Monetary Economics

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Money as a concept is a relative measure of value. Money as a currency is a store of value. Its strength is that it provides a benchmark for comparison of the value of different resources. Its weakness is that value is subjective.

At the risk of stating the obvious, money is our prime measure of economic performance. Our ability to measure economic performance is directly limited by any limitations in money's reliability. Economic leadership and activity based on unreliable information will result in inefficient use of resources.

The thrust of this paper is to argue that money is an unreliable measure, which results precisely in this misguided allocation of resources. To put it another way, if the principles in this paper are correct, we probably compound the misery of tens of millions of people living in the UK through misdirected government policy and through misguided corporate and individual behaviour.

This paper does not seek to provide an improved alternative to money. Rather, it seeks to identify some of the fundamental limitations in the use of money. This is the rationale for the paper on Resource economics looking for ways to compensate for the inadequacies. Using the two economic systems in combination is akin to providing a satellite view of the weather. No-one suggests that temperature and pressure measurements are not useful in predicting or understanding the weather. But the satellite view provides an additional perspective that transforms the use we can make of weather forecasting, despite it being of limited use in isolation.

We use money as an objective measure, but we pay too little attention to its inadequacies. Here are a few illustrations to highlight some deficiencies in monetary value as a measure of output.


1. Poor basis of valuations

We value goods and services by reference to what people pay for them, when measuring the economy. Yet many of the purchasers may value something much more than its cost, depending on how much competition there is in a particular market. In this respect, we end up undervaluing consumption by a potentially material, but unquantified amount.

Valuations based on demand also fail to reflect the value to people who would be happy to buy it, but who are are unable to afford to do so. Similarly, people who feel an item is overvalued rarely buy it. Their assessment of an item's value is also not taken into account.


2. Opportunity cost

We are largely incapable of reliable or useful measurement of opportunity cost, so we largely ignore it. This limits any historic assessment of how effectively an economy's resources have been applied. It also provides the means to vindicate inadequate decisions, and under-emphasises successful decisions.


3. Unskilled valuers

Humans are not skilled in valuation. How much someone is willing to pay for a good or service depends on how they value that item. Yet if we are in a bad mood, we are prone to value it less. In practice, we constantly change our minds about the value of an item, depending both on economic circumstances, on what other people think, and on vary fluid personal circumstances, such as custom or mood. We can not be relied on to know how we much value something. Some examples of human fallibility follow.

3.1 Time frame capacity

Humans are not very good at comparing past or future costs/benefits with current costs/benefits. Very few people are able to avoid overvaluing present consumption relative to future cost, when choosing whether to consume an item now or in the future. Where interest is involved, it is quite frightening how much some people are willing to pay. This lack of capacity makes for some very irrational decisions to be taken, particularly where the borrower is under emotional stress.

The way we use discounting amplifies the time-related issues. The overall net present value of an economy can change dramatically when we change our guess of future interest rates, when literally nothing else has changed. Yet predicting the impact of interest rates is difficult when so many people fail to evaluate properly the reality of future outgoings.

3.2 Valuing technical advance

Issues involving technological improvements are a manifestation of time-frame issues. Technological advance bestows better and less expensive products/services. Monetary economics is not good at measuring the improvements in quality.

It is not true, for example, that the first gramophone system that cost many thousands of pounds in today's terms is better than a modern sound system that costs today only a fraction. Yet the monetary measure of each item would appear to show we are worse off today than before, at least in respect of sound systems.

One explanation for such enormous errors is that money is actually a relative form of measurement, and not an absolute one. Factors that determine the price of an item change over time. Comparison of monetary measurements with a past economy becomes increasingly flawed the longer the interval between the periods.

3.3 Accounting limitations

We use accounts to compare the performance of one entity against another. But there are many, fundamental accounting imponderables which result in material inconsistencies in valuations even where accounting treatment may be consistent (eg. goodwill, valuation of land and property) .

We are not good at working out how to value assets whose useful life exceeds single consumption. What is the cost during a particular time frame of an asset whose resale value is unknowable? We do not value used assets whose costs have been written off, such as a Roman Road along whose path we still travel. How much value should be attributed to the know-how that provided paper on which Einstein could store and prove his theories, and the communication systems used to disseminate them. And what is the value of his individual contribution to the world's wellbeing?

