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Endogenous Money in 21st Century Keynesian Economics


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This chapter provides a theoretical treatment of money and its role in 21st century Keynesian economics and in the 21st century economy, e.g. with some reference to the credit crisis of 2007 onwards. To start, the treatment of money in 20th century Keynesian economics is reviewed, including that provided by Keynes. Then the current theory of endogenous money is briefly summarised as it developed towards the end of the century and into the current century. The chapter continues by elaborating the extensions to the consensus Post Keynesian theory in the literature. Money is defined in terms of seven characteristics: 1. trust, 2. divisibility, 3. “invariance” in value over space and time, 4. limitation in supply, 5. acceptance as a unit of account, 6. convenience and 7. attractiveness. The chapter goes on to elucidate the concept of economic invariance. The role of money in spatial and temporal economics is briefly addressed, so that the essential symmetry between exchange rates (exchange rates for different moneys at a point in time) and interest rates (costs of or return to holding one money over time) is highlighted. There is a brief discussion of the role of money in the current crisis. The chapter concludes with a discussion of one more attribute of money: money as magic.
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Terry Barker
Cambridge Trust for New Thinking in Economics
The use of money, like other human institutions, grew or evolved.
‘The mystery of money’, Allyn Abbott Young (1924; revised 1929), p. 2652
This chapter provides a theoretical treatment of money and its role in 21st Century
Keynesian economics and in the 21st Century economy, e.g. with some reference to
the credit crisis of 2007 onwards. To start, the treatment of money in 20th Century
Keynesian economics is reviewed, including that provided by Keynes. Then the
current theory of endogenous money is briefly summarised as it developed towards
the end of the century and into the current century. The chapter continues by
elaborating the extensions to the consensus Post Keynesian theory in the literature.
Money is defined in terms of seven characteristics: 1. trust, 2. divisibility, 3.
“invariance” in value over space and time, 4. limitation in supply, 5. acceptance as a
unit of account, 6. convenience and 7. attractiveness. The chapter goes on to elucidate
the concept of economic invariance. The role of money in spatial and temporal
economics is briefly addressed, so that the essential symmetry between exchange rates
(exchange rates for different moneys at a point in time) and interest rates (costs of or
return to holding one money over time) is highlighted. There is a brief discussion of
the role of money in the current crisis. The chapter concludes with a discussion of
one more attribute of money: money as magic.
Keywords: Money; endogenous money; Keynesian; Post Keynesian; 21st c.
JEL: E40
1This paper was published as
Terry Barker, ‘Endogenous money in 21 Century Keynesian economics’, chapter 6, pp. 202-
239 in Philip Arestis and Malcolm Sawyer (eds) 21 Century Keynesian Economics, Palgrave
Macmillan, 2010. Thanks to the editors Philip Arestis and Malcolm Sawyer for extensive and helpful
discussions on theory and to contributors to the 2009 Bilbao conference of Post Keynesian economists,
Martin Sewell, David Taylor, Serban Scrieciu and Paul Ekins for comments and Martin Sewell and
Mairéad Curran for editorial assistance. Thanks are also due to The Three Guineas Trust, one of the
Sainsbury Family Trusts, and to Cambridge Econometrics Ltd, for the financial and other support to the
University of Cambridge allowing the research underlying this chapter to go ahead.
2 The Book of Popular Science. New York: The Grolier Society. Group IX Ch. 31: 4231–40.
Reprinted in Mehrling and Sandilands (1999).
Barker Endogenous money
1. Introduction3
Money is a resource at the heart of the economic system. It is the blood of the system,
diffusing ever more thinly throughout the body politic, bringing energy and
supporting economic life. Money reaches extremities such as the hidden and criminal
economies that few other resources can touch. Interestingly, money is also like blood
in that there is a mystery about it, and something strangely indecent: talk of money is
exciting and often replete with plans and dreams of getting it and spending it. Finally,
it appears that humans have evolved such that their primary proximate goal is social
and sexual activity; and that wealth, among other attributes, may be considered by
many as a proxy for the value of human family, friendship, and mating; so it becomes
clear that humans are or might be strongly motivated to accumulate money. Money is
therefore a human tool, like the energy system or an emission trading scheme, to be
used to make more money and satisfy human desires for society and sex by hopefully
accumulating wealth.
The discovery of money is one of the great achievements of human society,
comparable to the discovery of fire. The use of some form of money - closer to a
commonly-accepted product used in barter than to a credit card in a modern economy
- appears to have been used in human societies for a very long time. Modern money
was invented as coin and paper notes in ancient Chinese civilization and its use has
become pervasive in economies throughout the world, with global currencies such as
the dollar, the euro and the yen being almost universally recognized4
‘Money’ is given many meanings in economic literature and discourse, ranging
over its identification with notes and coin in circulation, a set of monetary assets with
particular characteristics, and wealth in general as when we say ‘she has money’. At
its most general, money is in Simmel’s words ‘the symbol of the spirit, forms and
thought of modern civilization’ (quoted by Frankel, 1987). Money is a resource
created by human society. It is a social construct, being used and accorded value by
human society. One social group, namely the banking community, has as its main
function the creation and management of money in the economy.
This chapter provides a theoretical treatment of money and its role in 21st Century
Keynesian economics and in the 21st Century economy, e.g. with some reference to
the credit crisis of 2007 onwards. The objective is to explain what money is, why
3 This chapter draws heavily on the text and ideas in Chapter 3 of Barker (1996). This introductory
section treats money in general, not necessarily as it is treated in Keynesian economics. It is
impossible to treat all the Post Keynesian texts properly in the word limit of the chapter, so I have
relied heavily on King (1995) and referred to the first major publication by authors and later critical
references. Finally, ‘money’ and ‘liquidity’ are treated for the purposes of the chapter as synonymous,
although there are differences in that liquidity could be treated as a particular form of money associated
with the social groups that provide credit, e.g. as in Weintraub’s (1982) list of the characteristics of
liquidity, which are different from the list of properties of money given below.
4 Paper money first came into use in China, in the Ninth Century AD, according to Needham and
Tsuen-Hsuin (1959). Temple (1986) remarks that its original name was ‘flying money’ because it was
so light it could blow out of one’s hand. As ‘exchange certificates’ used by merchants, paper money
was quickly adopted by the government for forwarding tax payments. Real paper money, used as a
medium of exchange and backed by deposited cash (a Chinese term for metal coins) apparently came
into use in the tenth century. The first Western money was issued in Sweden in 1661. America
followed in 1690, Scotland in 1695, France in 1720, England in 1797, and Germany not until 1806.
Barker Endogenous money
money as a concept is so elusive, why it is difficult to measure at the best of times and
impossible to measure in a financial crisis, how the concept has evolved and matured
in Post Keynesian analysis, and what are the implications of the new theory of money,
expounded here, for understanding and resolving the global economic crisis. The new
theory is placed in the context of Keynesian economics and, more widely, the
classical, neoclassical and so-called heterodox traditions of economics.
Section 2 contains a review of the treatment of money in 20th Century Keynesian
economics, including the approach taken by Keynes. Then in Section 3 the current
theory of endogenous money is briefly summarised as it developed towards the end of
the century and into the current century. Section 4 elaborates the extensions proposed
to the “consensus” Post Keynesian theory in the literature as synthesised by Fontana
(2009). Money is defined initially in terms of seven characteristics: 1. trust, 2.
divisibility, 3. “invariance” in value over space and time, 4. limitation in supply, 5.
acceptance as a unit of account, 6. convenience and 7. attractiveness. The chapter
goes on in Section 5 to elucidate the concept of economic invariance. The role of
money in spatial and temporal economics is briefly addressed, so that the essential
symmetry between exchange rates (exchange rates for different moneys at a point in
time) and interest rates (costs of or return to holding one money over time) is
highlighted. Section 6 is a brief discussion of the role of money and monetary policy
in the current crisis. Finally in Section 7, the chapter concludes with a discussion of
one more characteristic of money: 8. money as magic.
2. 20th Century Neoclassical, Monetarist and Keynes’
Treatment of Money
Money in general-equilibrium theory (neoclassical) is treated as a means of exchange,
essentially, although not properly, as a means of making the indivisible divisible. As
the New School discussion puts it ‘Walras’s story [about the role of money] is full of
and ever since Walras’s work was recognised, neoclassical writers have been
trying to sort out the inconsistencies and contradictions. Walras himself thought that
money was a kind of capital needed for future payments (it is an asset after all, but so
is human education, a forest ecosystem and expert-system software) whose services
entered the consumers’ utility function. If so, money can be treated with the same
mathematical apparatus as all other products e.g. there is a marginal utility of
monetary services. The problem with this treatment (as stressed by Patinkin, 1956) is
that money is also required for transactions. How is money to be treated both as an
asset with desired services and as a requirement for exchange? An even greater
problem with the Walrasian treatment is that if money is needed solely in order to
make future payments, and the agents holding it have perfect foresight, why do they
need to hold it at all, because as an alternative they could hold an interest-bearing
asset? Hahn writes: The most serious challenge that the existence of money poses is
this: the best developed model of the economy cannot find room for it. The best
developed model is, of course, the Arrow-Debreu version of Walrasian general
equilibrium.’ (1983, p. 1). The Post Keynesian critique (Arestis, 2009) is that the
equilibrium models used by the central banks (following the New Keynesian
tradition) do not have, surprisingly, the banking sector in them, and so are intrinsically
Barker Endogenous money
incapable of modelling any banking crisis, despite the fact that there are many such
past crises for empirical modelling (Reinhart and Rogoff, 2008).
