Confusion in economics often resides in methodology – an area where economists are weak, as Simon Wren-Lewis points out. When we engage in economic analysis it is often unclear whether we are referring to specific objects in the economy or a set of abstract properties, which may or may not have a single, measurable counterpart in our statistics. To give a mundane analogy, we can count the number of chairs in the economy, or we can refer to all objects which are used for sitting – which will encompass a far wider set of objects, including, occasionally, the steps of cathedrals.
I label definitions of a set of abstract properties as a ‘type 1’ definition and distinct sets of measured objects in economic statistics ‘type 2’.
I want to use the example of the analysis of money to illustrate how these two forms of definition are frequently conflated, and the source of much confusion.
A monetary theorist is likely to say that abstract theory is not describing distinct, necessarily measurable things in the economy, but identifying a set of abstract properties which warrant the definition ‘money’ – so theory is all about type 1 definitions. And the challenge for empirical work is to identify the closest real world approximation. But a review of most theoretical work in this area, reveals that this distinction is rarely recognised. Christopher Sims in his otherwise excellent theoretical article, “Paper Money”, nowhere makes clear what the abstract properties of money are, which allows him to effortlessly conflate money and government debt. I would go as far as to contend that the entire Fiscal Theory of the Price Level is based on a methodological confusion (for example, if money is simply a liability of the state, it fits neatly into a fiscal solvency equation and the thorny issue of fluctuations in the demand for money can be ignored).
Consider the distinct measurable things (type 2) which exist in the economy and are periodically designated ‘money’: bank reserves, physical cash, bank deposits, money market funds, various short-dated government bonds, and in common parlance – for example, ‘she has lot’s of money’ – all forms of wealth. There are also lots of ‘informal’ monies, cigarettes in prisons and Pokemon cards on playgrounds.
My own preference is to restrict the type 2 label ‘money’ solely to the monetary base. This is largely for clarity and to avoid confusion. Also, base money has unique properties. Usually, when we designate a thing with a descriptive name we are identifying its defining property, the defining property of the monetary base is to pay for things or to settle the differences in bank balances – that is not its sole property, but without this property it would be called something else. This is not true for many other things periodically labelled ‘money’ – for example, deposits. Firstly, there are deposits which – contingently – can be used for payment, and there are deposits which are not used for payments, such as time deposits. I would appeal to linguistic efficiency: the clarity of the label ‘deposit’ is not enhanced by calling it ‘money’.
This is an attempt to designate actual things in the economy – analogous to counting chairs, and distinguishing between steps, chairs, and benches. But theory should attempt to focus on the properties of potentially many things which might be called ‘money’. We can provide a narrow type 1 definition of ‘money’ as a ‘means of payment’. However, this is in fact quite vague, because often a number of things are involved in a single act of payment. For example, Felix Martin, in his entertaining unauthorised biography of the word, designates all parts of the payment and clearing system ‘money’.
For type 1 accuracy, we can distinguish between objects that facilitate payment and quantities of a thing – money – which is actually debited and credited in the act of payment. For example, the quantity of credit cards is clearly distinct to the amount of credit available on credit cards – the latter which may legitimately have the properties of the theoretical quantity ‘money’.
It is also important to recognise a unique form of type 1 ‘money’, which I think illustrates the uniqueness of its real world counterpart, the monetary base – that is, money with no settlement risk. That is one of the unique characteristics of paying with physical cash – payment occurs without clearing or settlement risk.
The ambiguities and conflation of the distinct meanings I am identifying here, also explain both why the word ‘liquidity’ exists, and why it is often used to refer to very different things. The standard meaning, as applied typically to financial assets, is the ease with which an asset can be sold – or converted to cash. S&P500 futures are, in this sense, highly liquid. Physical mines, less so – as the mining sector is discovering. But the term ‘liquidity’ is also used to designate some broad, immeasurable quantity of ‘money’ in financial markets. This is what is meant by the phrase, ‘vast amounts of global liquidity are driving up asset prices’.
A lot of confusion in economics is centred around the interface of ‘type 1’ and ‘type 2’ definitions, without being explicit that this is the bone of contention. Typically, most measured (type 2) economic quantities have multiple properties and consequently satisfy multiple ‘type 1’ definitions. Bank deposits, again, are a case in point. The total stock of deposits in the economy should be reasonably easy to identify as an empirical quantity, but as an abstract set of properties, deposits overlap with many other distinct measurable quantities. Typically, deposits are liabilities of banks – in the specific sense that they can be redeemed – they have fixed nominal values, pay an interest rate, can have varied terms, have credit risk, can sometimes be used as a means of payment.
Many other things have some of these properties – for example, corporate bonds, money market funds, physical cash, and government bonds.
This may be a reason why empirical economics is destined to imperfection. There is no straightforward map from our theoretical concepts to the things we can measure. To make matters worse, the properties of empirical quantities can change – one day a deposit is ‘money’, the next day its the liability of a leveraged financial entity.
 Suggesting that it is not just banks, but also Amex, Visa and MasterCard which can create ‘money’ at the stroke of a pen – for example by increasing credit limits. So too, arguably, can a futures exchange when it reduces margin requirements or changes eligible collateral. It might even be argued that there is no ‘means of exchange’ involved in most of payments system – because debits and credits are simply netted off, and payment using a means of exchange only occurs to settle balances between banks.
 The Italian economist Augusto Graziani, I believe, defines ‘money’ as a final means of settlement (h/t Steve Keen).
 Deposits stop being a means of payment in a banking panic, or if the term of the deposit is changed.