Interest-bearing capital and monetary policy: A heterogeneous agent Marxian model

Xiaonan, Qiao Article Interest-bearing capital and monetary policy: A heterogeneous agent Marxian model China Political Economy (CPE) Provided in Cooperation with: School of Economics, Nanjing University Suggested Citation: Xiaonan, Qiao (2024) : Interest-bearing capital and monetary policy: A heterogeneous agent Marxian model, China Political Economy (CPE), ISSN 2516-1652, Emerald, Leeds, Vol. 7, Iss. 1, pp. 72-103, https://doi.org/10.1108/CPE-06-2024-041 This Version is available at: https://hdl.handle.net/10419/319475 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Interest-bearing capital and monetary policy: a heterogeneous agent Marxian model Xiaonan Qiao School of Economics, Nankai University, Tianjin, China and Collaborative Innovation Center for Socialist Economic Construction with Chinese Characteristics, Nankai University, Tianjin, China 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 inthe 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 capitaldetermined by heterogeneous technologies and exogenous capital-labor relation and analyze the impact of capital differentiation on the economy. Keywords Interest rate, Leverage ratio, Asset price, Monetary policy Paper type Translated paper CPE 7,1 72 © Xiaonan Qiao. 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 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. This is a translation of an article original post at: https://doi.org/10.3969/j.issn.1674-7542.2022.05. 007 The current issue and full text archive of this journal is available on Emerald Insight at: https://www.emerald.com/insight/2516-1652.htm Received 14 September 2024 Accepted 14 September 2024 China Political Economy Vol. 7 No. 1, 2024 pp. 72-103 Emerald Publishing Limited 2516-1652 DOI 10.1108/CPE-06-2024-041 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 interestbearing 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 China Political Economy 73 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 interestbearing 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. CPE 7,1 74 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. China Political Economy 75 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 mcapitalists exist in this economy, each possessing an identical amount of own capital W. Though capitalists possess an equal amount of capital, there are disparities in their techniques. To facilitate the analysis, assume that only two production technologies exist: high efficiency and low efficiency. The proportions of capital with the above technologies are represented by γand 1 −γ, respectively, where 0 ≤γ≤1. This assumption implies that heterogeneity in capital is limited to technological heterogeneity rather than own capital. If capital is invested in the production sector and the total amount of capital invested is denoted as K, there may be a discrepancy between Wand K. Assume that this discrepancy arises from debts incurred, denoted as B, then B¼K−W. Let the leverage ratio, denoted by η , be the proportion of the total invested capital to own capital (also called equity capital), then η ¼K=W, and ð η −1Þ= η represents the debt-to-assets ratio. Capitalists utilize Kto purchase means of production and employ workers, thereby organizing production. Assume that ris the profit rate and the profit earned on the investment Kis rK. However, not all the above profits can be entirely garnered by industrial capital, for it holds debt and must pay interest on capital borrowed. Let irepresent the interest rate; the return on equity (ROE) for industrial capital is denoted by roe to reflect the return on its investment, as illustrated in Equation (1). roe ¼rK �iB W¼rþðr�iÞB W¼rþðr�iÞð η �1Þ(1) As indicated in Equation (1), the ROE is influenced by three factors: profit rate r, the spread between profit rate and interest rate ðr−iÞand the leverage level ð η −1Þ. When r−i>0, it indicates that operating with debt can yield an “interest premium,” i.e. roe >r, and leveraging up is advised. Conversely, when r−i<0, it suggests that borrowing is unnecessary and that engaging in productive investment may result in an “interest loss,” causing roe <r. In this case, deleveraging becomes imperative and stimulates the withdrawal of capital from production in favor of pursuing interest income. Assume the proportions of industrial and loan capital in the social total capital are denoted as μ and 1− μ , respectively, leading to