The monetarist school does not normally distinguish the characteristics of money
and the monetary assets that embody these characteristics. Friedman (1987) states
that money has three properties: a means of exchange, a store of value, and a unit of
account. In monetarism, put simply, in the long run the growth of the money supply
determines inflation, so that if the money supply is exogenous and if it can be
controlled, the rate of inflation can be managed by controlling the money supply.
Friedman has since partially repudiated his reworking of the classical and neoclassical
quantity theory of money (2003).
Keynes (1921, 1937) paid great attention to the role of money, and developed a
theory of the speculative demand for money. Weatherson6
Keynes distinguishes four motives for holding money (General Theory (GT)
[Keynes (1936)]: Ch. 13; Keynes 1937: 215-223). Two of these, the transactions
motive and the finance motive, need not detain us. They just relate to the need to
make payments in money and on time. The third, the speculative motive, is often
linked to uncertainty, and indeed Keynes does so (GT: 201). But ‘uncertainty' here is
just used to mean absence of certainty, that is the existence of risk, which as noted
above is not how I am using ‘uncertainty’. As Runde (1994) points out, an agent who
is certain as to future movements in interest rates may still hold money for speculative
reasons, as long as other agents who are not so certain have made mistaken
judgements. The fourth motive will hold most of my attention. Keynes argues that we
may hold money for purely precautionary reasons.’
(2002, pp. 47–62),
contains a summary of Keynes’ views on money:
Importantly, Keynes accepted equilibrium as an organising concept (Johnson, et al.,
2004) and largely, as many of his predecessors and successors, treated the macro
economy in terms of aggregated variables such as land, labour and capital, e.g. the
concept of the ‘marginal efficiency of capital’ (Johnson, et al., 2004 p., 224). His
theory also implied the endogeneity of money, despite him also arguing that money
can be treated as exogenous (Foster, 1986).
However, all these authors and schools accept equilibrium as an organising concept
in economics. A more productive line of reasoning regards equilibrium as a
misleading if not worthless concept in economics (and empirically unverifiable)7
3. Endogenous Money in 21st Century Keynesian
21st Century Keynesian, Post Keynesian and post-Keynesian Economics
Keynesian economics also generally accepts equilibrium as a useful concept, but Post
Keynesians (e.g. Philip Arestis, Cardim de Carvalho, Paul Davidson, Sheila Dow,
7 In addition the uses of aggregated variables and assumptions (e.g. the representative agent) in these
and other schools of economic thought ignore the individuality of people and social groups (Barker,
1996: chapter 2, 1998, 2008: section 4) and the probability of evolution when a species knowingly
faces possible extinction.
Barker Endogenous money
Giuseppe Fontana, Nicholas Kaldor, Hyman Minsky and Malcolm Sawyer) do not.
Critical realists (e.g. Tony Lawson), who refer to post-Keynesian economics, appear
to be more philosophers than economists, and some realists discount the usefulness of
econometrics, or dispute whether average representations of economic behaviour can
be included usefully in models, or whether economic events, such as the outcome of
the 2007–2009 crisis, can be predicted. Some Post Keynesians (see Cardim de
Carvalho, 2009) have recognized the problem of aggregation that can be resolved by
distinguishing the many forms, which monetary assets take, from the characteristics of
money (see below), where the common feature of monetary assets is that their
nominal price is fixed. However, all Post Keynesians stress the importance of
uncertainty and expectations in understanding economic behaviour.
The Post Keynesian Horizontalist-Structuralist theory of endogenous money
Moore (1978, 1879, 1981), Kaldor (1981), Weintraub S. (1982), Arestis (1987, 1988),
Arestis and Biefang-Frisancho Mariscal (1995) and Sawyer (2009a) explain why
money is endogenous. Fontana (2009, chapter 8) presents the main sides of the debate
between those who favour the Horizontalist and those that favour the Structuralist
analysis of endogenous money (see Lavoie, 2006, and Dow, 2006, for the
Horizontalist and Structuralist analyses respectively). Money is endogenous because
its demand is derived from the desire of holders of money in all its forms for liquidity.
Banks provide liquidity in exchange for returns from bank lending for financial or real
investment, or speculation (if they are acting as “casino banks”), so the desire for
loans then leads to the banks supplying loans. The loans thereby create money as a
property of the banking system. And the degree to which the money created remains
in existence depends on the willingness of social groups to hold money (the ‘demand
for money’) and the reserve requirements of the regulator (a ‘supply-side’
Fontana reconciles the Horizontalist and Structuralist analyses by a diagram
showing the interconnectedness of interest rates, bank loans, bank deposits and bank
reserves and by making a distinction between a single-period and a continuous or
series of sequential, dynamic adjustments, relying on Hicks’ development of
monetary theory (Fontana, 2009, chapter 6).
. In other words, the creation of money by the banking system is a
systemic property in that social groups taking out bank loans then deposit the money
in banks, so that the banks can lend it out again, all subject to reserve requirements. In
short, the supply of money becomes derived from the demand, and money is
The assumptions underlying the theory set out by Fontana (op. cit.) are: 1. we
know what “money” or “liquidity” is, although whether this means “perfect money”
(as defined below), or a monetary aggregate, is unclear; 2. we can reasonably restrict
the analysis to a producer-consumer-banks economy in multiple time periods, in the
context of general uncertainty and inability to convert all risks to certainty
equivalents; 3. non-egodicity, “history has effects”; and 4. institutions matter and can
change. And the key results are: 1. the formation of expectations is critical to the
system; 2. money is normally demand-led via creation of bank liabilities; 3. banks
8 Sawyer (2009b ) argues that the demand and supply analysis of money should be discarded. However
it does seem useful to allow for money having a demand derived from its proxy value as a resource to
achieve social and sexual well being, and as constrained by supply, e.g. the available quantity of gold
in an entirely gold-based economy.
Barker Endogenous money
create money subject to central banks’ reserve requirements and interest-rate policies
(in normal times, namely away from the “zero-bound”) as expounded by Robinson
(1943); 4. portfolio choices by wage earners, commercial banks and central banks are
critical and inconsistencies can lead to collapse of the financial system 5. monetary
and fiscal policies should be inter-related and flexible to accommodate “events”.
Structuralist theory of endogenous money: a critique aimed towards an extension
The Structuralist theory represents the more complex and more realistic view of the
role of money, so a critique starts with the realism of the assumptions required in the
theory. Taking these one by one as listed above.
1. Structuralists know what money is. However Barker (1996, p. 95) argues, in
contrast to the structuralists (Sawyer, 2003) that we do not know what money is,
collectively, since it is subjective and any aggregation depends on a definition
that, in turn, is specific to a specific currency-region and period-of-time where and
when expectations are stable, i.e. in well-behaving economies in normal times.
2. The analysis should include at least the aggregate social groups of national
economies, governments, investment banks, and non-bank financial companies
dealing in assets, so as to be able to explain financial crises and the Big Crunch of
September 15, 2008, and their consequences.
3. If history has effects, then the treatment of endogenous money should be seen in
the context of the irreversible and asymmetric history of money creation and
destruction, e.g. the Big Crunch is a catastrophic non-linear event.
4. And if institutions matter and can change, then monetary theory can be developed
to explain monetary evolutions via institutional change and destruction.
Extensions to the theory of endogenous money
The critique above suggests some extensions to the theory. First, the treatment of
monetary assets as forms of money with money having many characteristics is critical
to understanding money (Barker, 1996, elaborated below). Second, there is space-
time symmetry in the price of money (exchange rates and interest rates). Third, it is
worth embedding the monetary institutions such as banks (central, investment or
wholesale, and retail) in the wider economic system. Fourth, it is also worth
distinguishing well-behaving economies from ill-behaving ones. This distinction is
critical in understanding the behaviour of the world economy since the collapse of the
world money supply became apparent in September 2008. And fifth, expectations
themselves can be asymmetrical, leading to Keynesian liquidity traps and the current
global crisis emerging with the collapse of various banks starting in 2007. These five
extensions are set out in the sections of the chapter that follow.
4. Properties of Money
For the purpose of the analysis that follows, money will be defined precisely as a
‘resource with a set of characteristics that are embodied in different combinations in
monetary assets’; examples of such assets are notes and coin, bank deposits, credit
and debit cards, bank loans and various government-backed, short-term bills of
exchange. The important distinction between the characteristics of money or its
Barker Endogenous money
‘essence’ on the one hand, and the forms of money or monetary assets on the other,
was clearly set out by Simmel in 1900 (1978 translation, pp. 119–120), who also
emphasized the innumerable errors that arise if this basic distinction is not made.9
Key concepts in 21stC Keynesian economics are ‘banks’ and ‘liquidity
preference’. Banks are social groups whose primary function is to create and
manage forms of money, such as notes and coin, debit and credit cards, and (until
the crisis of 2007 onwards) collateralized debt obligations (CDOs). Liquidity
preference is the demand for money (effective or not) by social groups such as
governments, banks, companies and households. Banks and liquidity preference
are discussed later in the chapter. Good banks in well-behaving economies do not
need to be modelled because they are by definition trusted, so that the role of
banks and money becomes hidden and it is not necessary to model them whilst
bad banks in ill-behaving economies, e.g. the investment from 2007 onwards, are
not trusted and they demise or any collapse in the money supply must be
modelled to understand the dynamics of the system.
