An interesting and useful
analysis of a monetary system appears in the paper titled, A
General Analytical Framework for the Analysis of Currencies and Other
authored by Warren Mosler and Mathew Forstater. The paper can be
viewed at http://www.warrenmosler.com.
Following is a brief synopsis.
Components of Money
The model to be
presented in two parts, referred to as the vertical component
the horizontal component to aid in visualization. The
component is illustrated in the following diagram:
and Central Bank)
The horizontal component (not
to the expansion and contraction of credit in the private sector.
The Vertical Component
At the top is
the State, which
is the sole issuer of units of currency in all of its
At the bottom is the consumption of that currency resulting
taxes paid to the State. The middle is occupied by the private
which exchanges goods and services for the currency units, and
what is left over after taxes (State deficit spending) in the form of
in circulation, reserves (clearing balances at the State's Central
or Treasury securities ("deposits" offered by the CB). Central
policy determines the relative distribution of the accumulated currency
units in the private sector. State deficit spending determines
magnitude of those accumulated financial assets.
Agents are said to participate in vertical activity when
State currency, pay taxes to the State, or intermediate the
Since taxpayers must pay taxes in State currency, they are motivated to
offer goods and services in the private sector in that currency.
There naturally follows a general recognition and acceptance of that
of account in private sector transactions.
is what the private sector uses to ‘finance’ business activity and
the economy. In contrast with the vertical component which is
the horizontal component is endogenous. It is a leveraging in the
vertical component. It grows or contracts as the demand for
grows or contracts, but it always nets to zero. That is, private
sector credit is balanced by an equal private sector debt. Credit
in the form of bank deposits achieves credibility by virtue of its
to State currency.
when a buyer desires to make a purchase by borrowing that which the
demands. If the buyer borrowed directly from the seller, the item
sold would be exchanged for an IOU of the buyer, denominated in the
currency unit. Depending upon one’s definition, that IOU can be
a form of money.
The Role of the Banking System
be intermediated by a bank. If the seller did not want to accept
the note of the buyer, but would accept a bank deposit, the buyer could
go to a bank and request a loan. If approved, the bank would hold
the buyer’s note and grant the seller a deposit in the bank. In
role, a bank assumes the credit risk of the buyer and would need to
a rate of interest sufficient to cover that risk.
allowed to function
as intermediaries between the State and the private sector. This
happens whenever a bank check is used for payment of taxes. The
system accepts funds from the State as needed to cover checks submitted
for clearing, on terms that are dictated by the State.
the State must
spend or otherwise provide that which is necessary to pay taxes.
The private sector will normally desire to obtain more currency units
the State than the minimum required in exchange for its goods and
The extra units accumulated are net private sector savings of
assets denominated in the unit of account.
If the State
does not provide
the opportunity to net save desired by the private sector, horizontal
cannot make up the difference. The clearing of any shortage must
involve the vertical component, i.e. the action of the State.
the Central Bank can resolve a reserve imbalance.
State deficit spending could result in a deflation that stabilized only
when prices fell enough for the private sector to lower its collective
desire to net save. This implies price sensitivity to supply and
demand changes that may originate in the vertical component. Only
when the State runs a fiscal policy that allows the private
to hold the desired level of net financial assets will fiscal balance