In a recent issue of this journal, Louis-Philippe Rochon (1999) compares three distinct approaches to money creation--the neoclassical view, the Post Keynesian view, and the circuit approach. Through this juxtaposition Rochon aims to clarify the economic roles that banks, money, and finance play in developed capitalist economies. He also seeks to provide some guidelines that might lead to a general theory of money. Such a theory is needed because neither the neoclassical view of money (which sees money as a means of exchange with no real consequences) nor the major heterodox alternatives (such as Post Keynesian theory, Sraffian economics, and institutionalist economics) have set forth fully satisfactory explanations of how and why money affects the macro economy.
Rochon argues that ultimately the Post Keynesian approach comes too close to the orthodox approach to money. Both emphasize the importance of the supply and demand for money and both see money primarily as an asset rather than as a flow. Rochon goes on to support the circuit approach as the most reasonable of the three theories and the one most likely to yield a general explanation for the role of money in economic activity. Circuit theorists reject the supply and demand approach to money and focus on flows of money rather than on stocks. After a brief summary of the circuit approach, which (following Rochon) examines how money flows through the economy, this note will focus on some of the major limitations of that approach.
The Circuit Approach
According to Rochon, the first phase of the money creation process is that firms must decide to invest and expand production. But to invest, firms have to be able to buy resources--new capital equipment, more parts, and the labor services of workers. This takes credit, which is in short supply, and constitutes the "primary constraint operating on firms' production plans" (8).
Once firms have decided to expand production, the next step is obtaining financing in order to implement their plans. This means that firms need access to bank credit. Rochon notes disagreement on the question of what actually gets financed through credit. Some individuals within the circuit school argue that credit is needed to finance new investment, while others see only wage costs as the cause of borrowing from banks. In any event, some credit is needed to finance business expansion, so firms must borrow from banks. This creates bank deposits and money. At bottom, according to the circuit approach, "the demand for credit is made at the initiative of the customer" (9).
This leads to step 3 of the circulation process, where decisions are made...