For Young (1929, Mehrling and Sandilands, 1999, p. 266) the crucial characteristic of
money is its exchangeability, whilst money itself can take many forms. He counts ten
forms of money (Mehrling and Sandilands, 1999, p. xviii), and what (he argues) they
have in common is that they ‘are all elastically “interchangeable” with the standard
money, gold.’
The characteristics that form the set that describe ‘perfect money’ include the
following seven distinct items10
1. complete trustworthiness
If money is to be accepted as a means of exchange, then those who are to receive it
will be willing to do so only to the extent that they trust that it will have effective
value in future exchange.
2. perfect divisibility
Money has to be divisible in order to allow exchange with integral goods and services
of any value. Perfect money has the characteristic of complete non-integrality.
3. complete invariance over space and time
Money is most useful if its value remains constant over space and time. This can be
seen as an aspect of the trustworthiness on money.
4. complete limitation of supply
A freely available asset is no use as money. Only those assets that are scarce by
nature (e.g. gold or silver) or by design (e.g. government-printed notes) can be used as
money, unless social conventions or taboos are sufficiently strong. If supply is not
limited and managed by a public (e.g. nationalized central bank) or a private
9 The neoclassical approach to money, based on the quantity theory of money, does not make this
distinction and seems rather confused.
10 Weintraub (1982) has seven motives for liquidity.
Barker Endogenous money
regulator, then the value of money (in terms of its purchasing power) will not be
completely invariant over space and time.
5. complete acceptance as a unit of account or numeraire
Money is used in pricing as a measure of value, and in accounting as a unit of
6. perfect convenience as a means of exchange
Since it is to be used in both everyday transactions and multimillion dollar deals,
money has to be available in a convenient form, facilitating those transactions of very
low value as well as those of very high value. This is a practical aspect of the
divisibility property of money.
7. attractiveness as a physical object, or as an immaterial form of money, e.g.
credit cards.
Since money is used by everyone in an economy, perfect money is also physically
alluring and attractive.
It may be difficult to find some way in which all these characteristics are
combined. Some of these characteristics are mutually exclusive, e.g. a perfectly
divisible and attractive asset such as mercury is no use as perfect money because it is
inconvenient to carry about or to divide, apart from being poisonous. And some
characteristics imply others, e.g. invariance if experienced for long enough yields
trustworthiness. And some are much more important than others, with divisibility,
invariance and convenience being key properties. Simmel (1978, p. 137) has an
amusing ‘recorded fact’ concerning Russian silver coins of several centuries ago of
such minute size that they could not be picked up by hand. Following an exchange,
the purchaser had to tip the coins out of the purse on to a surface, and divide them,
and both the purchaser and the seller had to pick up their own coins with their tongues
and spit them into their respective purses. Convenience and hygiene were sacrificed
for exchange and divisibility.
Although we think of money in physical terms - gold, silver, notes and coins - it is
the services that monetary assets offer that are important, not their physical form.
Most of these services are yielded when money is exchanged, but one of these
services (money as a unit of account) is a general service yielded through time,
allowing the valuation of all goods and all other services in an economy. The services
are attached to certain assets, usually financial (pieces of paper and certificates,
promises to pay or contracts), i.e. monetary assets.
There is no single asset that embodies all the characteristics of money. Various
monetary assets, such as US dollar bills, come close, but with the following
qualifications. They are not limited in supply, being under the control of the US
Treasury; they are not convenient for very high value transactions, because one would
need suitcases full of notes; they are not perfectly divisible, but are practically divided
into quarters, nickels, dimes and cents; and they are not invariant over time, since the
average price of the basket of goods and services bought by the dollar-bill user is
liable to rise, a feature also known as price inflation.
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Monetary assets whether created by central banks or created by banks are subject
to regulation by the central bank (or similar) with the central bank acting as lender of
last resort. Such assets are in fact the principal means of exchange throughout the
world today. Governments and central banks create and regulate money on behalf of
their citizens and have done so for hundreds of years. Often, several different monies
(e.g. gold and silver, dollars and roubles) may be in circulation at the same time (e.g.
when their citizens opt to use another country’s money), but governments and central
banks are usually in the position to manage only one of these monies. Since there is
no perfect money, it is impossible to give an unambiguous and precise definition to
key concepts in the management of money. For example, changes in the ‘money
supply’ have to be defined in terms of changes in the total of a set of monetary assets.
If notes and coins are added to bank deposits, different combinations of monetary
characteristics are added together, rather like adding apples to oranges in the
definition of the ‘fruit supply’. In obtaining an index of the value, supply or price of
fruit, each type of fruit is weighted together using some conventional procedure. Only
in the case of measuring the total value of fruit at a particular time, would the values
of the different fruits be simply summed. In order to compare the stock of fruit at two
different times, it is usual to distinguish quantity and price (unit-value) changes.
Similarly with the money supply: if the change in the stock of money is interesting,
then some procedure allowing for the different unit-values of the different kinds of
money is useful.
The rest of this section is concerned with a more detailed discussion of seven
properties of money, starting with trust and continuing with the role of money as a
means of making the indivisible divisible. It goes on to elucidate the concept of
economic invariance (with its opposite, economic variance) an essential and
measurable characteristic of perfect money as well as being a measurable
characteristic of other resources.
1. Trustworthiness as a Property of Money
The importance of money and the trust in the quality of goods and services that
money can buy, and the reputations of the bankers who create money and of other
market players, leads on to the concept of trust. Trust by definition cannot be bought
and sold. Rather, trust is a central feature of social relations, a moral resource. Trust
is similar to, but not the same as, compassion, love, altruism, and care for others.
Trust can no more be bought and sold than compassion can be bought and sold. It is
quite obvious that the purchase of compassion is meaningless, because compassion is,
by definition, expressed without the expectation of reward; trust is in the same
Trust is closely related to reputation. Trustfulness is an inherent characteristic of
people; it is instinctively assessed when people meet and is revealed by experience; it
represents consistency in behaviour and has the connotation of integrity in behaviour.
Some individuals may be very charming, but also very untrustworthy, or some firms
may seem to offer a very good bargain in the goods and services they sell but be
untrustworthy in that they are liable to sell goods and services with negative
characteristics that only emerge when the goods are in use.
This suggests that the treatment of trust as a commodity, whatever that means, is
one of what Boulding calls ‘errors of taxonomy.’ Clearly, trust is not a characteristic
Barker Endogenous money
of goods and services but an inalienable characteristic of people and social groups,
although there is a sense in which the quality of replicated goods corresponds to the
trust in the group, usually the company that produces these replicated goods is fully
aware of this fact.
Goodwill, however, is sold when, for example, companies go bankrupt: their
reputation is assessed, a value put on it, and then it can be put on the market and sold;
many companies go bankrupt without any goodwill whatsoever. Normally goodwill
is exchanged in private deals before the bankruptcies are arranged. The goodwill that
is associated with reputation and the quality of life of the employees, and the general
social standing of the firm, can be very valuable, especially for service providers
where there is no physical good to be measured. Goodwill is an important part of the
value of a firm, for example when a company is bought or sold.
2. The Divisibility Characteristic of Money
Simmel explains the divisibility of money as one of its most important properties as a
means of exchange. In the development of a barter economy the
‘value of both objects of exchange becomes more easily commensurable if one
object is divisible; The most developed form of divisibility is attained with
exchange against money. Money is that divisible object of exchange, the unit of which
is commensurable with the value of every indivisible object’ (1900, quote from 1978
translation, pp. 127–128)
Or, again more recently, in his attempt to introduce ‘indivisible commodities’ or
The veil of money is so transparent yet so effective in hiding the divisibility of
money, that this function can easily be overlooked. People come to believe that goods
and services are, to all intents and purposes, perfectly divisible, simply because their
possession can be shared and their value distributed by using money. The exchange
of money in a transaction is a sleight of hand whereby the characteristic of divisibility
is imputed to the good or service bought, and not recognized in the money itself.
into Walrasian general equilibrium theory, Broome declares ‘One of the
essential characteristics of money is that it is divisible within anyone’s perception,
and thus permits easy trade.’ (1972, p. 227)
The Divisibility of Monetary Assets
Gold and silver, used as money, have the property of being divisible as much as
necessary, although the actual division is costly and inconvenient. Minted and printed
money is divisible by design, with the smallest unit being the smallest unit of value
seen to be useful in the economy. Thus in general, economies with low incomes tend
to have lower-value coin and notes than economies with high incomes.
The divisibility of money is distinct from its role as a medium of exchange. In
parts of East Africa, cattle have been used as a means of exchange, but the cattle are
not divisible, at least if they are to survive as cattle (and money) rather than being
11 Economic indivisibility or integrality is defined as ‘that property of resources which gives them
economic value such that if they are divided they lose value to some significant extent.’ Alternatively
and more concisely a good or service is defined as integral if its economic value falls if and when it is
Barker Endogenous money
reduced to meat. But then cattle become more likely the unit of account, and exchange
of goods can be measured in terms of sub-units of cattle with some form of ledger to
record the transactions. One of the important developments in the history of money
has been the increasing ease with which it can be divided, firstly by use of coins, then
by that of coins and paper money, and most recently by the addition of credit and
debit cards.
Money’s Role in Sharing Integral Resources
The divisibility of money also allows it to be used as a means of allocating integral
resources. The ownership of economic organizations can be divided such that they
can be separately owned by any finite number of individuals and other social groups.
