Arnold Kling sent me a long speech by Thomas Sargent. Although he’s a great economist, he’s not a good speaker. It wasn’t easy to figure out the points he was trying to make. One theme was the difference between the”real bills doctrine” championed by Adam Smith, and the “Quantity Theory of Money,” championed by Milton Friedman. Sargent seems to prefer the real bills doctrine, on “efficiency” grounds.
In my view the efficiency issues are trivial compared to the macro issues; which policy provides a more stable path for NGDP? But let’s put that aside. It seems to me that Sargent overlooked an important distinction, the difference between the “medium of account” and “money,” conventionally defined. The point of this post is to show that the medium of account is a useful concept, which helps us to better understand longstanding historical disputes.
At the time of Adam Smith gold or silver was the MOA, and banknotes were credit. Today gold and silver are no longer MOA (it’s debatable when gold stopped being the MOA, some time between 1933 and 1968.) The MOA is now currency and bank reserves. When Milton Friedman was alive neither currency nor reserves paid interest, so it wasn’t clear that they were “credit” in any meaningful sense of the term. I think of them as “paper gold”. Alternatively, the QTM arguably held for swaps of cash for T-bonds in 1978, but not 1928 (when the US price level was determined by the global gold market.)
The issuance of bank notes had only a small impact on the price level in Adam Smith’s day. (Sargent says no impact, but that’s wrong because bank notes reduce the global demand for specie.)
If we stopped talking about “money” and started talking about “MOA” then a lot of age-old disputes in monetary economics would be much less confusing, and perhaps easier to resolve.
When I say “money” I mean the MOA. And when I say “credit” I mean promises to pay a specific amount of the MOA at a future date. But that’s just me.
PS. If you get to the end, Sargent’s comments on moral hazard are actually pretty good. He points out that post-Lehman the big banks have far more incentive to engage in risky behavior than pre-Lehman. That’s a scary thought.
PPS. Ben Southwood sent me an excellent Lars Christensen article on monetary offset (in City AM)