What IS money? Wrong question

The mere existence of the word money does not mean it has to refer to something essential.  Money is emergent and economists’ use of the concept should probably be pragmatic.

I have recently noticed some of my favorite bloggers engaged in debate over what money really is and what role it plays in society, the economy and the study of each.

I don’t have much to offer on the technical elements of that debate, which doesn’t interest me very much.  But I would like to assert, yet again, that any enquiry into the true essence of money is probably a waste of time.

As I see it — now under the spell of the physicist Sean Carroll [1] — we have evolved various social customs and institutions from which the concept of money emerges.   Accordingly, the meaning of money is context-dependent and changes over time, along with the customs and institutional framework.

I am still too amateur in this area to make a strong claim about this, but I want here to relate the scientist’s concept of emergence with my own preference for philosophical pragmatism over idealism, and then apply that link to the debate over money.

Within physics, as I understand it, various emergent concepts or models have different spheres of applicability. For example, considering water, quantum mechanics applies at the scale of the hydrogen and oxygen nuclei, while fluid mechanics applies to everyday human experience, when the temperature is above freezing.

Fluid mechanics emerges from quantum mechanics, although there is no need for engineers to understand quantum mechanics, which was actually developed long after fluid mechanics.

What I want to assert, but not yet with much confidence, is that the sphere of applicability is subjective and determined by our level of knowledge and interests.  To paraphrase Carroll , if we knew the relevant particles’ locations and velocities with sufficient detail, and bizarrely cared to know physical reality at the ultimate level of detail, then there would be no need for emergent fluid mechanics. But those conditions do not apply, and so fluid mechanics does.

This seems to rhyme pretty closely with the philosophical pragmatist’s claim the answer to many seemingly metaphysical questions can be resolved by asking, why do we care?  For pragmatists,  the sphere of applicability would be a choice made by people, based on their level of knowledge and interests.

To see how this might work with money, consider the case of a “money”-financed fiscal expansion or helicopter drop, as it is sometimes called.  Much of the confusion around this issue results from economists obsessing over what money essentially is in this context, even though money is emergent and a coarse graining of deeper forces, such as social custom and the institutional set-up.

That confusion can easily be cleared up, I think, by forgetting about what money is and just tracing through the practical and (to us) important implications of the Fed and Treasury co-operating on an initiative that people might call a helicopter drop.

For example, if the Fed were to promise to pay for a fiscal expansion of, say, 5% of GDP with additional seniorage on the currency stock, then how much would the path of nominal demand have to be raised above baseline to allow the Fed to keep that promise? And would the inflationary consequences of that be acceptable?

I have worked through those implications and concluded that in the United States h money is implausible, because it requires committing to an intolerably high rate of inflation in order even to be relevant. (One way to tell that this calibration issue is serious is to observe the ridiculous gymnastics Adair Turner and Ben Bernanke have gone through to “resolve” it. If tempted to renege we can just tax the banks! True, that would be reneging.)

The best work I have seen on this issue was developed by Jordi Gali, who is long on simulation and estimation and short on essences.  Ironically to me, Gali comes out in favor of h money as a cure for lowflation.  But it is very telling that he must assume a derisively small fiscal expansion, just 0.5% of GDP, in order to get there.  And I don’t think the advocates of h money really think they are talking about a program worth 0.5% of GDP, cumulatively. (Original 2014 paper, to which I refer, here. And updated version, which I have not yet even skimmed, here.)

There is some chance that my extreme skepticism of h money is wrong, obviously.   But whether I am or not has nothing to do with the debate over the essence of money.  I would hope that the people who disagree with me on h money would concede at least that.

This idea of emergence and its link to superiority of philosophical pragmatism over idealism – at least within macro – is for me a BIG IDEA.  If I am remotely on the right track here, I would guess the implications extend far beyond just money.  I also suspect that I am awkwardly going over ground has already been well tilled by others better informed than I am.

But I will boldly venture this one concluding thought just the same. Enquiring into the true essence of money is often said to be taking the “philosophical” approach. But it would be more accurate to say that it is taking a philosophical approach, that of Platonic idealism.  Pragmatism is also a philosophical pose, and one that seems to be much more fruitful, at least in macroeconomics which is not just a form of math.

I find it striking that those who dwell in essences often fancy themselves as uniquely philosophical and are judged as such by others too.  But the trick is not to be philosophical, which is unavoidable in any case.  The trick is to pick the right philosophy, the one that helps. In my view that would be pragmatism, as the debates around money seem to demonstrate.

An Example of Money Emerging

In the United States, the Fed has promised to contain the erosion of the estimated utility value of Federal Reserve notes to about 2% a year.

And it has done a pretty good job at delivering on this promise in recent decades. Between 1994 (roughly when the promise was implicitly made) and 2007, the average headline PCE inflation rate was about 2%.  Since the Crisis, there has been about 60bps of slippage relative to target on average, and this has raised some debate about whether the Fed can even hit its objective when in the neighborhood of liquidity trap.  But within the public, the idea that inflation will remain around 2% is long established and so far seems durable.

Because the utility value of Federal Reserve notes is believed stable, it is convenient to denominate credit instruments in these notes.  And the more liquid of these instruments (along with the notes themselves) have — to varying degrees — characteristics that we associate with “money”.

But in this set-up, money emerges from several more fundamental or — less coarse — forces, such as the social convention of notes, the existence of a Federal Reserve with the right to issue them, and that institution’s promise to maintain a roughly stable utility value of those notes.  These more fundamental forces can be identified and analyzed directly, and with much less controversy than necessarily attends enquiries into the true essence of money.

To return to my example of a helicopter drop, the primary force at work is the Fed changing its promise,in order to finance a fiscal expansion. In that story, the promise is fundamental and the path of the money stock incidental. (Certainly, the initial effect on the money stock is totally irrelevant.) To say that money-obsessed analysts do not get this would be quite an understatement.

Moreover, we can easily imagine different institutional set-ups in which money would emerge in a different way. For example, during the intra-war Gold Exchange Standard regime, the Fed promised to maintain the gold value of Federal Reserve notes. During that period, “money” has quite different characteristics, some of which were found to be quite wanting.  Many of the inflationistas who so badly misled us during the largely-harmless QE experiment were obviously – even in real time – using a Gold Standard conception of money.  That is a separate discussion, I guess.  But the point is that money obviously emerges from deeper forces and has no essence.  Enquiries into that essence, then, would seem to be largely a waste of time.

[1] A few months ago, I read a popular book on physics by Sean Carroll called The Big Picture.  It helped crystalize some thoughts I had had on philosophical pragmatism and has had a big impact on my own thinking. The risk here, though, is that I have recently obtained just enough knowledge of physics to be dangerous. 😉  So I am more inclined to press my preference for pragmatism, about which I am confident, than to insist on the connection to physics.  Get Carroll’s book and read it. Then, stop obsessing so much about essences.