For example, commercial companies can be partly owned through the equity share-
holding of banks, other companies or individual people. The consumption of an
integral good or service can be divided between several people by using money. If a
few friends, for example, want to go on a car journey together, they can share the cost
between them by using money. (The car and the journey are both indivisible, the car
by its function, and the journey because it has to be complete.)
The Integrality (Illiquidity) of Some Monetary Assets
Although one of the primary attributes of money is its divisibility in space and time,
some monetary assets are, paradoxically, integral (or indivisible) in time because they
are defined for time periods, e.g. a 60-day time deposit account with a bank, whose
value falls if this period is divided, usually through incurring a penalty cost, agreed in
advance, for transferring value out of the 60-day account before the 60 days have
elapsed. This integrality over time is illiquidity. In general most assets, whether
physical, monetary, or other financial, can be made liquid (i.e. turned into a monetary
asset such as notes and coin or a current account balance) at the risk of a cost penalty.
The difference between a monetary asset, such as a 60-day account, and most other
assets, is that the account is managed by a bank and expected to be a close substitute
for other monetary assets; it automatically becomes another monetary asset (a current
balance) at a fixed date in the future, and its value, excluding interest rate receipts,
fluctuates with that of other monetary assets.
3. Money as Invariant12
Perfect money should retain its value over space and time. Economic variance is the
tendency for resources, including individuals, social groups, institutions, money,
goods and services, their characteristics and their values, to change over space and
time (Barker, 1996, p. 83). Perfect invariance is the persistence of the resource
characteristics completely unchanged over space and time. On the time-scale of the
human race, the daily cycle of sunrise and sunset is perfectly invariant.
over Space and Time
12 I am indebted to Michael E. McIntyre for suggesting the name for this property. The term invariance
is used in mathematics and physics, e.g. in the term automorphism invariance, meaning a special type
of transformation which leaves a relation unchanged (Narens and Luce, 1987). Faden (1977, p. 56)
uses the term isomer, borrowed from chemistry, to indicate a resource not tied down to a specific
region or time instant, i.e. invariant over space and time; the word invariance has more appeal and is
used here with a less precise meaning than that given to isomer.
Barker Endogenous money
Invariance and people
The invariance of the human mind and body is essential for trade over economic
space-time. It allows for the separation of production and consumption across space,
with products made for the domestic market also being suitable for the foreign
market, and for their separation in time, with production having to come first.
One particular characteristic of a person is an invariance through time in
personality and mental facilities, and in physical attributes on maturity. The same
relative invariance can be observed over time in social groups, neighbourhoods,
villages, cities, regions, nations and supranational groups. This allows the
development of continuing, tailored, personal services such as medical, dental or
beauty-care provision at one extreme, and at the other, the ability to recruit new
employees, and the reasonable assurance of employers that their existing employees
will continue to be skilled and experienced; it allows workers to choose new
employers and to be confident of what sort of conditions they are likely to experience;
and it allows for the collection of reasonably consistent economic statistics.
Some aspects of the individual do change in time. People ‘learn by doing’ and
‘learn by consuming’; indeed they learn by experience in all the economic roles they
act out, and modify their behaviour accordingly. Formal education and training also
change the characteristics of individuals so that they cannot be assumed to be
invariant over time in certain key abilities and skills.
The invariance of replicated units
Many, if not most, replicated units (goods and services) have the property of almost
perfect invariance over economic space-time, i.e. they retain their combination of
characteristics in different locations and over time. For example, a tin of Heinz baked
beans, or a Walls Magnum ‘stick product’ (an ‘ice lolly’) are recognizably similar, if
not identical, in different countries and cities, and from one year to the next. In fact,
manufacturers go to great lengths to maintain this invariance as much as possible, and
the commercial rights associated with it are topics of great importance to many
multinational corporations. Recipes and ingredients are commercial secrets and the
subject of extensive legislation regarding their ownership and use.
Economic invariance is not, however, complete and perfect for any resource.
Some allowance usually has to be made for local conditions and changes over time,
partly because of the high costs of maintaining the invariance and partly because of
local differences in taste. For example, European continental taste allowsand even
encourages—flecks of vanilla pod as a visible constituent of a vanilla Magnum; in the
UK until recently this was unacceptable, being regarded as alien to ice-cream.
Correspondingly the appearance of a Magnum and its packaging may be modified
slightly from one year to the next, but not so much that the consumer would notice.
Branding and invariance
The power of branding, the term used by the advertising trade for the creation of a
product, its maintenance in the consumer vision, and its relationship to economic
invariance is illustrated by the experience of the Coca-Cola Company when it slightly
modified the formula for the Coca-Cola drink. The episode, recounted by Schultz
(2001), is revealing about the importance of branding to the producer and the
Barker Endogenous money
consumer. Branding creates an image of a product or service whose quality
characteristics can be relied upon, irrespective of location or date of purchase;
branding helps to identify and safeguard the characteristic of invariance over
economic space-time. The consumer wants some guarantee of what he or she will
eventually receive when a product is purchased for subsequent consumption. The
producer wants to retain consumer satisfaction and a continuing (through time) and
expanding (through space) market for the product.
The value of the branded replicated unit is so great that it can, and is, readily
extended to related products. Associated with Magnum ice-cream is a whole
collection of quality stick products aimed at the adult luxury ice-cream market.
Indeed, the value of a brand can extend to apparently wholly unrelated products, e.g.
the application of the Caterpillar tractor brand to a type of boot. However, the
replicated unit does not need to be branded. It may be just an internationally
recognized standard, e.g. a quality of crude petroleum with characteristics similar to
those of Brent crude oil.
The property of economic invariance extends far beyond replicated units. One
central invariance for human biology and the social sciences is that of the human
mind and body. By and large, the human body retains the same shape and abilities
over space-time. People have become heavier, taller and stronger and they live longer
(although not in all societies), but these changes are rather slow in economic terms,
and relatively smooth and predictable. This relative invariance is relied upon in the
design and manufacture of many economic products, either because these products are
made for the human bodyto eat, to sit in or on, to live, work or sleep in or on, or to
use—or because they require human attendance for their operation, so they have to be
safe and unthreatening, as well as designed for human attention in case they go
The invariance of money
The economic invariance of money over space means that at any given moment large
numbers of almost simultaneous, identical transactions can take place over a monetary
area. Millions of people can buy National Lottery tickets across a country, paying the
same price, and each person can be sure that every other person has the same chance
(per unit of stake) through the fact that money has the same value throughout the
monetary area. Similarly, it may be important that all the people in a profession, say
primary school teachers, are paid on the same salary scale on the same day, for the
same work, throughout the country. The invariance property of money over space
allows such transactions to happen as a normal feature of an economy.
However, it is also the case that many replicated goods and services have different
prices in different locations in the same monetary area at the same time; in some real
way they are location-specific. The invariance-over-space property of money and the
fact that these goods and services are replicated (i.e. they are exactly the same in all
characteristics other than location) allows us to know that they have different
economic values depending entirely on location, and hence to deduce the favourable
and unfavourable locations in particular markets. Since the attributes of locations
normally change relatively slowly over time, a comparison of the prices of replicated
units in different monetary areas, allows for the measurement of international
comparisons of purchasing power.
Barker Endogenous money
5. Perfect Money should be Limited in Supply
Invariance is a fundamental concept in economics, especially for money, allowing
plans to be made and helping to make predictions easier, both for producers in
designing their goods and services with the expectation of a market, and for
consumers in feeling confident that their purchases will give satisfaction when
eventually consumed. Perfect money should be limited in supply, so that its value is
maintained over time.
5. Money as a Numeraire
The characteristic of money as a numeraire is different from that of money as a means
of dividing integralities. In a world where all goods and services are perfectly
divisible, money would still have several other functions including those of a means
of convenient exchange and of a numeraire. This aspect of money (its use in
converting every other resource into one special resource, money, using monetary
units) if taken to extremes (‘economism’), leads the world around us to become
homogenised through common monetary valuation. There are other valid valuations,
such as those associated with aesthetics, love and compassion, and ethics or ‘right’
behaviour, that can contradict or negate the monetary valuation. In other words,
intrinsic values should be distinguished from monetary values (Barker, 2008, section
6. Convenient money
Clearly this is a useful property as money is used as medium of exchange and that
process of exchange will be facilitated by money being available in convenient forms.
For example, money in the form of a debit or credit card is easy to carry around for
use in buying goods and services, but perhaps surprisingly, not necessarily equally of
use in buying monetary services13
7. Attractive money
And money might as well be attractive, as gold, silver, notes and coin.
5. Symmetry in the Spatial and Temporal Roles of
Money in Space-Time Economics
The spatial and temporal variance of money is critical in understanding the
relationship between interest rate and exchange rate policy. The next section provides
an analysis of the demand for monetary assets and an explanation for Goodhart’s
Law: ‘any observed statistical regularity [in the growth of monetary assets] will tend
to collapse once pressure is placed upon it for control purposes’. The effects of
exchange and interest rate changes are then explored, and the relationship between the
two rates is discussed: exchange rates allow exchange of monetary assets over space;
and interest rates allow the exchange of monetary assets over time. Finally the
asymmetrical expectations regarding interest and exchange rate changes as interest
13 In the UK in 2009, it is more time-consuming to transfer money between banks than to buy other
goods and services from retailers via cards.
