Friday, 18 December 2015

Money as a Good and Money as a Record

In a recent post, Nick Rowe has been playing around with how to think about money when measured money can be both posive and negative.

It is worth distinguishing two models of money, which on the face of it are very different.

In the first model, money is a type of good.  Monetary exchange means that every purchase involves the buyer delivering the agreed amount of money to the seller in return for goods and services.  It's useful to imagine this as a physical delivery - the buyer hands over some gold coins or paper notes to the seller.

In the second model, monetary exchange takes place through a series of accounts kept by a central registry (the Bank).  Each agent holds an account, which is nothing more than a record of a balance at the close of each day.  When a purchase takes place, the buyer requests the Bank to debit the purchase price from his own account and credit it to that of the seller.

In each case there is a limit on how much people can spend.  In the first model, this is a physical limit.  The buyer cannot hand over more paper notes than he actually has - you can't have negative notes.

In the second model, there is no physical limit.  If the buyer spends more than he holds, his balance simply becomes negative.  However, the Bank will want to impose some limits.  The more an account goes negative, the greater the risk to the Bank if the accountholder fails to get it positive again.  So the Bank will decline payment requests which will make accounts more negative than it wants.

So in the first model, the limit is necessarily zero.  In the second model, it may be any non-positive number and will depend on the Bank's view on credit risk.

This question of limits is the essential difference between the two models, rather than any question of whether money is in bearer or registered form.  Of course, the form money takes may dictate the limit - you can't have negative bearer notes.  But it's the limits that matter.

This allows us to see that the first model is simply a special case of the second model.  In the second model, the limit need only be non-positive.  In the first model, it must be zero.

Negative account balances in the second model are debts of the accountholder.  We can have debts in the first model as well, where the Bank (or any other agent) lends notes to someone.  However, there is a clear distinction here between debts and money.  Although the paper notes may constitute debts of the Bank, as far as the non-banking sector is concerned debts and money are quite different things.

This makes it easy to isolate a particular thing - in this case the collection of paper notes - and identify it as money or the medium of exchange.  Helpfully, such a thing can be captured in a single aggregate measure.  So, it's often easier to think through monetary mechanics using the first model, and often this is OK.

However, in the general case the distinction between medium of exchange and debt becomes more blurred.  We can no longer think of money as a simple aggregate; we need to start to think about the general liquidity position.  This manifests itself in the way counterparties to monetary contracts - both banks and non-banks - agree the terms under which those contracts may be settled on demand.

The second model is a closer reflection of the real world.  We can learn useful things from thinking about models where money is a good with a strictly positive value.  But we should not be misled into believing that everything we see in those models will translate neatly to the real world.


  1. If the bank issued its own bank notes on loan, then once again the first model becomes identical to the second model.

    1. Do you mean the following?

      When a buyer wants to make a payment to the seller, the bank makes him a loan for the appropriate amount and provides him the notes to deliver to the seller (or provides them direct to the seller).

      If so, then I'd agree that we can use this concept to extend the first model so that it conforms with the second.

      What I think is important here though, is understanding the terms on which such a loan is available. Is this loan negotiated at the time the buyer wishes to make the purchase? Or is it a standing facility, pre-agreed by the bank, that the borrower can draw on at will? This helps us recognise that the buyer liquidity position, his purchasing power if you like, may not be captured effectively simply by his actual holding of notes. The off-balance sheet arrangements with the bank are critical.

    2. Yes, that's what I meant. But the more I think through the first model, the more I see that they all conform to the second. Credit cards, checking accounts full of borrowed money, bank notes lent on demand, etc, all fit the second model.
      Even coins fit the second model. If I need more coins than I have in my pocket, I take 1 ounce of silver to the mint and have it stamped into a coin. If I don't have an ounce of silver, I take 1 oz worth of apples to the mint and the mint will find the silver for me.

    3. I don't disagree, but again I think that with all these things, to understand the overall level of liquidity we have to understand how easy it is to use them to generate the means of payment.

  2. We can imagine a world in which positively-valued green bearer notes are an asset to the holder, but not a liability of anyone. It is tabu to create them, or take them from others' pockets without permission, and anyone who does so will be ostracised.

    We can imagine a world in which negatively-valued red bearer notes are a liability of the holder but not an asset to anyone. It is tabu to destroy them, or put them in others' pockets without permission.

    (There is a similar tabu against dumping your negatively-valued garbage over your neighbour's fence.)

    So I can see your point that it is the non-negative limit that counts, rather than the physical form. But it's also useful to see the symmetry, and consider a non-positive limit as well.

    1. I'm not against these weird thoughts experiments and I'd agree there useful.

      Part of the issue we have here is that the red / green world we inhabit is not symetric, eventhough it has both monies. There is a limit on holdings of red notes, but no limit on holding of green notes. That means we can't see the red only world as a special case of the red / green world with a green limit of zero.

      That doesn't mean we can't think about what a red only world might look like. But we more likley to run into conceptual problems relating it to the real world.

    2. Nick R.
      It occurs to me that your green and red money is identical to a tally. When a shopper bought some apples worth 1 ounce of silver, he would carve "IOU 1 oz." into a block of wood and then split it in two. The "stock" of the tally (green money) was kept by the merchant, while the "stub" of the tally (red money) was kept by the shopper.
      (But I never heard of a case where one guy's stock was not the liability of someone, or where one guy's stub was not someone else's asset.)

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    4. They Green notes are a liability. They are a liability of the general population that agrees to accept them as payments. Members of general population agree to supply economic resources to the holder of the green notes, if those members enter into commerce in an economy where the green notes are recognized as money. Within the group of people who recognize the green notes as money , the holder of the green notes has a procedural claim on the economic resources of the group as a whole , and in that sense they are a liability on the population that uses them, as long as they continue to use them.
      However in the real world , where money is created by loan contracts, the value of the money is the value of the economic resources that the borrow is contractually obliged and obligated to supply in order to re-quire the money to honour the loan contract. Not only does the borrower consider that they will be able to supply these economic resources in the future, a bank loan officer also makes this judgement to the affirmative when a loan is made and money is issued.

    5. I have some sympathy wth this view Dinero. If one person holds a financial asset which enables him to claim real resources, that is in some sense a burden on everyone else, even if it's not technically a liability of anyone.

  3. Hi Nick
    I was commenting to a follow up post on Nick R's site, when I surprised myself with a statement which seems relevant to this post and which I'd be interested to hear your opinion on.

    To the extent that money is a record of some real activity and not a good in its own right, I asserted, somewhat boldly, that the demand for money cannot be separated from the trade because it is just the record of it. And so, contrary to Nick R's theory of recessions as an excess demand for money, one would have to say that recessions are in fact, if anything, the consequence of a lack of demand for money / trades.

    To the extent that there is any merit to that little theory, it would seem that the 'choice' of treating money as a good or as a record in theory might have very far reaching implications for possible policy prescriptions.

    1. I'm not sure I follow.

      I think it is reasonable to argue that money cannot be demanded in its own right, but only for its future use (although I don't necessarily agree with that), but I don't think you can identify the demand for money with past trades.

    2. My comment wasn't very precise. A recession is a lack of demand for (new) goods. By Nick R's theory that is because there is an excess demand for money. But if one says that money cannot be demanded in its own right but is rather just the reflection of a demand for goods, Nick R's theory is like saying a lack of demand for goods (recession) is actually an excess demand for goods.

    3. Ah, well the point there is that people hold money for the purposes of buying goods at some future point, rather than right now. So, it's actually saying that the lack of demand for current goods is an excess of demand for future goods.

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