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.
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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- Fall '14
- Monetary Policy, Monetary economics