Essays in Monetary Theory and Policy: On the Nature of Money (5)

By Samuel Ellenbogen*

The nature of money has been a discussion entailing ongoing debate between historians, philosophers, and economists for centuries as Bell (2001) wrote. There is no easy solution to the delineation of almost all aspects of money; from discussions concerning the origins of money to discussions concerning the functions of money to discussions concerning the “proper” policy prescription parameters involving decisions about how to spend government money. This is because money has been defined in various different contexts, as Bell (2001) discusses its ambiguousness as “A numeraire, a medium of exchange, a store of value, a means of payment, a unit of account, a measure of wealth, a simple debt, a delayed form of reciprocal altruism, a reference point in accumulation, an institution, and/or a combination of these”.

Arguably, the most important distinguishing criterion for the way the economy functions involves an explanation of what money is, what it is used for, and what the origins are. Each school has its own viewpoint on what money is, and therefore must explain its role in the economic system. Certainly, examinations of both the orthodox and heterodox schools have valuable insights. The orthodox schools (classical, neoclassical, and their modern macroeconomic offshoots) agree on what money is and what the origins are; but there are defining differences in terms of the functionality of policy prescription parameters. The heterodox schools tend to agree amongst one another, but view the nature of money in a radically differing manner than the orthodoxy in terms of origins, usages, and policy prescriptions. This means that there is no uniform understanding of money for the standard orthodox framework the heterodox framework. First, a depiction of each of these delineations of the nature of money, (including a narrative of the origins and functions of money) are necessary. This will be done for the orthodox as well as the heterodox approaches. Then, a summary of the variety of policy prescriptions for both the orthodoxy and the heterodoxy will follow. A conclusion will not be written given the nature of the essay-the reader can simply refer to sub-titled sections for review.

The Nature of Money: An Orthodox Approach

For the orthodox view, money is typically described in money and banking textbooks in the context of its medium of exchange function. This understanding is predicated from the primitive bartering system that the orthodox schools refer to in terms of the origin and development of money, such as Samuelson (1975.) It is understood under this conceptual framework on the nature of money that the bartering system was ineffective; it requires two people to have a simultaneous double coincidence of wants for a trade to transpire. Money is said to facilitate this problem and make the process much more transparent; instead of going and finding someone in the community who wants what I have and has what I want (which is quite difficult in many, many situations) now everything is salable in the revolving currency and is denominated in terms of the cardinal magnitude of that currency. It becomes a unit that merely facilitates exchange; it has no functionality in the real economy for the orthodox schools of thought. This is what has been termed the classical dichotomy- the separation of the so-called “real” factors of production in the economy from the monetary factors-the modern factors being fiat currency and banking institutions.

The orthodox view on the nature of money insists that the first means of payment were things with intrinsic value; that is to say that these money “things” had value regardless of whether they were used as “money things” in markets as a medium of exchange, as Cecchetti  (Second Edition) explains. The understanding here is that successful commodity monies had characteristics that were unique, often to the commodity in consideration. For example, a block of salt is valuable in the sense that it keeps food from going stale or un-edible. Commodity monies could be made into standardized quantities, making accounting non-arbitrary. They are durable, reducing the risk of accidental destruction of assets. It had high value relative to weight and size, which made them transportable to wherever a purchase was made. Finally, they are divisible into small units to make trade amongst cultures accessible.

The Origins of Fiat Money: An Orthodox Articulation

A discussion of the nature of money for the orthodox view would not be complete without a historical reconciliation of the origin of fiat money. As Cecchetti discusses, the origins of fiat money in Europe began in 1656 by a Swede named Johan Palmstruck, who founded Stockholm Banco. At the time, the commodity accepted as payment for debts in Sweden was the Swedish copper ingots, which did not carry much value per unit weight. The currency solved this problem and was welcomed at first. Palmstruck’s partner (the king of Sweden) took to the currency almost immediately and convinced Palmstruck to print more of the notes to help the King finance the war. The realization was that since bills were redeemable on demand for metal, the system had stability, so long as people believed that there was enough metal sitting in Palmstruck’s vaults. However, soon the number of notes circulated dramatically, and Swedish people lost confidence in the notes and began redeeming them for metal. The result was a run on the bank that led to failure. The key point is that both the belief that the metal was sitting there and the belief that the metal was no longer sitting there gave stability and yet took stability away. Fiat money is thereby irrelevant when trust in the money is altered or destroyed. Finally, fiat money has very little intrinsic worth and cost of producing it is very low relative to its face value.

