MODERN MONETARY THEORY By the same author MONEY ECONOMIC THEORY: Equilibrium and Change NEW DIRECTIONS IN ECONOMIC POliCY THE COST OF TRUCKING: Econometric Analysis (with others) RESOURCE ALLOCATION AND ECONOMIC POliCY (editor with Michael Allingham) MODERN MONETARY THEORY M. L. Burstein 'Mais nous nous representons l'avenir comme un re{let du present projete dans un espace vide, tandis qi'il est le resultat, souvent tout prochain, de causes qui nous echappent pour la plupart. ' - Marcel Proust, )l la Recherche du Temps Perdu, Vol. xii, La Prisoniere (Paris: Gallimard, 1923)p. 146. Palgrave Macmillan ISBN 978-1-349-18072-1 ISBN 978-1-349-18070-7 (eBook) DOI 10.1007/978-1-349-18070-7 © M. L. Burstein 1986 Softcover reprint of the hardcover 1st edition 1986 All rights reserved. For information, write: St. Martin's Press, Inc., 175 Fifth Avenue, New York, NY 10010 Published in the United Kingdom by The Macmillan Press Ltd. First published in the United States of America in 1986 ISBN 978-0-312-54108-8 Library of Congress Cataloging in Publication Data Burstein, M. L. (Meyer Louis), 1926- Modern monetary theory. Bibliography: p. Includes index. 1. Money. I. Title HG22l.B77 1986 332.4'01 85-14318 ISBN 978-0-312-54108-8 ForMilka Why with time do I not glance aside To new-found methods and to compounds strange? Why write I still all one, ever the same And keep invention in a noted weed, That every word doth almost tell my name, Showing their birth and where they did proceed? So all my best is dressing old words new, Spending again what is already spent; (Shakespeare, Sonnet LXXVI) Contents Preface: Apologia XV PART I THE ONTOLOGY OF MONEY 1 THE ESSENTIAL PROPERTIES OF MONEY 3 1.1 Introduction 3 1.2 Money of Account 4 1.2.1 Foundations 4 1.2.2 Money Illusion and Neutrality 5 1.2.3 Seven Sets of Propositions 5 1.2.4 Coda to Section 1.2: Colonial Monetary History 7 1.3 Money as Property and Monetary Properties 8 1.3.1 Preliminary Remarks 8 1.3.2 Means of Payment 9 1.3.3 Standards of Value 9 1.3.4 Interme72o: The Idea of Money is Amorphous 10 1.3.5 Interme72o: The Spectrum of Government Securities and Money 10 1.3.6 Stores of Value II 1.4 Money and Finance 12 1.4.1 Monetary Theory Studies Residues of Financial Actions 12 1.4.2 A Clearing Union Model 12 1.4.3 Seigneurage 14 1.4.4 Concluding Remarks: The Perpetual Perplex of Monetary Theory 15 2 CHOICE OF CURRENCY AND OTHER TOPICS 16 2.1 Competing Currencies 16 2.1.1 Coda to Section 2.1: Measurement of Currency Supply Change 17 vii viii Contents 2.2 Convertibility 17 2.2.1 Convertibility at Micro and Macro Levels 17 2.2.2 Reserves, Pyramiding of Reserves and Access to Reserves 18 2.2.3 Panics and Convertibility 18 2.2.4 System-Wide Restrictions on Convertibility 20 2.2.5 Corollaries to 'Convertibility and Reserve Principles'; The Federal Funds Market; Discounting at the Central Bank 20 2.3 Monetary and Other Liquidity Bases and Prices and Other Nominal Values 22 2.3.1 Model One 22 2.3.2 Model Two 23 2.3.3 Model Three 26 2.4 Monetary Theory and Relativity 27 3 INTEREST ON MONEY 29 3.1 Preliminary Remarks 29 3.2 Money Does Not Yield Interest 29 3.2.1 Analysis 29 3.2.1.1 The Central Bank Does Not Pay Interest on Its Deposits 29 3.2.1.2 The Central Bank Pays Interest on Its Deposits 30 3.2.2 Eschew Monetary Determination of the Real Cost of Capital; The Central Bank Does Not Pay Interest on Its Liabilities 31 3.3 Money Flexibly Yields Interest 31 3.3.1 Preliminary Comments 31 3.3.2 A Distinct (B;) Sector Pays Flexible Interest Rates on Its Monetary Liabilities 32 3.3.3 A Unified Financial Intermediary Sector (B!) 33 3.4 Applications of the Theory of Sections 3.1-3.3 34 3.4.1 A Model Suggested by Robertson (1926): Banking Policy and the Price Level 34 3.4.2 A Supply Side Equivalent to the Liquidity Trap 37 3.4.3 Concluding Remarks: Sections 3.3 and 3.4 37 3.5 Tobin (l982a): 'Financial Structures and Monetary Rules' 38 Contents IX 3.5.1 Shocks 38 3.5.2 Further Discussion of Central Bank Deposit Rate 40 3.6 Coda: The Structure of the Markets in Financial and Non-Financial Liabilities in the Model 40 PART II OPERATIONAL STUDIES 4 THE PURE THEORY OF COMMODITY MONEY 45 4.1 Preliminary Remarks 45 4.2 Homogeneity and Commodity-Money Systems 46 4.3 Commodity Money in Keynesian and Other Macrotheory 48 4.4 A General Stock-Flow Paradigm 49 4.5 Specialisation of the Stock-Flow Paradigm to a Commodity-Money Model 51 4.6 Extensions to a Properly Dynamic Analyses of Commodity Money 52 4.7 Coda to Chapter 4: A Sketch of a Theory of Bimetallism 54 5 OPEN-LOOP v. CLOSED-LOOP MONEY SUPPLY CONTROL SYSTEMS 58 5.1 Introduction 58 5.2 On the Principle of Reflux 59 5.2.1 Introductory Remarks 59 5.2.2 Origins of Invalid Forms of the Principle of Reflux (Commercial Loan Theory of Banking, Real Bills Doctrine) 59 5.2.3 Prologue to a Formal Analysis of the Principle of Reflux 60 5.2.4 The Principle of Reflux in an Open Model 62 5.2.5 The Principle of Reflux in Closed Models 63 5.3 Monetary-Aggregate v. Interest-RaJe Targeting 66 5.3.1 Introductory Remarks 66 5.3.2 Poole's Analysis 67 5.3.3 Some Poolian Algebra 68 5.3.3.1 Some More Poolian Algebra: The Model of Poole ( 1978) 69