Barker Endogenous money
rates approach zero are discussed. These imply the potential ineffectiveness of
reflationary monetary policy, with the likelihood of unstable rates over space and
time, as the economic system falls into a Keynesian liquidity trap. In a modern
economy, with innovations such as telecommunications and the Internet, the role of
money becomes even more important simply because at any instant of time, e.g. when
using a telephone or a fax, individuals or groups can transact at a distance purchases
and sales with confidence in the stated monetary value in the different parts of the
economy, in the different parts of economic space. For example, if I wish to send
flowers to someone in another part of the country, I can effectively negotiate with a
distant florist the exact value of the flowers, using the function of money as a means
of exchange over economic space.
Money allows production and consumption to be separated. Without money, the
producer of a particular good or service must first seek out those who wish to use that
particular good or service and is then limited to barter trade. Money widens the scope
of barter exchange, for it is then enough for the producers to accept money in
exchange for their goods and services. On the consuming side of the transaction, no
longer do the consumers need to seek out particular producers in order to conduct
trade, or indeed offer something else immediately useful for exchange. Instead, the
consumers can use money to go to the market and buy the goods and services as and
when they wish.
The existence of money allows the separation of production and consumption not
only across time but also across space.
‘The extent and intensity of the role that money playsismanifested as the
conquest of distance. [It] makes possible those associations of interests in which
the spatial distance of the interested parties is absolutely negligible.’ (Simmel, 1978,
p. 476)
The Role of Money in Continuous Pricing
The lowest value coin, that is to say the smallest indivisible unit of money, is a unit of
almost negligible value in the economy; thus money is as divisible as required. The
divisibility of money is much enhanced in a credit money system where potentially
the smallest unit of money becomes limited by the number of decimal places people
are willing to employ. The divisibility function of money allows prices to be virtually
continuous for individual goods and services so that a replicated good can have one
price in one location, and a different price in another.
The possibility of almost continuous changes in price across economic space may
be illustrated by the prices of a replicated good sold at various stations along a railway
line running across the US, from New York on the Atlantic to San Francisco on the
Pacific. Assume that time can be ignored, that there is a certain amount of
competition between the suppliers of the good, that normal profits are made, and that
there is a market at each station along the route. The price of the replicated good can
and will vary according to the distance from its origin, say New York, along a
continuum according to the transport costs. Assuming rational behaviour, and
allowing for overhead costs, it would be expected that the gradation of price-change
would be more-or-less in proportion to the distance.
Barker Endogenous money
A similar phenomenon can be observed in the price of a fixed quantity of petrol
that varies according to the distance from the refinery. This is a more complicated
example because there are many refineries, many companies, many petrol stations,
and different degrees of competition within the different markets. However, by-and-
large the further the distance of the sale of petrol from the refinery, the greater the
increase in price of the replicated good compared with its price at the point of
The Temporal Role of Money
‘Rhythm may be defined as symmetry in time, just as symmetry is rhythm in space
Rhythm is for the ear what symmetry is for the eye The development of money
...exhibits certain rhythmic phenomena...’ (Simmel, 1978, pp. 488–493)
Money is a convenient, and indeed, efficient, means of exchange over time. This is
particularly obvious over short periods (days, weeks and months) in economies with
low inflation, when monetary assets are treated as invariant over time. In these
periods, the temporal invariance of money allows wages to be paid once a week or
once a month, invoices to be raised and subsequently paid, credit of all sorts to be
issued, and contracts to be made including payment at future dates.
Perfect money can allow the separation of activities over time; it can allow
specialisation at an early stage of production by one social group, and at a later stage
by another; it can allow the separation of production and consumption, of investment
and saving. One of Keynes’ achievements was to explore and analyze the invariance-
over-time property of money, i.e. money as a store of value. Keynes’ insight (1936,
pp. 233–234) was that, in some circumstances, the benefit of holding wealth in the
form of current account balances to take advantage of money as a store of value,
might well completely outweigh the benefit of holding the wealth in the form of
interest-bearing assets. If individuals and social groups become extremely concerned
about the future and the value of non-monetary assets, or if interest rates approach
zero (the liquidity trap), they may well be prepared to forego all interest and other
receipts and hold all their wealth in non-interest-bearing monetary assets in order to
take advantage of the invariant value of money over time.
The Demand for Aggregate Money
The total demand for money cannot be directly observed, except by introspection,
since it includes many forms of money although it may be measurable by the
technique of hedonic functions, when the most important characteristics of the forms
of money in the aggregate are measured and allowed for in the estimation of the
function. However, the demand for different monetary assets is measurable and is
widely measured and, through understanding the nature of this demand, the roles of
the rate of exchange and the rate of interest rate can be explained.
The markets for monetary assets have the following features. Each monetary asset
combines different characteristics of money. All are divisible in space but with
varying degrees of divisibility or liquidity over time. To illustrate, take three
characteristics of money, namely convenience, return and risk are important for an
analysis. Convenience refers to divisibility and use in exchange; return is the
monetary benefit or cost of holding the asset, including the foreign exchange
conversion, interest or other return; and the risk is that of monetary gain or loss in the
Barker Endogenous money
case of illiquid assets. A tentative allocation of different characteristics to different
forms of money is shown in Table 1.
Table 1: Characteristics of money and monetary assets
characteristic notes
& coin debit
cards bank
& loans time
deposits index
••• ••• ••• •• •• ••• ••
•• •• ••• ••
•• •• •• •••
••• •• •• •••
•• •• ••• ••
••• •••
Note(s) ••• denotes: almost perfect
•• denotes: viable
denotes: not very good
As a result of economies of specialization and scale, these assets are available only
in a finite number (i.e. there is no continuous spectrum of assets), each with a
different combination of characteristics. The following seven assets, rated in
domestic currency (£) are chosen for the purpose of this analysis: notes and coin or
‘cash’; debit cards, current account balances in commercial banks; balances in saving
and loan accounts; time-deposits in banks; balances in a fictitious current account
index-linked to inflation which holds its value in spite of inflation by means of a rate
of return guaranteed at the rate of inflation; and foreign exchange values in the
domestic currency. The last asset, a current account in dollars, is included to show
how exchange rates enter into decisions.
The assets are desired for their characteristics, not for themselves. For ease of
understanding, all characteristics are expressed as positive ones, which the holder is
assumed to desire: more convenience, higher return and lower risk. The holdings and
the market are in a state of flux in time with cash being spent, cards being used,
cheques being written, balances being run down and replenished, and time-deposit
accounts maturing. There is a cost in collecting information and making transactions
in the rebalancing of the portfolio of assets to satisfy some criterion, such as a legal
requirement, or the need to avoid an overdraft, or the accumulation of liquid assets to
permit a house purchase. Because of economies of scale and indivisibilities, the
rebalancing is not continual, but periodic; and in many organizations the rebalancing
is done regularly by specialized departments. To offset the costs of rebalancing, there
are monetary gains from shifting the portfolio towards assets with higher returns and
away from the accumulation of losses.
Figure 1 and 2 show a notional individual’s and a nation’s holdings of monetary
assets on 1 January to illustrate the theory. The Figures are each divided into three
Barker Endogenous money
graphs. The top right-hand graph shows the convenience of the asset along the
horizontal axis, plotted against its nominal return on the vertical axis. In general, the
more convenient is the asset, the lower is the return. The lower right-hand graph
shows convenience plotted against risk, with certainty shown along the lower
horizontal axis. The top left-hand graph shows the current nominal value of the
holdings of each asset on 1 January, plotted against the return. The positions of the
assets in the figures are schematic, since it is not easy to obtain or estimate returns, or
risks, let alone ‘convenience’.
If the markets have the features set out as shown above, and assuming that
exchange rates and interest rates are fixed and the economy is growing at say 2% pa
with a similar rate of average price inflation, the positions of the assets in the figures
will follow a pattern as follows.
Figure 1: One person’s holdings of monetary assets, 1 January
Barker Endogenous money
Figure 2: National holdings of monetary assets, 1 January.
1. All the assets will be efficient ones in the sense that none will be dominated by
any other in the combination of characteristics they possess, i.e. none will be
inferior in every characteristic compared with another asset. Note, however,
that only the three characteristics are shown in the Figures. There are other
characteristics that may also be important.
2. The Figures also show that there is plenty of room for new assets to emerge
with new combinations of characteristics which will find a ready market,
although probably at the expense of existing assets that are close to the new
one in its combination of characteristics.
3. Trade-offs between convenience, return and risk suggest the following
relationships: the higher the convenience, the lower the return, assuming that
the risk of the assets in question is equal; the lower the risk, the lower the
return, assuming that the convenience is equal; and the higher the
convenience, the higher the risk, assuming that the return is equal.
4. Since perceptions and expectations of convenience, returns and risk are
changing all the time, there is likely to be a rather poor relationship between a
simple addition of these assets and the measure of activity in the economy,
such as the sum of monetary flow transactions for production, i.e. gross
output. The idea that managing the money supply of money will in turn
manage the level of activity appears to be far-fetched, but it has had great
influence in the conduct of economic policy.
5. The attempted control of the growth of one or a combination of monetary
assets as a means of controlling the ‘supply of money’ or even as a means of
controlling the rate of inflation, is liable to become increasingly ineffective as
the financial system switches to existing or new monetary assets that are not
controlled. This is Goodhart’s Law, named after Charles Goodhart, a former
Barker Endogenous money
Chief Adviser to the Bank of England, and a member of the Bank of England
Monetary Policy Committee.
