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ENTREPRENEURIAL ECONOMICS Money and Banking

Explore the world of money, banking, and economics with Prof. Dr. Stefan Kooths at UE Berlin in the summer term 2019. Learn about the nature and impact of money, central banks, monetary policies, foreign exchange systems, and more. Delve into topics like free banking and Target2 imbalances in the Euro Area along with readings on Austrian economics and monetary theory.

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ENTREPRENEURIAL ECONOMICS Money and Banking

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  1. ENTREPRENEURIAL ECONOMICSMoney and Banking Prof. Dr. Stefan Kooths UE BerlinSummer term 2019 www.kooths.de/bits-mb

  2. Contact data Prof. Dr. Stefan Kooths Head of Forecasting Center Kiel Institute for the World Economy Office Berlin In den Ministergärten 8 10117 Berlin 030/2067-9664 stefan.kooths@ue-germany.com www.kooths.de

  3. Outline • Introduction and Overview • Nature and Origin of Money • Finance, Banking, and Credit Creation • Value and Impact of Money • Central Banks and Monetary Policy • Foreign Exchange and Currency Systems • Monetary Reform and Currency Competition • Free Banking (student presentation) • Target2 imbalances in the Euro Area (student presentation)

  4. Outline • Introduction and Overview • Nature and Origin of Money • Finance, Banking, and Credit Creation • Value and Impact of Money • Central Banks and Monetary Policy • Foreign Exchange and Currency Systems • Monetary Reform and Currency Competition • Free Banking (student presentation) • Target2 imbalances in the Euro Area (student presentation)

  5. Curricular context • Subjectivist theory of capital • Capital and production as a structure • Hayekian triangle • Input-Output-Analysis • Capital accumulation and growth • Time preference • Intertemporal coordination • Interest theories (in particular agio theory of interest)

  6. Reading • Menger, C. (1892): The Origins of Money; Economic Journal (2), 239-55. • Mises, L. v. (1953): The Theory of Money and Credit; New Haven, Conn.: Yale University Press. • Huerta de Soto, J. (2009): Money, Bank Credit, and Economic Cycles; 3rd ed., Auburn, Ala.: Ludwig von Mises Institute. • Hülsmann, J. G. (2008): The Ethics of Money Production; Auburn, Ala.: Ludwig von Mises Institute. • Hülsmann, J. G. (2012, Ed.): Theory of Money and Fiduciary Media – Essays in Celebration of the Centennial; Auburn, Ala.: Ludwig von Mises Institute. • Mayer, T. (2018): Austrian Economics, Money and Finance. London: Routledge. • Rothbard, M. N. (2011): The Austrian Theory of Money; in: Economic Controversies; Auburn, Ala.: Ludwig von Mises Institute: 685-707 • Salerno, J. T. (2010): Money – Sound and Unsound; Auburn, Ala.: Ludwig von Mises Institute.

  7. Reading on Target2 imbalances in the Euro Area • Sinn, H.-W., and T. Wollmershäuser (2012): Target loans, current account balances and capital flows: the ECB’s rescue facility. International Tax and Public Finance, Vol. 19 (4): 468-508. • Kooths, S., and B. van Roye (2012): Euro Area: Single Currency - National Money Creation. Kiel Working Papers, No. 1878. • Fiedler, S., S. Kooths and U. Stolzenburg (2017): Target (im-) balances at record level: Should we worry? In-depth analysis for the European Parliament, Committee on Economic and Monetary Affairs, Brussels. • Gern, K.-J., S. Kooths and U. Stolzenburg (2019): Euro at 20: The Monetary Union from a Bird's-eye View - A concise critical assessment. In-depth analysis for the European Parliament, Committee on Economic and Monetary Affairs, Brussels.

