The Macroeconomics of Credit Money

Central banks cannot choose whether to control interest rates or monetary aggregates directly.  Quantity controls over the supply of credit money are simply not feasible. (xi)

Modern commercial banks are price setters and quantity takers in both their retail deposit and loan markets.  As a result at every moment of time the money supply function should be viewed as horizontal. (xii)

Since credit money is the good generally accepted in settlement of debt, it can never be in "excess supply."  Any increase in the nominal supply of money will always be demanded. (xiii)

False propositions: (xv)

Government deficits are responsible for high interest rates.

Real interest rates are determined in the long run by real forces of productivity and thrift.

Inflation is caused by an excess supply of money.

Savings determines investment and so governs the rate of capital accumulation.

Inflation serves primarily to redistribute wealth between debtors and creditors.

In general the central bank is unable unilaterally to initiate decreases in the total high-powered base, even though the base consists of the central bank’s own liabilities.  Were it to attempt to do so, the liquidity of the banking system would be imperiled. (17)

Banks do not wait for excess reserves before providing new loans to the public.  Nor are new loans made at the initiative of the banks themselves.  Banks are essentially in the business of selling credit.  As with all firms the amount of goods and services they can sell depends ultimately on the demand for their product. (46)

Bank credit standards vary inversely with the interest rate charged, because the higher the interest rate the lower is the loss-earnings ratio per dollar of bad debts.  This is one reason for the rise in credit often observed in the face of higher interest rates. (56)

The Fed supplies reserves on demand so that any reduction or increase in the required reserve ratios will be accompanied by a completely offsetting fall or rise in the Federal Reserve security holdings so as to maintain interest rates unchanged and the money stock demand-determined. (96)

Central banks do not, as the money-multiplier analysis presumes, control the rate of growth of monetary aggregates by increasing or reducing the size of the high-powered base through open market purchases or sales at their discretion.  Central bank open-market transactions are overwhelmingly defensive. (109)

In a world of credit money and central banks, interest rates can never be endogenously determined solely by market forces.  The authorities cannot choose not to affect interest rates. (254)

So long as the aggregate demand does not exceed the economy’s potential output, investment creates its own required saving through the finance process. (258)

Long-term interest rates will reflect financial market participant’s expectations of future short term rates over the life of the financial instrument. Since short term rates are exogenously administered by central banks, long-term rates will reflect the capital markets’ collective expectations of future short-term rates that the central bank will establish. (259)

The quantity of credit demanded expands as ex ante real borrowing costs are reduced.  It follows that nominal interest rates should not be administered by central banks substantially below the expected inflation rate, in order to prevent excessive credit-driven monetary growth and the possibility of hyperinflation. (264)

The true advantage of flexible exchange rates is that they permit national monetary authorities a greater range of discretion in setting nominal domestic interest rates, thus increasing the power and independence of domestic monetary policy. (274)

Central banks are always able to buy unlimited quantities of assets for their portfolios. They finance these purchases simply by issuing their own liabilities, which are domestic money.  Consequently they are generally able to reduce interest rates and exchange rates to any desired level.  But they are faced with an asymmetry in their ability to raise these rates.  After they have sold all their existing holdings they will be unable to depress further the prices of their assets. (275)

Commodity money is a physical asset, not a financial claim.  It is an asset to its holder and is a liability to no one.  Commodity money is distinct from all other assets:  It is perfectly liquid and so represents immediately available purchasing power, carries no credit risk, pays no interest, and carries no price risks. (371)

Credit money, in contrast, is that set of financial claims making up the total liabilities of all institutions issuing transactions deposits. (372)

In the short run, investment determines savings rather than the reverse.  In the long run the ex ante real reward on financial assets must be sufficiently high to induce wealthowners to accumulate such claims voluntarily.  This is the sense in which, in the long run, savings governs investment. (376)

Macroeconomics is in a state of chronic disarray.  As its mathematical sophistication has intensified, its contribution to our understanding of the real world has diminished.  Increasing rigor has been accompanied by increasing mortis.  Nevertheless, one can see signs of positive countercurrents, as more and more economists incrementally reject the general equilibrium price-auction paradigm. (392)

Basil J. Moore is professor emeritus of economics at Wesleyan University.  His book Horizontalists and Verticalists, The Macroeconomics of Credit Money, 1988, was published by Cambridge University Press, ISBN 0 521 35079 4.