital” and “represent both the centralization of monetary capital of the lenders and the centralization of the borrowers” (Marx, 2004, p. 453). Banks provide credit in various forms, “such as bills of exchange on other banks, cheques on them, credit accounts of the same kind, and finally, if the bank is entitled to issue notes — banknotes of the bank itself. A banknote is nothing but a draft upon a banker, payable at any time to the bearer, and given by the banker in place of private drafts” (Marx, 2004, p. 454). In particular, Marx indicates that if the principal bank issuing banknotes is the national bank, then such banknotes become a legal instrument of payment backed by national credit. After the Bretton Woods system collapsed, gold receded from its prominent role in the international monetary system, and a pure credit-based standard based on national credit was established. Therefore, the so-called “modern credit money system” is essentially a pure credit money system based on national credit in the form of legal tender, relying on the banking system composed of central banks and commercial banks to create credit money.
In the modern credit money system, the original lending relationship changes in form, and this transformation is related to the balance sheet structures of diverse entities. The previous discussion on capital loans fundamentally refers to the loans of physical capital. For instance, Party A possesses high-efficiency technology and Party B possesses low-efficiency technology. When Party A necessitates leveraged borrowing, Party B lends its physical capital to Party A. Then, Party A seizes control of more physical capital by elevating its debt-to-asset ratio, enabling it to expand its production scale, while Party B exits the production domain and becomes loan capital.
If a commercial bank is introduced herein, the above physical capital borrowing and lending will be implemented through credit money creation. Specifically, this capital lending process would involve three main steps regarding the organization of production activities: Firstly, the bank provides a loan to Party A. Upon receiving the loan and before its expenditure, a deposit equal to the loan amount would simultaneously be credited to Party A’s account. From the bank’s perspective, a loan is an asset, while a deposit is a liability. Conversely, Party A views the loan as a liability and the deposit as an asset. Secondly, Party A uses the deposited loan to buy physical assets from Party B to expand production capacity. This transaction results in the expenditure of the money deposit in Party A’s account, matched by an increase in physical assets. Therefore, the balance sheet of Party A reflects a decrease in the cash asset, offset by the increased value in physical assets, without altering the overall asset-liability structure. Concurrently, Party B experiences a decrease in physical assets and an increase in cash assets. If the transaction is completed through a bank transfer from Party A’s account to Party B’s account, it should be noted that the deposit initially increased by the commercial bank’s credit to Party A will not decrease – it merely shifts from Party A’s account to Party B’s. Thirdly, Party A earns income by manufacturing and selling goods, which enables it to repay the bank loan and interest. Although Party B selling its physical assets forgoes the opportunity to generate revenue through production, it gains deposit interest from the bank for the deposit increase. The commercial bank earns loan interest from Party A while paying deposit interest to Party B. The interest margin represents the bank’s revenue, indicating that the bank’s income comes from company profit. Extending this process to a banking system consisting of multiple commercial banks does not alter the fundamental logic of credit-money creation organizing production. It should be noted that Party A ends its debtor–creditor relationship with the bank once the principal and interest are repaid, which is contingent on the completion of the money-capital production cycle. Therefore, if Parties A and B fail to arrange and complete the borrowing of physical capital independently, the role of commercial banks in credit-money creation becomes pivotal to the organization of production.
In recent years, some emerging monetary and monetary policy theories have dissected how the banking system creates credit under the modern credit money system. Specifically, when a production enterprise needs to purchase raw materials and labor, it can apply for a loan from a commercial bank. Once the bank approves the loan, a creditor–debtor relationship forms between the bank and the company, and both the bank and the company experience changes in their respective asset-liability structures due to the loan. Therefore, for commercial banks, assets precede liabilities and loans precede deposits. The credit money held by the company, created by the bank, mirrors the debt relationship between the two parties. Hence, it is essential to understand the mechanism of money creation and issues concerning monetary policies from the perspectives of credit and balance sheets.
