Two Views of MoneyImplications for Fiscal & Monetary               Policy
Exogenous vs. Endogenous Money• Recap:  – Orthodox (exogenous): Money is a commodity    (e.g. gold, silver). It functions ...
Exogenous vs. Endogenous Money• Recap:  – Heterodox (endogenous): money is no object –    not a physical commodity w/ intr...
Endogenous Money• Money enters the economy as a result of the  need to finance real economic activity.  – M – C … P … C’ –...
Endogenous Money• Vertical Money Creation Process:  – Government spending: The state’s liabilities are the    money of acc...
Monetary Policy (Exogenous Story)                             r   MsEquation of Exchange:MV = PQ     Causality            ...
Monetary Policy (Endogenous Story) The CB cannot control the money supply      r But, it can control the interest rate (fe...
Fiscal Policy• In order to get fiscal policy right, we need to understand  how our monetary system works.• Being wrong can...
Endogenous Money & Stock-Flow            Accounting• In order to formulate good macro policy, we  need to begin with good ...
Endogenous Money & Stock-Flow            Accounting• There are three broad sectors to the economy:  Domestic Private Secto...
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Two views of money

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Two views of money

  1. 1. Two Views of MoneyImplications for Fiscal & Monetary Policy
  2. 2. Exogenous vs. Endogenous Money• Recap: – Orthodox (exogenous): Money is a commodity (e.g. gold, silver). It functions as medium of exchange. Agents not fooled by it; they respond only to changes in relative values of real goods - Money is neutral – Money enters the economy from without – imagine Fed Chairman Ben Bernanke flying around in a little helicopter making it rain cash!
  3. 3. Exogenous vs. Endogenous Money• Recap: – Heterodox (endogenous): money is no object – not a physical commodity w/ intrinsic value. Money cannot be neutral – in a monetary production economy (M – C – M’) – Keynes: “The possession of actual money lulls our disquietude; and the premium we require to make us part with money is a measure of the degree of our disquietude.” (GT, 1936)
  4. 4. Endogenous Money• Money enters the economy as a result of the need to finance real economic activity. – M – C … P … C’ – M’ • Production takes place before sale, which must be financed either internally or externally. For the economy as a whole this must be external. • Thus, loans are required to finance productive activity, which are then retired once the business enterprise realizes the increase in value through sales. • Horizontal Money Creation: Loans -> Deposits
  5. 5. Endogenous Money• Vertical Money Creation Process: – Government spending: The state’s liabilities are the money of account; high powered money; show up as net financial assets – Gov. Spending creates money; gov. taxation destroys it. – If G > T, then deficits accumulate to stocks of outstanding G liabilities – i.e. the national debt. – If G < T, then surpluses subtract from the stock of outstanding G liabilities – i.e. paying down the national debt. – More on this later
  6. 6. Monetary Policy (Exogenous Story) r MsEquation of Exchange:MV = PQ Causality r* MD MQ
  7. 7. Monetary Policy (Endogenous Story) The CB cannot control the money supply r But, it can control the interest rate (fed funds rate).Equation of Exchange: Ms r*MV = PQ MD Causality MQ
  8. 8. Fiscal Policy• In order to get fiscal policy right, we need to understand how our monetary system works.• Being wrong can have disastrous consequences on the economy – i.e. Volcker Recession of 1981 • Quantity targets failed which caused the interest to rate to rise to really high levels. • Erroneously believed the inflation is related to the quantity of money in circulation • Caused a recession – probably responsible for starting the decline of American manufacturing (along with trade policy).• Exogenous story leads to belief that G can run out of money. Leads to fears of rising interest rates, unsustainable debt levels, etc.
  9. 9. Endogenous Money & Stock-Flow Accounting• In order to formulate good macro policy, we need to begin with good accounting:• Flows accumulate to stocks – Deficits are flows; debts are stocks – Surpluses are flows; savings are stocks• One’s financial asset is another’s financial liability: An IOU (liability) generates a flow of income to the holder of the IOU (asset)
  10. 10. Endogenous Money & Stock-Flow Accounting• There are three broad sectors to the economy: Domestic Private Sector Balance + Domestic Government Balance + Foreign Balance = 0 Over any given period, each sector will either run a surplus, a deficit, or a balanced budget. And they must sum to zero. This true by extension of the accounting principle that one’s financial asset is another’s financial liability.

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