8. What monetary economics is about

By: Andrea Terzi

Money in a monetary economy

A monetary economy is an economy in which items that people consider valuable are transferred through contractual arrangements, and thus real claims and real liabilities have monetary counterparts that can be ultimately settled only by delivery of a monetary claim on the sovereign state. This substantially differs from an economy where people give and receive real values either with no direct, well-defined counterpart or with a collective system of real settlement.

In a monetary economy, “money” designates two aspects of contractual payments: First, it is the unit of account by which one side of contractual debt is denominated. Second, it is the generally accepted means that settles that debt, i.e., the object that by virtue of transfer will discharge debt. This means that if I buy a cup of coffee that costs one unit of a dollar, this is the unit of account of my debt, and I can pay my debt only by delivering one unit of a dollar, this being the means of settling my debt.

When giving and receiving are driven by hierarchical or gift-with-reciprocity relations, there is no need to make use of a means of settlement, except in organized non-monetary economies where this is but a document representative of a real claim. In contrast, the means of settlement in a monetary economy is a nonredeemable credit, carrying nominal value, monopolistically issued by a politically sovereign state that claims the right to declare it to be the ultimate means of payment of residents’ liabilities, notably taxes, towards that state.

Limits of the general equilibrium paradigm

The above definition of the subject matter of monetary economics contrasts with the definition of the subject matter of economics as embraced in the general equilibrium track. In the latter, free individuals engage in good-faith trade activities, for present and inter-temporal exchange, in a natural condition where resources are considered fixed and wants are considered unlimited. Agents are willing to trade something real (i.e., their time and efforts) for something else real (i.e., a consumption good), where money is a convenient medium of exchange that serves to lower the costs of organizing and managing a barter system.

In an account that is equivalent, for all practical purposes, to an organized barter economy, it is further assumed that in any given time period anyone’s desire for any given thing marginally diminishes with increasing possession, while the cost of producing any given thing marginally rises with increasing production. It can be concluded that output of any given thing will be set at a quantity rate so that its marginal desirability (or utility) equals its marginal cost. In this sense, Marshall said that output is determined by “supply and demand” in the same way that a piece of paper is cut by both blades of a single scissor.

A logical consequence of assuming free (barter-like) exchange activities in a natural condition of unlimited wants and fixed resources is that all resources should always be “fully utilized” (i.e., used as desired) given the assumed spontaneous tendency not to leave idle any resource that could still satisfy someone’s wants. This optimal result can be prevented only if someone (an individual or a group) has the power to prevent such outcome, either out of individual interest or out of ignorance.

Accordingly, the general equilibrium paradigm describes economics as the study of the efficient allocation of scarce resources among alternative uses. In this logic, policy efforts should thus aim at eliminating restrictions and preventing imperfections that produce sub-optimal economic efficiency. Although it disregards the contractual and monetary nature of giving and receiving, this paradigm remains a deeply rooted belief in a significant portion of modern economics, only partly shattered when economic events develop adversely in contemporary monetary economies.

Next module: A paradigm for understanding monetary economies
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