  8. Outline • Introduction and Overview • Nature and Origin of Money • Finance, Banking, and Credit Creation • Value and Impact of Money • Central Banks and Monetary Policy • Foreign Exchange and Currency Systems • Monetary Reform and Currency Competition • Free Banking (student presentation) • Target2 imbalances in the Euro Area (student presentation)

  9. Brainstorming • What is money?

  10. (The enigmatic phenomenon of) Money One of the greatestsocio-cultural achievementsof mankind

  11. Nature of money: Conventional (textbook) view Deutsche Bundesbank, Money Museum

  12. Essence of money as an economic category Generally accepted medium of exchange • Unit of account (numéraire): follows, not specific • Store of value: necessary, not specific

  13. Direct vs. indirect exchange • Direct exchange (barter trade) • A  B • Double coincidence of wants • Indirect exchange (via money) • A  M, M  B • M must be more marketable than A and B • Vast reduction of transaction cost (search and matching) • Dramatic deepening of division of labor (specialization) • Allowing for open societies (complex and anonymous)

  14. Money as a good sui generis • Objects of consumption (1st order goods) • Means of production (higher order goods) • Medium of exchange (money) • Pervasive good • Utility does not depend on quantity

  15. Evolutionary vs. regulatory origin of money • Evolutionary learning • Discovery by individual human interaction (social process) • Fruit of indirect exchange and increasing specialization • Knies (“Geld und Credit” 1873), Menger (1892) • Different degrees of saleableness (liquidity) of commodities • Money as a spontaneous product of the market • State regulation (Chartalist School) • General convention or law • Plato, Aristoteles, Romans, …, Roscher, Knapp (“The State theory of money” 1905), Peacock (“Introducing Money” 2013) • When? Why around the globe?

  16. Spontaneous (= evolutionary) order “Social structures of all kinds were the result of human action,but not the execution of any human design.” Adam Ferguson (1782)

  17. A (very short) history of money IMedia of exchange around the globe Deutsche Bundesbank, Money Museum

  18. A (very short) history of money IIStone money: The world’s largest currency Island of Yap (Federated States of Micronesia) Deutsche Bundesbank, Money Museum

  19. A (very short) history of money IIIEmergence of coins (700 BC) Deutsche Bundesbank, Money Museum

  20. A (very short) history of money IVEmergence of banknotes (1000 AD) Deutsche Bundesbank, Money Museum

  21. A (very short) history of money VHard and heavy money (Sweden, 1700 AD) Deutsche Bundesbank, Money Museum

  22. A (very short) history of money VIFirst bank notes in Europe (Sweden, 1700 AD) Deutsche Bundesbank, Money Museum

  23. Money production, minting, and sovereigns • Precious metals • Homogenous • Durable • Reversibly divisible • Ideal characteristics for medium of exchange • Transaction costs • Weighing (e.g. gold balance) • Checking the degree of purity (fineness) • Standardization (minting) • Sovereigns • Monopolization of minting • Diluting purity (inflation) • Conflict of interest: Standard setting vs. fiscal financing Seigniorage (profits from counterfeiting)

  24. Seigniorage SourceKemmerer, E. W. (1944): Gold and the Gold Standard – The Story of Gold Money, Past, Present and Future; McGraw-Hill, New York; p. 22

  25. Money proper and money substitutes Money in the broad sense • Money proper(money in the narrow sense) • Useful to make bids for other goods in market exchanges • Not a claim on other goods • Money substitutes • Money certificates(full coverage) • Fiduciary media(no coverage) claim

  26. Classification of money (Mises)Following Hülsmann (2012:34) • Money proper • Commodity money • Precious metals • Other • Credit money • Fiat money • Fiat token coins • Fiat notes • Fiat bank deposits • Money substitutes • Money certificates (100%) • Token coins • Notes • Bank deposits • Fiduciary media (0%) • Token coins • Notes • Bank deposits

  27. Monetary transformation:From commodity money certificates to fiat money I PROMISE TO PAY THE BEARER ON DEMAND THE SUM OF TWENTY POUNDS

  28. Monetization/Monetary Transformation: Regression theorem (Mises) ? Purchasing power of money • Application of subjective theory of value to money • Purchasing power (PP) = value in exchange • Value of money = industrial value (consumption, production) + value as medium of exchange (additional use) • Sequence of valuation: PP of immediate past  today • Regress back to first appearance as medium of exchange (monetization) • Historically-continuous component in exchange value of money depends on thedemand for money Demand for money depends on its purchasing power

  29. Demand for money and uncertainty/disequilibrium Human action takes place in a context of uncertainty Demand for sums of money to be held in reserveagainst unforeseen or uncertain expenditures

