Sitting on cathedral steps

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’.[1]

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.[2]

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.[3]

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.

[1] 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.

[2] The Italian economist Augusto Graziani, I believe, defines ‘money’ as a final means of settlement (h/t Steve Keen).

[3] Deposits stop being a means of payment in a banking panic, or if the term of the deposit is changed.

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

5 Responses

  1. Egmont Kakarot-Handtke

    Confused confusers
    Comment on Eric Lonergan on ‘Sitting on cathedral steps’

    You write “Confusion in economics often resides in methodology – an area where economists are weak, …”

    Confusion in economics is due to the scientific incompetence of economists and nothing else.

    (i) The first thing one has to realize is that economics is a failed science, see blog post ‘How the intelligent non-economist can refute every economist hands down’

    (ii) As you correctly state, economic methodology is a deplorable mess, see blog post ‘Towards the true economic theory’

    and ‘How economists became the scientific laughing stock’

    (iii) With regard to monetary theory you are part of the crowd of confused confusers (2013), see blog post ‘Money and debt in six elementary steps’

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like
    an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series,
    2207598: 1–16. URL

  2. Eric Lonergan

    Egmont, your comments are punchy. I will reply in a similar tone. I have just read your ‘Money and debt in six elementary steps’. You omitted cathedral steps … repeating precisely the error I am describing. You do not even argue that money is a debt, you simply assert it: ‘The firm issues IOUs and these are used in turn by the households to buy the output. […] Clearly, IOUs are debt and they are used exclusively for the elementary transactions between the business and the household sector.’ Clearly not. This is a straightforward analytical error: as soon as an IOU starts being used as money it becomes something more than an IOU – in the same way as when you sit on a cathedral step, it becomes a chair.

    I look forward to reading your other articles …

  3. Oliver

    Interesting post!

    Some thoughts:

    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.

    Or we can ask what it means to sit. After all, to be able to refer to all possible objects that can be used for sitting, it is critical to first define what the act of sitting emcompasses. Or, to loosely quote blogger Nick Edmonds, it might be more sensible to ask what money does rather than to quarrel about which asset class counts as money and which doesn’t. Sitting, not seats should be the object of monetary theory, imo.

    And I’d also disagree with you that there is no clearance risk involved with central bank money. That is only true for a closed economy. Also, as far as individuals are concerned, bank deposits are as good as cash. A debit / credit from my account is a final payment from my perspective. Interbank clearance is just a black box. I couldn’t care less whether there is a one, two or seven tier banking system attached to my account.

    Which isn’t to say that there is no merit to studying the hierarchies of financial systems. But I’d say such musings, Perry Mehrling, Minsky or Randy Wray come to mind, are orthogonal to the question of what separates monetary assets / liabilities from non-monetary assets / liabilities, say deposits or cash from government debt.

    Similarly to Egmont above (although he is quite likely the rudest person in the economosphere who seems to waste most of his energy fighting straw men) I find the monetary theory of production, especially in its guise as French Circuit theory, promising in this respect because it tracks the objects that money refers to in its theory, as opposed to treating money itself as an object. One conclusion being for example that not only can different types of assets (say physical cash, deposits, other types of credit – all abstracted into a ‘bank’) serve the same purpose but also that one type of asset may refer to different types of objects in the real world, making it conform more or less to the normative reference point of the ideal money circuit. It also allows one to distinguish clearly between money and investment, irrespective of the asset class involved etc..

    Best not to cram a whole body of work into two sentences though. So I’ll allow myself to post a link to an introductory paper. One that also addresses Egmonts favourite point on monetary losses / profits btw.. But apparently he’d rather call a mangled version of it his own than acknowledge his pedigree…

    • Eric Lonergan

      Thanks for the comment Oliver. I am not sure we are in disagreement on your first point. The essence of my blog is that there is a distinction between measureable, indentifiable things in the economy – i.e. deposits – and theoretical economic quantities which are usually identifying properties of things. It is important to be clear about this because conflation of this distinction leads to a lot of confusion, as exemplified by Egmont’s note on money, and your comment on deposits. You say it is critical to define the act of sitting – of course it is. In order to identify ‘money’, you have to define its properties. Likewise ‘debt’, or any other economic concept. That is part of what I am arguing. However, once the properties of an economic thing have been identified one has to recognise that there may not be straightforward counterparts in the real world. Some things have multiple properties. This is relevant to your comment on deposits – ‘as far as individuals are concerned bank deposits are as good as cash’ – this is not true during a bank run. Part of the reason deposits are not always money is precisely that their properties are not constant, and they can in certain circumstances lose the properties necessary to be money.

      As regards what the properties of money are, or ‘the act of sitting’ I have defined it in the piece, and also in ‘Money is not a cigarette’ which may be of interest.
      Also, note that I referred to the absence of settlement risk (not ‘clearance’) with base money and gave the example of no settlement risk with cash – I think this is uncontentious. Also I cannot see how there can be settlement risk in payments between reserve accounts held by banks at the CB. (In all cases, I am ignoring fraud and error).

      • Oliver

        Thanks for your reply.

        I meant settlement risk, not clearing, silly me.

        But I still maintain that cash only has 0 settlement risk within a closed economy. A currency crisis is analoguous to a run on banks but on a different hierarchical level. And since the end of the gold standard, and as opposed to currency areas with central banks (which means all nowadays), there is no international system by which debts between nations are netted and settled finally. Debts can just pile up on both sides. In fact, the situation between currency areas is similar to the situation within countries before central banks came about. In extention, your claim that only central bank money deserves to be called money would mean, that there was no money before central banks came about. That seems an odd thing to say. If anything, the term should be omitted alltogether. Let deposits be deposits, cash be cash, reserves reserves (or settlement balances), debt be debt etc.. Each are distinct and serve a different purpose.

        And the reason the circuit theories refer to deposits as ‘actual money’ is because it is the fact that they are (sometimes) created to finance production (as opposed to doing other things such as guaranteeing smooth payments or ensuring that deposits from bank a trade at par with deposits from banks b) that puts them at the beginning and end of the ‘production’ cycle and thus in the centre of a ‘production’ view of the economy. That is, of course, a matter of focus.

Leave a Reply

Your email address will not be published.

* Checkbox GDPR is required


I agree