Crisis and the Role of Money in the Real and Financial Economies—An Innovative Approach to Monetary Stimulus

Giuseppe Littera,Nigel Culkin,Richard Simmons,Paolo Dini

doi:10.3390/jrfm14030129

Abstract

‘Financial crisis’ is sometimes regarded as synonymous with ‘economic crisis’, but this is an oversimplification and risks missing the feedback loops between the financial and real economies. In this paper, the role of money is revisited in the context of distinguishing the real economy from the financial economy. A theoretical framework is developed to explain how endogenous (bank credit) and central bank exogenous (quantitative easing, QE) money creation feed into the real and financial economies. It looks at how the velocity of monetary circulation varies between the two economies and across asset types within the financial economy. Monetary transmission mechanisms are set into a framework that helps explain how QE stimulus risks combining asset price bubbles with poor growth in the real economy. The real economy transmission mechanism of ‘helicopter money’ is given context, enabling an assessment of the efficacy of both the QE and helicopter money policy routes. Finally, we present a new type of monetary transmission, ‘Smart Helicopter Money’, to deliver monetary stimulus to innovators, SMEs and high-growth firms via both complementary currencies and a modified form of QE in order to achieve proportionally greater impact on the real economy.

Highlights

We postulate that developed nations have an economic base consisting of two separate and distinct economies: the real economy of Main Street, focused on ‘value adding’, and the financial economy of Wall Street, focused upon the wealth management of existing assets
The puzzle that this chart reveals is the subject of our analysis where we present the outline of a theoretical framework to explain how the US Fed’s interventions in March 2020 stabilized financial markets but, despite injecting record amounts of new monetary assets, have failed to restart Gross Domestic Product (GDP) in the real economy
Added, which can be broken down into Traded Gross Value Added (GVA), or J, where the relevant service is traded at a known market price, and Non-Traded GVA, or GNTS, where the service is provided outside the market system

Summary

Introduction

We postulate that developed nations have an economic base consisting of two separate and distinct economies: the real economy of Main Street, focused on ‘value adding’, and the financial economy of Wall Street, focused upon the wealth management of existing assets. The narrative in the real economy is one of output, capital investment, innovation and productivity, whilst in the financial economy it is of increases in existing asset values and yield. Both real and financial economies depend upon money to function and grow. Starting from say 1970, there has been growing divergence largely as a consequence of financial market deregulation. Starting with the breakdown of the fixed-currency Bretton Woods world, through to the repeal of the Glass Steagall Act in 1999, financial regulation barriers have been dismantled and the financial Prometheus allowed to let rip

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Conclusion