The Explanation for Goodhart’s Law14
The Law is defined as ‘Any observed statistical regularity will tend to collapse once
pressure is placed upon it for control purposes.’ (Chrystal and Mizon, 2003, p. 223)
The purpose of controlling the “money supply” was ultimately to control the rate of
inflation, following the acceptance of the monetarist analysis of the causes of inflation
in the 1980s, e.g. by the UK Government under Prime Minister Margaret Thatcher.16
The problem is that any particular monetary asset only imperfectly supplies the
services of money, and the financial system may be adept at creating new assets to
perform particular functions of money. In other words, different monetary assets may
be highly substitutable in terms of the monetary services they provide, and indeed
these services are largely unmeasurable. This in turn implies that attempts to control a
specific set of monetary assets (the target), for example by controlling interest rates
(the instrument)
One of the best examples of the Law in action relates to the attempt by the UK
Government to control the rate of inflation by controlling the measure of broad money
£M4 in the late 1970s. £M4 appeared to be a good leading indicator of inflation, so it
was controlled without imposing any other measures to control aggregate demand
(Chrystal and Mizon, 2003, p. 225–226). The attempt failed and inflation rose sharply
in 1979 and 1980, following the second world oil price shock.
The analysis implies further that if a control variable, or instrument of policy, such
as a tax rate on a product such as a carbon tax on fossil fuels, cannot be substituted by
other tax rates, because all are subject to the legal control of the governments, then as
long as the product being taxed cannot be replaced easily by untaxed products, the
generalized Law will not become operative.
, may well fail, because the financial system is sufficiently flexible
in providing the underlying monetary services demanded by social groups. This will
be especially true if the financial system is being deregulated and new financial
services and institutions are being created and tested as in the UK in the 1980s.
The Supply of Monetary Assets and the Level of Economic Activity
One of the principal services required of monetary assets is their use as a means of
exchange, e.g. as a way of buying and selling goods and services. It seems reasonable
14 McIntyre (2000) adds ‘Professor Marilyn Strathern FBA, following Hoskin (1996), has re-stated
Goodhart’s Law more succinctly and more generally [Strathern, 1997]: “When a measure becomes
a target, it ceases to be a good measure.” Goodhart’s law is a sociological analogue of
Heisenberg’s uncertainty principle in quantum mechanics [but with crucial differences relating to
the observed and the observer in the social sciences]. Measuring a system usually disturbs it. The
more precise the measurement, and the shorter its timescale, the greater the energy of the
disturbance and the greater the unpredictability of the outcome. See also the extended discussion
by Hoskin (1996). Hoskin’s article illustrates the wide applicability of Goodhart’s law, and
provides an illuminating historical discussion of what ‘accountability’ has come to mean today.’
15 Chrystal and Mizon (2003, p. 222226) give an excellent assessment of the Law and point out that
it was first formulated and demonstrated in relation to the control of monetary aggregates by means
of interest rates.
16 The theory was developed by Friedman and the Chicago School. It has since been partially
repudiated by Friedman (2003).
Barker Endogenous money
that the stock of assets required for this purpose should be related to the total value of
the transactions involved. However, this value includes not only transactions in the
current flow of goods and services as might be measured by gross output, but also
those involving transfers between people (such as gambling), the exchange of houses
and other second-hand physical assets, and the exchange of financial assets, such as
stocks and shares and foreign currencies. This total value will be very much larger
than gross output, and in countries such as the UK and the US, changes in its price
level are likely to be dominated by changes in prices of financial assets. If the
economy is growing smoothly so that the value of gross output is closely correlated
with the total of monetary transactions, then a relationship between the value of some
monetary aggregate and the value of gross output might appear for a short period in an
economy, but it is unlikely to be stable. It seems even less likely that the effect of
reducing the supply of some monetary asset will of itself reduce the general price
level for the flow of new goods and services.
Exchange Rates and Interest Rates
Exchange rates and interest rates are closely linked, one being the rate for transferring
money over space and the other the rate for transferring money over time. However,
space and time in economics are not symmetrical, and the demand for money is
derived from the demand for goods and services for consumption. Consumption
requires production; and production, in the long term, requires investment. The rate
of interest provides an incentive for those holding monetary assets to agree to abstain
from the use of those assets; one function of the banks and the financial system is to
allow investment to be financed from the savings of those receiving the interest on
monetary assets.
A Change in the Exchange Rate
What will happen if, after a long period of fixed rates, the authorities reduce the
exchange rate, and this change is both unexpected and generally seen as unlikely to be
repeated? There will be a rebalancing of portfolios in favour of assets with a higher
return, in this case favouring $-assets, whose return will be higher in terms of £s; the
value (in £s) of the asset will rise. The holdings of $-assets will rise as a higher return
is sought at the expense of risk and convenience. If devaluation leads to an
expectation that the domestic currency is less stable, then the risk of $-assets will fall,
providing a second incentive to move holdings into them.
A Change in the Rate of Interest
What will happen if, after a long period of fixed rates, the authorities raise the rate of
interest, and this change is both unexpected and generally seen as unlikely to be
repeated? Again there will be a rebalancing of portfolios in favour of assets with a
higher return - the interest-bearing assets. This may take some time, since asset-
holders have to wait until some assets reach maturity before rebalancing their
portfolios, unless the penalty cost is less than the potential gain in extra interest.
Changes in Both the Rate of Interest and the Exchange Rate
When both rates change together, the situation is much more complex and the
outcome less predictable. The various expectations of all those affected come into
Barker Endogenous money
play, each group affecting other groups. Small, apparently inconsequential, events
can change the public mood and lead to large swings in market sentiment.
A whole-system approach
The institutions that create and destroy money should be embedded in any model of
the wider economic system and the system extended to include government and trade,
e.g. to include national economies, governments, investment banks, and non-bank
financial companies dealing in assets. It should also be extended to allow for
systemic risk, and the international-investment banks being unregulated compared to
the national-retail banks regulated by the central banks. The institutions should be
refined in their definitions to distinguish well-behaving economies versus ill-behaving
ones and to include many diverse consumers, producers, governments, prices, wage
rates, monetary assets and interest rates. Finally, the system approach should allow
for space-time symmetry in the prices of money (exchange rates and interest rates)
and asymmetrical expectations and the Keynesian liquidity trap. These features are
discussed in section 6.
6. Implications for Understanding Money and
Monetary Policy in the Current Crisis
Neoclassical, New Keynesian and monetarist theory all tend to be limited in scope so
limiting analysis of key features of the Big Crunch, i.e. that the investment banks
creating loans and financial assets have been unregulated, without central bank
control, that the rapidly changing dynamics of monetary collapse have not been well
understood or measured. The evidence here is that few empirical measures of trust or
uncertainty in the system (volatility over time of various market ratesstock prices,
exchange rates, commodity prices, interest rates) have been widely agreed or
published. In addition, the debate has had weak or no emphasis on (or expected
fitting to) macroeconomic or indeed any data and has been much more oriented to
debate, education and learning. Since the theory has not developed sufficiently to
allow for competing governments (governments make laws, tax activities and spend
to provide public goods) it has not been able to explain “light-touch regulation” or the
emergence of a massive unregulated supply of money that eventually turned toxic.
Well- and ill-behaving economies
Well-behaving economies should exhibit full employment, have no severe structural
imbalances (e.g. urban-rural), with inflation not expected to arise at full employment,
social partners content with distribution of income, stable expectations about the
future, key signals to manage markets “working”, i.e. the central banks being in
control of interest rates via banks’ base rates or exchange rates and finally the rule of
law being generally observed, e.g. bankruptcy when a bank becomes insolvent. The
role of money in well-behaving economies is that, given stable expectations, all social
groups can plan their use of money in an orderly way, and respond to signals
appropriately. This means that the finance ministry and central bank can manage the
economy via signals and incentives, such that credit is created in response to the
demand for credit, which is linked with real investment..
The analysis so far suggests some testable postulates: first, those monetary
aggregates may provide information on, for example, intentions to spend, but they do
Barker Endogenous money
not affect behaviour: people do not spend because they have money, but possession of
money may signify intention to spend. Second, the volume of money in existence can
be ignored in an analysis of the real economic system without affecting the
explanatory power of the analysis, provided that banks provide credit on demand (to
creditworthy customers). When banks apply credit rationing, then the workings of
banks do have a (possible substantial) impact on ability to spend and hence on the real
economy. Third, that when an economy becomes ill-behaving, the policy rules
become misguiding and perverse and money matters again.
The analysis also suggests a theory to explain the Big Crunch. The banks should be
divided into international investment banks that are unregulated and national retail
banks that are regulated by the central banks. The governments should be included in
the theory to make laws, to tax and spend and to provide public goods. The theory is
that effective money supply collapsed to an unknown extent when the Lehman bank
went bankrupt September 15 2008. Effective money demand fell in a vortex of
distrust, increasing debt, collapsing output and increasing unemployment. The rate of
fall of global output and trade has been similar to that of the Great Depression
(Eichengreen and O’Rourke, 2009) suggesting that the collapse is governed by the
inertia in the system rather than the extent of the mistrust. Interest rates, exchange
rates, prices and wage rates become unstable; prices flutter. The outlook may
continue to deteriorate until trust is re-established via the bad banks being made
bankrupt. When trust in banks is damaged, non-banks move deposits from more to
less risky banks and to bank notes. In the specific period September 2008 to
September 2009, trust was partly restored after March 2009, when President Obama
adopted a consensus approach to the banks while injecting substantial liquidity into
the system. However the crisis appeared far from being resolved in September 2009.
