Arnold Kling  

Money as a Store of Value

From Poverty to Prosperity<... Unchecked and Unbalanced

A commenter asks how I reconcile my assertion that money is a store of vaue with my view that macroeconomics should not emphasize the role of money as a store of value. It is only the second view--that money is not so important--that is controversial.

There is a fundamental methodological error in macroeconomics that leads to saying that if there is no excess demand for money then there can be no excess supply of goods. I think that the methodological error comes from ignoring the heterogeneity of goods, labor, and capital. The methodological error goes back to Joe, the representative agent, working at the GDP factory.

Under the fundamental methodological error, the only way to break Say's Law (supply creates its own demand) is for people to want to hold on to money as a store of value. Instead, I have been arguing that there can be all sorts of excess demands and supplies for different types of output that are not derived from excess demand for money. The idea that many markets can be out of equilibrium for reasons having nothing to do with the supply and demand for money as a store of value should be very obvious, once you think about it. What is remarkable is how much of the formal macro literature starts by assuming away those non-monetary reasons for disequilibrium. My contention is that the traditional emphasis on money as a source of disequilibrium reflects this misleading approach to doing macroeconomics, rather than the real world.

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COMMENTS (16 to date)
Daniil Gorbatenko writes:

Thanks for the post, Arnold. I wish you could also post on the logic of fiscal stimulus - whether you think it may possibly work and if yes, how likely it is.

Chris writes:

Essentially you are saying that dynamic inefficiencies don't occur with the introduction of money into the economy. That is wrong. If people aren't perceptive of the value of money as a store of value it can lead to a real impact on the economy.

winterspeak writes:

ARNOLD: Since we are speaking about the financial system, can you please translate your terms into financial accounting.

For example, bank deposits (liabilities) count as money. How about receivables (assets)? When the bank makes a loan by crediting a deposit and a receivable, have they created money? If someone pays back a loan, thus debiting a deposit account and a receivable, has that money been "uncreated"?

Can you help me understand how a store of value can get created and uncreated like this?


Greg Ransom writes:

Joe the representative agent working at the GDP factory is also responsible for the widely false but widely held belief that a demand for commodities is a demand for labor -- Mill's test for economic incompetence.

Greg Ransom writes:

There are two ways to think about money -- Hume did it both ways.

1) Micro -- money "injects" into the economy at particular points, changing particular relative prices as it flows out into the economy, e.g. from a new gold mine, and into the community around the gold mine, etc.

2) Macro -- everyone's money doubles magically over night.

The contemporary math macroeconomists picture of money as a source of disequilibrium is purely #2 macro.

But there is a powerful and earlier money "tradition" which uses Cantillon and Hume and _micro_ -- and this micro tradition identifies money as a causal agent systematically changing relative prices as it flow through the economy, say via massive leverage and regulatory pathologies shunting massive trillions into housing and mortgage securities ...

Money CAN be a micro / relative prices source of disequilibrium in _particular_ production streams and in _particular_ labor markets, and in _particular_ savings and investment and consumption plans across time.

winterspeak writes:

GREG: Whatever tradition, please translate into financial accounting.

That way we can keep our terms straight.

Even better, since we're talking about the financial system, and financial accounting is the language by which that works, and the language the rules are written in, we can also be sure that our discussion has some relation to reality and is not drivel.


Greg Ransom writes:

winterspeak -- whatever.

Ritwik writes:

winterspeak: "When the bank makes a loan by crediting a deposit and a receivable, have they created money? If someone pays back a loan, thus debiting a deposit account and a receivable, has that money been "uncreated"?"

Yes exactly. This is the view that you will arrive at if you don't want to separate M (the number of units of money) and V (how often each unit is circulated on average). This is the Humean 'if you lock up a coin, you make it disappear' tradition.

However, if you were to separate M and V and try to look at them as distinct entities, you will not say that M has been created or destroyed, you will say that V has increased or decreased.

The distinction between M and V is perhaps an error, but it makes analysis in terms of Fed policy simpler. If you refuse to distinguish between the two, you could follow two paths. You could either consider monetary policy exogenous, believe that the Fed could have and should have done more to prevent the crisis and go towards the path of Sumner, Woolsey and other monetary disequilibrium theorists. Or, you could consider money endogenous and say that money is nothing but debt, that Fed is powerless to follow a monetary policy independent of the animal spirits in the economy and even a barter economy with lending and borrowing is actually a monetary economy. Then you'd become a modern Post-Keynesian, like Steve Keen.

Sumner's story is one of 'monetary only' disequilibrium in which money is quite powerful and so is the Fed, but the Fed is often wrong. Kling's purported story is one of 'real only' disequilibrium, in which money by itself is powerless because it is just a manifestation of the real economy. Keen's story is one in which there is no 'money by itself'- it is simply the manifestation of private debt, and debt is powerful. I think Kling's story might be an exaggeration to point out the flaws of a 'money only' story.

You can look at this in purely financial accounting terms, but then you will be unable to come to terms with a Fed printing money out of nowhere (creating an asset with no liability), and so will necessarily end up leaning towards Keen (the asset is created because the liability has already been created in the economy).

winterspeak writes:

Greg: Excellent choice!

Ritwik: I am distinguishing between M and V. When the bank makes a loan (credits a receivable, debits a reserve, credits a deposit, credits a reserve) it is an increase in M and V. When the transaction is reversed, it is a decrease in M but an increase in V. If no transactions happen, M stays the same, V shrinks.

