Some Notes on the Nature of Money and the Future of Monetary Policy

Abstract

In a debate on the future of monetary policy and the displacement of money, Woodford argued that, even if innovations should lead to a situation in which the banks' demand for reserves at the central bank is zero, the central bank can still influence the economy's interest rates because its liability is the economy's unit of account. This paper deals with these topics by considering the implications of emphasizing the function of money as unit of account. In the analysis of money from this perspective, social, institutional and economic factors play a crucial role. Money is a social and historical relation. Therefore, the displacement of money and central banks, though possible, is a complex process involving economic, social and political factors, not merely the result of innovations. The paper also looks at some aspects of Kaldor's theory, which is centered on the fundamental importance of money as unit of account.

Keywords:

• money
• central banking

Acknowledgements

I would like to thank Mario Amendola, Andrea Attar, Jean Cartelier, Geoff Harcourt and two anonymous referees for their observations and suggestions that helped me to improve previous versions of the paper significantly. The responsibility for any possible remaining error is, however, solely mine.

Notes

1 The debate was originated by an article of Benjamin Friedman (1999) in International Finance on the effects of financial and technological innovations on monetary policy, followed the next year by a symposium on the future of monetary policy in the same journal, with contributions by Woodford (2000), Goodhart (2000), Freedman (2000) and a rejoinder by Friedman (2000).

2 The notion of effectiveness used here is limited. The central bank's monetary policy is said to be effective if it influences short-term market rates. It is not an object of this paper to further investigate either the way in, and the extent to, which changes in short-term interest rates affect longer-term rates or the extent to which changes in interest rates in general produce significant changes in the real sector of the economy.

3 In the “monetary view”, the public demands bank-issued money, against which commercial banks must have reserves at the central bank. When the central bank changes the supply of reserves, banks must change their supply of money to the public and changes in the interest rate follow. In the “credit view”, the public demands loans from banks, which create money by lending. The banks’ demand for reserves is positively related to the volume of their lending. If changes in the demand for reserves are not matched by changes in their supply by the central bank, there must be changes in the amount of bank loans, with consequent variations in interest rates.

4 This is what Friedman calls “decoupling at the margin”, i.e. changes in the variables controlled by central banks do not give rise to corresponding changes in the relevant variables for the economy as a whole (Friedman 2000).

5 “Even in the technological utopia imagined by the enthusiasts of ‘electronic money’—where financial market participants are willing to accept as final settlement transfers made over electronic networks in which the central bank is not involved—if debts are contracted in units of a national currency, then clearing balances at the central bank will still define the thing to which these other claims are accepted as equivalent” (Woodford 2001: 346).

6 Dow and Smithin (1999) provide a useful short survey of those positions that, not necessarily for the same theoretical reasons, see the displacement of money and central banks as possible and/or desirable. For analyses of the obstacles to the displacements of money as unit of account and medium of exchange see, for example, Dowd and Greenaway (1993), Krueger (1999) and Holthausen and Monnet (2003).

7 “Now by the mention of contracts and offers, we have introduced law or custom, by which they are enforceable; that is to say, we have introduced the State or the community. Furthermore it is a peculiar characteristic of money contracts that it is the State or community not only which enforces delivery, but also which decides what it is that must be delivered as a lawful or customary discharge of a contract which has been concluded in terms of the money of account. The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contract. But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time.” (Keynes 1971: 4, emphasis in the original).

8 Hicks (1989: 51–52) calls money proper “fully money” and any other instrument “quasi-money”.

9 “A particular kind of bank money is then transformed into money proper—a species of money proper which we may call representative money” (Keynes 1971: 6).

10 Hicks (1989: 44–54) offers a succinct but insightful analysis of the origins and role of central banks. See also Goodhart (1988) and Giannini (2004). All these authors underline the strong link between the state and the creation and development of central banks.

11 Goodhart (1989: 26–28) underlines the difference between the concept of medium of exchange and the concept of means or payment.

12 Hicks prefers to use the term “standard of value” instead of unit of account, in order to stress that money (the standard) is more than merely the economy's numeraire (Hicks 1989: 41–43).

13 The current mainstream literature on central banking pays little, if any, attention to the role of lender of last resort. Laidler argues that such a role is still crucial. Also Minsky (1975, 1982) underlines the important stabilizing role of central banks acting as lender of last resort.

14 Recently, Ingham (1996, 2002, 2004) has developed the analysis of money as a social process. The chartalist approach is also based on the rejection of the traditional neoclassical notion of money. See, for example, Wray (1998).

15 The recent experience of the Argentinean currency board can be seen as an illustration of this.

16 Goodhart (2000: 201), for example, points out that the demise of conventional money could happen only if “an authoritarian government should decree that it must happen”.

17 See Freedman (2000) for an analysis of historical and institutional factors that make ordinary banks prefer central banks for their settlements.

18 For a thorough critique of the analysis of the Euro in terms of the dominant monetary theory, see Goodhart (1998).

19 For a more detailed exposition of Kaldor's analysis, see Sardoni (2007).

20 The convenience yield of money depends on the ratio of the money stock to the volume of money payments. It falls to zero when the ratio exceeds a certain critical value (Kaldor 1980: 61–62).

21 If there is a long-term loan market and there exist forward markets, the long-term interest rate is an average of forward short-term rates, which depend on expected short-term rates and the risk premia attached to them.

22 The marginal efficiency of an asset is defined by Kaldor as the relationship of its future return to its present cost of production, i.e. its long-period supply price (Kaldor 1980: 59).

23 “… all assets other than money can adjust their own-rates of money-interest to that of money by a variation of their current price in terms of money; while the money-rate of money-interest can only be changed by varying money's own-rate of own-interest” (Kaldor 1980: 70).