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Bottom-Up Monetary Policy

There are two essential forms of monetary policy. One is the European form, the top-down monetary policy.

The second is the American monetary policy.

This is the bottom-up monetary policy.

The first American to advocate for it formally was Benjamin Franklin, in a brilliant paper he wrote when he was barely a 23-year-old lad! He was simply defending a practice initiated by Massachusetts colonists in 1690. The American Revolution, it is now becoming clear again, was fought to preserve the power of the colonists to create the money they needed for industry and commerce against threatened infringement from the Bank of England. This power was inscribed in the very first article of the United States Constitution. The most vigorous attempt to exrcise this power was made by the greatest of American presidents, Lincoln.

This policy has never quite taken hold in academia because it seems to have no inner restraints, and it has indeed been put into practice many times without any established restraints. The limits within which this policy can be safely implemented are listed below; they were first more formally presented in the paper on the “golden standard” that I wrote in collaboration with Norman Kurland.

The Definition of Money

Economic theory has no definition of money. It distinguishes among the functions of money; but functions are not definitions.

Money is a legal institution with economic effects. Money is a contract. It is a contract between the holder of whatever form money assumes and the rest of society. It is a mutual obligation.

The most important obligation of society is to preserve the value of money.

The most important obligation of the individual person is to create the economic value that money represents: real goods and services.

The Administration of Money

Ever since time immemorial, it has been found useful to grant the administration of money to an official Monetary Authority, be it the King, a Central Bank, or the Federal Reserve System. It is the function of monetary policy to determine the functions of the Monetary Authority.

The most important determinations of monetary policy concern the modality of the creation of money; the flow of the money; and the quantity of money.

Two Forms of Money Creation

Money can be created either as a debt or as an asset. When the Monetary Authority borrows money from the public and lends it to a government agency or a private institution, the MA puts money in circulation as debt. It basically lets the banks or other private institutions create the money. The MA creates money as an asset when it "discounts" a note from the public, a note that represents the value of (current and expected) real goods and services. The MA then does not borrow money; it lends money out. The MA then creates moneyan asset.

Alternative Flows of Money

The flows of money are better followed through the following figure:

Alternative Money Flows

Figure 1

As it can be seen from this figure, the Central Bank either creates money or allows banks to create money. This fact is rooted in the very nature of money and credit. Money starts as an “I Owe You” (IOU) note between two people. When the IOU note is accepted by a third and a fourth party, the note becomes a “public” note; eventually, it becomes legal tender, i.e., a contract between the holder of the note and society as a whole. And with this transformation, it becomes necessary to go beyond the question of private trust between two parties into the issue of public trust. With this transformation, the nation acquires the responsibility to guarantee the value of the note and the right to create notes.

The United States Constitution and the legislation that created the Federal Reserve System give entrepreneurs, corporations, and governments with taxing powers the right of access to national credit; the Discount Window was created for this purpose.

In a Trickle-Down Monetary Policy, or the European conception of money, the Discount Window is used as a last resort. In a Bottom-Up Monetary Policy, or the American conception of money, the Discount Window is the preferred use to create money and put it into circulation.

The advantages of a Bottom-Up Monetary Policy are numerous and extremely important. Money is created in perfect correspondence with the need of the nation to create real wealth (national credit, i.e., new money, is not created to purchase consumer goods or other financial instruments); money is created at cost (not at an arbitrarily changing interest rate); money is created to benefit those who create real wealth (not those who create financial wealth, paper wealth).

CG July 23, 2008

October 16, 2008