Base money basics
Paul Krugman and Steve Randy Waldman both have a gift for writing. But when they write about base money their prose becomes fuzzy and vague, at least to me. Just like the writing of many market monetarists, by the way. I’ve tried to figure out where and why I lose track of all this writing. It turns out to be the concept of ‘base money’, as it’s used by these writers (or by me). The point is: there are in fact different kinds of base money and Krugman and Waldman do not really seem to differentiate between the different kinds. What’s the matter? Different organisations produce different kinds of money in our society. A (non-exhaustive) list:
I. The government not only creates money but also produces the ultimate design: coins, made of copper, platinum, whatever, with names like Dollars, Yen or Guilder which serve, very important, as the template for the unit of account.
II. The central bank produces banknotes which the government accepts, by fiat, as payment by banks for coins at a 1:1 ratio (and as a means to pay tax debts).
III. The central banks produces bank reserves which can be used by banks to buy coins or bank notes from the government or the central bank (1:1, of course)
IV. Banks produce new deposit money but need to accept a new private debt to be allowed to do this. In a way, the private sector buys this (temporary) money by issuing (temporary) debt. This deposit money can be used to buy coins and notes from the banks at a 1:1 ratio and can be used to pay tax debts.
I+II+III = (base money), according to Wikipedia. The defining characteristic is that the government (including the central bank) produces it. This is, however, not exactly the same stuff as the money we use to buy bread and butter. IV is not included, for instance. And loads of base money are not owned by the private sector but by banks and do therewith not function as a means of exchange in the non-financial economy. The table shows the connections between base money and M-3 ‘exchange’ money, albeit in a somewhat stylized way (no explicit international sector, for instance). According to Austrian economists, deposit money owned by the government should be considered ‘exchange money’ too (good point) but this does not make too much of a statistical difference.
I’m continuously getting the impression that many and especially American economists do not make enough of a distinction between different kinds of (base) monies and especially between the stuff left and right of the red line. Left of the red line, everything is pretty interchangeable. Right of the red line, the same holds more or less (surely in the somewhat longer run). Not every kind of money can however cross the red line without a helicopter. An increase in for instance A5 does not automatically translate into higher posts right of the red line (‘financial capital’ is a phrase borrowed from the Bundesbank who used to use the German equivalent to define less liquid kinds of deposit money, i.e. some kinds of longer term savings). As I see it, Krugman and Waldman are only talking about E1:E3. And indeed, as Waldman states H1 might at the moment be pretty 1:1 interchangeable with E1 and E2 and E3. But as long as you can’t buy bread and butter with it and as long as the private sector has to increase its net borrowing to increase M-3, E1:E3 as well as H1 is not really the same thing as M-3 monies. But maybe I’m the one who’s confused.
Update: in the comments Bruce reminds me that in the USA it’s not the central bank but the treasury who prints bank notes (see the table). Which leads to a little less confusion.
Table 1. Different kinds of money shown by originating (blue) and owning (white) sector