Sargent on “money” and “credit”

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)



24 Responses to “Sargent on “money” and “credit””

  1. Gravatar of lxdr1f7 lxdr1f7
    11. September 2013 at 06:04

    “When I say “money” I mean the MOA”.

    So broad money isnt money in your definition?

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    11. September 2013 at 07:41

    I thought it was a pretty effective speech. Sargent’s lack of polish–all those hesitations–made it easier to absorb. I hadn’t thought of Wealth of Nations in quite the way Sargent does, so that was interesting.

    Most importantly his content supports, or I think it does, some of the ideas in the Klemperer and Bulow paper I linked to last week;

    In our ideal world, deposit accounts would follow a money market fund model. Government guaranteed accounts would be like existing money market funds that invest in government-guaranteed debts, along the lines of 100% reserve proposals. Currently, depositors in effect receive short-term government-guaranteed debt, acquired from banks that obtain it in return for unsecured bank debt plus mispriced, cheap, deposit insurance. We would eliminate the ‘middle man’, so that depositors directly hold loans from the government.5

    Creditors could still acquire short-term unsecured (i.e., non-collateralized) bank debt in much the way they can acquire short-term debt from, say, mortgage securities. Investment trusts could purchase ERNs and pool and tranche them, issuing more senior and shorter-term claims to those who want them, The difference is that in a panic, which might cause an investment vehicle to sell some of its bonds to pay short-term claims, losses would be borne by those who took levered, junior claims in the trust without any short-term repercussions for the underlying banks’ financial condition. Furthermore, investors who wanted to reduce or eliminate the tail risk of their ERNs could do so by buying equity puts. They could transfer the risk to any willing buyer — just not to the taxpayer.

    Some of the senior unsecured claims generated by such trusts might be held in non guaranteed money market accounts, operated under rules akin to those proposed by the US S.E.C. in 2012, with floating net asset values so that it would quickly become clear to investors that the accounts had some risk like in a very short-term bond fund.

    Similar principles could be applied to the funding of derivatives and other potential liabilities.

    It’s an approach completely at odds with the ‘We need the right kind of bank regulation.’ school represented in Dodd-Frank.

  3. Gravatar of Doug M Doug M
    11. September 2013 at 09:10

    If Alice has money, but her marginal demand is so low that I would rather hoard my money than spend it. And Bob has desires that exceed his ability to pay for them.

    If Alice lends her money to Bob for a commitment from Bob to pay future dollars back to Alice demand has increased across our little economy.

    We can stick with a narrow definition of M and say that increasing credit increases V. Or, we can use a broader definition of M and let V hold more or less constant.

    I prefer the broad definition of money — credit is money.

  4. Gravatar of ssumner ssumner
    11. September 2013 at 10:41

    lxdr, I consider them credit, not money.

    Patrick, I agree he’s good on regulation. My problem is his views on money and inflation.

    Doug, I prefer the narrow definition, it’s the one controlled by the Fed. Yes they can target M2, but then why stop there? Why not target NGDP?

  5. Gravatar of Tom Brown Tom Brown
    11. September 2013 at 10:56

    Scott, having just been spending the last few days reading at least ten or so posts (all w/ lengthy comments sections) on MOE vs MOE that you (you personally did about 5 or 6 posts!), Rowe, Woolsey, Glasner, Koning, Sproul and Saturos either wrote or just commented on… I have to say that your statement here truly made me laugh out loud!

    “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.”

    While the first sentiment is true enough:

    “”If we stopped talking about “money”…”

    (I think Koning, for one, heartily agrees with you there) … the rest of it is an eyebrow raiser. Like I say, I’m not quite to the end of that extremely long confusing debate, but even just a week or so ago you and Rowe were still not settled on this!

    … I guess Nick is “still thinking.”

    Also, as far as I can tell from the seemingly unending debates, this statement of yours:

    “The MOA is now currency and bank reserves.”

    …is very far from being accepted by your peers!

    For anyone that’s interested, here’s Bill Woolsey’s** definitions of MOA, UOA and MOE:

    IMO those are the clearest and most precise definitions of the terms I’ve seen.

