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Introduction to economics MEB435/MEBn5035
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Money and finance
Vladan Hodulák
This powerpoint serves as a study material for the students of the course Introduction to economics
(MEB435/MEBn5035) at FSS MU in Fall 2019. Using this presentation for other purposes without
consent of the author is prohibited.

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Introduction to economics MEB435/MEBn5035

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Introduction to economics MEB435/MEBn5035

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Money and society
̶What is money?
̶How is money produced?
̶How does it get/lose value?
̶What is the relationship between money and states?
Introduction to economics MEB435/MEBn5035

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The standard economic story (metallist)
̶Carl Menger (1892)
̶Problems of rational actors engaged in economic exchange
̶Double coincidence of wants
̶Type of an evolutionary explanation – increasing effectiveness of economic exchanges
̶Precious metals (gold, silver) were selected due to their properties, particularly their high
exchangeability
̶Paper and later electronic money were introduced as a transaction cost saving device, originally
they were to represent the „real money“ deposited in vaults
̶With this theory, money is first and foremost a means of exchange, its other functions (unit of
account, store of value) are secondary
̶Money is neutral (at least in the long run) and exogenous (to the economic system)
̶Inflation × deflation (a sustained increase/fall in the general price level)
̶Barter -> money -> credit
̶
Introduction to economics MEB435/MEBn5035

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Problems with the standard approach
̶Questionable role of the state
̶It is considered unnecessary for monetary system to operate
̶States have a tendency to destabilize their monetary systems
̶But in some cases it’s recognized that states have some important role to play (prevents
counterfeiting, guarantees quality
̶Theoretical problems
̶Hoarding of a thing makes it more scarce and thus less likely to be used as money
̶Unstated presuppositions (economic exchange, property rights)
̶Empirical issues – anthropological surveys are at odds with the barter story, money predate coins
by millennia
Introduction to economics MEB435/MEBn5035

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State/credit theory of money
̶Money is first and foremost a unit of account for recording debts, its primary purpose is to
enable economic coordination for public purpose
̶It is an IOU (I owe you) and is created when an IOU is issued
̶Its value depends on the credibility of the promise
̶Money is an institution – a generalized and formalized type of an obligation (debt)
̶Anyone can issue money (obligations) and almost anything can represent it (cattle, salt, wood,
paper)
̶The crucial problem is: How to make people accept it? How to make it generally recognized? (only
then a generalized means of exchange is possible)
̶Money is endogenous and NOT neutral
̶credit -> money (-> barter)
̶Problems (role of the private sector, legitimacy issues)
̶
Introduction to economics MEB435/MEBn5035

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Essence of money
̶What is money?
̶measure of value
̶People coordinate their economic behavior in various ways, the most common in-group coordination
mechanism is some form of credit -> money usually measures debts (credits)
̶It’s vital to differentiate between money (unit of account), money as an expression of debts and
money things (what represents debts)
̶How is money produced?
̶By issuing an IOU (× destruction of money)
̶How does it get/lose value?
̶Credibility × quantity theory of money × taxes (it’s complicated)
̶Some historical examples – Sumer, Lydia, early US banking
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Money and states
̶A state is able to determine its money (unit of account) once it enforces taxes/fees in it
̶Governments use money to mobilize resources for public purpose
̶Money is accepted for several reasons: trust, habit, authority, but the ultimate reason is power
̶The fact that a state issues its money and declares that it will accept it back in the form of
taxes is an expression of power (+legal tender)
̶Governments can buy anything that is for sale in its currency and is in theory able to overbid
anyone
̶Money has distributional consequences and is therefore prone to be abused for political gains
̶Debtor × creditor interests
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Modern money
̶Usually one state – one currency rule
̶Governments owing in their own currency can’t be forced to go bankrupt but they can decide to do
so
̶Fallacy of composition – what is true for a part (an individual) doesn’t have to be true for the
whole
̶Individuals × states
̶In a closed economy is true by definition that expenditures = incomes
̶Hierarchy of money (government > banks > firms > households)
̶Most money today is issued by private commercial banks
̶Governments are for historical and political reasons limited in their power to exploit their
monetary systems
Introduction to economics MEB435/MEBn5035

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Limits of domestic monetary power
̶Struggles over monetary systems
̶Ancient Greece, Rome, England 17th century, Great Financial Crisis
̶Political and institutional constraints
̶Central bank independence
̶Deficit limit
̶Debt ceiling
̶Limited money supply (metal standard, currency peg)
̶Inflation and real constraints (output level)
̶International constraints
̶Balance of payments constraints
̶Debt in a foreign currency
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Government debt (% of GDP in 2017)
Russia
13
UK
85
Switzerland
30
Spain
98
China
48
United States
105
Germany
64
Portugal
126
Ireland
68
Greece
179
Hungary
74
Japan
253
Source: IMF
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Definujte zápatí - název prezentace / pracoviště
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Who owns UK goverments debt?
Source: jubileedebt.org.uk, UK Treasury

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Capital
̶Capital (investment)
̶For an individual
̶For the society as a whole
̶Capital consists of assets that can enhance one's power to perform economically useful work
̶Capital goods, are already-produced, durable goods or any non-financial asset that is used in
production of goods or services
̶Financial vs. real capital
̶Interest is a payment for borrowing money
̶Interest rate is a price of credit and plays the role of the cost of capital.
Introduction to economics MEB435/MEBn5035

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Financial system and banking
̶Financial system - a system that allows the exchange of funds between lenders, investors, and
borrowers
̶Orthodox account of banking
̶Banks are intermediaries between lenders (savers) and borrowers
̶Money multiplication – additional credits created from deposits
̶Heterodox account of banking
̶Banks finance capitalist production (financial investments precede savings)
̶Money created “out of thin air” loans created simultaneously with deposits
̶Problems with liquidity a and solvency
̶Minimum reserves requirements and capital requirements
Introduction to economics MEB435/MEBn5035