David R. Henderson  

Do Economists Study Money?

The Bankers' View... If You Don't Like It...
Non-economists often think that "economists study money." The reality, though, is that most academic economists hardly think about money at all. Whether we're talking about tariffs, wages, Social Security taxes, or pollution, the analysis (though often couched in dollar terms for the benefit of the general public) really is grounded in microeconomics and would work just as well if we were talking about a barter economy. In fact, in a typical Ph.D. program, students study models with money in them only when explicitly trying to answer questions about central-bank policy. Even in these cases--in which the very purpose is to draw conclusions about appropriate monetary policy--the underlying logic of the model doesn't really have a role for money. Instead, economists insert money into the model somewhat awkwardly, through various ad hoc assumptions.
This is the opening paragraph of the Econlib Feature Article for June. The article is "Modeling Money," and it's by one of the Article section's heavy hitters, Robert Murphy. Unlike his usual piece, it's not policy-oriented. Rather, he lays out two main ways that economists put money in their models and considers the pros and cons of each.

I discussed this issue somewhat in discussing Tom Sargent's work last year. See the Postscript of this post.

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COMMENTS (7 to date)
BZ writes:

Great article -- further proof that I learn the most when you brains take a step back for a second to give background.

aaron writes:

Money is like the dye in a CAT scan.

We're really studying social behavior.

aaron writes:

Right now, when we inject money we see it pool in banks and the government, and not getting to people in debt.

Joe Cushing writes:

I think money is a symbol for what economists study. Money by itself is meaningless. It takes economic transactions to give it meaning and it's these transactions that economists spend a significant part of their time studying. Money is a measuring tool for cost and utility for most of the things economists study. It does not measure all of them though. The trade off between time spent kayaking vs time spent playing baseball is an economic decision without a transaction and therefore money is not involved. So to say one is studying money is to say one is studying these transactions, the cost/utility involved in them, and the side effects of 3rd party manipulation of these transactions.

Peter H writes:

Murphy's article seems to be lacking an important element, namely, a discussion of what an economist in the various models he describes, means by "money."

This is a non-trivial definitional problem. In the broadest sense, money constitutes anything used to intermediate a transaction. This is a very broad definition, and includes many transactions we would consider to be barter-based.

A slightly narrower definition is any currency + any debt or debt instrument used to intermediate a transaction. In this case for example, the balance of your bank account comprising a debt owed to you by your bank and payable in currency. Currency is the means of alleviating debt, since it can, by fiat, be used to satisfy all debts.

We then can narrow further into the definitions commonly used by economists, which specify types of debt instruments based on their legal status. I won't go into the specifics (here's a good summary for those not familiar http://en.wikipedia.org/wiki/Money_supply#Empirical_measures_in_the_United_States_Federal_Reserve_System ).

When Murphy talks about macroeconomists discussing V, he is discussing the ratio of a narrow definition of money (M0) to a broad definition of money (M1 usually). Moreso than economics would like to admit, velocity of money is defined by government-specific legal principles over how banks work. Velocity isn't a definitional concept the way he's making it out to be, it's a specific artifact of the regulatory and legal environment that individuals and banks exist within.

Similarly, when discussing the micro case, Murphy focuses on one side of money (the holder of the debt) but does not even mention the activity of the other half of the money equation for all non-currency money, the borrower (usually a bank). The way Murphy describes money in this scenario seems to be limiting money to physical currency, only. But very little of what we call money is currency, and the amount of debt people and firms (including banks) choose to hold can vary as long as they have corresponding currency or debts owed to them by others to satisfy the debts.

I guess what I'm getting at with this is that if Murphy is going to make some quite insightful criticisms of how economists model money, it would be nice if he explained how we can model money better, rather than just saying that two common approaches both have flaws. Without exploring how we should treat money given those flaws (and integrating a fuller understanding of what money is into that treatment), the piece seems lacking.

Charlie writes:

When Murphy pays on both his inflation bets (with you and Bryan), can we stop hearing his musings on money?

David R. Henderson writes:

You can stop hearing his musings any time you want. But to go to the serious point I think you’re making, one can think clearly about money, as he does in this article, and still make bad predictions about increases in the money supply and in velocity, as I think Bob did.
If you have criticisms of his article on money, it would be better to make your criticisms rather than make fun of his predictive ability.

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