New School Economic Review

The problem with Money in economics

by Benjamin on April 10, 2010

I spent yesterday at a workshop on “The Origin of Paper Money in Theory and Practice” which was thoroughly enjoyable, looking at how paper money had emerged, failed, succeeded and generally impacted people and economies in the past and today.  Some consensus seemed to emerge that ‘paper’ money – unlike money on paper, which was missing the point – could emerge privately and publicly but its successful widespread use required some systemic / macro factors to be in place: Particularly the credibility of the issuer was paramount if they were to guarantee the value of the fiat, but there also had to be a social acceptance of instability. This was an interesting point I thought, and the argument was made that we can’t forget the issue of deception, if you trust someone 100% economic logic dictates that they will try to deceive you… This was attributed to Hegel and Adam Smith’s “Deception of Nature”, and the point was that people knew there was some risk in attributing value to a fiat, and they have to  accepted this to have a widely used fiat money.

Some of the papers had stock-flow consistent models or purely theoretical models built around the quantity theory of money and similar devices and this led to some debate after the issue of a standard fiat money was raised. The argument was made that any fiat money needed a denominator, be it a price level, gold ingots, goods bundle or something which it could base its value on. I suggested that this was not the case, and there were several cases where paper money had been based on ability to pay taxes in that currency. The Maryland Dollar (1720-70)  and French Asignat (1790s) were both examples of this, and papers presented by Farley Grubb and Patrice Baubeau had earlier talked about them, so it seemed an obvious thing to say. The problem is that economists don’t like modelling, or thinking about,  money not based on a common denominator. “It feels wrong” was a comment made. The irony is that not only does it feel wrong, but in set theory, which all our economic modelling in this field is based on, it is wrong. Ben Fine has made the point in a paper well worth reading that money as a variable ‘M’ would be mathematically inconsistent if it values itself and stood as a measure of value for all other goods. Ironically that is exactly what fiat money does, and to avoid that in modelling we use M/x, where x is some denominator which, sadly, makes the money a relative price and not money at all. Funny thing money…

Finance is back on the curriculum

by Benjamin on January 27, 2010

At least, that’s what I saw to my disappointment as I perused the £1,000 plus ($1,500+) Easter school being offered by the venerable Royal Economic Society this April. Last year they talked about Auctions and Markets – interesting, but this year they have gone for “credit, business cycle and finance”.

I am being overly harsh. If the whole thing was a big collection of theoretical Merton-Scholes / Fama financial-theory-is-fantastic-don’t-worry kind of thing there would be good reason to criticise them. I still remember Nassim Taleb’s call to boycott any business school that continued to teach portfolio theory in 2009. They still do teach that stuff, but some of the things slated for the Easter school isn’t all bad. There seems to be a focus on empirical work, at least in the recent working papers on the first lecturer (Princeton’s Prof. Hyon Shin) and a lot of his recent work looks at financial intermediaries. The second lecturer (also from Princeton, prof. Hirotaki) seems interested in empirics, but only to the extent that they fit into “theoretical models”, and an older (pre-crisis, 2007) paper of Prof Shin’s uses the assumption that traders use Value-at-Risk models and finds that this may amplify shocks to the system if traders are risk neutral. A second very timely paper of his and Gara Afonso showed, in October 2008 no less, that:

banks attempting to conserve liquidity cause an increase in the demand for intraday credit and, ultimately, a disruption of payments. Additionally, we find that when a bank is identified as vulnerable to failure and other banks choose to cancel payments to that bank, there are systemic repercussions for the whole financial system.

I think this sounds rather interesting actually, although how much of the course will be talking about exciting empirical results and research, and how much will be on theory remains to be seen. I don’t think we need to throw Taleb’s book at these people, but I am not going to throw a grand their way either. Hey, there’s a recession ending over here, (with 0.1% growth), no need to go nuts just yet.