Only commercial banks and production enterprises are involved in the credit creation process. Thus, a question arises: What is the role of the central bank? It can be explained by the “pyramid of credit money,” where the central bank creates base money and commercial banks create deposit money, dividing the credit money into base and deposit money. Mishkin (2010) details the central bank’s money supply mechanism using the Federal Reserve as an example. He approaches it from the perspective of a central bank’s balance sheet, simplifying the liabilities to currency in circulation and reserves and the assets to securities (bonds) and discount loans. The central bank issues the currency, and the currency that the public holds is the currency in circulation. The reserves include the commercial bank’s deposits with the central bank and currency stored in the bank’s vault – the former includes legal reserves and excess reserves, while the latter refers to vault cash. These reserves are liabilities of the central bank and also assets of the commercial banks. The securities (bonds) are assets purchased from commercial banks by the central bank through open market operations. When the central bank increases the purchase of securities (bonds), it provides reserves to commercial banks, thereby increasing the money supply. Discount loans from the central bank to commercial banks can also increase the money supply. The interest rate set on these loans is the discount rate. Open market operations and discount loans have the same effect on the central bank’s balance sheet, i.e. increasing assets and liabilities simultaneously. However, their impact on the commercial bank’s balance sheet differs. Open market operations only change the structure of a commercial bank’s assets by decreasing securities (bonds) and increasing reserves, while discount loans increase both assets and liabilities of a commercial bank, namely, growing liabilities while increasing reserves. As previously mentioned, customers can engage in investment activities upon acquiring deposits, causing deposit money circulation. Theoretically, commercial banks are enterprises with a finite duration but bear the credit creation function with an infinite demand and public service characteristics in the modern credit money system; therefore, an issue of liquidity exists. Moreover, commercial banks can only exchange assets and not liabilities, creating a need for clearance. Thus, the significance of the central bank creating base money lies in establishing the link between national credit and its economy and solving liquidity and clearance problems through base money supported by national credit as an institution with government features that can last indefinitely.
The modern monetary theory (MMT), based on the state theory of money, argues that loans create deposits and proposes a pyramid structure of money (Minsky, 1986; Wray, 1998, 2015; Mitchell et al., 2019). It believes that money is a form of the national debt and that people are willing to accept it because the state requires individuals to use it to pay taxes, i.e. taxes drive the currency. Furthermore, it suggests a hierarchy regarding money as debt, with sovereign money as the national debt and bank deposits as bank debts, in addition to corporate and household debts, where settling lower-level debts involves upper-level debts. Therefore, there exists a degree of variability in the liquidity among different debt tiers.
The implementation of monetary policies relies on the modern banking system, comprising the central bank responsible for regulating the money supply and various commercial banks creating credit. Thus, the banking system formed by the central bank and various commercial banks plays a crucial role in ensuring sustained and stable economic development and serves as a vehicle for the effective implementation of monetary policy. More importantly, previous lending relationships among different types of capital depend on the banking system that creates credit to realize the organization of production after the banking system is introduced. Therefore, the theoretical model proposed in this paper serves as a benchmark from which discussions about monetary policies should develop and further introduce the banking system to study the policy goals, instruments and transmission mechanism [5].
6.2 Constraints on credit creation and challenges in monetary policies
After recognizing the banking system as the vehicle for credit expansion and money creation, a more important consideration is whether there is any constraint on its function of credit creation. Obviously, the constraints on the banking system when creating money involve capital, liquidity, risk management and loan demand. Although the MMT emphasizes that nations with full monetary sovereignty can break the constraints of “sound finance” and adopt the principle of “functional finance,” this theory does not promote uncontrolled spending. The rationale lies in the fact that nations must also address constraints related to resources, environment, productivity and inflation (Jia and He, 2020a, b).
Regarding constraints on credit creation, this paper asserts that a clear distinction must first be made between productive and financial investments. As the preceding study has shown, demonstrated in the research earlier in this paper, the demand for credit money creation varies across different stages of technological diffusion in production and financial investments. Therefore, without effectively distinguishing the nature of the demands for credit money creation, it is impossible to determine which demands are reasonable and should be satisfied.
Regarding the demand for monetary credit creation associated with productive investments, this paper argues for considering three constraints, i.e. constraints of physical capital, socially necessary labor time and value realization.