The Nature of Money: A Heterodox Alternative

Now that the orthodox vantage points concerning the nature of money have been discussed, and its origins have been sufficiently summarized, we can turn to the non-orthodox, or heterodox conceptual framework concerning these criterions for money. According to the heterodox view, money is simply an IOU. All exchange cancels debts by parties involved. It is therefore a unit of account that keeps records of debt. As Wray (September 2007) writes, “money is neither a commodity (such as coined gold), nor is it “fiat” (an asset without a matching liability)”. Furthermore, this means that money is ultimately a credit relation (Innes, 1913); any denominated unit that is generally acceptable and thus, facilitates an exchange of debts can be used as money. Therefore, all forms of money are credit monies, and all credit monies are debt instruments. Exchange yields a credit on somebody’s books and a debit on somebody else’s books, regardless of what the unit of account is. Third, a sale is not the exchange of a commodity for some intermediate commodity called the medium of exchange, as the Neo-Classical model would have. Rather, as (Innes, 1913) described, “It is the exchange of a commodity for a credit”. This means that credit and only credit is money, and only sales of property or skills give us credits that offset debts. As Levine (1983) articulates, nothing significant changes when you add money to a society because money is based on commodity relations; money only solves the technical problem. It is because we can imagine exchange existing preemptively to the emergence of money things that Levine has come to such a conclusion.

In recognizing the nature of money as a social unit that is predicated upon credit and debit relationship based on commodity relations, money’s medium of exchange function is irrelevant to a depiction of what money actually is in the heterodox vision. It is understood in the context of credits and debits that such a system predates the view of markets as necessary financial intermediaries between buyers and sellers. As Levine says, “money is the value of commodities existing outside of them”. Here, he explains a situation where commodities embody the already existing wealth which money represents. This means that for the heterodox, the unit of account function is a much more accurate depiction of what money actually is; money is a socially accountable representation of “commodity ratios” where we can distinguish value from one commodity to the next. With this understanding, money can be understood as “scorekeeping”, as Wray (2013) and Mosler (2010) put it.

A further understanding on the nature of money is to reflect and regulate economic activity, as Foley (1987) writes. As originally delineated in Marx (1867) however, money is used as a “social construct” as the object of production in capitalist systems. Wray (2010) has described a situation in which not merely the way social evaluation of output is measured; production is deemed to be “thoroughly monetary at essence”. This approach was first articulated by Marx with the M-C-M’ delineation of money as the end goal of capitalism, not C-M-C’ as the classical writers supposed. This means that if production is thoroughly monetary, the goal is to make money in a capitalist economy. Both Keynes (1936) and Veblen (1904) expounded on this framework. In addition to this shared understanding of Marx amongst Keynes and Veblen, Keynes associated money as a function of fundamental uncertainty in capitalist economies; Veblen recognized money as an institution whereupon possession of money gives the holder power.

The nature of money for the institutionalist is that money itself is an institution.  Money sustains the life process in modern capitalist systems, but also allows people to “conspicuously consume” and “pecuniarily emulate” peers. This means that for the institutionalist, part of the social process of money is to “fit in” with our neighbors and friends. Institutionalists insist that the public seeks out money to impress our colleagues and establish ourselves within a community. He who has money is perceived to have power and social status.

The Origin of Money: A Heterodox Narrative

While the precise origin of money has been lost over the course of time and contributes to the debate between heterodox and orthodox as Wray (2012) writes, the heterodoxy points to the historical record for proof of the variety of forms money has been documented to take, as Forstater (2006) discusses. Simultaneous to this understanding, the heterodoxy has accepted it as a stylized fact that the ascertainment of the first use of money in civilization will most likely never be realized. Even with such a device as a time machine it would be exceptionally difficult to be transported to the precise moment in which man first used money; It would require a great deal of communication by our part throughout the world in a time where the English language and writing were not developed yet.

In fact, many historians note the origins of writing to be inexorably tied to keeping track of the community’s prevailing commodity money stock. It has been further articulated that the purpose of keeping track of these IOUS was to keep track of debts of crime that were committed by community members. Even in very primitive society, people had to keep track of debts; this is because there were crimes that communities demanded to be re-paid. This led to a demand for a commodity to pay for these debts (to facilitate the payment process). There was no necessary reason to have a unit of account in tribal societies, but clearly there was a great incentive embedded into society to denominate a unit of account in the community to keep track of payments of debt. In this context of record-keeping, money did not originate out of the barter system; the fundamentals of money (primarily) even pre-date a bartering system.