Asymmetric Expectations when the Rate of Interest approaches Zero (the liquidity
When interest rates are well above zero, say above 3%, (‘interest rates’, as other
prices in this paper, are always taken to be defined as nominal interest rates) then
expectations will normally be such that social groups will be divided as to whether the
next movement for whatever reason will be up or down. These expectations can be
managed by the banks to reflate or deflate the economy. However when interest rates
approach zero, and since zero is regarded as a floor, expectations become increasingly
deflationary: at zero, any interest rate change can only be upwards, therefore
deflationary and this will have potentially catastrophic effects on the holding on
monetary assets for speculative purposes, a situation identified by Keynes as a
liquidity trap. When interest rates can only rise, bond prices can only fall, so all
bonds will be potentially converted into money at unpredictable rates. Expectations
themselves become unstable because the monetary regime is in uncharted territory as
reflationary monetary policy becomes increasingly ineffective, and all social groups
do not know how the banks and the governments will respond. Command-and-
control policies become the main means by which the authorities can manage the
system, giving a pronounced advantage to systems, such as the Chinese one, which
can respond quickly and effectively to restore effective demand.
Barker Endogenous money
The Japanese Liquidity Trap, 1995–2002
Figure 3: ECB Analysis of risks of a liquidity trap
Source: Coenen and Wieland (2003)
The Japanese economy fell into a liquidity trap in the early 1990s, so there is recent
experience of how it will affect the global economy in 2009. Figure 3 shows the
outcome of a set of stochastic simulations of an econometric model of the global
monetary system operated by researchers at the European Central Bank (Coenen and
Wieland, 2003). The figure shows the chance of Japan falling into a liquidity trap (the
zero bind) at various ‘equilibrium’ rates of interest, with equilibrium defined as the
long-run solution for interest rates. The chance is about 20% for a 2% rate of interest.
The US had interest rates at around 2% in mid-2003, so that if the US monetary
system is at all similar to the Japanese one, there was already an appreciable chance of
the US falling into the trap before the financial crisis took hold, with the risk
increasing by any chance series of deflationary shocks. Monetary and fiscal policy
proved ineffectual to push or pull Japan out of the trap over the 8 years since 1995.
With the US, Japan, and the UK all with near-zero interest rates, there is now a
serious risk of the global economy repeating the Japanese experience in a global
liquidity crisis that could, on past evidence, last for years.
The Risks of Falling into a Global Liquidity Trap in 2009 and 2010
The risk of a liquidity trap has now become substantial at the global level in 2009 and
2010, a far more serious situation than Japan in the 1990s since there are no external
sources of reflation and optimism to help pull the different world economies into
strongly positive expectations and growth rates. Any economy that seeks to reflate
strongly alone, e.g. China in 2009, will see an appreciable proportion of any extra
effective demand leaking to imports, making the policy more difficult to succeed. The
full theoretical and quantitative analysis of the global liquidity trap requires the
understanding, firstly, of how the economic system in particular fixed investments,
responds to interest rates and changes in stocks of monetary assets, and, secondly, of
how economic policy, both monetary and fiscal, operates in small and large open
economies and in the world economy. Here the main reasons for concern are listed.
Reasons for Concern for the World Economy after 2008
Under the policies being promoted by many governments and bankers in late 2008,
the risks of a liquidity trap have increased as various central banks have reduced
Barker Endogenous money
interest rates towards zero. Individual private banks benefit from the liquidity trap
because they can borrow at near zero interest rates and lend at higher rates and hence
restore their balance sheets and restore profitability. However it is not in the interests
of the banking system as a whole because once in the trap, it becomes very difficult
for policies to provide sufficient traction to pull economies out of the trap, certainly at
a country level.
There are several reasons to suggest that the global liquidity trap closed in early
1. The private banks have slowed their own investing. Typically social groups
facing bankruptcy will not invest as much as before for the future, which has become
much more uncertain. Since the banking and finance sector’s investments world-wide
are substantially larger than those of, for example, the electricity sector, the global
economy will experience a recession if the banks behave as if they are bankrupt.
2. The private banks are encouraging savers to save and not consume (a reversal of
their earlier money creation). It is now in their interests to promote saving rather than
consumption as in the pre-crisis periods.
3. The banks are cutting their lending and forcing real-economy companies and
households into bankruptcy. In their efforts to restore their own balance sheet
profitability, they are withdrawing loans and adding stricter conditions for new
lending, so actively reducing growth investment throughout the global economy.
4. Investors are in despair, prices are unpredictable, and carbon prices tend to zero,
hence real investment is in “free fall”. This is despair in the ‘animal spirits’ of
investors in Joan Robinson’s vivid language.
5. Householders are also very concerned and are seeking to restore their own saving
rates, after they have fallen in the US and UK to near zero. The recovery of these
rates to normal levels of about 7% or higher over the next two or three years will
alone bring about a global depression.
6. Governments are also concerned about their long-term balance sheets, and some
are seeking to cut future spending to reduce potential deficits. However, in order to
get out of a liquidity trap, governments must take radical action: print money, spend
aggressively, and hopefully restore the system to stable growth.
7. Globalization accelerates and spreads the reductions in national effective demand
in a “classical” multiplier process. The equipment exporters (e.g. construction,
vehicles, Japan, Germany) suffer first and most. This is perhaps the most serious
deflationary force of all.
World governments in 2009 appear not to understand the depth and scale of the
financial crisis. The situation remains unresolved beyond the governments taking
over the risks to the banking system and meeting to decide new rules on transparency
and integrity, much needed but too late. The key fact is that the co-ordinated actions
over 10–12 October 2008 to the time of writing have not yet restored LIBOR and OIS
rates to “normality”. One solution after another has so far failed to calm the markets
for more than a day or two since the scale of the problem was revealed by the
bankruptcy of Lehman Brothers on 15 September 2008. There is a risk that the crisis
will continue to get worse, that the partial nationalisations will reveal debts toxic even
Barker Endogenous money
at the scale of government debt. It may be that in order to restore trust in markets, to
get the global economy back on an even keel, and to lance the political animosity
building up against the banks, something even more radical needs to be done. This
section briefly summarises the cause of the crisis as discussed above, but mainly
focuses on a global plan to solve it.
The LIBOR Rates
The LIBOR and OIS rates are obvious indicators of mistrust between the banks and
this mistrust will end only when the toxic debt is identified and somehow removed
from the system. The proposed solution of flooding the banks with good money
(government-backed liquidity) will not help because the good money is being added
to untold amounts of the bad money, which has accumulated nearly everywhere with
access to the investment banks’ toxic debt18
Therefore the governments’ guarantees on commercial terms will not restore trust.
The bad banks will remain bad and the bad money will remain diffused through the
system. The state is flooding the system with good money hoping that this will drive
out the bad money, but it is the bad money that appears to be keeping the ex-
investment banks afloat. The end result of adding good money to all this bad money
may be a dollar crash and global hyperinflation. The extra liquidity is therefore
potentially catastrophic for the real economy.
. (There are no major investment banks
left at this stage in the crisis, because the stock markets have valued them as
worthless, or they have been turned into retail banks and given access to liquidity and
the retail banks’ small depositors’ cash.)
The scale of the financial catastrophe
Those managing the money supply understand that we are living through and
observing a non-linear catastrophic event in the global monetary system that requires
fundamental changes in the system to restore trust. However, many bankers are in
denial: they think their banks are “really” solvent; “the markets have gone haywire
and are not to be trusted”; “the herd is panicking”; and we should as soon as possible
return to “normal”. However, a wider assessment of the policy events of the last year
suggests that the bankers themselves have been seeking to support their banks, via
interference by central banks and governments in the operation of the financial
markets to change the rules and take on the private risks.
There is probably a temptation to close the markets, as has been done in Russia
several times since the big crunch. Another temptation may be to suspend bank
shares, to avoid market valuations in a switch from mark-to-market valuation to “fair”
18 An extended analogy of the situation is as follows. In the global village, the bankers are in charge of
the well of clean water needed for health and growth in the global economy and the governments are in
charge of the springs of clean water that all flow into the well. When the banks report that the well and
indeed the ground water are full of toxic debt, that poisons the economy, the governments provide a
tanker of clean water. However, when poured down the well, this proves ineffective and the water
remains poisoned. The bankers request a second tanker, but this time after they have received it, they
refuse to pour it down the well, saying that they need it for themselves; otherwise they too will be
poisoned or bankrupted. The rest of the economy is starved of funding and forced into lower growth
and potential bankruptcy.
Barker Endogenous money
Fundamental reform of the system
. Again, these solutions will not work because the fundamental problem of
the bad money diffused through the system is not being addressed.
No one knows what will work to stop the collapse and restore order. We are in
uncharted territory. A crisis of this magnitude is unprecedented in scale, although not
in relation to previous bank failures and their effects on economies. The problem is
global, a systemic market failure whose correction must involve all the major parties
including at least the main OECD economies and Brazil, India, Russia and China.
Without global coordinated action to restore the market system by forcing the banks
that would otherwise be bankrupt except for state support into bankruptcy, or at least
simulated bankruptcy, it seems very likely that the crisis will continue to deepen and
develop into a twenty-first century Greater Depression (Barker, 2009.