At an even more fundamental level, we are still unsure whether an individuals' wealth should reflect her estimated current asset valuation or her unknowable, discounted net future cash flows.

3.4 Human error

Humans make mistakes when buying goods/services. Some purchases are difficult to evaluate in advance (eg. complex price tariffs, untried goods, overwhelming choice); some are irrational or based on erroneous decision making (eg. poor recommendations, not liking something in practice, failing to appreciate in advance aspects of the item, changing preferences, unawareness of/unable to establish key information prior to purchase); some arise through market viscosity (eg. purchase of faulty item which costs more to return than to keep, in terms of time, money or humiliation); some result from decisions that are too complex for our simple minds (eg. net benefits of ground-source heating in a given situation; are we really worth it?); some mistakes are the result of undue influence (coercion, advertising, peer pressure, cultural demands); and some mistakes result in purchases that are never used. Monetary economics has no substantive accommodation of purchasing mistakes. The amount we pay for an item, on which the value of output is based, does not necessarily represent the benefit it turns out to be.

3.5 Scope of Measurement

Some resources are not paid for. The time taken travelling to work is often entirely ignored, as is nursing a family member or bringing up children (social, cultural and educational development of 100% of the future productive population). Monetary economics focuses its overwhelming emphasis on paid resources. Depending on the definition of productivity, this can result in very much more than 50% of the economy being unmeasured (in developed economies) and even as much as 80-90% (in undeveloped economies).

Slightly more conventionally recognised examples of unmeasured contributions are acts of kindness, black market labour, slave labour, personal support of friends or family, activities of retirees, students, people living outside the law, homeless people, immigrants precluded from welfare support, contributions of many people with mental illnesses, and contributions to Wikipedia and YouTube.


4. Power Plays

Payment for services, including payments to employees, are determined to a great extent by the relative power of the parties involved. In a circumstance of absolute poverty, someone will do a particular block work for much less than someone who is less desperate. In monopoly situations, the opposite is usually the case. The ultimate value paid for goods (which include all the labour costs paid along the chain), depends on the relative power between the buyer and seller. In conventional terms, the extent of competition (such as commercial/structural barriers to resource flows, temporary restrictions, government policy, cultural demands) plays a huge part in determining the ultimate price.

Since we measure output by reference to payment, it should be clear that the monetary measure of output can change when the balance of power shifts, even where output of the economy overall remains static.


5. Quality of Life

Money is a means to an end. The “end” is quality of life. Monetary economics' single biggest failing is that measures only part of the means of achieving quality of life, but not the quality of life itself.


6. Conclusions

Little discussion is held these days regarding the purpose of an economy. Is it to maximise output, to maximise quality of life or to influence social justice? The concept of “improving an economy” means different things to different people, especially to people at different ends of the power spectrum. Some common sense measures of effectiveness of an economy include efficiency of allocation of resources and provision of wealth to its members. Decisions on design of an economy, and its efficiency or effectiveness are predominantly based on monetary measures.

This paper highlights just a few of the inadequacies of money in this task. The consequence is resources are likely to be misallocated relative to the objectives of society. The best tools we have at our disposal by which to steer the economy are fundamentally flawed. That is not to say they are useless, and it goes without saying they have a crucial role. But it is important to recognise quite how flawed are the tools we currently use when evaluating the equally flawed alternatives.

The way we use money to steer an economy is synonymous with a simplistic attempt to determine the productivity of a corn field by measuring the extent of its irrigation channels. In this simplistic analogy, no appropriate measures are available for other growth factors, such as the quantity or quality of sun, the existence of pests or the quality of genes. On occasions, we become so exclusively focused on channels and have such disdain for consideration of the other growth factors, we end up with the bizarre outcome of building so many channels that we decimate the volume of land available for the corn in the first place. In today's economy, one such outcome is characterised in the banking crisis. And in the overwhelming direction of today's economics with its fixation on monetary channels, is that in order to establish how much corn is grown, we don't even try to measure it.

We should open a discussion about what society is trying to achieve, and how well the role of Monetary Economics serves that purpose. We need to recognise the limitations of the monetary tools at our disposal, and search for additional tools to help us improve the quality of society's management.

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