The orthodox view simply ignores this point, however; the historical record is not a factor for the orthodox. Metallic units, such as (gold and silver) are really all that is referenced in the orthodox literature- they assert that the first money was gold coins from the ancient Sumer civilization. In this regard, they ignore the reality that money has taken the form of many different commodities. One example of a primitive money that the heterodoxy has alluded to as a different unit of account in Forstater (2006) is the cowry currency that was used in parts of Africa or Asia. It is speculated that this commodity unit of account began in the late 13th century. Another is tally sticks, which were used well into the 19th century as Innes writes (1913).  Therefore, money has taken the form of many different commodity units over the course of time; it did not have to have intrinsic value that exists outside of a market in order to be used to facilitate an exchange, as the orthodoxy insists. Money can simply perform its record-keeping function without such criteria. As Smithin (1994) writes, “It is fairly obvious that this is a change of form rather than of substance”.

The Functionality of Money: A Heterodox Articulation

While money has been denominated in many different units in different time periods and societies, the functionality of money (in terms of a recognized social construct predicated on trust) has always been maintained throughout the differing mediums. In every medium, economic agents have to have trust in exchanging IOU’s, whether the IOU’s are commodity moneys, fiat moneys, or tally sticks. If trust is not there, money’s functioning as a debt cancellation process breaks down. Even in a bartering system, trust is imbedded in the exchange of good A for good B; the holder of good A trusts that the holder of good B will accept good A for good B when the trade occurs (Innes, 1913.) Money loses its value if the commodity unit of account is not accepted everywhere.

Fiat Currency: A Heterodox Reconciliation

Fiat money makes trust in government debts ubiquitous, as long as the government accepts payments of debts in its own currency and can sufficiently collect these debts in a timely manner. Furthermore, this is precisely why government debt is at the top of a “pyramid” of liabilities (Bell 2001.) If the state imposes an obligation on citizens, it must also accept fulfillment of these obligations in the states’ currency. This implies that the state promises to accept its own IOU’s. In this implication, money is a record of the state’s debt to you, and payment of taxes in the unit of account fulfills the citizens’ debt to the state.

Fiat currency issuance is a state-controlled monopoly that is designed not to facilitate a market exchange to deal with the double coincidence of wants issue that we can conceptualize in a primitive bartering system. It is rather used to drive the demand for the state’s money of account: government IOU’s, as Wray (2013) discusses. Since the nature of money is at essence simply credit, (Innes 1913) anything that is generally accepted in a society as forms of payment can be used. This admittedly creates trouble for governments who are interested in expanding into new markets that use units of account that are not redeemable in the mother country’s unit of account. This conflict of interest was resolved when the mother country (who presumably seized control of the new land) imposed new obligations on its citizens. These obligations are commonly known today as taxes, but they are not limited to strictly taxes. Any obligation imposed is sufficient and has taken the form of “fines, tithes, fees, duties, or tributes.” (Wray 2007). In this understanding, both fiat money’s origin and its use has to do with the notion that taxes drive the demand for money, as Forstater (2006) discusses.

This notion of taxes driving money is what is called chartalism, where money is a function of sovereign state power. As Lerner articulates in (1947), “Whatever may have been the history of gold, at the present time, in a normally well-working economy, money is a creature of the state.” He goes on to say that “its general acceptability, which is its all-important attribute, stands or falls by its acceptability of the state.” In other words, the public doesn’t hold money because of its relation to gold; they hold it because it is accepted for payment of debts (because the government says it has value.) Hence the demand for sovereign currency is initiated, and if the demand is initiated, money is functional. Finally, the imposition of required obligations to the government onto the citizens through taxation actually destroys government IOU’s. Therefore, sovereign states harness inflation, since the only accepted unit of account for payment of government debt is the fiat currency. This means that fiat money is also used to keep inflation in check, as Lerner originally wrote (1946.) In this conception, government spending or selling of its fiat currency can be used to remove monopoly power from private interests. Lerner called this process counter-speculation. Last, taxation is never used to finance government spending; it is used to curb inflation.