Equation (2). The left side of this equation represents the loan demand of industrial capitalists, where the total number of capitalists investing in industrial capital is μ m. The amount of each industrial capitalist’s loan CPE 7,1 76 demand is B, and consequently, the total loan demand in society is μ mB. Moreover, as B¼ ð η −1ÞW, μ mB ¼ ð η −1Þ μ mW. The right side of Equation (2) represents the supply of loan capital, where the total number of capitalists investing in loan capital is ð1− μ Þm, and the amount of loan capital supplied by each capitalist is W. Thus, the total loan capital supplied in society amounts to ð1− μ ÞmW. It is evident that when supply equals demand in the loan capital market, η ¼1= μ holds, which signifies that the leverage ratio is a function related to the proportional relationship between industrial capital and loan capital. In other words, the mechanism determining the leverage ratio is the same as determining the proportional relationship between industrial capital and loan capital. It should be noted that this discussion assumes perfect information, which means the collateral requirements for leveraging up under asymmetric information conditions are temporarily disregarded. μ mB ¼ ð η �1Þ μ mW ¼ ð1� μ ÞmW (2) 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 lowefficiency 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 rand iare functions of μ , and given that η ¼1= μ ,roe can be transformed into a function of μ . This will contribute to establishing a theoretical framework in which leverage ratios, interest rates and profit rates are endogenously and uniformly determined. 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). aλþl¼λ;λ¼l 1�a(3) Equation (3) illustrates the determination of the value contained in a unit of commodity, denoted as λ, when produced using a linear production technology ða;lÞ→1, where aand l represent the quantity of the means of production and living labor inputs consumed to produce one unit of output, respectively. The condition 1 −a>0 ensures that net output is more than zero, thereby satisfying the “net output possibility condition” and making production meaningful. f ¼1 λ(4) 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 aλ transferred from the consumed production materials and the directly consumed living labor time l. Consequently, TLP, compared to LP, provides a more comprehensive reflection of the China Political Economy 77 efficiency improvements achieved under the machine-dominated industrial production mode, where machines replace human labor. λ<λ; f > f ;a>a;l<l(5) Setting high-efficiency technology and low-efficiency technology as ða;lÞ→1 and ða;lÞ→1, respectively, Equation (5) differentiates the characteristics of the two technologies, where λ<λand f > f reflect the disparity in TLP between the two kinds of technologies, while a>aand l<lindicate that the transition from low-efficiency technology to high-efficiency technology falls under the “capital-using and labor-saving” (CU-LS) category of technical change. This implies that the technical and organic composition of capital will increase due to the technical change. ðpa þpblÞð1þrÞ ¼ p(6) Equation (6) outlines the determination of production price p. Since this paper focuses on a single-sector model, the production prices pon both sides of this equation can be eliminated. Additionally, Equation (6) highlights the relationship between wages in kind band average profit rate r. An increase in bleads to a decrease in r, indicating that the capital-labor relation is antagonistic, assuming that 1 −ðaþblÞ>0, i.e., the conditions for production surplus and profit are met. aþbl >ð<Þaþbl ;b<ð>Þbc¼a�a l�l(7) 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 bcbe the critical value of band ruand rdthe profit rate when all capital is used high-efficiency or low-efficiency technology, respectively. It can be seen that b>bc,ru>rd, and when b<bc,ru<rd, indicating that when wages in kind are high, the widespread adoption of high-efficiency technology is more likely to lead to an increase in the profit rate. In other words, the capital– labor relation influences the choice of technology. 