Monetary Economics

Monetary economics is the branch of economics dealing with moneyOpens in new window and monetary relationships in the economy.

This is a broad definition which can include topics such as the reasons for the existence of money, the roles money performs in economic exchange, the transfer of wealth or models of economic growth.

As a branch of economics Opens in new window, monetary economics is concerned principally with monetary relationships in the economy Opens in new window. Hence, it is interested in the links between money and the general level of prices, output, and employment both in the short- and long-term.

However, monetary economics is still often seen as an esoteric subject and is less widely studied than many other areas of economics. This is partly due to the controversial nature of the subject. This, in turn, derives in part from debates over the role of money in the economy and views of precisely what money is Opens in new window.

Monetary economists have been particularly concerned with the relationship between the rate of growth of the money supply Opens in new window and the rate of inflation and the question of the ‘neutrality’ of money — whether changes in the quantity of money in an economy have an impact on the ‘real’ values of output and employment or influence only the general level of prices.

This has led to a great deal of theory but we should always recall that a major aim of monetary economics is to produce a better understanding of the operation and impact of monetary policy Opens in new window:

what, if anything, governments and/or central banks can do to improve the way in which economies perform through the use of the instruments of monetary policy or, at least, to avoid damaging the performance of the real economy.

Monetary policy is now regarded as central to the welfare of households and the profitability of firms. The regular decisions of central banks on interest rates are major new items. Changes in exchange rates are part of every day journalism.

Monetary policy has become so sensitive that over recent years many countries have made constitutional decisions regarding its operation, notably in granting their central banks independence from the political process in interest rate decisions.

Despite this, the study of monetary economics is generally regarded as esoteric — a specialist area tackled by a relatively small proportion of undergraduate economics students. This occurs at least partly because of the controversial nature of the material.

The subject is full of disagreements and conflict. The standard throw away line, that on any subject two economists will have three opinions, seems to apply to monetary economics par excellence.

Even the reasons for the existence of money, the role it plays in economies and its definition have been controversial. It is clear that people talking and writing about money are not always dealing with the same thing.

The word money Opens in new window is used in everyday speech in a number of ways, often in different senses from its meaning within monetary economics. Oxford Reference Online (Oxford University Press) Opens in new window list over 100 quotations using the word money, ranging from the Bible to the Beatles — from “the love of money is the root of all evil” (Epistle of St Paul to the Ephesians, vi. 10) to “For I don’t care too much for money, For money can’t buy me love” (John Lennon).

Many everyday usages do not correspond to definitions of money Opens in new window used by monetary economists. For example, in many of the quotations, money means income or wealth. This is not new. Adam Smith noted in 1776 that “wealth and money … are, in common language, considered as in every respect synonymous” (Smith, 1776, IV, I). In economics Opens in new window, on the other hand, income and wealth can be expressed in money terms but are certainly not synonymous with money.

A greater problem is that even within monetary economics money can be viewed in a variety of ways and different definitions of money follow. And we begin by examining carefully what money is and why it exists Opens in new window.