Policy Prescription Parameters: The Orthodox Approach

As previously mentioned in the introduction, the orthodox view of the nature of money is generally agreeable; it is the policy prescription of its use that differentiates from school to school. At one point, there was simply one understanding: Keynes’ work in the General Theory (1936). Policy prescriptions parameters in response to economic recession or depression were virtually invented by Keynes in the General Theory, although it was vastly misinterpreted. This misinterpretation was originally predicated from Sir John Hicks’ interpretation of Keynes. His work became known as the Neo-Classical synthesis, which took Keynes’s work and the Classical school’s work and essentially combined them both.  It is still used for the Orthodox schools of thought, despite the evolution within orthodox schools concerning policy in the past 50 or 60 years.

Hicks constructed what he defined as the IS-LM framework, where the interest elasticity of investment demand is delineated as a backdrop for desirable policy. In a world where the money supply is exogenously determined by a central bank, if the interest elasticity of investment demand was perfectly elastic, only monetary policy was effective for stimulating the economy in the short run, and policymakers should pursue its use. Conversely, if the interest elasticity of investment demand was perfectly inelastic, fiscal policy was desirable for stimulating the economy in the short-run, and policymakers should employ its’ use. Keynes believed that this was indeed the case; (at least that it was nearly perfectly inelastic for Keynes.) Neo-Classicals eventually formed policy prescription parameters in the context of the Phillips curve when Phillips (1958) first articulated the costs of reducing unemployment at the expense of inflationary measurements. This view prevailed in the Neo-Classical synthesis until the stagflation phenomenon of the 1970’s occurred. Inflationary pressure with simultaneous high unemployment had no articulation in the Neo-Classical synthesis. Therefore, the policy prescription parameters were in question, and the road was paved for the first evolution of the Neo-Classical synthesis.

Evolution #1 of the Neo-Classical Synthesis: The Monetarists

The implications of policy making for the Monetarist school derive from Friedman and Schwartz (1956) original work, which recognizes a world where money prices are relatively stable and the public is both rational and backwards-looking. In this context, laborers adapt their inflationary expectations into their labor contracts based on previous expected inflation rates. In this context of stable prices and rational thinking by economic agents that are backwards-looking, if policymakers are interested in stimulating output and employment, they can do so in the short-run by increasing the money supply. This understanding of policy assumes that money can be exogenously controlled by the central bank, meaning that the money supply is governed by regulation and regulators can therefore control the money supply.

The Monetarists argue this for two reasons: first, because workers will be temporarily “fooled” into supplying more labor, and second, Monetarists insist that there is positive correlation in economic growth and money supply increases (which again, is assumed to be exogenously controlled by the central bank.) Employers can therefore afford to give their employees wage increases, and because laborers view this as a signal of their productivity, laborers are fooled- they are happy and supply more labor in the short-run, as the substitution effect of labor dominates the income effect. However, after the laborer goes to the bank, cashes his or her paychecks, and realizes that their income only buys the same amount of goods as it does before, the laborer decreases the amount of hours he is willing to supply, and the economy moves back towards the output level that it was at before. As Friedman warned, the only result long-term is a permanently higher level of prices. The Monetarists said that there should be a slow, steady increase in the money supply to properly grow the economy, and any short-term stimulus would simply come at the cost of longer-term inflation, given their understanding of the rational expectations augmented Phillips curve. With the revival of Monetarism in place, further thinkers eventually adopted new ideas to improve it.

Evolution #2: The New Classicals

The New Classical school adopts Friedman’s rational expectations augmented Phillips curve in terms of policymaking as well as the stability of the velocity of money to the Neo-Classical synthesis, as Wray writes (January 2010.) However, instead of laborers being backwards-looking, they are forwards looking and adaptive for the New Classical. Lucas (1972) implied that Friedman’s assumption of laborers negotiating contracts predicated on past inflation rates is problematic because of the serial correlation that is involved. There is a time-lag between increasing or decreasing the money supply and the level of inflation, so that wage contracts are not accounting for an accurate level of inflation (most of the time). Instead, the New Classical school advocated the notion of “fooling” the public to stimulate output in the context of underlying perfect competition microeconomic foundations. The assumptions firstly include that laborers have perfect information about what the Fed is going to do. This is a very weak assumption because they only have a probability distribution concerning what the Fed is going to do; the Fed could behave randomly. Second, there are no transactions cost to obtaining this information, and third, markets are continuously clearing. In this context, laborers can be fooled into believing what the Federal Reserve says if the Fed says one thing and does another thing in terms of policy in for example, interest rate determination. The result of which is an increase in output and employment. The New Classical School advocates that the public can be consistently fooled into making personal finance investment decisions, labor allocation decisions, business investment opportunities, and the like.