The first is the constraint of physical capital, which encompasses two layers of significance. The first to address is the constraint of physical capital, which has two meanings: One is the quantity of physical capital, namely, the stock amount of physical capital that an economy possesses in the current period, which determines the boundaries of mobilizable financial resources when organizing production. The other pertains to the distribution of ownership of physical capital. In the model put forth in this paper, it is assumed that each capitalist possesses an equal quantity of capital, and capital borrowing is considered on this premise. However, capital may not be evenly distributed – capitalists with high-efficiency or low-efficiency production techniques may possess more resources in different circumstances. Evidently, the leverage ratio formed in organizing production varies in these two cases, thereby imposing different demands on the scale of credit creation by the banking system. If asymmetric information leads to collateral requirements for loans, the impact of the distribution of physical capital ownership will be more intricate. Furthermore, a critical question remains: Can the credit created by the banking system of this economy extend beyond its national borders and garner resources on a global scale? In other words, is the credit money issued by this economy acceptable to other countries? Bolton and Huang (2017) and Bolton (2020) discussed the national capital structure, including whether to obtain resources through external debt, with an analysis paradigm using the corporate capital structure for reference. This paper posits that if an economy can expand its credit globally in the context of a credit money system, it can potentially break through domestic resource boundaries. However, the key deciding factor as to whether this economy utilizes such ability boils down to whether it can enhance production efficiency and profit rate by using the acquired external resources. The underlying theoretical mechanism is that debts are always to be repaid – even if the issuance of external debt is at a premium, it is not a problem as long as the rate of profit increase is high enough. In contrast, if foreign debts cannot be effectively utilized, excessive foreign debts would pose a risk or burden.
The second constraint is socially necessary labor time, which was the focus of the previous discussion and is influenced by wages in kind, technical disparities and the extent of new technological diffusion. Essentially, the socially necessary labor time determines the value of a commodity, and the difference between individual labor time and socially necessary labor time highlights the heterogeneity of capital production efficiency. This heterogeneity determines the variations in profit rates and further forms the basis for the lending relationships, leverage ratio and interest rates. In some situations, high-efficiency capital prefers to underscore its efficiency advantage by leaving low-efficiency capital in the production field, which means that the effect of leverage is insufficient to offset the impact of profit rates and interest rate spreads. At this point, high-efficiency capital loses the incentive to leverage, meaning enterprises do not need loans or expand their production scale even if they obtain loans. It should be noted that this finding contrasts with the Keynesian economic view that increasing the money supply and reducing interest rates can expand investment. The paper proposes that at this point, even if credit grows, the transfer of means of production from low-efficiency to high-efficiency producers does not increase output. Instead, it may divert funds from the real economy, causing asset prices to rise by changing the relative prices of goods and assets and leading to commodity price deflation while asset price inflation at the macro level. Hence, when credit is expanded, the decision of monetary policies must carefully consider the willingness to leverage under the given technology and capital–labor relation. In the preceding situation, mere monetary policy becomes ineffective, necessitating an adjustment in the capital–labor relation.
Finally, there is the constraint of value realization, i.e. investigating the influence of the relationship between aggregate supply and aggregate demand on the constraint of value realization from the perspective of social reproduction. As previous sections focused on micro-agent heterogeneity without considering the relationship among macroeconomic aggregates, this section analyzes the logic of social reproduction. Consider a closed economy where
Typically, the capitalist’s consumption can be regarded as an exogenous constant, and the accumulated productive investment is a function of the profit rate. Under the conditions that conform to relations of social reproduction,
It should be emphasized that the mentioned constraints of physical capital, socially necessary labor and value realization are essentially loan demand constraints related to productive investment. Although this paper does not deny other constraints highlighted in existing literature, such as liquidity and capital adequacy ratios, it primarily dissects the intricacies of constraints on loan demand from the perspective of Marxist political economy.
