Credit, Money and the Economy

  • Richard A. Werner

Abstract

Having identified the key feature that makes banks unique, it is now time to re-examine the link between the tangible economy and the monetary or financial part of the economy. In order to identify where possible errors could have been made in the construction of the edifice that is mainstream macroeconomics, it is necessary to return to first principles. As we saw, the various theories all rely on the quantity equation MV = PY. The textbooks consider it an identity that is true by definition and requires little further discussion. Handa (2000) writes that MV = PY However, is this actually true? Following the inductive method, it is of interest how this equation came about. We find that a quantitative link has been proposed between money and the economy for hundreds of years, if not much longer. A quantity relationship was mentioned by ancient Chinese classical scholars (von Glahn, 1996), Spanish scholastic writers of the Salamanca School (Humphrey, 1997), and many others (including Locke, Hume, Cantillon and Ricardo).

is an identity since it is derived solely from identities. It is valid under any set of circumstances whatever since it can be reduced to the statement: in a given period by a given group of people, expenditures equal expenditures, with only a difference in the computational method between them. (p. 25)

However, is this actually true? Following the inductive method, it is of interest how this equation came about. We find that a quantitative link has been proposed between money and the economy for hundreds of years, if not much longer. A quantity relationship was mentioned by ancient Chinese classical scholars (von Glahn, 1996), Spanish scholastic writers of the Salamanca School (Humphrey, 1997), and many others (including Locke, Hume, Cantillon and Ricardo).

Keywords

Income Rosen Librium Milton Monopoly 

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Notes

  1. 8.
    Knut Wicksell (1898, 1906) presented a model of a pure credit economy, emphasizing the important function of banks as creators of new purchasing power. In his model, all transactions are settled by bank transfer or cheque drawn on cheque accounts with banks. He assumed that all saving is deposited with banks, banks do not hold reserves and can issue any amount of loans without risk of insolvency, all investment is bank-financed, banks lend solely to finance investment, and the economy is at full employment. For a lucid discussion of the role of bank credit in the theories of Steuart, Smith and Hilferding, see Lapavitsas (2004).Google Scholar

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© Richard A. Werner 2005

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