The New Classical School was an improvement upon the serial correlation errors of the Monetarist school, but was still not very realistic in terms of policy. On one hand, there is the issue that the assumption that the public has all the information about economic performance is particularly erroneous one; not even economists have all of the correct information, so it is not plausible to make such an assumption. On the other hand, markets simply do not continuously clear in the real world; there are a variety of nominal rigidities that prevent such circumstances, such as the inside-outside labor model, the notion of efficiency wages, the reality of the principal-agent problem, asymmetric information between laborer and employer which often results in adverse selection scenarios, and a variety of others that are well documented in the microeconomic literature. These realities left room for further evolution in terms of policy prescription parameters.

Evolution #3: The Real Business Cycle School

The Real Business Cycle School rejects the notion that velocity of money is stable as the Monetarists and the New Classicals propose in the revival of the quantity theory of money. For the Real Business Cycle economist, the role of technology is always prevalent and able to change the amount of money the public wishes to hold, as Plosser delineates (1989). In conjunction with this understanding, the Real Business Cycle school argues that the Monetarists have reversed the causality of money; it isn’t that increasing the money supply leads to directly increasing levels of output. Rather; it is the increase in output that accommodates the demand for increasing the money supply. The demand for real money balances increases after it is determined that profit opportunities exist in a growing economy. In addition, the Real Business Cycle school emphasizes that there are inter-temporal substitutions of goods for labor and labor for goods when technology advances, and advocate an economy that can exist without money altogether (the Robinson Crusoe model.) In this context, the economy has no long-term natural rate of growth as the Monetarists propose (that is primarily determined in the quantity theory equation.) Rather there is a change in the rate of growth of the economy as technology improves. The result of all of these frameworks for RBC thinkers is that the central bank shouldn’t do anything; nor should it hope to be able to do anything in terms of policy’s ability to change the economy’s growth path. Monetary shocks are unpalatable in this context for the Real Business Cycle economist. However, the reality of modern economies entails the use of monetary policy. Damage to the monetarists was evident in some respects, but hardly any economists found the Real Business Cycle’s assumptions to be realistic as Wray (January 2010) writes. Yet, there was still room for another evolution in orthodox theory- to their current state in the Orthodox approach.

Evolution #4: The New Keynesians

The final stop for a discussion of the orthodox view in terms of the role of money’s involvement with policymaking is the advent of the New Keynesian school. New Keynesian economists follow the Hicksian IS-LM framework as a backdrop for understanding policy (and therefore see the money supply as being exogenously determined by the central bank). However, they adopt microeconomic market failure foundations into their understanding of the world. For the New Keynesians, it is understood that the Neo-Classical framework that assumed away nominal rigidities is not relevant to the world in which we actually live- one that has all of the microeconomic flaws of monopoly, monopsony, and (the others previously mentioned in the brief summary of the critiques of the New Classical school.) New Keynesians such as Mankiw began revising the Neo-classical synthesis to accommodate these realities in the early 1980’s as an attempt to improve policy prescriptions by the Federal Reserve. Modern economists that the public has often heard of that subscribe to this school are regulators such as Ben Bernanke and Janet Yellen.

Policymaking: A Heterodox Narrative

Now, a discussion about regulatory policy parameter measures in the context of each heterodox school’s vision for the role of money is in proper order. For the institutional economist, making money is the goal of the machine process, as Veblen (1904) wrote. The industrial complex (capitalists and capitalism) require organized technology and institutions for progress. Furthermore, consumption and production are a function of the evolution of technology and institutions simultaneously, and the industrial complex acts as an intermediary between the private sector and the public to determine how we make a living. In this framework, money is the goal of business and the making of money is how we “keep the machines running” as Clarence Ayres (1944) put it. Institutionalists recognize correct policy parameters to be those that allow the technological side of society to be utilized in this context of production. They argue that creation of policy should be focused on either creating institutions to accommodate technological innovation (for example, as in the New Deal) or reforming institutions to accommodate the progressive uses of technology. The argument is that the technological side is constrained by institutions, and proper policy parameters can facilitate the adoption of technology to help make the life process better.