7. Conclusion: Money as Magic
This chapter has briefly summarized the treatment of money in 20stC and 21stC
Keynesian economics. It has then explored in more detail the treatment in Post
Keynesian economics, relying on Fontana (2009) for a review, then developed the
theory by suggesting extensions and expounding the analysis in (Barker, 1996) to
explain seven properties of perfect money, as distinct from the properties of monetary
assets, the monetarist approach to money. The essential symmetry of money over
space and in time is then discussed, and this leads into the use of the theory to
understand the credit crisis of 2007 onwards and propose (briefly) a seven-point plan
for resolving the crisis starting with the bankruptcy of the bad banks.
The analysis also suggests a further property of money that becomes apparent
when it goes bad: money as magic. Money is a mystery (Allen, 1929; Kalecki, 1940).
“Money is also a very vague concept and can only be defined arbitrarily” (Boulding,
p. 67). In English culture, children are asked “Does money grow on trees?” “Does
money come out of a “hole in the wall”?” At a certain age, about 8 to 10 years old,
children treat money as “growing on trees”. Children believe that banks create and
destroy money20
. For children, money is magical in that there is a provider with
complete discretion and the money buys what children want. And there seems no
limit to the supply, because it is not “real”, just attractive coin and note or a
credit/debit card. When the system of money creation collapses, money disappears
like magic, and the world economy collapses.
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... This discussion is drawn from(Barker, 2010).8 The neoclassical approach to money, based on the quantity theory of money, does not make this distinction. ...
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‘New economics’, as outlined in this chapter, is developed from the Post Keynesian approach to macroeconomics to allow for intrinsic values, institutional change and diverse consumers and producers. The chapter presents a self-evident set of assumptions on which to base the theory and then develops an analysis of demand-driven markets within a historical process of globalisation. The asymmetry between consumption and production is emphasised, with production being concentrated and preceding consumption, but consumption being more generalised and causing production. A theory of economic growth through endogenous technological change and increasing trade is presented. Fiscal policies and regulation, with incomes policies, are required to manage the system to achieve full employment, with monetary policies accommodating demand for money. The chapter concludes with a discussion of the quantitative modelling at the global level to represent the economic system in accordance with the theory.
... America followed in 1690, France in 1720, England in 1797, and Germany not until 1806. 8 See Barker (2009) for more discussion of the treatment of money in the literature. ...
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The Big Crunch was the implosion of the global money supply on 15 September 2008, following the bankruptcy of the Lehman Brothers' bank. It was a non- linear and sudden catastrophic event for the global economic system, unprecedented in scale in human history. The initial shock alone has been great enough to provoke at least a strong recession in several industrialized economies (e.g. US, UK, Japan, Germany) even with fiscal stimuli to offset reductions in real investment that are already evident in many economies, particularly in housing. If trust is not rapidly restored, the world economy may face a depression more severe than the Great Depression, 1929-1934. This paper starts by explaining the characteristics of money that are essential in understanding the Big Crunch and then outlines the likely sources and consequences of the crisis as based on loss of trust in money and the banking system. The paper concludes by outlining a seven-point plan for resolving the crisis, including a programme of real investment, which will also kick-start the long-term action needed to avoid dangerous climate change. Global GDP is expected to fall by 2.3% in 2009 and again by 2.3% in 2010 on policies announced as of January 2009. The 7-point plan is projected to limit the decline to 2009. Version: big-crunch v3.doc 1 This paper draws extensively on text in Chapter 3 of the revised edition of Space-Time Economics, (Barker, 1996). See Table 4 in the Appendix of this paper for a contrast between traditional and new thinking in economics. The article introduces some concepts rather briefly where they are covered extensively in the book, which is being prepared for a second edition. The text of the chapter on money is being revised in the light of the financial crisis and its effects on the world's money and economy. 2 This is a draft and comments are welcome. Thanks to Ramona Meyricke for comments on this draft and to Martin Sewell for checking the references. Thanks also to the Three Guineas Trust (one of the Sainsbury Family Trusts) for providing financial support for the development of the E3MG model and the global projections reported in the paper. And finally thanks to Athanasios Dagoumas, Hector Pollitt, Unnada Chewpreecha and Şerban Scrieciu for the team-work involved with developing the projections using E3MG of the depression and its resolution.
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This article outlines a critical gap in the assessment methodology used to estimate the macroeconomic costs and benefits of climate and energy policy, which could lead to misleading information being used for policy-making. We show that the Computable General Equilibrium (CGE) models that are typically used for assessing climate policy use assumptions about the financial system that sit at odds with the observed reality. These assumptions lead to ‘crowding out’ of capital and, because of the way the models are constructed, negative economic impacts (in terms of gross domestic product (GDP) and welfare) from climate policy in virtually all cases. In contrast, macro-econometric models, which follow non-equilibrium economic theory and adopt a more empirical approach, apply a treatment of the financial system that is more consistent with reality. Although these models also have major limitations, they show that green investment need not crowd out investment in other parts of the economy – and may therefore offer an economic stimulus. Our conclusion is that improvements in both modelling approaches should be sought with some urgency – both to provide a better assessment of potential climate and energy policy and to improve understanding of the dynamics of the global financial system more generally.
The paper considers the links between financial system, economic growth and environmental pollution and damages through: (1) investment in the real economy; and (2) financial instruments for environmental policy. The literature on the effect of finance on pollution is dominated by econometric studies of the effect of financial variables on the Environmental Kuznets Curve. The paper reviews this literature and finds that financial development in general, apart from financial crises, tends to reduce pollution. The paper will explain how financial crises affect the environment through reductions in effective demand, by forcing a switch to earlier technologies, and by encouraging the use of lower-cost, more polluting fuels. The paper explores the causative links between the nature of the recession and the reduction in long-term GDP growth via reductions in the share of investment in GDP. This is followed by an exploration of the necessity of investment and green banking in encouraging environmentally friendly development pathways. It will discuss the problems in modelling the effects of the financial system on the real economy, especially in respect of long-term growth and environmental pollution, with a focus on climate change and the mitigation of climate change.
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The author focuses on the money endogeneity in the context of common monetary policy implementation in the euro area. The empirical analysis shows money demand function instability during the financial crisis. The instability is described by decrease in credit money creation and money velocity changes. The cointegration tests identifed long-run positive relationship between monetary aggregates and economic activity. Concurrently, the economic activity is treated to be weakly exogenous in the model. The conclusions are discussed with Postkeynesians’ assumption, that central banks cannot fix the stock of money in a country. The causality is directed from economic activity to money demand.
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The author focuses on the current problems of the common monetary policy implementation in the Eurozone in context of output stabilization function. The author focuses on the money demand function stability and its estimation. The stable money demand function ensures that the money supply would have predictable impact on the macroeconomic variables such as inflation and real economic growth. The instability is described by PoskeynesiansÌ assumptions of money endogeneity. Although central banks may have certain control over the money supply, they cannot fix the stock of money in a country. According to the PostkeynesiansÌ assumptions, the enterprises do not need ex ante stock of savings in order to carry out investment decisions. The causality is directed from economic activity to money demand. Interaction between the money demand and supply is arranged by multiplier effect of deposits.
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Some of the major differences between the approach of Kalecki and that of Keynes on the question of money are outlined. It is argued Kalecki’s approach is closer to that which is now referred to an endogenous money, whilst Keynes’s approach was much closer to an exogenous money view. Their differing views on money have important implications for their views on the causes of unemployment.
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The purpose of this chapter is to consider the implications of treating money as endogenously created within the banking system rather than the more traditional use of the assumption of exogenous money (that is money created by an external agency such as the central bank) for the teaching of macroeconomic analysis and how that teaching could be approached. The underlying view on which this chapter is based is that macroeconomic analysis based on endogenous money has to be substantially different from one based on exogenous money, and the differences are much more fundamental than merely shifting from an assumption that the stock of money is given to the one that the (policy) rate of interest is given (cf. Romer, 2000). With the endogenous money approach, in contrast with the exogenous approach, ‘money matters’ for the level of economic activity and for the evolution of the economy over time2. Expenditure can only take place if it is backed by purchasing power, and expenditure has to be financed through the possession of money, which can come from provision of loans by the banks. The level and composition of expenditure clearly determines what is produced and sold. The decisions on loans by banks influence the number of investment plans that can be financed and which can take place, and thereby the size and character of the capital stock, and hence on the development of the supply side of the economy.
This review contends that the study of consumption and commodities represents a major transformation in the discipline of anthropology. It documents this metamorphosis by examining how the debate on gifts and commodities transcended its original formulation as good versus evil. It then examines the recent growth and maturity of material culture studies and nascent developments that may give rise to a political economy of consumption. It notes, however, that there is still a paucity of ethnographic research specifically devoted to these topics. The review concludes by arguing that the study of consumptiona nd commoditiesis particularly close to traditions established in the study of kinship and it may come to replace kinship as the core of anthropology, even though the two topics often have been viewed as antithetical.
Few disavow the principle that scientific propositions should be meaningful in the sense of asserting something that is verifiable or falsifiable about the qualitative, empirical situation under discussion. What makes this principle tricky to apply in practice is that much of what is said is formulated not as simple assertions about empirical events – such as a certain object sinks when placed in water – but as laws formulated in rather abstract, often mathematical, terms. It is not always apparent exactly what class of qualitative observations corresponds to such (often numerical) laws. Theories of meaningfulness are methods for investigating such matters, and invariance concepts are their primary tools.