This paper posits that the main factors driving demand for credit money creation associated with financial investments hinge upon changes in asset prices over periods and their comparison to the rate of return on productive investments. Whenever the increase in asset prices over periods exceeds the return rate of productive investments, demand for credit money creation generated by financial investments will arise and expand. Given that MBTC would lead to a decreased rate of return in the long term, technologies of this kind are more likely to cause anticipation of relative increases in asset prices at the late stage of technological diffusion and further cause the change in the relative return rates between productive investment and financial investment, leading to the problem of diverting funds out of the real economy. This also explains why an economy typically experiences financialization coinciding with a relative stagnation in technological innovation. Generally, the creation of monetary credit requires collateral for a loan. However, it is essential to note that this collateral should be measured in terms of physical capital. If financial assets are also included, the “financial accelerator” effect will arise when the prices of financial assets fluctuate. More importantly, when asset prices continue to rise, if they are only viewed as a “perpetual bond” without allowing their potential conversion into physical assets upon sale, the “financial accelerator” effect will only lead to the expanding volume of financial assets. Once they are converted into physical assets through sales, there will be changes in the relative prices of physical and financial assets and inflation.
Considering the demand for credit money creation from both productive and financial investments, monetary policy faces two primary challenges: First, if only productive investment is considered, the credit demand from high-efficiency capital will shrink in the late stage of technological diffusion, so it is impossible to foster output growth by reducing interest rates for facilitating the transfer of the means of production from low-efficiency producers to high-efficiency ones. Second, in some cases, when considering both productive investment and financial investment simultaneously in the late stage of technological diffusion, the credit creation demand for financial investment continues to increase when productive investment shrinks. This distinction between different types of credit creation demand and implementing structurally targeted policies to avoid the misuse and siphoning of credit money by financial speculation becomes a challenge for monetary policy. Currently, a nascent technological revolution and industrial transformation are underway globally. Concurrently, the technological capabilities in emerging developing nations are gradually approaching those in developed countries, signifying a “late phase” in the technology life cycle. Consequently, intense global competition has emerged around critical technologies, resulting in persistent friction, and continuous monetary credit expansion has significantly driven up asset prices, even showing a tendency toward “economic bubbles.” Meanwhile, the recovery of the real economy remains an arduous journey, compounding the dilemma of monetary policy.
6.3 Tools and goals of monetary policy
Both the conventional IS-LM model and the modern IS-PC-MP model of the new consensus monetary policy theory posit that investment is a function of the nominal interest rate. Therefore, the loan demand constraint is referred to as the interest rate constraint, which means that the central bank can manipulate policy rates to impact lending rates, subsequently affecting loan demand and ultimately constraining the ability of commercial banks to create deposits.
While this paper also proposes that monetary policy should emphasize price-based tools, its theoretical underpinning differs significantly from the “new consensus.” Drawing upon the model presented in the preceding text and given the different profit rates of heterogeneous capital, the determination of the deposit rate should be based on the profit rate of low-efficiency capital, while the loan rate is determined by adding a premium to the deposit rate with consideration of the bank’s earnings. The theoretical mechanism is that deposit rates must satisfy the participation constraints of low-efficiency capital and loan rates must leave a profit margin for high-efficiency capital. Furthermore, with the prevalent trend of central banks worldwide replacing a monetary supply-targeting framework with an interest rate-targeting framework, the interest rate corridor has been widely adopted (Whitesell, 2006; Berentsen and Monnet, 2008; Pérez-Quirós and Mendizábal, 2012; Niu et al., 2015). The interest rate corridor refers to the lending and deposit facilities provided by the central bank to commercial banks, serving as two short-term financing tools that enable the central bank to maintain the money market interest rates near the target rate by adjusting the upper and lower limits. This approach fosters stable market expectations and avoids the need for frequent open market operations by central banks, thereby lowering the operational costs for monetary policy. Based on the model mentioned above, under the interest rate corridor approach, the profit rate of high-efficiency capital corresponds to the upper limit, while that of low-efficiency capital corresponds to the lower limit, with the target interest rate falling between them.
