Sunday, November 15, 2009

Money and Credit Confused

No one could be a student of Leland Yeager without having the distinction between money and credit drummed into their thinking.

Money is the medium of exchange. The quantity of money is the amount of money that exists at a point in time.

The demand for money is the amount of money that people want to hold at a point in time. To hold money is to not spend it.

The supply of credit is the amount of funds people want to lend during a period of time.

The demand for credit is the amount of funds that people want to borrow during a period of time.

An increase in the demand for money is not the same thing as an increase in the demand for credit.

An increase in the demand for credit means that households and firms want to borrow more. While it is possible that they want to borrow money in order to hold it, the more likely scenario is that they borrow in order to increase spending on some good or service, including, perhaps some other financial asset.

An increase in the demand for money could result in an increase in the demand for credit. People might borrow money in order to hold it. However, the more likely scenario is that people demanding more money will reduce expenditure out of current income, purchasing fewer other assets, goods, or services. Of course, they could also sell other assets.

An increase in the supply of credit isn't the same thing as an increase in the quantity of money. While it is possible that new money is lent into existence, raising the quantity of money over a period of time while augmenting the supply of credit, it is also possible for the supply of credit to rise without an increase in the quantity of money. Purchases of new corporate bonds by households or firms, for example, adds to the supply of credit without adding to the quantity of money.

Because shifts in the share of the total supply of credit associated with money creation are possible, the quantity of money can rise over a period of time when the supply of credit is shrinking.

There are relationships between the supply and demand for money and the supply and demand for credit, both in disequilibrium and equilibrium. But money and credit are not the same thing.

One of the first rules of monetary economics is to never confuse money and credit.

3 comments:

  1. Are you saying that money is a stock and credit a flow?

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