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 CPE 7,1 78 high-efficiency technology and low-efficiency technology are θand 1 −θ, respectively, with the constraint that 0 ≤θ≤1[2]. Consequently, Equations (8) to (12) offer a method to determine the representative technology. as¼θaþð1�θÞa;ls¼θlþð1�θÞl(8) a>as>a;l<ls<l(9) λs¼ls 1�as; f s¼1 λs(10) λ<λs<λ; f > f s> f (11) 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 ðas;lsÞ→ σ to reflect the average productivity level. Equation (8) defines the input share of the representative technology ðas;lsÞbased on the proportion of each type of technology. Equation (9) illustrates the relationship between the input consumption of each representative technology and that of the two types of technologies. λsand f scan be calculated based on ðas;lsÞ, as shown in Equation (10).Equation (11) can be derived from Equation (8). λ*¼θλ þð1�θÞλ(12) 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 λ*can be calculated from Equation (12), which falls within the range λ<λ*<λ, indicating that λsdoes not equate to the social value standard defined by Marx. θ�λ*�λ�þð1�θÞ�λ*�λ�¼0 (13) 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 λ*and λs,λ*¼λs holds true only when θ¼0 or θ¼1, while λ*≠λswhen 0 <θ<1, leading to f *≠ f s. This indicates that there must be λ*≠λsduring the process of technological diffusion, unless the technical change is completed instantaneously. σ ¼ f * f s¼λs λ*(14) Given the differences between λ*and λs, a production efficiency adjustment coefficient σ is introduced, taking into account the input of representative technology ðas;lsÞand the socially necessary labor time λ*, as shown in Equation (14). Thus, the representative technology can be expressed as ðas;lsÞ→ σ . Therefore, the defining of representative technology can be interpreted as determining the input parameters of representative technology based on the average input of embodied labor and living labor, followed by adjusting the output quantity China Political Economy 79 technology must still be satisfied, i.e. 1 −½ ψ ðaþbl Þ� >0. Given that ψ reaches its maximum when ψ ¼ f = f , 1 −½ ψ ðaþbl Þ� >0 ensures that the minimum profit rate remains above zero [3]. Third is the “interest spread condition,” which is r>r. This condition essentially ensures the feasibility of MBTC under technological heterogeneity and can be expressed as 1<aþbl aþbl < f f . Based on these three constraints, this paper initially defines several boundary values for the wage in kind to facilitate discussion and analysis (see Table 3). The range of wages in kind should be ba<b<bunder the two types of technology, based on the results calculated from the boundary values in Table 3. Finally, the proportion of high-efficiency capital is set. When there are heterogeneous capitalists, it is evident that 0 <γ<1. It is reiterated that changes in γreflect the extent of the diffusion of high-efficiency production technology. Furthermore, the proportion of highefficiency capitalists in the industrial capital is denoted by θ, defined as θ¼γ= μ . 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 γ¼0:5, the paper provides numerical examples for three scenarios of the optimal capital leverage ratio μ *: μ *¼γ,γ< μ *<1 and μ *¼1. Since the technology and its diffusion level are fixed, the key determinant of the optimal capital leverage ratio is the wage in kind. Therefore, it can be observed how the ROE of industrial capital changes with μ as the wage in kind varies within ba<b<b. The first scenario illustrates a situation where μ *¼γ, indicating that capital with highefficiency technology is inclined to leverage up, and consequently, only such capital becomes industrial capital. In contrast, capital with low-efficiency technology withdraws from production activities and becomes loan capital. At this stage, society has the highest level of leverage, where the optimal leverage ratio of producing enterprises aligns with society’s optimal leverage level, which implies the realization of the optimal total social production efficiency. Let b¼0:034; Figure 1 demonstrates that roe peaks at μ *¼γ. Since η ¼1= μ , the leverage ratio is at its peak at this point, indicating the highest demand for loans across the society. The second scenario illustrates the situation where γ< μ *<1, signifying that although capital with high-efficiency technology is willing to leverage up, it is not inclined to leverage up too high. Consequently, besides all capital with high-efficiency technology becoming industrial capital, a portion of the capital with low-efficiency technology remains in the production field, and the remaining capital with low-efficiency technology becomes loan Constraints 1 −ðaþblÞ>0 1 −½ ψ ðaþbl Þ� >0 1 <aþbl aþbl < f f Definition of boundary values bu¼1−a lbd¼1−a lb¼� f = f �−a lba¼a−� f = f �a � f = f �l −lbc¼a−a l−l Range of values b<bub<bdb<bba<b<bc Calculation of boundary values bu¼0:055556 bd¼0:05 b¼0:04 ba¼0:021739 bc¼0:041667 Source(s): Table created by author Table 3. Constraints and boundary values related to wage in kind CPE 7,1 86 capital. In this case, the social leverage ratio is lower than that in the first scenario. The optimal leverage ratio for the production enterprises deviates from the socially optimal leverage ratio, meaning that spontaneous capital decisions cannot optimize the total social production efficiency. Let b¼0:032, and Figure 2 demonstrates that the value of μ *realizing the highest roe is characterized by γ< μ *<1. Similarly, because η ¼1= μ , the leverage ratio is slightly lower at this point, indicating that there is still some demand for loans in society, but it is relatively sluggish. The third scenario illustrates a situation where μ *¼1, indicating that capital with highefficiency technology is unwilling to leverage, resulting in both types of capital with different efficiencies becoming industrial capital. At this point, the society’s leverage ratio declines to 1, meaning that investment in productionsolely relies on its capital. Inother words, due to the absence of social demand for loans, the lending relationship cannot be established; hence, capital can’t be loan capital. A completely unleveraged situation is not optimal for total social production efficiency. Let b¼0:03; Figure 3 depicts that the value of μ *realizing the highest roe is 1. Consequently, since η ¼1= μ , there is no leverage or loan demand. 0.6 0.7 0.8 0.9 1.0 0.214 0.216 0.218 0.220 0.222 0.224 Note(s): The vertical axis represents roe, and the horizontal axis represents μ Source(s): Author’s own work 0.6 0.7 0.8 0.9 1.0 0.2295 0.2300 0.2305 0.2310 0.2315 Note(s): The vertical axis represents roe and the horizontal axis represents μ Source(s): Author’s own work Figure 1. Numerical example of μ *¼γunder the MBTC condition Figure 2. Numerical example of 0< μ *<1 under the MBTC condition China Political Economy 87 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, γ, increases from 0.1 to 0.2 and from 0.8 to 0.9, exemplifying the early stage and the late stage, respectively. Continuing with the settings provided in Tables 1 and 2, and given specified values of b, information for Tables 4 and 5is derived, both of which illustrate the impact of technological diffusion during the early and late phases on leverage ratio, interest rate, ROE and asset price. The effect varies due to different values of b. During the early stage, regardless of whether γis 0.1 or 0.2, businesses with high-efficiency technology have a distinct advantage, resulting in relatively great profit rate and interest rate spread effects. Increasing leverage can significantly boost the ROE, creating a strong demand for capital loans. Meanwhile, a 0.6 0.7 0.8 0.9 1.0 0.238 0.240 0.242 0.244 0.246 Note(s): The vertical axis represents roe and the horizontal axis represents μ Source(s): Author’s own work Figure 3. Numerical example of μ *¼1 under the MBTC condition CPE 7,1 88 high ROE yields a high asset price. However, as the proportion of enterprises with highefficiency technology increases, the effect of leverage on increasing ROE weakens, resulting in significant drops in asset prices. For instance, when γincreases from 0.1 to 0.2, Tables 4 and 5 report a corresponding decline in asset prices by �0.4665 and �0.4944, respectively. Generating returns from productive investments is a more favorable option then. In contrast, in the late stage of technological diffusion, regardless of γbeing 0.8 or 0.9, the technological advantage of enterprises with high-efficiency technology is not clear. Regarding improving the ROE, leveraging is less effective than lowering the average productivity of society by keeping enterprises with low-efficiency technology in the production field. Therefore, the demand for capital loans disappears, and enterprises are unwilling to leverage. Moreover, as highefficiency technology exhibits the characteristics of MBTC, further diffusion of technology may lead to a gradual decline in these high-efficiency enterprises’ ROE, but with a concurrent reduction in interest rates as defined by low-efficiency enterprises’ profit rates. When the decrease in interest rate exceeds the decline in the ROE of enterprises with high-efficiency technology, asset prices will rise instead of falling. However, whether the increase in asset prices makes investments in financial