Monetary circuit theory

Last updated

Monetary circuit theory is a heterodox theory of monetary economics, particularly money creation, often associated with the post-Keynesian school. [1] 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.


Contrast with mainstream theory

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).

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. [2]

Circuitist model

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.


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.

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.

Monetary creation

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. [3]

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.

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.

In 2014, economist Richard Werner conducted an empirical study to determine if, in the process of issuing a loan, banks create new money or transfer money from another account. The study involved taking out a loan with a cooperating bank and monitoring their internal records to determine if the bank transfers the funds from other accounts within or outside the bank, or whether they are newly created. The study determined that the bank did not transfer funds between any accounts when the loan was issued. [4]


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 ). [5]

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.

Modeling difficulties

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:

A comprehensive model of the total monetary circuit, which is free from the above difficulties, was presented recently by Pokrovskii et al. [6] [7]

See also

Further reading

Related Research Articles

<span class="mw-page-title-main">Macroeconomics</span> Study of an economy as a whole

Macroeconomics is a branch of economics which deals with the performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and government spending to regulate an economy's growth and stability. This includes regional, national, and global economies. According to a 2018 assessment by economists Emi Nakamura and Jón Steinsson, economic "evidence regarding the consequences of different macroeconomic policies is still highly imperfect and open to serious criticism."

<span class="mw-page-title-main">Inflation</span> Devaluation of currency over a period of time

In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. The opposite of inflation is deflation, a 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. As prices faced by households do not all increase at the same rate, the consumer price index (CPI) is often used for this purpose. The employment cost index is also used for wages in the United States.

<span class="mw-page-title-main">Post-Keynesian economics</span> School of economic thought

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.

<span class="mw-page-title-main">Business cycle</span> Intervals of expansion and recession in economic activity

Business cycles are intervals of expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are measured by examining trends in a broad economic indicator such as Real Gross Domestic Production.

<span class="mw-page-title-main">Knut Wicksell</span> Swedish economist (1851–1926)

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.

<span class="mw-page-title-main">Money creation</span> Process by which the money supply of an economic region is increased

Money creation, or money issuance, is the process by which the money supply of a country, or of an economic or monetary region, is increased. In most modern economies, money creation is controlled by the central banks. Money issued by central banks is termed base money. Central banks can increase the quantity of base money directly, by engaging in open market operations. However, the majority of the money supply is created by the commercial banking system in the form of bank deposits. Bank loans issued by commercial banks that practice fractional reserve banking expands the quantity of broad money to more than the original amount of base money issued by the central bank.

The real economy concerns the production, purchase and flow of goods and services within an economy. It is contrasted with the financial economy, which concerns the aspects of the economy that deal purely in transactions of money and other financial assets, which represent ownership or claims to ownership of real sector goods and services.

<span class="mw-page-title-main">Modern Monetary Theory</span> Macroeconomic theory

Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly 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 opposed to the mainstream understanding of macroeconomic theory and has been criticized heavily by many mainstream economists.

<span class="mw-page-title-main">Hyman Minsky</span> American economist

Hyman Philip Minsky was an American economist, a professor of economics at Washington University in St. Louis, and a distinguished scholar at the Levy Economics Institute of Bard College. His research attempted to provide an understanding and explanation of the characteristics of financial crises, which he attributed to swings in a potentially fragile financial system. Minsky is sometimes described as a post-Keynesian economist because, in the Keynesian tradition, he supported some government intervention in financial markets, opposed some of the financial deregulation of the 1980s, stressed the importance of the Federal Reserve as a lender of last resort and argued against the over-accumulation of private debt in the financial markets.

Monetary inflation is a sustained increase in the money supply of a country. Depending on many factors, especially public expectations, the fundamental state and development of the economy, and the transmission mechanism, it is likely to result in price inflation, which is usually just called "inflation", which is a rise in the general level of prices of goods and services.

<span class="mw-page-title-main">Multiplier (economics)</span>

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.

<span class="mw-page-title-main">Credit theory of money</span> Economic theory

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.

<span class="mw-page-title-main">History of macroeconomic thought</span> Aspect of history

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

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

<span class="mw-page-title-main">Endogenous money</span>

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.

<span class="mw-page-title-main">Chartalism</span> Heterodox theory of money

In macroeconomics, chartalism is a heterodox theory of money that argues that money originated historically 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.

The monetary/fiscal policy debate, otherwise known as the Ando–Modigliani/Friedman–Meiselman debate, was the exchange of viewpoints about the comparative efficiency of monetary policies and fiscal policies that originated with a work co-authored by Milton Friedman and David I. Meiselman and first published in 1963, as part of studies submitted to the Commission on Money and Credit.


  1. Zazzaro, Alberto (April 2002), "How Heterodox is the Heterodoxy of the Monetary Circuit Theory? The Nature of Money and the Microeconomy of the Circuit", Working Papers
  2. "The Myth of the Money Multiplier". Money: What it is, how it works. Archived from the original on 2012-02-14. Retrieved 2012-01-21.
  3. Realfonzo, Riccardo, Money and Banking. Theory and Debate, p. Money and Banking. Theory and Debate, Edward Elgar, Cheltenham (UK) and Northampton (USA), 1998
  4. Werner, Richard A. (2014-12-01). "Can banks individually create money out of nothing? — The theories and the empirical evidence". International Review of Financial Analysis. 36: 1–19. doi: 10.1016/j.irfa.2014.07.015 . ISSN   1057-5219.
  5. Aréna, Richard; Graziani, Augusto; Salvadori, Neri, Money, credit, and the role of the state, p.  p. 137
  6. Pokrovskii, V. N.; Schinckus, Ch. (2016). "An elementary model of money circulation". Physica A: Statistical Mechanics and Its Applications. 463: 111–122. doi:10.1016/j.physa.2016.07.006.
  7. Schinckus, Ch.; Altuckov, Yu. A.; Pokrovskii, V. N. (2017). "Empirical justification of the elementary model of money circulation". Physica A: Statistical Mechanics and Its Applications. 493: 228–238. doi:10.1016/j.physa.2017.10.054.