The Post-Keynesians/MMT Policy Approach

For the Post-Keynesian economist, money is endogenous to the system; the money supply cannot be directly controlled by the central bank. Therefore it is not determined exogenously by the central bank, but rather, horizontally. This closely follows the work of Basil Moore who first argued in favor of “horizontalism”, as Niggle and Wray (1989) review. The Federal Reserve simply sets the overnight interest rate and banks standby to supply the demand for loans to creditworthy borrowers as they come. It follows that in times of economic success the Post-Keynesian argues that expansions finance themselves, since money is demand-driven. The Fed keystrokes checking accounts as necessary in the process. Ultimately for the Post-Keynesian, expansions naturally accommodate money into the system without any external institutional control beyond interest rate targets.

Post-Keynesians are therefore very skeptical about the role of monetary policy in terms of influencing output. Not only because of the horizontal conceptual framework concerning banking procedures, but also because they argue that economic processes work in three periods simultaneously- the past, present and the future as Brazelton, Sturgeon and Weinel (1994) review. Therefore, any attempt to influence future output is futile in a context where we must understand the propensity of future outcome realizations by policy determinations in the present. Since money is endogenous to the system, any central banking policy procedure is likely to be irrelevant, because all it can do in terms of influencing the demand for money is set the overnight interest rate target; these loans will be accommodated regardless of what that target interest rate is.

Furthermore, the Post-Keynesian delineates that expectations of future profit returns are the most important criteria to predict future growth in capitalist systems. This is because Minsky (1986) like Keynes, understood that the economy is not just composed of markets; it is a complex financial system predicated on starting a business project with money and ending with more money than the project began with. Minsky writes that over time, “stability is destabilizing”, and at some point banks “make position by selling position” and the economy is highly vulnerable to banking profit motives. Therefore, any institutional restraint or restriction imposed by policymakers that is designed to stabilize the economy is actually undesirable. The logic is as follows: when investors expect profit margins to be high, they begin to invest, but they hedge their invested money with borrowed money. When expectations are relatively higher than when the economy came out of a recessionary period, past failures of investment schedules are soon forgotten, and investors are no longer hedging their own funds against borrowed money; they are purely borrowing money in speculation of profit margins. Eventually, investors are completely involved in what Minsky described as a “Ponzi finance” scheme, where borrowing money is not to accommodate increased production measures, but to finance interest on loans. At this point financialization has corrupted the markets, and recession/depression is necessary to wipe out debts.

Additionally, the Post-Keynesian economist understands the reality of constraints and parameters that are difficult to measure or that might shift quickly instead of gradually, as Brazelton, Sturgeon, and Weinel (1994-1995) carefully remind us. The Post-Keynesian economist dismisses the “correct” interest elasticity of investment demand as being a relevant policy conclusion. This is because this variable does not provide a medium for understanding the way the economy works in a world where fundamental uncertainty exists. Some constraints and parameters to policy making’s relative effectiveness include bottlenecks, price increases, or structural changes in the economy that is determined by factors that cannot be foreseen in today’s policy impositions. Post-Keynesians point to the reality of these complex market failures and caution us to be careful of policy parameter decisions in addition to the financial instability hypothesis’ presence.

However, there are policy prescriptions that can be condoned to deal with the aftermath of financial crises. In a world where money is not readily available because the private sector is dealing with a painful debt deleveraging process (post-financial crisis), it is understood that the government (as the sole sovereign monopoly currency issuer) has the means to fully re-employ resources. This is called the functional finance approach that was first proposed by Lerner (1947.) Lerner says that the role of government is to be like the steering wheel of a car: when the economy steers off course, government stands by to correct it. Lerner further argues that the question of whether government spending is “good” or “bad” is erroneous in terms of sustainability and affordability. The government, as the sole monopoly currency issuer, can always afford whatever it wants, as long as the debts are denominated in the sovereign’s currency. Lerner states (1946), “We owe this money to ourselves and not to anybody else.” In this context, rather, government should be concerned with spending effects on the economy in terms of a primary determinant for a necessary course of action. As Lerner continued to write in (1946), “the financial activities of government should be judged not by any traditional canons of fiscal propriety but by considering the effects of each act and deciding whether these effects are desired or not.”

