How is Money Defined?

Be sure to catch Krugman’s post, What is Money? We have issues with his extreme partisanship, but the economics of the piece is excellent.  He raises some very good points on how difficult it is even just to define money, much less measure it.  Krugman writes,

But here’s an even more basic question: what is money, anyway? It’s not a new question, but I think it has become even more pressing in recent years.

Surely we don’t mean to identify money with pieces of green paper bearing portraits of dead presidents. Even Milton Friedman rejected that, more than half a century ago. For one thing, a lot of those pieces of green paper are pretty much inert — sitting outside the United States, in the hoards of drug dealers and such. For another, checking accounts are clearly a close substitute for cash in hand.

Friedman and Schwartz dealt with this by proposing broader aggregates –M1, which adds checking accounts, and M2, which adds a broader range of deposits. And circa 1960 you could argue that those aggregates were good enough.

But now we have a large shadow banking system, in which things like repo serve much the same function as deposits; M3 used to capture some of that, but the Fed discontinued it, in part I think because it wasn’t clear which repo belonged there, and data on repo not involving primary dealers is scattered. Whatever.

The truth is that these days — with credit cards, electronic money, repo, and more all serving the purpose of medium of exchange — it’s not clear that any single number deserves to be called “the” money supply. Intellectually, this isn’t a problem; nor is there necessarily a problem maintaining monetary policy even if there isn’t any single thing you’re willing to call money. Mike Woodford has been writing about this stuff for years.

The classical definition of money — medium of exchange, unit of account, and store of value — is becoming increasingly blurred.

The Fed actually considered including equity mutual funds in the money supply figures at one time.  As the international reserve currency, the dollar is losing its role as a store of value to gold and other commodities.  OPEC, the Chinese, Russians, and others constantly threaten to ditch the dollar as a medium of exchange and unit of account in their international transactions.    Finally,  of the $900 BN of currency circulation, 50-70 percent is held outside the U.S.

This is one of our favorite topics and we will have more in future posts.

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4 Responses to How is Money Defined?

  1. Pingback: Monetarism Redefined: Crude, Fine Wine & Gold | The Big Picture

  2. Pingback: Is Gold Money? | The Big Picture

  3. Pingback: Is Gold Money? | The Garden of Princess Aileen 心灵的驿站

  4. Ellie K says:

    Money is currency. It is anything that functions as form of exchange, preferably a legal form of exchange. As in “legal tender”. Another criteria is this: When there is a flight to quality, what is “quality”? Sometimes it is gold. Deutschemarks and British Pound Sterling were good choices prior to the EU days and EU crisis now, respectively. For a very long time, flight to quality is the U.S. DOLLAR, or to instruments denominated in US Dollars.

    If I had to leave my mother on her own, to guard the fort, so to speak, and things were bad, I’d make sure she had some gold (5-10%) and the remainder in U.S. Dollars. That’s how I decide what is money.

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