I am neither a monetarist like Sumner (who has no idea how banks work) or a Circuitist like Keen (who has issues with stock/flow, and does not understand how the Fed interacts with the non-Govt sector, but understands the reserve system very well). Government deficits fund non-Government paid-in capital/net savings (the residual on the liability side of the balance sheet that is the difference between assets and liabilities). Private debt leverages on top of net private savings through bank lending -- exactly as I have described.

When the Fed prints money it does double entry book keeping as well. The Treasury pays someone something, it's booked as an increase in National Debt on one side, and an increase in private sector savings on the other. Look at the stock, you have national debt. Look at the flow, you have deficit spending. You absolutely have a liability associated with the asset.

Chartalists call Govt spending "vertical money" and private sector credit expansion "horizontal money". Keen is missing the "vertical money" part.

fundamentalist writes:

Mainstream macro needs to get over equilibrium. The world never has been and never will be in equilibrium. Equilibrium thinking is a mental construct that allows economics to do controlled experiments like the natural sciences. In equilibrium, we can hold everything constant while testing the effects of a change in one variable.

No natural scientist would equate the real world with his controlled experiment. So why do mainstream economists do that with theirs? It boggles the imagination!

The simple answer that the demand for money controls business cycles would be true in equilibrium, but it's not in the real world. But even in equilibrium, you have to ask why? Why do consumers suddenly want to hold more cash? The only answer possible is uncertainty. But why are they suddenly uncertain? Because things changed in an unexpected way. And if things changed unexpectedly, obviously we are no longer in equilibrium!

Karl Smith writes:


Suppose real money balances stay the same. Won't it be true then that all the other excess demands sum to zero?

That is if I am buying more butter I must be buying fewer guns. If my actions in one market are not counteracted by my actions in another then I am either hoarding or depleting money.

winterspeak writes:

Fundamentalist: How on earth did you get any belief in "equilibrium" from anything I wrote?! My argument is that we are not in equilibrium now because the Federal Government is not funding the demand for private savings.

People, like Arnold, who do not understand the role of Federal deficits are preventing a rebalance from happening by saying "go recalculate amongst yourselves!"

People like Jeffrey Rogers Hummel are displaying their ignorance of the monetary system by uttering garbage like "The US will default!"

The only equilibrium I've been able to spot is the gold standard assertions of the economics profession. That seems to be in stasis, just happens to be the wrong one!

KARL: I have no idea what you mean by "real money balances". Net private savings must stay constant unless the Government adds to them or drains them. Private credit can be extended or paid down. Velocity can do whatever, either balance sheets change or they don't.

Karl Smith writes:


So people have some of their savings as money. Suppose that amount doesn't change. Then the total amount of spending in the economy must be the same as it was before.

In terms you like to use, if the money supply is constant, prices are constant and velocity is constant then output must be constant.

Arnold seems to be saying that even in a world of stable money and prices Output can change without a change in Velocity. This is necessary for money as a store of value to be unimportant, since money as a store of value influences velocity.

winterspeak writes:

KARL: I'd love to answer your question, but need some clarification. You say "people have SOME of their savings as money". This can be in a deposit account, cool. But what are the REST of their savings if it is not in money?

If M, p, and V is constant, then Y cannot change, contra Arnold.

Also, as for Arnold's assertion that money is a store of value, think through the accounting of bank loans.

Banks extend a loan by crediting a receivable (asset) and a deposit (liability). They expand both sides of their balance sheet at the same time.

When a loan is paid back, the receivable and deposit are both debited. The balance sheet contracts.

So, you have balance sheets expanding and contracting, money being created ex nihilo and then being returned to nothingness as loans are paid down.

Does this strike you as describing something that's a "store of value?" Do you know of any other "store of value" that is routinely created out of nothing, and then destroyed?

Gold was a store of value. We haven't used that for money for quite a few decades now. Maybe Arnold has not gotten the memo.

Bo Zimmerman writes:

I love these conversations, but I'm having a hard time following. In absence of familiarity with the shorthand used, I tend to interpret what I'm reading a bit literally, leading to my confusion.

For example, how can money be a store of value if its value is constantly changing? Isn't the "value" of my money simply my mental idea of how many goods and services I can command with it today? (An idea that certainly changes over time -- $2.35 used to mean "a McDonalds value meal" and now it means "a couple things off the shrinking $1 menu".)

"Velocity" of money seems to mean its rate of turnover, but in trying to understand this, I picture two people with stacks of money making widgets A and B respectivity. They hand each other $1 and get a widget as soon as the other person makes one for them to buy. But, while their relative money stacks remain constant, their velocity doesn't seem to be independent of their productivity, and is definitely limited in the real world. I can only do so much in a day, and this is putting aside the fact that each person only wants "so many" widgets.

Any responses are appreciated.

winterspeak writes:

Bo: The point with "velocity" is that a small amount of money can generate a near infinite amount of revenue so long as its "velocity" is high enough. The more of your income that you spend, and the faster you spend it, the higher the "velocity" of money is.

As you have surmised, it has nothing to do with productivity.

The important part is the inverse of velocity--savings. Since one person's spending is another person's income, a sector cannot increase its net savings. If it tries, you see velocity fall, and aggregate demand fall, which produces unemployment.

I used to believe this was not the case, as money in the bank just gets lent out. I learned that banks do not lend out deposits (see the accounting above) so understood that savings really was money that just "vanished". Money may have been a store of value in gold standard days, but now it's just a unit of account.

If you also see why the Federal deficit adds to net private sector savings, you are a million miles ahead of most people.

Most macro makes no sense because it is garbage.

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