A Brief Introduction to Money

At this stage in the course we need to tackle a few big items in macroeconomics: monetary policy, fiscal policy and the nature of money itself. I briefly introduced fiscal policy - mostly just defining it - just prior to our second exam. However, to really do it justice we need to introduce money in a more systematic way.

Most principles courses will deal with these issues separately, but as we shall see going forward, these items are interrelated. So much so, that it is difficult to talk about each without defining the others. And both fiscal and monetary policy will depend upon our understanding of money; i.e. What is it? How can we understand it? How has it changed over time? We need to know at the outset what type of monetary arrangement we have, so that we can start to consider its relationship with the state and the rest of the economy.

Below is probably the best introduction to the US monetary system by one of the leading scholars in the field. He also happens to be a member of the faculty here at UMKC.

Note: You'll most likely come across some ideas in this video that challenges your current understanding of money. Keep an open mind and be sure to write down any question you have, so we can take them up in class.




Caveat: The concepts covered in this video are not presented in the text. I am not aware of a textbook in existence that does cover this. Use the text as a guide, but just be aware that these are divergent views.

Two Views of Money and Implications for Monetary Policy

Last time we introduced money. I presented two views of money:
Here is a brief review

1. An exogenous story
2. An endogenous story

The first story is consistent with the neoclassical doctrine that money is neutral. The second is inconsistent with that. Why is the second inconsistent with the neutrality of money principle? Because money is that which allows us to settle our obligations as they come due. In the first story, there is no theory of debt. In the second, debt enters into the theory very explicitly.

Income - Expenditure Model: Keynesian Cross

Keynesian Cross: Analyzing planned expenditures versus actual output using the Keynesian Cross

The Consumption Function

Consumption Function Basics: The basic idea of a consumption function

The (neo) Classical Model

The Classical Model

Today we build up our first macro model – the classical model. Prior to Keynes’ publication of the General Theory of Employment, Interest, and Money (1936), there was not a conception of “macroeconomics.” There was just this idea of economics.

Why the difference? 

Well, when we develop the Keynesian model, we’ll see that we need a theory of output and employment determination that is distinct from the theories that describe individual and firm level decisions. This is because as I suggested earlier in the course, there is this phenomena in economics we call the “paradox of thrift,”  which shows how seemingly rational decisions to save for the future can lead to the inability of society as a whole to do so. This is closely related to Say’s Law and its failure, which leads to unemployment, declining incomes, and ultimately diminishes our ability to save.

In order to understand Keynes’ critique of Say’s Law we need to first lay out the classical model which relies upon Say’s Law.

Investment and Consumption

Components of GDP