Monetary circuit theory
Encyclopedia
Monetary circuit theory is a heterodox
theory of monetary economics, particularly money creation
, often associated with the post-Keynesian school
.
It holds that money is created endogenously by the banking sector, rather than exogenously by central bank lending; it is a theory of endogenous money
. It is also called circuitism and the circulation approach.
theories of money creation
is that circuitism hold that money is created endogenously by the banking sector, rather than exogenously by the government through central bank lending: that is, the economy creates money itself (endogenously), rather than money being provided by some outside agent (exogenously). Circuitism also models banks and other firms separately, rather than combining them into a representative agent
as in mainstream neoclassical models.
These theoretical differences lead to a number of different consequences and policy prescriptions; circuitism rejects, inter alia, the money multiplier
as a causal agent, arguing that money is created by banks lending, which only then pulls in reserves from the central bank, rather than by re-lending money pushed in by the central bank.
It also emphatically rejects the neutrality of money
, believing instead that the money supply and its growth or decline are critical to the functioning of the economy.
– bills and coins), and a purchase subtracts money from the buyer's account with the bank, and adds it to the seller's account with the bank.
– money that is exchangeable at a given rate for some commodity, such as gold – and credit money
. Unlike mainstream monetary theory, it considers credit money created by commercial banks as primary (at least in modern economies), rather than derived from central bank money – credit money drives the monetary system. While it does not claim that all money is credit money – historically money has often been a commodity, or exchangeable for such – basic models begin by only considering credit money, adding other types of money later.
In circuitism, a monetary transaction – buying a loaf of bread, in exchange for dollars, for instance – is not a bilateral transaction (between buyer and seller) as in a barter economy, but is rather a tripartite transaction between buyer, seller, and bank. Rather than a buyer handing over a physical good in exchange for their purchase, instead there is a debit to their account at a bank, and a corresponding credit to the seller's account. This is precisely what happens in credit card or debit card transactions, and in the circuitist account, this how all credit money transaction occur.
For example, if one purchases a loaf of bread with fiat money
bills, it may appear that one is purchasing the bread in exchange for the commodity of "dollar bills", but circuitism argues that one is instead simply transferring a credit, here with the issuing central bank: as the bills are not backed by anything, they are ultimately just a physical record of a credit with the central bank, not a commodity.
When the loan is repaid, with interest, the credit money of the loan is destroyed, but reserves (equal to the interest) are created – the profit from the loan.
In practice, commercial banks extend lines of credit to companies – a promise to make a loan. This promise is not considered money for regulatory purposes, and banks need not hold reserves against it, but when the line is tapped (and a loan extended), then bona fide credit money is created, and reserves must be found to match it. In this case, credit money precedes reserves. In other words making loans pulls reserves in (assuming that the regulatory need for bank reserves exists), instead of reserves being pushed out as loans which is assumed by the mainstream model.
The failure of monetary policy during depressions – central banks give money to commercial banks, but the commercial banks do not lend it out – is referred to as "pushing on a string", and is cited by circuitists in favor of their model: credit money is pulled out by loans being extended, not pushed out by central banks printing money and giving it to commercial banks to lend.
in ,
following an earlier outline in .
The notion and terminology of a money circuit dates at least to 1903, when amateur economist Nicholas Johannsen
wrote Der Kreislauf des Geldes und Mechanismus des Sozial-Lebens (The Circuit Theory of Money), under the pseudonym J.J.O. Lahn; . In the interwar period, German and Austrian economists studied monetary circuits, under the term , with the term "circuit" being introduced by French economists following this usage. The French circuitists stemmed from the works of Bernard Schmitt (Monnaie, Salaires et Profits, 1966).
Circuitism draws from Chartalism
in a number of respects, notably emphasizing the fiat nature of (credit) money, and in distinguishing between government-created (exogenous) money and bank-created (endogenous) credit money.
