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Drawing the line

Where in practice does one draw the line between money and other assets? Here, even though I prefer to reserve the term “money” for the monetary base, I will bend to popular usage and use "money” to refer to “money in the broad sense,” which consists mainly of credit.

The economists most concerned with where to draw the line have been, naturally, the monetarists. They were interested both in what assets people use most commonly in payment and what definition of money has changes that correspond well statistically with changes in prices and output. The monetarists settled on M2 as the most appropriate definition in the United States and most other countries. In the United States, M2 comprises

  • M1, consisting of currency held by the public + traveler’s checks of nonbank institutions + demand deposits + other checkable deposits, such as NOW accounts, and
  • these additional components: savings deposits, time deposits less than $100,000, and balances in retail money market funds.

The monetarists’ confidence in M2 was such that the Federal Reserve Bank of St. Louis, a monetarist stronghold that tracked many definitions of money, stopped calculating M3 in 2006, although it has recently restarted calculating a version of it, as I will explain below.

The Austrians did not think about the question as a practical matter until the monetarists had already worked on it for some years. One reason was that at the time, the number of active Austrians could be counted on the fingers of one hand. Murray Rothbard made an attempt in America’s Great Depression, published in 1963, the same year as Milton Friedman and Anna Schwartz’s Monetary History of the United States, 1867-1960.  (See pages 87-91 of the hyperlinked edition. Rothbard signaled his hostility to the monetarists by citing them little.)

Although some other Austrians have followed Rothbard’s lead, overall the Austrians have shied away from strongly advocating any particular measure of the money supply, even with the caveats Rothbard had in applying it.

Another strand of Austrian thought offers a different approach. Rather than establishing a sharp dividing line between money and other assets, it  recognizes a spectrum of “moneyness.” W.H. Hutt was to my knowledge the first Austrian, or Austrian fellow traveler, to tease out the implications of the idea in his 1956 essay “The Yield from Money Held.” Hutt cited as his partial inspiration an obscure Dutchman, Tjardus Greidanus, whose book The Value of Money (1932, 1950), remains a neglected gem. Hutt in turn influenced George Selgin, through whom I and others got led back to Greidanus.

It has been quite a while since I read the second edition of Greidanus’s book, and I do not have it handy, but judging from the first edition, Greidanus was unaware of the work of a contemporary, the French economist François Divisia, who devised a basis for measuring the money supply that corresponded to Greidanus’s ideas. Divisia likewise seems to have been unaware of Greidanus.

Divisia monetary aggregates do not just add up components of the money supply; they give different components different weights based on their degree of “moneyness.” (My phrasing here is quite imprecise, but good enough for a blog post.) The leader in measuring Divisia aggregates is William Barnett, formerly of the Federal Reserve Bank of St. Louis and the Federal Reserve Board of Governors, now at the University of Oklahoma. Barnett is the author of a recent book on Divisia aggregates and a monthly calculation of them for the United States.

After Barnett began publishing his calculations, the Federal Reserve Bank of St. Louis revived its calculations of Divisia M3, although not of plain M3.

Long-time monetarists continue to consider plain M2 the most useful monetary aggregate for practical purposes of assessing monetary policy. The Austrians, though, would do well to look at the Divisia aggregates, which are more consistent with characteristics of goods that Austrians are wont to stress in other contexts. Many types of financial assets are substitutable for one another, but usually they are not perfectly substitutable, and the degree of substitutability may vary over time, for instance becoming less during recessions, when appetite for risk is lower.