Nick Rowe, Scott Sumner, and most recently, David Glasner, all say that the US's current medium of account is the dollar. I disagree. I think that the current medium of account is CPI units. Here's why.
First, there's been some sloppiness with definitions in the links above, so let's define the term. The medium of account is whatever defines the unit of account. I think this a pretty standard definition. That's Bill Woolsey's definition here. David echoes this definition in his comment here.
Take an old-style central bank that holds 100% gold reserves in its vault. It chooses the word "dollar" to stand as the unit of account. The bank then goes on to define the dollar as equal to x grains of gold. Thus the medium of account is gold. Our central bank issues paper notes which are to be used as the medium of exchange. Shopkeepers post prices in terms of the unit of account, the dollar, and accept notes as payment. Some shopkeepers might even choose to post prices in grains of gold rather than the dollar unit of account. If they do, this won't affect the fact that gold remains the medium of account.
Inspired by the Bank of Canada, our 100% gold bank chooses to sell all its gold for bonds. Next it chooses to redefine the value of the dollar as an idealized basket of consumer goods that declines in size by 3% a year. It threatens to do open market operations in a manner that ensures that its definition sticks.
What has changed? Shopkeepers continue posting prices in the unit of account, the dollar. Notes issued by the central bank are still the medium of exchange. But the definition of the dollar, the medium of account, has changed from a quantity of gold to a gradually shrinking quantity of consumer goods.
Some shopkeepers might even post prices in terms of this imaginary basket of goods. When shoppers arrive at the till to pay, they obviously can't hand over CPI baskets. Rather, the shopkeeper will download the central bank's most recent CPI-to-dollar ratio and quote the customer their final price in terms of notes, the medium of exchange.
To sum up, in moving from a fully-reserved gold bank to a modern CPI targeter, all that's happened is that our central bank has changed the medium of account from gold to CPI. Nick has to understand where I'm coming from since I'm just using the same technique he used in this post.
JP: Hmmm. You seem to have hoist me on my own slippery slope!
ReplyDeleteI'm not sure. When Canada had fixed exchange rates to the US, would you say that the Canadian medium of account was the US Dollar? (Would you also say, by symmetry, that the US medium of account was the Canadian dollar??)
Nick, when the C-dollar was fixed to the US, it would seem to me that the Canadian medium of account was the US dollar. As for the US, dunno. I think the US's medium of account would have still been gold, at least during Bretton Woods. 1/35 oz.
DeleteBut the medium of account idea is a new one for me, I'm just playing around with it and am pretty open to being dissuaded. What do you think the medium of account was when the C-dollar was fixed to the US$?
JP: I would say it was still the C Dollar. On the grounds that....hmmm....there's a distinction between the social fact of what good people choose to express prices, and what it is the Bank of Canada chooses to target? Dunno. Your post has made my views more fluid too.
DeleteBTW (off-topic) last night I emailed William Parke recommending he add your blog to Economics Roundtable. I see he has now done so. http://www.rtable.net/index/rt/economics/recent/
ReplyDeleteSo that was you! I saw that last night. Thanks, Nick.
DeleteWhy aren't the bonds that the central bank has exchanged for gold the new medium of account? It seems like if you are arguing that gold was the medium of account as defined by the balance sheet relationship of the bank's assets to it liabilities you can't ignore the fact that the bank now has a new asset in place of the gold.
ReplyDeleteScott, that's a good question. Firstly, I borrow my definitions from Bill Woolsey who in turn contributed to the New Monetary Economics (NME) wave of the 1980s. These economists broke down all of money's various functions into component parts and gave a name to each one. Since they've already done the work, and done it well, I defer to them.
DeleteNME introduced one other definition I haven't touched on: settlement media. For instance, in the BFH (Black-Fama-Hall) System, one of NME's core models, the dollar was defined as a bundle of consumption goods. This definition was enforced by sales and purchases of gold in the market. The precise quantity of gold used to redeem dollars would have a market value equal to that of the bundle of goods defining the dollar ie. it was variable. In BFH, gold was referred to as the settlement media. The bundle of goods was the BFH's MOA.
In our case, the dollar is also defined as a bundle of goods, but the settlement media is bonds. I hope that makes sense. Sorry to throw so many definitions at you.
It seems simple to me - the medium of account is defined by the legal tender laws. If US dollar currency is legal tender, then you must expect to receive US dollar currency in settlement of debts owed to you, and nothing better (and similarly, you may use US dollar currency to pay your debts). If the Fed decides to raise its inflation target or Canada stops pegging to the US dollar, you have no recourse to ask your debtor for something other than US dollar currency. And by the way, I would consider US dollar currency as the medium of account, and the US dollar as the unit of account. The distinction is clearer in the case of the UK, in which the medium of account would be sterling and the unit of account the pound, or China, in which the medium of account is renminbi and the unit of account is the yuan.
ReplyDeleteRebel, it sounds to me like we are using different nomenclature. What is the word you use to represent the fact that a pound in the 17th century was defined as 113 grains of gold? In the language I've been using, unit of account refers to the word "pound", the medium of account ie. the definition of the pound, is gold, specifically 113 grains worth.
DeleteLegal tender laws set out the medium-of-exchange that must be used in certain transaction, at least in the language I've been using. Slightly off topic, but Dror Goldberg wrote an excellent paper on the meaning of legal tender, it's worth a read.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1292893
I have not yet read in detail the blog exchanges you mention, so perhaps I misunderstand the standard meaning of "medium of account", but I would expect it to mean the thing in which wealth and obligations are expressed, and the unit of account is the quantity of that thing used as a counter - in the case of sterling, it could have been pennies instead of pounds. What you describe sounds like a (Isaac Newton's) gold standard to me. But, unless gold was declared as the only legal tender, the gold standard was just a guarantee by the issuer of the currency, and had no legal bearing on everyday contracts unless they had a gold clause.
ReplyDeleteThe definitions I'm using for medium of account, unit of account, and medium of exchange come from NME (see comment above). Here is an example:
Delete"A medium of exchange is an asset that is widely accepted in trade and to settle financial obligations. Currency notes or transferable bank deposits are typical examples. A medium of account is the commodity defining the unit of account. A unit of account is a specific amount of the medium of account. For example, for the gold standard the medium of account is gold, while the unit of account might be one ounce or one pound of gold of specific purity. A unit of account is the unit in which the medium of exchange and other assets are denominated and in which other values and prices are expressed."
Warren Coats, 1994.
A medieval debt might be expressed in terms of the unit of account, pounds, or in terms of the medium of account, grains of gold, or in terms of the medium of exchange, say guineas or sovereigns.