James Akiakpor writes:



< Somewhere along the line in the late nineteenth century economists began to cite the medium of exchange function as the first identifier of what money is.  They thus started to include instruments of credit, like checks or checkable deposits, in their definition of money.  As Francis A. Walker (1878) writes in objection to that practice, "Money is that which passes from hand to hand in final discharge of debts and full payment for goods... [D]eposits, like every other form of credit, save the use of money; they do not perform the functions of money. Money is what money does." >



James concludes that "A pure credit system thus does not have money, properly so called."



But Francis Walker can hardly be held up as the ultimate arbiter of the definition of money as that which is used in hand-to-hand settlement of debts. In a pure credit economy (i.e., one in which debts are settled through transfers of chequable deposit accounts, as in Wicksell's definition of "credit") this "credit" is money just as much as cash would be. (Many "time" deposits are highly liquid, but are not strictly "money" in this sense if they must first be converted into demand deposits before the actual settlement of debts can be made.)

Demand deposits are book-keeping entries expressed in terms of the unit of account such as the dollar. So, as Tom Humphrey rightly implies, they comprise a unit of account every bit as easily and logically as James's hand-to-hand cash money. And they can equally be the means of exchange and aggregated to give us a measure of the money supply.

If the banks extend credit - by making a book-keeping entry in the name of a borrower - unconstrained by any reserve requirement and in excess of any increase in the demand for money (in chequing accounts) as a proportion of real GDP, there will - as in Tom's logic - be inflation. The central bank can then either increase the discount rate or can insist on a positive reserve ratio that would act as a constraint on inflationary credit (money). However, maybe this violates the assumption of a _pure_ credit economy. In reality, however, a bank would presumably be constrained by its capital even if not by mandatory reserve ratios.



James is correct that a check is an _instrument_ rather than money itself. We know that. But the deposit being transferred by check is money. It is the means of payment and medium of exchange. No cash is being used. And only as and when savings and time deposits (or other financial assets) are actually drawn down and transferred into chequable deposits or cash can purchases be settled. It is in this sense that the quantity theory makes sense. To claim otherwise is to say that an increase in the savings rate is inflationary. An increase in the money supply (cash plus bank deposits actually used to make payments) relative to the demand for money is inflationary. An increase in savings with no increase in the money supply is not.



This is why there has been so much confusion over whether the central bank should control the supply of money or control "credit" - when "credit" is taken to mean the supply of loans regardless whether this is via newly created money or via an increase in the savings rate [whereby one person refrains from spending as much as before in order to allow someone else potentially to spend her income instead].



I haven't read Leland Yeager (SEJ 1978) to which James refers re the confusion of money and credit. But if memory serves, Yeager (Atlantic Economic Journal, Dec 1978) on "What are Banks?" insisted that cash plus demand deposits are money and that banks can create a "momentous roundabout process" whereby the quantity theory works through to prices.



Tom reminds us that Wicksell defined "credit" as chequable demand deposits. Lauchlin Currie, in "The Treatment of Credit in Contemporary Monetary Theory" (JPE 1933) urged that we abandon the word "credit" because it has been defined and used in so many different ways, with sometimes catastrophic policy implications. He showed why the Fed's focus on the control of "credit" in the form of loans (following the real bills doctrine) led it to ignore what was happening to the money supply (cash plus demand deposits), bringing on and then exacerbating the Great Depression. James's posts show why we need to revisit Currie's injunctions and insights - as well as those of Wicksell (whom Currie admired).



- Roger Sandilands