    IMO Koning has the best summary of this never ending MOA debate so far, but it needs to be updated with the latest two from Scott. I’d provide a link, but I can’t link there for some reason. These two in particular from Koning:

    “Discussions of the medium-of-account could be more well-done”

    “My synopsis of the MOE vs MOA debate”

    In contrast, David Glasner, comes to a very sensible conclusion here I think (in terms of his analysis):

    “Rather than work through the analysis in terms of a medium of account and a medium of exchange, I prefer to talk about outside money and inside money.” — David Glasner

    I would add, that another advantage of “inside” and “outside” is that the Federal Reserve offers a crystal clear universal (not specific to the US) definition of those terms in the 1st paragraph of this document:

    Because these terms are defined in a relative and universal manner by the Fed, they don’t have to be exactly the same ones as David uses, and are thus adaptable to a lot of situations (different countries, bitcoin, gold, different sectors of the economy, etc)!

    From the point of view of the private sector economy in the US, “outside money” is nearly the same as “base money” and also your definition of “MOA” (the difference being coinage and the rare US notes (NOT reserve notes!)… which are outside money to the Fed… but any inventory at the Fed is not counted as base money (MB) because it’s not in circulation… but that’s a minor difference!).

    “MB: The total of all physical currency plus Federal Reserve Deposits (special deposits that only banks can have at the Fed). MB = Coins + US Notes + Federal Reserve Notes + Federal Reserve Deposits”

    The nice thing about “outside money” and “base money” is you can point to the Fed definitions so everyone’s on the same page. “Outside money” has the added advantage that it can be universally applied… it’s not just for the US, or from the view of the private sector: money is “outside” or “inside” from a particular vantage point: it depends on who’s liability it is, or whether or not it has intrinsic value.


    JP uses pretty much the same definition as Bill, and extends MOA and UOA to a fiat system with inflation targeting (using the CPI as a measure). I suppose that could be extended to other targets. Rowe responded:

    “JP: Hmmm. You seem to have hoist me on my own slippery slope!”

    Since JP used this post by Rowe as part of his justification:

  6. Gravatar of Tom Brown Tom Brown
    11. September 2013 at 11:00

    1st paragraph, should read “MOE vs MOA”

  7. Gravatar of Tom Brown Tom Brown
    11. September 2013 at 11:20

    Also, Bill doesn’t quite extend the definition to where Koning takes it for an inflation targeting central bankd (1st of the articles I reference above by him):

    “What has changed [in leaving the gold standard]? Shopkeepers continue posting prices in the unit of account, the dollar. Notes issued by the central bank are still the medium of exchange. But the definition of the dollar, the medium of account, has changed from a quantity of gold to a gradually shrinking quantity of consumer goods.”

    “To sum up, in moving from a fully-reserved gold bank to a modern CPI targeter, all that’s happened is that our central bank has changed the medium of account from gold to CPI. Nick has to understand where I’m coming from since I’m just using the same technique he used in this post.”

    I realize that would have to be updated under NGDPLT: just another step (step 11?) in Nick’s sequence.

  8. Gravatar of Doug M Doug M
    11. September 2013 at 11:56

    Yes they can target M2, but then why stop there? Why not target NGDP?

    M2 is too narrow. Target M3. Oh, the Fed stopped tracking M3.

    I have less confidence than you do that the Fed could accurately target NGDP if the were to try. They could target the growth of a broad money aggregate and hope that NDGP growth tracked the growth of that broad money aggregate.

    The Fed isn’t very good at forecasting NGDP. How do they now how much money to add to hit their target if they don’t even know what they are shooting for. I know, that is why you want a market mechanism to derive the forecast.

    Furthermore, it is an important question regardless of model the Fed is using to manipulate the money supply. If credit drives demand and GDP. The Fed must understand the channels that turn base money into credit and into broad money. Even if it isn’t used to target OMO, it is relevant in the Fed’s other functions.

