The upcoming discussion will update you about the difference between Gross Money Doctrine (GMD) and Net Money Doctrine (NMD).
Gurley and Shaw have made a distinction between Gross Money Doctrine (GMD) and Net Money Doctrine (NMD) for monetary analysis. In their “modified second model”, they divide the economy into three sectors – consumers, business firms and government. In the financial market, there are deficit spending nonfinancial units, surplus income units, and financial intermediaries.
They deal in primary and secondary securities which are called financial assets. Financial assets are further divided into inside financial assets and outside financial assets. Inside financial assets consist of financial claims by one class of individuals and firms on others within the economy.
When banks create deposits through loans and advances to individuals and firms, these return to them as secondary deposits. Inside financial assets are called inside money which is based on domestic primary securities.
Outside financial assets come from outside the private sector. They consist of money issued by the government, gold, and foreign and government securities. It is called outside money which is based on the debt of a unit (the government) exogenous to the economic system.
G-S explain the relationships among the three sectors of the economy for monetary analysis in the framework of sectoral balance sheets. The first framework relates to NMD in which money is entirely of the inside variety. NMD is that which nets out all private domestic claims (i.e. financial assets) against counterclaims (financial liabilities). It, in turn, means that the net financial assets of the private sector are zero.
The regard NMD as inappropriate for monetary analysis because it includes money held by the business and consumer sectors and excludes that held by the government and monetary sector. On the other hand, GMD includes both inside and outside financial assets. Therefore, this doctrine is relevant for monetary analysis.
These two doctrines help in estimating the supply of money for monetary analysis. The aggregate stock of money in an economy consists of currency issued by the monetary system plus demand deposits. Here currency is outside money and demand deposits are inside money. Under GMD, the gross money supply equals the sum of inside and outside money.
The aggregate stock of money supply is equal to the amount of inside securities held by the monetary system. The aggregate stock of outside money is equal to the assets held by the monetary system in the form of gold, foreign and government securities.
Thus a given stock of outside money, according to GMD, is the aggregate money stock minus inside money. But, according to NMD, it is the sum of the value of gold, foreign securities and government bonds. This is because under it the net value of inside money is zero. That is why G-S favour GMD for monetary analysis.
Next, G-S discuss the determinants of the demand for real balances in the context of these two doctrines. In NMD, the total stock of real wealth is the sum of the real value of the currency and foreign securities and government bonds. In other words, it is the sum of outside money and bonds. Thus the determinants of the demand for money for real balances are the stock of real wealth, yield on real wealth, interest rate on bonds and real income.
The real value of private sector securities is excluded from independent variables. On the other hand, the total stock of real wealth in GMD includes the real value of both outside and inside assets. The determinants of demand for real balances are the physical stock of real wealth, real income, real interest rate and nominal rate of interest.
According to G-S, an economy with only inside money is “money-less and bond-less”, so that its price level is indeterminate. Patinkin does not agree with G-S that the price level is indeterminate. According to him, an increase in the price level will not affect any demand functions in such an economy. It will be decreasing M/P, create an excess demand for money and an excess supply of bonds.
This will increase the interest rate, thereby creating an excess supply of commodities and bringing down the price level again. He, therefore, finds no basis for G-S’s contention that NMD leads to indeterminacy and that “the net money doctrine overlooks the bearing of portfolio balance on real bahaviour”.
So far as the portfolio balance is concerned, the increased price level disturbs the portfolio equilibrium of the private sector by decreasing its real money holdings relative to its bond holdings, and the attempt of the private sector to reestablish equilibrium will cause the system to return to its original position.
Patinkin also contradicts another argument of G-S that the net money doctrine implies that the “management of inside money cannot come to grips with the rate of interest.” G-S argue that open market purchases will not affect the rate of interest when money is of inside variety.
This is because under the assumption of full employment there is only one rate of interest at which the commodity market is in equilibrium. Hence any change in the bond or money markets alone cannot affect the equilibrium rate of interest. Patinkin does not agree with this reasoning.
According to him, the open market purchases of private bonds create an excess demand for bonds and an excess supply of money, thereby bringing down the rate of interest. Patinkin thus gives equal importance to the net money doctrine along with gross money doctrine for monetary analysis.