Not only does the sovereign government have the means to adopt a full employment jobs program; this is desirable- output gaps are reduced very quickly while effective demand is restored. Lerner keenly states “It is unlikely that any other single way of increasing the efficiency of our economic system can add so much to the social output.” Put simply, the private sector is not in business to employ people simply for welfare’s sake; it is profit-motivated (Wray, 2013.) In opposition to this understanding, however; government does not have to be concerned with profits. And as Godley originally explains in the sectoral balance approach (1999), when the government has a deficit, the private sector has a surplus and the reversal. Additionally, the two can’t be in surplus at the same time because this process behaves according to accounting identity. This means that when the government is at a surplus, the private sector is in a deficit. Therefore, spending in terms of a full employment program that correlates with a government deficit is both affordable and desirable. It is affordable because of sovereign monopoly currency issuance; it is desirable for two separate reasons. The first is that government spending puts more money into the private sector than it takes out. The second is that a full employment program is superior to any monetary stimulus that “may suffer slips from the cup to the lip” as Keynes (1936) famously put it. It is also superior to fiscal policy such as infrastructure spending or tax cuts, which may or may not lead to increased effective demand; it depends on the marginal propensity to consume as Keynes (1936) delineated. Furthermore, monetary and fiscal policy actions suffer from inside and outside lags as Friedman (1948) articulated. A full employment program can be conceptualized and mandated very quickly; one only needs to review Roosevelt’s New Deal program for evidence- within two months, his plan was “articulated, proposed, and adopted in practical use” as Kregel puts it (2009).

*A Note:

For the next few weeks we will be running a series of articles on monetary theory and policy. These are final essays written by MA students in my class this past Fall semester. I was very happy with the results—students indicated that they had a firm grasp of both the orthodox approach as well as the heterodox approach to the subject. Most of them also included some Modern Money Theory in their answers. I asked about half of the students in the class if they would like to contribute their essay to this series. Sometimes students are the best teachers because they see things with a fresh eye and cut to what is important. They are usually less concerned with esoteric academic debates than are their professors. Note that these contributions are voluntary and are written by Masters students. I told students they could choose to use their own names, or they could choose an alias. Comments are welcome, but please be nice—remember these are students.

For your reference, here were the topics for the paper. The paper had a maximum  limit of 6000 words.

Choose one of the following. You must consider and address both the orthodox approach and the heterodox approach in your essay. Where relevant, include various strands of each.

A) What is the nature of money? Given the nature of money, what approach should be taken to policy-making?

B) What is the nature of banking? Given the nature of banking, what approach should be taken to policy-making?

C) According to John Smithin there are several main themes throughout controversies of monetary economics, each typically addressed by each of the various approaches to monetary theory and policy. In your essay, discuss how each of the approaches we covered this semester tackles these themes enumerated by Smithin. 

L. Randall Wray


Ayres, Clarence. The Theory of Economic Progress. University of North Carolina Press. 4th edition. 1944. Print.

Bell, Stephanie. The Role of the State and the Hierarchy of Money. Cambridge Journal of Economics, 2001, Vol. 25, pp 149-163

Brazelton, Sturgeon, and Weinel. Alternative Economic Perspective: A Primer on the Streams of Macroeconomic Analysis. Kendall/Hunt Publishing. 1994-1995 edition. Print.

Cecchetti, Stephen. Money, Banking, and Financial Markets. McGraw-Hill/Irwin, 2008. 2nd edition.Print.

Foley, Duncan. Money in Economic Activity. In John Eatwell, Murray Milgate, and Peter Newman (eds.) The New Palgrave: Money. New York and London: W.W. Norton. Print.

Forstater, Matthew. Tax driven money: Additional Evidence From the History of Economic Thought, Economic History and Economic Policy. 2006.

Friedman, Milton and Schwartz, Anna. Studies in the Quantity Theory of Money. The University of Chicago Press, 1956. Print.

Friedman, Milton. A Monetary and Fiscal Framework for Economic Stability. The American Economic Review, Vol. 38. No. 3. pp 245-264. (June, 1948).

Godley, Wynne. Seven Unsustainable Processes: Medium-Term Prospects and Policies for the United States and the World. Strategic Analysis. Annandale-on-Hudson, NY: Levy Economics Institute of Bard College. 1999.

Innes, Mitchell. What is Money? The Banking Law Journal, 1913.

Keynes, John M. The General Theory Of Employment, Interest, and Money. New

York: Harcourt, Brace, and Company.1936. Print.

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