money-lecture_notes-Lec 02--The Natural Hierarchy of Money

From the point of view i have been developing both

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Unformatted text preview: importance of scarcity and the importance of elasticity. From the point of view I have been developing, both have part of the truth but neither has it all. Thus, liquidity is at the same time both naturally scarce and naturally elastic. How can this be so? The Scarcity of (ultimate) Money The Elasticity of (derivative) Credit ↔ ↔ Currency Principle Banking Principle The natural scarcity comes from the fact that agents at any particular level in the hierarchy cannot by their own actions increase the quantity of the forms of money at a higher level than themselves. Just so, governments cannot increase the quantity of gold, and banks cannot increase the quantity of government currency. The availability of money thus serves as a constraint that holds the system back in its attempts to expand. The natural elasticity comes from the fact that agents at any particular level in the hierarchy can, by their own actions, increase the quantity of forms of credit at their own level, and possibly also below them. If you and I want to make a trade and you are willing to accept an IOU from me, then we can trade and what makes the trade possible is an expansion of credit. The elasticity of credit thus serves as an element of freedom that facilitates breaking loose from any constraint that may be standing in the way of expansion. Mehrling 9/14/2009 6 This natural elasticity applies to banks as well. By trading among themselves, banks can and do break loose of the constraint of central bank reserves. The important point is that the system involves at all times a balance between discipline and elasticity, with sometimes one and sometimes the other serving as the more dominant feature. IV. I have used the word “natural” in my title, and now I want to explain why. I use it to emphasize that the hierarchical character of the system, and its dynamic character over time, are deep features of the system. The institutional organization of the monetary system is hierarchical because of this underlying feature, not vice versa. That is to say...
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