Two kinds of money

1. The good kind;
2. The bad kind

The good kind is “whole money”. That is, it is both the MoE and MoA. Bad money loses its MoA property, but keeps its MoE property. In that sense you could say, like Scott, that MoA is money´s defining characteristic or “the essence of money”. I would say “that´s good money defining property”

Bad money reflects a “sickness” in the economic fabric. Usually this sickness is manifested in very high, rising AND uncertain inflation. In those situations people search for “something” to play the role of MoA. That “something” could be gold, but in modern times the dollar is the usual stand in for the MoA.

Brazil provides an interesting experiment. For almost two decades inflation was high, rising and uncertain. Not many countries have gone on functioning for so long with that “sickness” hanging about (Argentina, for example, quickly “dollarized”, with the dollar becoming both the MoE and MoA). Brazil managed to create all sorts of palliatives to mask the sickness, and they usually worked for a time. Then, a new set of “anti-aids cocktail” was created and the country marched on. The “palliatives” were even reflected in architectural designs. If you visit apartments built in the 1980s and early 1990s, you will be surprised by the size of the pantries, sometimes just as large as the kid’s bedrooms.

Sometimes we were so “smart” that we managed to have a constant 23% per month inflation for all of twelve months. That actually happened between late 1991 and late 1992. It ended up in smoke when the new president told the nation he was very distraught because his mother could not afford to buy medical drugs. Immediately inflation took off, climbing to 30% and then 35% (that´s per month). Those “kind words” from the new president signaled that once again the country would resort to price-freezes and everyone rushed to get his own price quickly higher.

The chart below shows the last stretch of (hyper)inflation, which followed on the president´s thoughts on medical drug prices.

By February 1994, inflation was 40% (per month). On March 1^st future president Cardoso, at the time the Finance Minister, introduced a new “MoA”, the “URV” (“Real Unit of Value”). At that date all prices were converted into URV at a stated “exchange rate”. During the next four months, until June 30, everyday a new “exchange rate” between the MoE (at the time called the Cruzeiro Real (CR$)) and 1 URV was posted. While MoE prices were rising MoA prices were stable.

The URV was the MoA and prices were quoted in URVs. What happened? Now there was a “stable” MoA. Shopkeepers who felt their URV price, which had been determined freely on March 1^st , was “too high”, lowered it. Shopkeepers who thought their URV price was “too low” increased it.

On June 30, presuming an “equilibrium” price level in URV had been established (with relative prices having had the time to adjust), the government announced that on July 1^st the URV would disappear. The new MoE AND MoA would be called Real and 1 Brazilian Real would equal 1USD. In effect, the exchange rate to the dollar became the anchor of the new currency.

Things worked perfectly, so that by August inflation had fallen from almost 50% in June to “just” 2%. There was no recession and no unemployment. Demand for the new “good money” soared and the Central Bank accommodated.

On January 1999 the foreign exchange anchor was abandoned. The real depreciated by 100% between December 1998 and February 1999. You wouldn´t have guessed something so drastic took place by eyeballing the monthly inflation chart above.

That happened because the MoA property of the real remained “standing”. That it did so was mostly due to the fact that Brazil quickly introduced (with surprisingly “instant credibility”) an inflation targeting regime as the new anchor for the domestic money.

For “money” to have meaning it has to have both properties, otherwise you are in limbo. If the central bank only worries about the MoA property of money it will be concerned only with inflation (because that´s what is able to “destroy” that property). If it is concerned with overall economic stability, it will do better by pursuing an NGDPL target. If it does that, it will be concerned also with the MoE property of money and thus avoid undesirable economic fluctuations.

Other discussions on the “MoE/MoA” properties of money are:

Scott Sumner (who got the ball rolling)

Nick Rowe, and

Bill Woolsey