Australian economist Steve Keen
ascribes these difficulties to inappropriate use of general equilibrium
methods, hence implicitly static or steady state
, while he considers circuitism essentially dynamic, and thus advocates instead the use of the dynamic methods of differential equations or difference equations, producing circuitist models that do not have the shortcomings of earlier attempts. , , ,
Heterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...
theory of monetary economics, particularly money creation
Money creation
In economics, money creation is the process by which the money supply of a country or a monetary region is increased due to some reason. There are two principal stages of money creation. First, the central bank introduces new money into the economy by purchasing financial assets or lending money...
, often associated with the post-Keynesian school
Post-Keynesian economics
Post Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, although its subsequent development was influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor and Paul Davidson...
.
It holds that money is created endogenously by the banking sector, rather than exogenously by central bank lending; it is a theory of endogenous money
Endogenous money
In economics, endogenous money refers to the theory that money comes into existence driven by the requirements of the real economy and that banking system reserves expand or contract as needed to accommodate loan demand at prevailing interest rates. It forms part of Post-Keynesian economics...
. It is also called circuitism and the circulation approach.
Contrast with mainstream theory
The key distinction from mainstream economicMainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...
theories of money creation
Money creation
In economics, money creation is the process by which the money supply of a country or a monetary region is increased due to some reason. There are two principal stages of money creation. First, the central bank introduces new money into the economy by purchasing financial assets or lending money...
is that circuitism hold that money is created endogenously by the banking sector, rather than exogenously by the government through central bank lending: that is, the economy creates money itself (endogenously), rather than money being provided by some outside agent (exogenously). Circuitism also models banks and other firms separately, rather than combining them into a representative agent
Representative agent
Economists use the term representative agent to refer to the typical decision-maker of a certain type ....
as in mainstream neoclassical models.
These theoretical differences lead to a number of different consequences and policy prescriptions; circuitism rejects, inter alia, the money multiplier
Money multiplier
In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system. Most often, it measures the maximum amount of commercial bank money that can be created by a given unit of central bank money...
as a causal agent, arguing that money is created by banks lending, which only then pulls in reserves from the central bank, rather than by re-lending money pushed in by the central bank.
It also emphatically rejects the neutrality of money
Neutrality of money
Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption....
, believing instead that the money supply and its growth or decline are critical to the functioning of the economy.
Circuitist model
Circuitism is easily understood in terms of familiar bank accounts and debit card or credit card transactions: bank deposits are just an entry in a bank account book (not specieCoin
A coin is a piece of hard material that is standardized in weight, is produced in large quantities in order to facilitate trade, and primarily can be used as a legal tender token for commerce in the designated country, region, or territory....
– bills and coins), and a purchase subtracts money from the buyer's account with the bank, and adds it to the seller's account with the bank.
Transactions
As with other monetary theories, circuitism distinguishes between hard moneyHard money
Hard money may refer to:* Hard currency, globally traded currency that can serve as a reliable and stable store of value* Hard money donations to candidates for political office* Hard money currency policies...
– money that is exchangeable at a given rate for some commodity, such as gold – and credit money
Credit money
Credit money is any claim against a physical or legal person that can be used for the purchase of goods and services. Examples of credit money include personal IOUs, and in general any financial instrument or bank money market account certificate, which is not immediately repayable in specie, on...
. Unlike mainstream monetary theory, it considers credit money created by commercial banks as primary (at least in modern economies), rather than derived from central bank money – credit money drives the monetary system. While it does not claim that all money is credit money – historically money has often been a commodity, or exchangeable for such – basic models begin by only considering credit money, adding other types of money later.
In circuitism, a monetary transaction – buying a loaf of bread, in exchange for dollars, for instance – is not a bilateral transaction (between buyer and seller) as in a barter economy, but is rather a tripartite transaction between buyer, seller, and bank. Rather than a buyer handing over a physical good in exchange for their purchase, instead there is a debit to their account at a bank, and a corresponding credit to the seller's account. This is precisely what happens in credit card or debit card transactions, and in the circuitist account, this how all credit money transaction occur.