The goals of monetary policy include promoting economic growth and maintaining price stability for goods. This principle is highlighted in economic textbooks and universally followed by countries worldwide in executing monetary policy. For instance, according to the Law of the People’s Bank of China, the central bank must “maintain the value stability of money, thereby promoting economic growth.” Therefore, to understand the goals of monetary policy based on the fundamental principles of Marxist political economy and linear production models, it is necessary to consider the following factors.
The first is the relationship between economic growth and potential output. The latter represents the output level determined by an economy’s production capacity over time. This capacity includes not only technological capability but also natural resources. Potential output indicates the maximum output level achievable at a given time, setting the ceiling for economic growth within a specific period. Theoretically, if production capacity could be fully released, the economic growth mirroring this potential output should be roughly consistent with the actual economic growth. However, the key is that the release of production capacity always occurs with specific production relations; thus, the degree to which potential output is realized is not determined by the productive forces but is also influenced by the production relations. The scenario in which societal output is maximized or production efficiency is optimized involves low-efficiency capital exiting production to become lending capital, fully transferring its controlled production resources to high-efficiency capital. However, in some circumstances, high-efficiency capitalists seeking to maximize profits may prefer that some or even all low-efficiency capital remain in active production. This reluctance to increase leverage leads to suppressed loan demand, preventing the full realization of potential output. Particularly, when high-efficiency capital makes decisions based on changes in profits, it involves wages in kind, which are determined by the capital–labor relation, so the capital–labor relation is involved in determining the extent to which potential production capacity is released. Furthermore, from a value realization perspective, if the investment is a function of the profit rate, which is affected by wages in kind, then the capital–labor relation also influences the release of potential production capacity through the value realization mechanism. This suggests that monetary policies to foster economic growth should consider production relations in addition to productive forces. Otherwise, a mismatch between credit money creation and economic growth rates may arise. In other words, monetary policies alone might be ineffective and should be accompanied by income distribution regulation policies.
The second is the relationship between potential output and employment. This paper employs a linear production model akin to the Leontief production function, also known as the fixed-proportion input production function, and its isoquant is significantly different from that of the Cobb–Douglas (C–D) and constant elasticity of substitution (CES) production functions. The difference lies in whether perfect substitutability exists between the inputs of the means of production and labor. Market clearing is more easily achievable if perfect substitution is allowed within a given technology. Hence, according to Western economic theory, the market mechanism can attain full employment in the absence of factors such as price stickiness; if capital and labor cannot be perfectly substituted, technical changes that replace labor with machines will invariably result in a relative surplus population. The analysis above pertains to the theoretical model, and in reality, there is some degree of substitutability between capital and labor, though it can never be absolute. Therefore, the following conclusions can be drawn: (1) When means of production are abundant and labor is scarce, full employment can be achieved upon reaching the potential output level; however, if means of production are scarce and labor is abundant, even achieving potential output will not ensure full employment. (2) When the means of production are scarce, labor is abundant and the economy has not yet reached potential output, expansionary monetary policy to increase credit and aggregate demand can help promote employment. However, it may not achieve full employment in the end. This explains why a high unemployment rate may persist even when output targets are met, though monetary policy is effective. (3) In the circumstance of the scarcity of means of production and the abundance of labor, the adoption of capital-intensive and labor-saving technological change, though potentially increasing potential output, will also augment the relative surplus population. In such cases, monetary policy alone cannot resolve the problem. (4) If labor-saving, high-efficiency enterprises governing capital use are willing to leverage, the unemployment rate may rise while the output increases. In other words, output and employment do not necessarily change in the same direction. Therefore, based on the linear production model, the Marxist political economy is distinct from Western economics based on C–D or CES production functions.