  30. Outline • Introduction and Overview • Nature and Origin of Money • Finance, Banking, and Credit Creation • Value and Impact of Money • Central Banks and Monetary Policy • Foreign Exchange and Currency Systems • Monetary Reform and Currency Competition • Free Banking (student presentation) • Target2 imbalances in the Euro Area (student presentation)

  31. Financial capital markets Financial capital (loanable funds) = Temporary transmission of purchasing power

  32. Markets for securities • Securities (in a broad sense) • Shares • Bonds • Credit contracts • IOUs • … • Documented claims to (re-) payments • Market sides and transactions • Demand for capital = Supply of securities • Supply of capital = Demand for securities • Exchange of present purchasing power for future purchasing power

  33. Financial intermediation in the macro economy:Circular flow diagram (expenditures and loanable funds) Expenditures (products) | Income flows | Financial flows

  34. Financial intermediation in the macro economy: IS-Identity

  35. Economic system (monetary flows): Surplus and deficit sectors Private investment Gross income Households Firms Private consumption Taxes Imports Capital market Private investment Savings Net exports Publicbudgetdeficit Exports Transfers RoW Government Public consumption and investment

  36. Economic system (monetary flows): Surplus and deficit sectors Private investment Gross income Households Firms Private consumption Taxes Imports Capital market Private investment Savings Net exports Publicbudgetsurplus Exports Transfers RoW Government Public consumption and investment

  37. Economic system (monetary flows): Surplus and deficit sectors Private investment Gross income Households Firms Private consumption Taxes Imports Capital market Private investment Savings Net imports Publicbudgetsurplus Exports Transfers RoW Government Public consumption and investment

  38. Interest rate and market for loanable funds LFS=S i i* LFD=I + BD + NX LF

  39. Money market ?

  40. Reminder: Flows vs. stocks • Flow  period of time • Production • Savings • Investment spending • Stock  point of time • Wealth • Money

  41. Money market in a credit-backed monetary system (1/2) • Demand side: Money using real sectors (non-banks) • Private households • Companies • Government • RoW • Demand for money (L) • Supply side: Money producing banking sector (banks) • Commercial banks • Central banks • Supply of money (M) • Transactions • Exchange of securities • Production of money via credit creation (out of thin air) Monetary financial institutions (MFIs)

  42. Money market in a credit-backed monetary system (2/2) • Demand for money = Supply of securities • Supply of money = Demand for securities • Transactions between real economy and banking sector

  43. Financial markets Supply of capital(savings) Securities markets(shares, bonds) Demand for capital(investment) Credit market Credit intermediation Money supply Money demand Credit creation Banking sector Supply ofsecurities Demand forsecurities

  44. Interest rate and loanable funds including money market LFS=S i LFS=S+M i* iM LFD=I+BD+NX LFD=I+BD+NX+L LF

  45. Money production via credit creation: Balance sheet expansion

  46. Fractional-reserve banking: Central bank money and money supply • Monetary base (MB): Cash + Reserves • Cash = Currency in circulation • Reserves = Deposits of commercial banks at the central bank • Money supply (M): Cash + Demand Deposits • Cash = Currency in circulation • Demand deposits = Deposits of non-banks at commercial banks • Fractional-reserve money production • Reserves < Demand deposits (reserve ratio < 100 percent) • Interaction of central bank and commercial banks • “Public-private-partnership” (T. Mayer)

  47. Fractional-reserve banking: Balance sheets by financial and non-financial sectors

  48. Economic system (monetary flows): Surplus and deficit sectors Private investment Gross income Households Firms Private consumption Taxes Imports Capital market Private investment Savings Net exports Publicbudgetdeficit Exports Transfers RoW Government Public consumption and investment

  49. Economic system (monetary flows): Financial intermediation Private investment Gross income Households Firms Private consumption Taxes Imports Capital market Private investment Savings Net exports Publicbudgetdeficit Exports Transfers RoW Government Public consumption and investment

  50. Economic system (monetary flows): Financial system Private investment Gross income Households Firms Private consumption Financial system(market for securities) Taxes Imports Shares, Bonds Private investment Savings Creditintermediation Capital market Banks Net exports Publicbudgetdeficit Exports Transfers RoW Government Public consumption and investment

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