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Monetary circuit theory is a heterodox theory of monetary economics, particularly money creation, often associated with the post-Keynesian school.It holds that money is created endogenously by the banking sector, rather than exogenously by central bank lending; it is a theory of endogenous money. It is also called circuitism and the circulation approach.
Heterodoxy is a term that may be used in contrast with orthodoxy in schools of economic thought or methodologies, that may be beyond neoclassical economics. Heterodoxy is an umbrella term that can cover various schools of thought or theories. These might for example include institutional, evolutionary, Georgist, Austrian, feminist, social, post-Keynesian, ecological, Marxian, socialist and anarchist economics, among others.
Monetary economics is the branch of economics that studies the different competing theories of money: it provides a framework for analyzing money and considers its functions, and it considers how money, for example fiat currency, can gain acceptance purely because of its convenience as a public good. The discipline has historically prefigured, and remains integrally linked to, macroeconomics. This branch also examines the effects of monetary systems, including regulation of money and associated financial institutions and international aspects.
Money creation is the process by which the money supply of a country, or of an economic or monetary region, is increased. In most modern economies, most of the money supply is in the form of bank deposits. Central banks monitor the amount of money in the economy by measuring the so-called monetary aggregates.
The key distinction from mainstream economic theories of money creation is that circuitism holds that money is created endogenously by the banking sector, rather than exogenously by the government through central bank lending: that is, the economy creates money itself (endogenously), rather than money being provided by some outside agent (exogenously).
Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Also known as orthodox economics, it can be contrasted to heterodox economics, which encompasses various schools or approaches that are only accepted by their proponents, but not by economists in general.
These theoretical differences lead to a number of different consequences and policy prescriptions; circuitism rejects, among other things, the money multiplier based on reserve requirements, arguing that money is created by banks lending, which only then pulls in reserves from the central bank, rather than by re-lending money pushed in by the central bank. The money multiplier arises instead from capital adequacy ratios, i.e. the ratio of its capital to its risk-weighted assets.
In monetary economics, a money multiplier is one of various closely related ratios of commercial BANK money to central bank money under a fractional-reserve banking system. It measures the maximum amount of commercial bank money that can be created, given a certain amount of central bank money and ignoring leakages into currency held by the non-bank public. That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend when there are no leakages is equal to a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier. The actual ratio of money to central bank money, also called the money multiplier, is lower because some funds are held by the non-bank public as currency and most banks hold excess reserves
The reserve requirement is a central bank regulation employed by most, but not all, of the world's central banks, that sets the minimum amount of reserves that must be held by a commercial bank. The minimum reserve is generally determined by the central bank to be no less than a specified percentage of the amount of deposit liabilities the commercial bank owes to its customers. The commercial bank's reserves normally consist of cash owned by the bank and stored physically in the bank vault, plus the amount of the commercial bank's balance in that bank's account with the central bank.
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Circuitism is easily understood in terms of familiar bank accounts and debit card or credit card transactions: bank deposits are just an entry in a bank account book (not specie – bills and coins), and a purchase subtracts money from the buyer's account with the bank, and adds it to the seller's account with the bank.
A debit card is a plastic payment card that can be used instead of cash when making purchases. It is similar to a credit card, but unlike a credit card, the money is immediately transferred directly from the cardholder's bank account when performing any transaction.
A coin is a small, flat, round piece of metal or plastic used primarily as a medium of exchange or legal tender. They are standardized in weight, and produced in large quantities at a mint in order to facilitate trade. They are most often issued by a government. Coins often have images, numerals, or text on them.
As with other monetary theories, circuitism distinguishes between hard money – money that is exchangeable at a given rate for some commodity, such as gold – and credit money. The theory considers credit money created by commercial banks as primary (at least in modern economies), rather than derived from central bank money – credit money drives the monetary system. While it does not claim that all money is credit money – historically money has often been a commodity, or exchangeable for such – basic models begin by only considering credit money, adding other types of money later.
Hard currency, safe-haven currency or strong currency is any globally traded currency that serves as a reliable and stable store of value. Factors contributing to a currency's hard status might include the long-term stability of its purchasing power, the associated country's political and fiscal condition and outlook, and the policy posture of the issuing central bank.
In circuitism, a monetary transaction – buying a loaf of bread, in exchange for dollars, for instance – is not a bilateral transaction (between buyer and seller) as in a barter economy, but is rather a tripartite transaction between buyer, seller, and bank. Rather than a buyer handing over a physical good in exchange for their purchase, instead there is a debit to their account at a bank, and a corresponding credit to the seller's account. This is precisely what happens in credit card or debit card transactions, and in the circuitist account, this is how all credit money transactions occur.
For example, if one purchases a loaf of bread with fiat money bills, it may appear that one is purchasing the bread in exchange for the commodity of "dollar bills", but circuitism argues that one is instead simply transferring a credit, here with the issuing central bank: as the bills are not backed by anything, they are ultimately just a physical record of a credit with the central bank, not a commodity.
Fiat money is a currency without intrinsic value that has been established as money, often by government regulation. Fiat money does not have use value, and has value only because a government maintains its value, or because parties engaging in exchange agree on its value. It was introduced as an alternative to commodity money and representative money. Commodity money is created from a good, often a precious metal such as gold or silver, which has uses other than as a medium of exchange. Representative money is similar to fiat money, but it represents a claim on a commodity.
In circuitism, as in other theories of credit money, credit money is created by a loan being extended. Crucially, this loan need not (in principle) be backed by any central bank money: the money is created from the promise (credit) embodied in the loan, not from the lending or relending of central bank money: credit is prior to reserves.