The third is the relationship between output and prices. As mentioned, Marx (2004a) posits that “the quantity of money functioning as the circulating medium is equal to the sum of the prices of the commodities divided by the number of moves made by coins of the same denomination” (p. 142) and indicates that “the total quantity of money functioning during a given period as the circulating medium, is determined, on the one hand, by the sum of the prices of the circulating commodities, and on the other hand, by the rapidity with which the antithetical phases of the metamorphoses follow one another. On this rapidity depends what proportion of the sum of the prices can, on the average, be realized by each single coin. But the sum of the prices of the circulating commodities depends on the quantity, as well as on the prices, of the commodities. These three factors, however, state of prices, quantity of circulating commodities, and velocity of money-currency, are all variable. Hence, the sum of the prices to be realized, and consequently the quantity of the circulating medium depending on that sum, will vary with the numerous variations of these three factors in combination” (p. 144). Therefore, given a constant velocity of money and monetary supply, an inverse relationship exists between the quantity of goods produced and nominal prices [6]. When considering the divergence between industrial capital and loan capital, different leverage ratios impact the overall production efficiency of society and correlate with varying levels of total social output, which implies that leverage ratios also influence price levels. With the increasing adoption of unconventional monetary policies by developed countries in recent years, there has been growing concern about whether expanding monetary credit will lead to inflation. Clearly, many factors are involved, and the mechanism is highly complicated. However, there has been relatively little attention paid in the literature to the characteristics and diffusion of technical change, the divergence between industrial capital and financial capital, the optimization of leverage ratios based on the law of value and the impact of these factors on total output and the price level of material products. Specifically for the model in this paper, while high-efficiency enterprises’ increasing leverage is always beneficial to output growth, the enterprises may not always have the incentive to do so. Therefore, it is possible to maintain price stability only when the money supply increases and high-efficiency enterprises leverage up and further increase total output or though high-efficiency enterprises are reluctant to leverage up, the expectation for asset price rise attracts the increased money into asset “reservoirs”; otherwise, there is a risk of inflation. Thus, this paper supports Zhou's (2020) proposition of expanding the concept and measurement of inflation; specifically, monetary policy should consider asset prices.
The actual operation of monetary policy can be further examined based on the theoretical analysis of the above three relationships. It is worth noting that the People’s Bank of China has recently provided an updated statement of the modern central banking system and modern monetary policy framework. Yi (2020) indicates that the mechanism for regulating the money supply should be improved, with the growth rate of the money supply and social financing scale generally matching the nominal gross domestic product (GDP) growth rate that reflects potential output. Specifically, firstly, to adhere to the ultimate goal of stable currency value, i.e. to make the stable currency value the primary goal and pay more attention to the employment targets; secondly, to improve the anchoring method of intermediate targets, i.e. the intermediate targets of monetary policy should maintain broad money supply (M2) growth rate and social financing scale growth rate generally matching the nominal economic growth rate; finally, to achieve the operational targets through the central bank’s policy interest rate system, it is necessary to improve the central bank’s policy interest rate system based on the open market operation interest rate as the short-term policy interest rate and the medium-term lending facility (MLF) interest rate as the medium-term policy interest rate, thereby effectively achieving the operational target. The total social financing mentioned herein statistically includes RMB loans, foreign currency loans, entrusted loans, trust loans, unpaid bank acceptance bills, corporate bonds, government bonds, domestic equity financing by non-financial enterprises, asset-backed securities of depository financial institutions and loan write-offs. For example, in 2020, the financing achieved through leveraging loans and bonds accounted for more than 90% of China’s total social financing. Therefore, based on the model presented in this paper, regarding the above three relationships, especially the relationship between output and prices, it is significant to pay attention to the relative changes in leverage and nominal GDP to achieve the ultimate goal of currency stability, because if only the money supply is increased but high-efficiency production enterprises do not leverage up, due to the failure to release the efficiency of social production, there may be inflation or huge pressure for asset prices to continue to rise. Of course, a more precise monetary policy operation method should further discriminate the nature of leverage. For example, leverage by high-efficiency production enterprises benefits output growth, but leverage for financial speculation only exacerbates economic fluctuations.
