In Neoclassical theory, money is really added as an after thought to a model
that is based on a barter paradigm. In the long run, at least, money is
neutral, playing no role except to determine unimportant nominal prices. Money
is taken to be an exogenous variable-whose quantity is determined either by
the supply of a scarce commodity (for example, gold), or by the government in
the case of a "fiat" money. In the money and banking textbooks, the central
bank controls the money supply through its provision of required reserves, to
which a deposit multiplier is applied to determine the quantity of
privately-supplied bank deposits.
The evolving Post Keynesian endogenous approach to money offers a clear
alternative to the orthodox, neoclassical approach. With regard to monetary
theory, early Post Keynesian work emphasized the role played by uncertainty
and was generally most concerned with money hoards held to reduce
"disquietude", rather than with money "on the wing" (the relation between
money and spending). However, Post Keynesians always recognized the important
role played by money in the "monetary theory of production" that Keynes
adopted from Marx. Circuit theory, mostly developed in France, provided a nice
counterpoint to early Post Keynesian preoccupation with money hoards, focusing
on the role money plays in financing spending. The next major development came
in the 1970s, with Basil Mooreís horizontalism (somewhat anticipated by
Kaldor), which emphasized that central banks cannot control bank reserves in a
discretionary manner. Reserves must be "horizontal", supplied on demand at the
overnight bank rate (or fed funds rate) administered by the central bank. This
also turns the textbook deposit multiplier on its head as causation must run
from loans to deposits and then to reserves.
This led directly to development of the "endogenous money" approach that was
already apparent in the Circuit literature. When the demand for loans
increases, banks normally make more loans and create more banking deposits,
without worrying about the quantity of reserves on hand. Privately created
credit money can thus be thought of as a horizontal "leveraging" of reserves
(or, better, High Powered Money), although there is no fixed leverage ratio.
In recent years, some Post Keynesians have returned to Keynesís
Treatise and the State Theory of Money advanced by Knapp and adopted by
Keynes therein. Rather than imagining a barter economy that discovers a
lubricating medium of exchange, this neo-Chartalist approach emphasizes
the role played by the state in designating the unit of account, and in naming
exactly what thing answers to that description. Taxes (or any other monetary
obligations imposed by authorities) then generate a demand for that money
thing. In this way, Post Keynesians need not fall into the "free market"
approach of orthodoxy, which imagines some pre-existing monetized utopia free
from the evil hands of government. The neo-Chartalist approach also leads
quite nicely to Abba Lernerís functional finance approach, which refuses to
make a fine separation of fiscal from monetary policy. Money, government
spending, and taxes are thus intricately interrelated. This approach rejects
Mundellís "optimal currency area" as well as the monetary approach to the
balance of payments. It is not possible to separate fiscal policy from
currency sovereignty-which explains why the "one nation, one currency" rule is
so rarely violated, and when it is violated it typically leads to disaster (as
in the current case of Argentina, and-perhaps-in the future case of the
Like Keynes, Post Keynesians have long emphasized that unemployment in
capitalist economies has to do with the fact that these are monetary
economies. Keynes had argued that the "fetish" for liquidity (the desire
to hoard) causes unemployment because it keeps the relevant interest rates at
too high a level to permit sufficient investment to raise aggregate demand to
the full employment level. While it would appear that monetary policy could
eliminate unemployment either by reducing overnight interest rates, or by
expanding the quantity of reserves, neither avenue will actually work. When
liquidity preference is high, there may be no rate of interest that will
induce investment in illiquid capital-and even if the overnight interest rate
falls, this does not mean that the long term rate will. Further, as the
horizontalists make clear, the central bank cannot simply increase reserves in
a discretionary manner as this would only result in excess reserve holdings
and push the overnight interest rate to zero without actually increasing the
money supply. Indeed, when liquidity preference is high, the demand for, as
well as the supply of, loans collapses. Hence, there is no way for the central
bank to simply "increase the supply of money" to raise aggregate demand. This
is why those who adopt the endogenous money approach reject ISLM-type analysis
in which the authorities can eliminate recession simply by expanding the money
supply and shifting the LM curve out.