For example, if one purchases a loaf of bread with fiat money
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...
bills, it may appear that one is purchasing the bread in exchange for the commodity of "dollar bills", but circuitism argues that one is instead simply transferring a credit, here with the issuing central bank: as the bills are not backed by anything, they are ultimately just a physical record of a credit with the central bank, not a commodity.
Monetary creation
In circuitism, as in other theories of credit money, credit money is created by a loan being extended. Crucially, this loan need not (in principle) be backed by any central bank money: the money is created from the promise (credit) embodied in the loan, not from the lending or relending of central bank money: credit is prior to reserves.When the loan is repaid, with interest, the credit money of the loan is destroyed, but reserves (equal to the interest) are created – the profit from the loan.
In practice, commercial banks extend lines of credit to companies – a promise to make a loan. This promise is not considered money for regulatory purposes, and banks need not hold reserves against it, but when the line is tapped (and a loan extended), then bona fide credit money is created, and reserves must be found to match it. In this case, credit money precedes reserves. In other words making loans pulls reserves in (assuming that the regulatory need for bank reserves exists), instead of reserves being pushed out as loans which is assumed by the mainstream model.
The failure of monetary policy during depressions – central banks give money to commercial banks, but the commercial banks do not lend it out – is referred to as "pushing on a string", and is cited by circuitists in favor of their model: credit money is pulled out by loans being extended, not pushed out by central banks printing money and giving it to commercial banks to lend.
History
Circuitism was developed by French and Italian economists after World War II; it was officially presented by Augusto GrazianiAugusto Graziani
Augusto Graziani is an Italian economist, Professor in Economics Policy at University la Sapienza, most known for his contribution to monetary economics in founding monetary circuit theory.- References :* .* Philip Arestis, Malcolm C...
in ,
following an earlier outline in .
The notion and terminology of a money circuit dates at least to 1903, when amateur economist Nicholas Johannsen
Nicholas Johannsen
Nicholas August Ludwig Jacob Johansen was a German-American amateur economist, today best known for his influence on and citation by John Maynard Keynes. He wrote under two pen names: A. Merwin and J.J.O...
wrote Der Kreislauf des Geldes und Mechanismus des Sozial-Lebens (The Circuit Theory of Money), under the pseudonym J.J.O. Lahn; . In the interwar period, German and Austrian economists studied monetary circuits, under the term , with the term "circuit" being introduced by French economists following this usage. The French circuitists stemmed from the works of Bernard Schmitt (Monnaie, Salaires et Profits, 1966).
Circuitism draws from Chartalism
Chartalism
Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money. The name derives from the Latin charta, in the sense of a token or ticket...
in a number of respects, notably emphasizing the fiat nature of (credit) money, and in distinguishing between government-created (exogenous) money and bank-created (endogenous) credit money.
Modeling difficulties
While the verbal description of circuitism has attracted interest, it has proven difficult to model mathematically. Initial efforts to model the monetary circuit proved problematic, with models exhibiting a number of unexpected and undesired properties – money disappearing immediately, for instance. These problem go by such names as:- Losses in Circuit
- Destruction of Money
- Dilemma of profit
Australian economist Steve Keen
Steve Keen
Steve Keen is a Professor in economics and finance at the University of Western Sydney. He classes himself as a post-Keynesian, criticizing both modern neoclassical economics and Marxian economics as inconsistent, unscientific and empirically unsupported...
ascribes these difficulties to inappropriate use of general equilibrium
General equilibrium
General equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...
methods, hence implicitly static or steady state
Steady state
A system in a steady state has numerous properties that are unchanging in time. This implies that for any property p of the system, the partial derivative with respect to time is zero:...
, while he considers circuitism essentially dynamic, and thus advocates instead the use of the dynamic methods of differential equations or difference equations, producing circuitist models that do not have the shortcomings of earlier attempts. , , ,