7. Conclusion
This paper attempts to explain the determining mechanisms of interest rates, leverage ratios and asset prices using a heterogeneous agent model based on Marx’s theory of interest-bearing capital. The study finds that, first, if capitalists possess different technologies, the differences in production efficiency between different technologies will lead to differences in profit rates, thereby affecting the functional choices of heterogeneous capital in the movement of social total capital. Second, with the formation of lending relationships, interest rate, leverage ratio and asset price will be jointly endogenously determined. The interest rate is determined by the profit rate of low-efficiency capital, and the asset price of production enterprises can be determined by dividing its ROE by the interest rate. The determining mechanisms of the proportion of industrial capital in social total capital and that of the leverage ratio are similar, jointly determined by the profit rate effect, interest rate spread effect and leverage effect. Furthermore, as the proportion of industrial capital in social total capital increases, the profit rate effect and interest rate spread effect intensify while the leverage effect diminishes. Consequently, different leverage ratios can maximize the ROE. Third, the degree of technological diffusion can affect the willingness of industrial capital to take loans and the profit rate level, so the return on productive investment and financial investment may reverse in different stages of the technological life cycle, leading to diverting funds out of the real economy.
In addition to the above findings, this paper discusses the challenges, tools and goals of monetary policy in the credit monetary system. First, the challenges faced by the monetary policy are primarily in the late stage of technological diffusion, where high-efficiency capital is more inclined to make the low-efficiency capital stay in the production field in order to highlight its efficiency advantage. This results in a reduced incentive for leveraging and leads to a decline in credit demand, thereby hindering the transfer of means of production from low-efficiency producers to high-efficiency producers and impeding output growth through lowering interest rates. Take into account both investment in production and investment in finance. While the demand for monetary credit creation in investment in production shrinks, the demand for monetary credit creation in investment in finance will continue to expand. At this point, it becomes a challenge for monetary policy to distinguish between different types of demand and implement targeted intervention to avoid the misuse and siphoning of monetary credit by financial speculation. Second, monetary policy should emphasize the price tool – interest rate. Given the different profit rates of heterogeneous capital, the deposit rate should be based on the profit rate of low-efficiency capital, while the loan rate is determined by adding a premium to the deposit rate considering the bank’s earnings. If the interest rate corridor approach is adopted, the profit rate of high-efficiency capital would constitute the upper boundary of the upper limit, while the profit rate of low-efficiency capital would form the lower boundary of the lower limit; the target interest rate would be positioned between these two boundaries. Finally, the monetary policy target should focus on the relationship between potential output, employment and prices, and it is necessary to include asset prices. In particular, from the relationship between output and prices, paying attention to the relative changes in leverage and nominal GDP is crucial for achieving stable currency, which is the ultimate goal of monetary policy. Of course, a more precise monetary policy operation method should further discriminate the nature of leverage.
This paper provides a political economy analysis framework for interest rates, leverage ratio and asset prices, intending to clarify the intrinsic mechanism of the functional differentiation of capital determined by heterogeneous technologies and exogenous capital–labor relation and analyze the impact of capital differentiation on the economy. To simplify the core logic, the model does not incorporate expectations, mortgages, information asymmetry, value realization or exogenous random shocks. It also does not delve into the behavioral objectives and strategies of central and commercial banks. Additionally, this paper solely focuses on the functional differentiation of capital without considering the savings of workers and its impact. This leaves ample room for future expansion of this model, and only by integrating these factors into the model and discussing them in detail can a more complete Marxist monetary theory be developed, thereby offering a theoretical reference for China’s macroeconomic governance.