  9. Gravatar of Martin Martin
    11. September 2013 at 12:43


    I cannot view the video right now, but I believe it is based on this (older) article. This might be a bit easier to go over than a video (I personally prefer reading to watching).

  10. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    11. September 2013 at 15:06

    ‘My problem is his views on money and inflation.’

    What do you take his views to be?

  11. Gravatar of Lorenzo from Oz Lorenzo from Oz
    12. September 2013 at 01:09

    I don’t think banknotes were, or have ever been, credit. They were liabilities and they were originally typically redeemable for gold (or silver or silver or gold). But if I paid for something with banknotes, that closed the transaction. Which is what money does. It closes transactions without providing in itself production or consumption utility.

    Banknotes may be backed by debt, but that no more makes them credit than being backed by gold makes notes gold.

  12. Gravatar of Lorenzo from Oz Lorenzo from Oz
    12. September 2013 at 01:39

    Or, in the case of commodity money, closes transactions without use of its production or consumption utility.

    After all, it is ultimately all about the transactions. People’s willingness to enter into them, and on what scale. The point of money is to transact and it is macro-economically important only because it affects the number and scale of transactions.

    And when I say “credit” I mean promises to pay a specific amount of the MOA at a future date. Why limit to MoA? Credit extends the time over which a transaction operates, money closes (i.e. completes) the transaction. You can complete a transaction, including a credit transaction, without using a MoA. (Or, indeed, money at all.)

    The point of a gold/silver/specie standard is not to limit the number of notes (that is a misunderstanding of it; one cover ratios reflect–the BoE notionally had a cover-ratio constraint but they simply suspended it any time it looked like it might be binding), the point is to anchor the swap value of the money. It gives people confidence in the continuing value of the bank notes, it does not set up an expectation of being paid in gold but in something worth a certain amount of gold (or silver or either).

    In such a situation, the quantity theory of money does not apply to the MoE (banknotes), it applies to the MoA (gold/silver/specie). That does not mean, however, the banknotes are not money and cannot close transactions. Or that credit cannot be a promise to pay a certain amount of money in the form of banknotes whose value is anchored by the MoA.

    The essence of money is that it completes transactions without use of production or consumption utility. But whether the MoA or MoE role is the crucial one depends on the circumstances and the question.

    As an aside, the other great difference between money and credit is that credit has transactor-specific risks and money does not. (Money’s risks are more general.) Hence banknotes are legal tender and cheques are not. Hence also the importance of ensuring adequate liquidity (i.e. enough impersonal media of account–assuming it is a means of settlement–and exchange) during financial crises, which are marked by upsurges in doubt about debt-holding agents and the financial instruments derived therefrom.

    But I am tired and probably not expressing myself clearly.

  13. Gravatar of What Would Keynes Have Done? | askblog What Would Keynes Have Done? | askblog
    12. September 2013 at 05:03

    […] Sargent’s essay (I found a video of Sargent delivering his essay, and I passed it along to Scott Sumner, who seems to have had as much difficulty as I did following it.), I would not put it at the top of […]

  14. Gravatar of ssumner ssumner
    12. September 2013 at 06:01

    Tom Brown, The problem with using checks as the MOA is that I’d much prefer cash to a check, as I don’t know if the check is any good. A check is only useful if I can go to the bank and get some MOA with it.

    The CPI is not the MOA because the MOA is an asset whose nominal price is constant. Inflation is the inverse of the change in the value of the MOA.

    Doug, When I presented my NGDP futures targeting idea to them back in 1988, they said “No thanks. we are good at forecasting NGDP.”

    Thanks Martin.

    Patrick, He seems to have a fiscal theory of inflation, but I couldn’t really follow it.

    Lorenzo, Good comment. I’ll just quibble over one point. The QTM doesn’t really apply to specie, as there is no reason to believe the demand for gold and silver are unit elastic.

  15. Gravatar of Tom Brown Tom Brown
    12. September 2013 at 07:47


    I think you’ve got a good argument, I was just pointing out to anybody that’s interested, that using the term MOA is far from clarifying anything given all the controversies surrounding even what that term means (see my links above), amongst people who ought to know for sure.