When the loan is repaid, with interest, the credit money of the loan is destroyed, but reserves (equal to the interest) are created – the profit from the loan. Another explanation of the interest, in a simple, non-growth model is the interest enjoyed by the bank is from the spending of interest income of the bank in previous circuit. The same simple model applies for profit as well, in a simple model of non-growth non-modern-bank model composed only by entrepreneurs and the employed workers, entrepreneurs's spending on profit on previous circuit will compose the profit this group enjoy in new circuit.
The failure of monetary policy during depressions – central banks give money to commercial banks, but the commercial banks do not lend it out – is referred to as "pushing on a string", and is cited by circuitists in favor of their model: credit money is pulled out by loans being made, not pushed out by central banks printing money and giving it to commercial banks to lend.
Circuitism was developed by French and Italian economists after World War II; it was officially presented by Augusto Graziani in ( Graziani 1989 ), following an earlier outline in ( Graziani 1984 ).
The notion and terminology of a money circuit dates at least to 1903, when amateur economist Nicholas Johannsen wrote Der Kreislauf des Geldes und Mechanismus des Sozial-Lebens (The Circuit Theory of Money), under the pseudonym J.J.O. Lahn ( Graziani 2003 ). In the interwar period, German and Austrian economists studied monetary circuits, under the term Kreislauf , with the term "circuit" being introduced by French economists following this usage. The main protagonists of the French approach to the monetary circuit is Alain Parguez. Today, the main defenders of the theory of the monetary circuit can be found in the work of Riccardo Realfonzo, Giuseppe Fontana and Riccardo Bellofiore in Italy; and in Canada, in the work of Marc Lavoie, Louis-Philippe Rochon and Mario Seccareccia.
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While the verbal description of circuitism has attracted interest, it has proven difficult to model mathematically. Initial efforts to model the monetary circuit proved problematic, with models exhibiting a number of unexpected and undesired properties – money disappearing immediately, for instance. These problem go by such names as:
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies.
In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.
Post-Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, with subsequent development influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor, Sidney Weintraub, Paul Davidson, Piero Sraffa and Jan Kregel. Historian Robert Skidelsky argues that the post-Keynesian school has remained closest to the spirit of Keynes' original work. It is a heterodox approach to economics.
The business cycle, also known as the economic cycle or trade cycle, is the downward and upward movement of gross domestic product (GDP) around its long-term growth trend. The length of a business cycle is the period of time containing a single boom and contraction in sequence. These fluctuations typically involve shifts over time between periods of relatively rapid economic growth and periods of relative stagnation or decline.
A financial transaction is an agreement, or communication, carried out between a buyer and a seller to exchange an asset for payment.
Johan Gustaf Knut Wicksell was a leading Swedish economist of the Stockholm school. His economic contributions would influence both the Keynesian and Austrian schools of economic thought. He was married to the noted feminist Anna Bugge.
Horizontalism is an approach to money creation theory pioneered by Basil Moore which states that private bank reserves are not managed by central banks. Instead reserves will be provided on demand at the bank rate set by the central bank. This inverts the mainstream textbook money multiplier relationship between deposits and loans since loans are said to cause deposits which in turn cause reserves.
The real economy concerns the flow of goods and services, compared with the monetary sector that covers the circulation of money and other documents that represent ownership or claims to ownership of real sector goods and services. Most economics textbooks will treat the monetary sector as a "shadow" of the real sector; apples traded for oranges, labor for commodities, with real sector value determined by an actor tastes and preferences and the cost of production. The monetary sector only plays the part of influencing the price level, so in this simplified example the role of the supply and demand is generally limited to the quantity theory of money). This is the neoclassical school of economics where the money supply is determined exogenously by a central bank.
Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly for the government and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. MMT is an evolution of chartalism and is sometimes referred to as neo-chartalism. Its macroeconomic policy prescriptions have been described as being a version of Abba Lerner's theory of functional finance.
Dynamic stochastic general equilibrium modeling is a method in macroeconomics that attempts to explain economic phenomena, such as economic growth and business cycles, and the effects of economic policy, through econometric models based on applied general equilibrium theory and microeconomic principles.
In macroeconomics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable.
Credit theories of money, also called debt theories of money, are monetary economic theories concerning the relationship between credit and money. Proponents of these theories, such as Alfred Mitchell-Innes, sometimes emphasize that money and credit/debt are the same thing, seen from different points of view. Proponents assert that the essential nature of money is credit (debt), at least in eras where money is not backed by a commodity such as gold. Two common strands of thought within these theories are the idea that money originated as a unit of account for debt, and the position that money creation involves the simultaneous creation of debt. Some proponents of credit theories of money argue that money is best understood as debt even in systems often understood as using commodity money. Others hold that money equates to credit only in a system based on fiat money, where they argue that all forms of money including cash can be considered as forms of credit money.
Pushing on a string is a figure of speech for influence that is more effective in moving things in one direction than another – you can pull, but not push.
A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords.
Augusto Graziani was an Italian economist, Professor in Political Economy at University la Sapienza, most known for his contribution to monetary economics in founding monetary circuit theory.
Basil John Moore was a Canadian post-Keynesian economist, best known for developing and promoting endogenous money theory, particularly the proposition that the money supply curve is horizontal, rather than upward sloping, a proposition known as horizontalism. He was the most vocal proponent of this theory, and is considered a central figure in post Keynesian economics
Endogenous money is an economy’s supply of money that is determined endogenously—that is, as a result of the interactions of other economic variables, rather than exogenously (autonomously) by an external authority such as a central bank.
Riccardo Realfonzo is a well-known post-Keynesian economist.
In macroeconomics, chartalism is a theory of money that argues that money originated with states' attempts to direct economic activity rather than as a spontaneous solution to the problems with barter or as a means with which to tokenize debt, and that fiat currency has value in exchange because of sovereign power to levy taxes on economic activity payable in the currency they issue.