Saving Macroeconomics from the Grand Trap of Liquidity

Abstract

Money is neither a product nor an asset but the medium of exchange or “liquidity” as some call it. The money stock (M) can by no means affect the economy when separated from its velocity (V). Unfortunately, however, macroeconomists attach excessive meaning to “money” even though there is no way to estimate its velocity. As a consequence, there are some erroneous money-related ideas, among others, the quantity equation, the liquidity preference, and the liquidity trap. The common root cause for those errors is taking velocity as constant and paying attention to money by itself.

This essay starts from an analysis of lay people’s activities and shows why these three popular ideas are misconceived. On the one hand, we human beings take part in creating products (C) and (new) assets (I) and earn incomes. On the other hand, we buy products for present utility and assets for future utility. Along the way, we trade exiting assets to smooth and maximize our lifetime utility. All through our life, what is critical to us and to the economy is not money per se but a system (“credit line”) which gets the power of purchasing available to us on time. As a matter of fact, money has historically been nothing other than certain ways of credit certification.