  16. Gravatar of Tom Brown Tom Brown
    12. September 2013 at 10:28

    … I guess my point is that “base money” or “outside money” would be a lot more clear and universally accepted than “MOA” … as to whether or not base money serves the role you argue for is another matter (of debate between all of you!!), but at least you could all agree on what “base money” meant.

  17. Gravatar of ssumner ssumner
    12. September 2013 at 17:16

    Tom, Gold was not base money under the gold standard, but it was the MOA.

  18. Gravatar of Geoff Geoff
    12. September 2013 at 17:25

    Medium of account derives from medium of exchange.

    The reason why commodity X is used as a medium of account is because it is used as a medium of exchange.

    Medium of exchange is more fundamental.

  19. Gravatar of lxdr1f7 lxdr1f7
    12. September 2013 at 18:02

    Cullen wrote this relevant blog piece in response to you ssumner:

  20. Gravatar of Credit Is Money – Credit Is Money –
    13. September 2013 at 02:20

    […] in economics and in general, for people to differentiate between “money” and “credit” (Scott Sumner did it here today). This is largely the result of gold standard mythology when gold was viewed as the primary form of […]

  21. Gravatar of Tom Brown Tom Brown
    13. September 2013 at 05:24

    I guess it depends on what kind gold standard, de facto or specie, but I see your point.

    Also, it’s not the CPI itself but its reciprocal, such that with CPI targeting, MOA, and UOA combine to give us a definition of a dollar, at each point in time, in terms of explicit quantities of goods in the basket… so for a simplified basket we might have (for MOA and UOA combined):

    year 0: 1 dollar = 100 grams apples + 10 minutes entertainment

    year 1: 1 dollar = 98 grams apples + 9.8 minutes entertainment


    I realize that’s not precisely how it’s done, but that’s the basic idea.

    The role of the MOA in this case defines the basket and the basket’s goods’ relative quantities with respect to one another (not specific quantities). Just as in the gold standard, the MOA specifies “gold” but it’s left to the UOA to determine how much.

    That’s how I understood the point of Rowe, Woolsey and Koning’s articles.

    Of course we might not hit the CPI targeted each year but does that matter? And then how to translate into an NGDP level target? That is a difficulty with this approach. It’d be nice if you MM folks could agree on this stuff… but it’ll probably never happen 😀

  22. Gravatar of Tom Brown Tom Brown
    13. September 2013 at 05:35

    One difficulty with the “paper gold” concept is that it’s left floating in the air with no anchor to tie it to. What argues against this is that a dollar has actual value. Mike Sproul does a good job demonstrating that so-called “fiat” currencies are an illusion: according to him there has never been such a thing: all money which has value > 0, is effectively backed by “stuff” of real value. There are always some reflux channels open: if there weren’t, then value = 0.

  23. Gravatar of John Papola John Papola
    13. September 2013 at 06:08

    MOA is a yardstick, a denominator, but doesn’t the choice of which yardstick emerge entirely out of which yardstick is used as a broad medium of exchange?

    If next year in the US, the majority of exchanges moved from dollars to bit coins, prices would surely come to be generally listed in terms of bitcoins instead of dollars and thus bitcoins would become the MOA.

    At the most basic level, doesn’t the value of any “money” derive entirely from it’s use as a medium of exchange in terms of market forces (We know King Joffrey can dictate that his kingly tax be paid in a particular currency)?

  24. Gravatar of ssumner ssumner
    14. September 2013 at 06:23

    Tom, You said;

    “Of course we might not hit the CPI targeted each year but does that matter?”

    Yes, it matters. The price of the MOA never changes at all. Cash is the MOA.

    Regarding paper gold, cash provides a flow of liquidity services. That’s what gives it value. If you double the supply of cash it doesn’t provide any more liquidity services, hence it’s value in aggregate is unchanged. It’s value per dollar falls in half.

    I don’t agree with Sproul.

    John, I agree that the MOE is almost always the MOA, although I believe there have been a few cases where it wasn’t.

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