assets attractive varies in different situations, as shown in Tables 4 and 5. According to Table 4, when γincreases from 0.8 to 0.9, the rate of increase in asset prices achieves 0.0776. At this point, the yield obtained from asset price differences is still less attractive than that from investing in production. However, when γ increases from 0.8 to 0.9 in Table 5, the increase rate in asset prices reaches 0.3639, making investing in financial assets a more rational choice [4]. If the late stage of technological diffusion persists and monetary credit continues to expand, the scenario depicted in Table 4 is more likely to lead to inflation, while that in Table 5 will result in funds diverting from the real economy. Early stage Late stage γ0.1 0.2 0.8 0.9 μ 0.1 0.2 1 1 η 10 5 1 1 i0.0588 0.0588 0.0824 0.0706 roe 0.8774 0.4681 0.1660 0.1534 q14.9163 7.9582 2.0161 2.1726 Increase in q�0.4665 0.0776 Investment strategy Invest in production Invest in production Source(s): Author’s own work Early stage Late stage γ0.1 0.2 0.8 0.9 μ 0.1 0.2 1 1 η 10 5 1 1 i0.0112 0.0112 0.0337 0.0225 roe 1.0018 0.5065 0.1350 0.1226 q89.1569 45.0785 4.0039 5.4568 Increase in q�0.4665 0.3629 Investment strategy Invest in production Invest in financial assets Source(s): Author’s own work Table 4. Comparative analysis of numerical examples illustrating the diffusion of technology and its impact on asset prices (b¼0:035) Table 5. Comparative analysis of numerical examples illustrating the diffusion of technology and its impact on asset prices (b¼0:039) China Political Economy 89 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 profitseeking 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 CPE 7,1 90 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 fromParty 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 China Political Economy 91 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 CPE 7,1 92 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. China Political Economy 93 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 AS and AD represent the aggregate supply and aggregate demand in a given period, respectively, in which AS equals the aggregate output xof that period and ADconsists of the costs compensating for the reproduction, consumption of capitalists and accumulated investments for extended reproduction. Two types of capital with different efficiency levels are in the preceding model. Thus, the social aggregate output xcomprises the output of high- and low-efficiency producers and determines the aggregate supply, as indicated by Equation (24). The settings of AD refer to Equation (25), where hðaþblÞxþðaþbl Þxi denotes the costs compensating for the reproduction. Let CBand CB denote the consumption of capitalists with high-efficiency technology and low-efficiency technology, respectively; the aggregate consumption of capitalists is �CB þCB�. Similarly, let Iand Irepresent the accumulated productive investment of capitalists with high-efficiency technology and lowefficiency technology for extended reproduction, respectively, and the aggregate accumulated investment is �IþI�. 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, AS ¼AD should hold. However, if the decline in profit rate leads to a shortage in accumulated productive investment, causing AS >AD, it would imply an overproduction, meaning not all products can realize their value. If capitalists could foresee the aggregate demand and the degree of value realization of goods after production before deciding the leverage ratio, they would make adjustments in advance, which would impact the decision of the capital leverage ratio and the constraints of the credit expansion of commercial banks. Of course, the issues above are intricate, involving CPE 7,1 94 investment function and expectations. Due to space constraints, these issues are not discussed herein. Nevertheless, the constraint of value realization should not be overlooked. AS ¼x¼xþx，其中x¼βmW aþbl，x¼ð1�βÞmW aþbl (24) AS ¼x¼xþx;where x¼βmW aþbl;x¼ð1�βÞmW aþbl (24) AD ¼��aþbl�xþ�aþbl �x�þ�CB þCB �þ�IþI�(25) 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. 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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. Xiaonan Qiao can be contacted at: [email protected] For instructions on how to order reprints of this article, please visit our website: www.emeraldgrouppublishing.com/licensing/reprints.htm Or contact us for further details: [email protected] China Political Economy 103