Figures
Figure 1
Numerical example of
Figure 2
Numerical example of
Figure 3
Numerical example of
The setting of high-efficiency and low-efficiency technologies
| Types of technology | High-efficiency technology | Low-efficiency technology | ||
|---|---|---|---|---|
| Parameters | ||||
| Values | 2/3 | 6 | 1/2 | 10 |
Source(s): Table created by author
The unit value of goods and total labor productivity under high-efficiency and low-efficiency technologies
| Types of technology | High-efficiency technology | Low-efficiency technology | ||
|---|---|---|---|---|
| Parameters | ||||
| Values | 18 | 1/18 | 20 | 1/20 |
Source(s): Table created by author
Constraints and boundary values related to wage in kind
| Constraints | |||||
|---|---|---|---|---|---|
| Definition of boundary values | |||||
| Range of values | |||||
| Calculation of boundary values | |||||
Source(s): Table created by author
Comparative analysis of numerical examples illustrating the diffusion of technology and its impact on asset prices (
| Early stage | Late stage | |||
|---|---|---|---|---|
| 0.1 | 0.2 | 0.8 | 0.9 | |
| 0.1 | 0.2 | 1 | 1 | |
| 10 | 5 | 1 | 1 | |
| 0.0588 | 0.0588 | 0.0824 | 0.0706 | |
| 0.8774 | 0.4681 | 0.1660 | 0.1534 | |
| 14.9163 | 7.9582 | 2.0161 | 2.1726 | |
| Increase in | −0.4665 | 0.0776 | ||
| Investment strategy | Invest in production | Invest in production | ||
Source(s): Author’s own work
Comparative analysis of numerical examples illustrating the diffusion of technology and its impact on asset prices (
| Early stage | Late stage | |||
|---|---|---|---|---|
| 0.1 | 0.2 | 0.8 | 0.9 | |
| 0.1 | 0.2 | 1 | 1 | |
| 10 | 5 | 1 | 1 | |
| 0.0112 | 0.0112 | 0.0337 | 0.0225 | |
| 1.0018 | 0.5065 | 0.1350 | 0.1226 | |
| 89.1569 | 45.0785 | 4.0039 | 5.4568 | |
| Increase in | −0.4665 | 0.3629 | ||
| Investment strategy | Invest in production | Invest in financial assets | ||
Source(s): Author’s own work
Notes
IS represents the aggregate demand equation, PC the new Phillips curve and MP the monetary policy rule.
It is important to note that
Theoretically, some technologies may not meet the condition that the profit rate of industrial capital adopting less-efficiency technology remains above zero when the two types of technologies coexist. Given that
According to the model adopted in this paper, low-efficiency capital can be “loaned” by purchasing the stocks of enterprises with high-efficiency technology, thus optimizing resource allocation. In other words, the model in this paper can potentially be developed into the “MM theorem” based on Marxist political economy. The decision of production enterprises to either choose debt financing or equity financing does not solely depend on the different impacts of financing approaches on profits but is also closely connected to the financial market structure of a country. Obviously, an increase in equity financing, which bolsters the capital stock, will lead to a reduction in the leverage ratio. In this case, interpreting “loan capital” as “interest-bearing capital” is more appropriate, with “interest” herein referring to “dividends”. The focus on total social financing should likewise shift towards domestic stock financing projects among non-financial companies. Moreover, on the assumption of arbitrage, a balance between interest and dividends can be achieved.
Due to space constraints, this paper does not delve into the objectives and strategies of the central and commercial banks. For related studies, please refer to Ma and Wang (2014) and Ma et al. (2016).
Of course, the prices mentioned here refer to nominal prices. In a multi-sector model, the determination of prices of different commodities is first based on the commodities’ value. The production prices determine the relative prices and then determine the nominal prices based on the amount of money supply. Therefore, although nominal prices are affected by the money supply, they are still fundamentally based on value.
This is a translation of an article original post at: https://doi.org/10.3969/j.issn.1674-7542.2022.05.007
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Acknowledgements
This paper has been funded by the National Social Science Fund Major Project “Research on the Efficiency Enhancement and Synergistic Promotion of Promoting Common Prosperity in the Marketization of Labor Factors” (No: 22&ZD055), the National Social Science Fund General Project “Political Economy Research on the Construction of a Trade Powerhouse in the New Era” (No: 20BJL046) and the Special Project of the Ministry of Education for Philosophy and Social Sciences Research (Research on the Spirit of the 20th CPC National Congress) “Research on the Path of Realizing Common Prosperity for All People” (No: 23JD20103). This paper was presented at an internal symposium at the School of Economics of Nankai University, with grateful acknowledgment to professors Duan Wenbin, Hu Qiuyang, Li Baowei, Zhang Yun and Feng Zhixuan for their insightful comments.
Corresponding author
About the author
Xiaonan Qiao is Professor and Doctoral Supervisor at the School of Economics, Nankai University, and Researcher at the Collaborative Innovation Center for Socialist Economic Construction with Chinese Characteristics.