7. Nominal and real value: The legacies of Smith and Keynes

By: Andrea Terzi

The nominal character of monetary value

In a monetary economy, contracts are denominated in units of money value and so are prices, these latter being nothing else than offers of contracts for sale or purchase. The number of monetary units defined in the contract becomes the measure of value of the item being traded, irrespective of the subjective value that the buyer, the seller or a third party may be willing to attach to said item, before or after the trade. Contractual money value reflects the monetary liability of the buyer and the claim of the seller. It does not measure the quantity or the attributes of the item traded. Thus, monetary value is called nominal, as opposed to real.

Conversely, a real liability, or a real claim, is the contractual commitment to deliver or the right to obtain, at some future date, a specific good or a service: If I own a nominal $50 claim I expect to receive money for that amount, regardless of what products such money amount can buy. Instead, if I own a real claim, I expect to receive a specific item at a future date, irrespective of how its price may change until or after then.

The legacy of Adam Smith

The fundamental difference between nominal and real value was powerfully discussed by Adam Smith. In his 1776 book The Wealth of Nations, Smith argued that the wealth of a nation is measured not by its possession of money but by its capacity to produce the “necessaries and conveniences of life,” and it thus consists of the material and human resources available at a given time.

Anticipating the twentieth century’s technique for measuring national output, Smith defined the real revenue of a nation as its annual product. Money is the wheel of commerce, the means by which the whole revenue of society is distributed among all its different members, and it makes itself no part of that revenue.

The legacy of John Maynard Keynes

Smith had argued that “It is not for its own sake that men desire money, but for the sake of what they can purchase with it.” And yet, he acknowledged that nominal value “finally determines the prudence or imprudence of all purchases and sales, and thereby regulates almost the whole business of common life in which price is concerned.”

Keynes went further, outlining two reasons why monetary flows, not only real flows, matter in a monetary economy: a) the success or failure of production decisions depends on monetary flows; and b) consumers and producers develop a willingness to store part of their wealth in a monetary form.

The business activity of giving and receiving items of value is ultimately concerned with the net cash flows that this activity generates, not with the real worth of the items. Thus, both real and financial assets have value insofar as they can be expected to generate future cash flows. By the same token, because they are aware that future cash flows cannot be anticipated with adequate precision, private agents seek protection from uncertainty by storing part of their wealth in nominal figures, i.e., in the form of units of means of payment or financial assets. This is intended as a safety measure to secure today an uncommitted power to pay future bills while keeping one’s options open.

For Keynes, actual and expected monetary flows thus shape economic outcomes and can place a more stringent constraint on output than the overall capacity to produce given by existing capital goods, knowledge and labor force.

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