Keynes, Wicksell and active monetary policy

The acceptance of monetary policy into mainstream economic thinking was a difficult and slow process. Henry Thornton had already advocated monetary policy in 1802 in his monumental Paper Credit. However, it was not until the publication of Walter Bagehot's Lombard Street in 1873 that a theory of monetary policy was reintroduced into mainstream thinking, and even then it was in a restricted, defensive form. The profession had to wait another 25 years for a full-fledged theory justifying active monetary policy of the kind that Thornton provided, this time in Knut Wicksell's Interest and Prices (1898). This paper offers a brief survey of the slow rise of a theory of monetary policy in the nineteenth century. The paper then elaborates on Wicksell's innovative thinking on monetary policy, with a focus on Wicksell's influence on the work of Keynes. Keynes' early contributions to monetary theory and policy were embedded in the Cambridge monetary tradition and adopted monetary policy as an effective tool in fighting business cycles. In A Treatise on Money in 1930, Keynes presented a comprehensive analysis of that approach; he was well aware of his debt to Wicksell. The changes in Keynes' views that led to the General Theory 6 years later modified his attitude to monetary policy and to Wicksell as well. The paper re-evaluates both the changes in Keynes' thinking on monetary policy between 1930 and 1936 and how these changes are reflected in Keynes' changing attitude to Wicksell.