Understanding Money Mechanics

The Understanding Money Mechanics series by Robert P. Murphy, is a comprehensive overview of the theory, history, and practice of money and banking, with a focus on the United States.

Why do we have money in the first place? Where does it come from, and what determines its form? What qualities make for a good money? What role do banks play—is it something other than what money itself does for us?

Arguments over the gold standard are not merely technical disagreements. Rather, the gold standard often serves as a proxy for “sound money,” which was a central element in the classical liberal tradition of limiting government’s ability to wreak havoc on society.

The original justification for the creation of another central bank did not allude to the modern goals of “full employment” and “price stability.” Rather, the pleas of the time called for an “elastic currency” that would expand or contract according to the “needs of trade.”

Robert Murphy defines some of the conventional “monetary aggregates,” such as M1 and M2, and gives the textbook rundown of how the Federal Reserve and commercial banking system “create money” when the Fed buys assets and the commercial banks extend new loans.

Although it conjures up scary imagery, shadow banking is simply a term for banking operations that occur through financial intermediaries that are not traditional commercial banks.

In the wake of the financial crisis of 2008, the Federal Reserve and other central banks around the world adopted new “tools” to influence economic activity in addition to its standard open market operations.

Since the corona panic, the Fed has bought a ton of government bonds, but it's also started buying corporate bonds, has abolished reserve requirements, redefined their M1 measure, and switched to average inflation targeting.

The latest installment in the Understanding Money Mechanics series summarizes the theory of the business cycle originally published in 1912 by Ludwig von Mises and elaborated by Friedrich Hayek.

Although it is important to recognize that massive price inflation is always the result of massive monetary inflation, there isn’t a stable relationship between the two.

Economists have failed to explain the mechanism by which an inverted yield curve signals an impending recession. But the Misesian explanation of the business cycle quite easily explains the pattern we observe in interest rates.

By flooding the market with cheap credit, Alan Greenspan pushed interest rates (including mortgage rates) down to artificially low levels. This caused the bubble in house prices and misallocated too many real resources to the housing sector.

Over the years a chorus of critics has alleged that the textbook view of how a central banks buys government debt in "open market operations" is backwards. They argue that in reality commercial banks take the lead in making loans without regard to their reserves.

In this chapter, we’ll assess several popular explanations for why the Fed’s monetary inflation since 2008 hasn’t generated a comparable increase in price inflation.

Keynes viewed depressions as something that could naturally plague market economies when total spending was insufficient to support full employment. Only with wise oversight could we hope to achieve steady economic growth.

A relatively new challenge to the Austrian framework comes from the “market monetarists” and their endorsement of a central bank policy of “level targeting” of nominal gross domestic product.

In the latest installment of Understanding Money Mechanics, Robert Murphy explains what Bitcoin is, how it works, and how it fits into Misesian monetary theory.

The good news is that Stephanie Kelton—economics professor at Stony Brook and advisor to the 2016 Bernie Sanders campaign—has written a book on modern monetary theory that is very readable, and will strike many readers as persuasive and clever. The bad news is that Stephanie Kelton has written a book on MMT that is very readable and will strike many readers as persuasive and clever.