Furthermore, unlike orthodox economists, Post Keynesians reject a simple NAIRU
or Phillips Curve trade-off according to which some unemployment must be
accepted as "natural" or as the cost of fighting inflation. Earlier, some Post
Keynesians had argued for "incomes policy" as an alternative way of fighting
inflation, however, that rarely proved to be politically feasible. Lately, at
least some Post Keynesians have argued that not only is the
inflation-unemployment "trade-off" unnecessary, but that full employment can
be a complement to enhanced price stability. This is accomplished through
creation of a "buffer stock" of labor, according to which the government
offers to hire anyone ready, willing, and able to work at some pre-announced
and fixed wage. The size of the buffer stock moves counter-cyclically, such
that government spending on the program will act as an "automatic stabilizer".
At the same time, the fixed wage and benefit package helps to moderate
fluctuation of "market" wages. Finally, it is emphasized that the "functional
finance" approach to money and fiscal policy advanced by Lerner explains why
any nation that operates with a sovereign currency will be able to "afford"
full employment. In this way, it is recognized that while unemployment exists
only in monetary economies, unemployment does not have to be tolerated even in
monetary economies. When aggregate demand is low, fiscal policy-not monetary
policy-can raise demand and provide the needed jobs. The problem is not that
money is "neutral", but that when demand is low, the private sector will not
create money endogenously, hence, the government must expand the supply of HPM
through fiscal policy. If a deficit results, this will increase reserves held
by the banking system, which must be drained through sale of government bonds
in order to prevent a situation of excess reserve holdings from pushing
overnight interest rates to zero. Therefore, bond sales by the treasury are
seen as an "interest rate maintenance operation" and not as a "borrowing"
operation. Indeed, no sovereign issuer of the currency needs to borrow its own
currency from its population in order to spend.
FOR FURTHER READING
Brunner, Karl. 1968. "The Role of Money and Monetary Policy", Federal
Reserve Bank of St. Louis Review, vol 50, no. 7, July, p. 9.
Cook, R.M. 1958. "Speculation on the Origins of Coinage", Historia, 7,
Davidson, Paul. Money and the Real World, London, Macmillan,
Deleplace, Ghislain and Edward J. Nell, editors. Money in Motion: the Post
Keynesian and Circulation Approaches, New York, St. Martin's Press, Inc.,
Dow, Alexander and Schiela C. Dow 1989. "Endogenous Money Creation and Idle
Balances", in Pheby, John, ed, New Directions in Post Keynesian
Economics, Aldershot, Edward Elgar, p. 147.
Friedman, Milton. 1969. The Optimal Quantity of Money and Other Essays,
Grierson, Philip (1979), Dark Age Numismatics, Variorum Reprints,
-----. 1977. The Origins of Money, London: Athlone Press.
Hahn, F. 1983. Money and Inflation, Cambridge, MA: MIT Press.
Innes, A. M. 1913, "What is Money?", Banking Law Journal, May p.
Kaldor, N. The Scourge of Monetarism, London, Oxford University Press,
Keynes, John Maynard. The General Theory, New York,
-----. A Treatise on Money: Volume 1: The Pure Theory of Money, New
York, Harcourt-Brace-Jovanovich, 1976 .
Knapp, Georg Friedrich. The State Theory of Money, Clifton, Augustus M.
Kelley 1973 .
Lerner, Abba P. "Money as a Creature of the State", American Economic
Review, vol. 37, no. 2, May 1947, pp. 312-317.
Marx, Karl. Capital, Volume III, Chicago, Charles H. Kerr and Company,
Moore, Basil. Horizontalists and Verticalists: The Macroeconomics of Credit
Money, Cambridge, Cambridge University Press, 1988.
Mosler, Warren, Soft Currency Economics, third edition, 1995.
Parguez, Alain.1996. "Beyond Scarcity: A Reappraisal of the Theory of the
Monetary Circuit", in E. nell and G. Deleplace (eds) Money in Motion: The
Post-Keynesian and Circulation Approaches, London: Macmillan.
Rousseas, Stephen. Post Keynesian Monetary Economics, Armonk, New York,
M.E. Sharpe, 1986.
Wray, L. Randall. Understanding Modern Money: The Key to Full Employment
and Price Stability, Edward Elgar: Cheltenham, 1998.
-----. Money and Credit in Capitalist Economies: The Endogenous Money
Approach, Aldershot, Edward Elgar, 1990.