The Difference Between Italian and French Monetary Circuit Theory
Introduction
Monetary Circuit Theory (MCT) explains that
money is created through bank lending, circulated between firms and workers,
and destroyed through the repayment of loans. The term “circuit” refers to this
flow of money. The creation of bank money for firms is termed "initial
finance," while the firms' retrieval of money for repayment through
sales or the issuance of securities is termed "final finance."
Methodologically, MCT draws on the
approaches of Keynes (non-neutrality of money in “Treatise on Money”) and Marx,
particularly the M–C–M' form. MCT criticizes the neoclassical theory in which
money supply is exogenous and the price and interest rate are determined by the
relation between the demand and supply. In contrast, MCT claims that money is supplied
in response to firms' demand to pay wages for production.
As a type of macroeconomic theory, MCT aggregates
different economic agents into three sectors: firms, workers, and banks. Therefore,
transactions within the same sector are typically canceled out. This leads to a
difference with Marxian economics on theoretical explanation of bank credit. Marxian
economics claims that, within commercial credit among industrial capitals, the
capital specializing in credit operations eventually becomes banks. However, the
aggregation in MCT cancels out the inter-capital commercial credit. Therefore, MCT
presupposes the existence of banks from nothing. Moreover, MCT denies the
existence of commodity money with intrinsic value and asserts that money is
merely a valueless sign created from nothing through bank lending. Thus, this
view has difficulty explaining the historical existence of physical commodity
money (Graziani 1990,11). However, many proponents focus solely on the
contemporary monetary system.
MCT developed in two distinct schools:
French MCT and Italian MCT. Although they are often presented as similar, key
differences exist. Understanding these differences provides a deeper insight
into MCT. While other strands exist—such as the Dijon–Fribourg group—I focus on
the French and the Italian schools.
For example, The Elgar Encyclopedia of
Post-Keynesian Economics includes two separate entries: “Monetary Circuit –
French School” (Parguez 2023) and “Monetary Circuit – Italian School” (Veronese
Passarella, 2023). These entries contain critiques of each other's positions.
According to them, major points of difference include the role of the state and
the treatment of the price level. A further, less clearly defined difference
concerns how firms acquire production goods.
The Role of the State
Parguez (2023) emphasizes the role of the
state in two respects. First, money is issued not only through bank lending but
also through government expenditure (ibid., 280). Second, he argues that money requires
state endorsement. Parguez and Seccareccia (2000) write:
“Because of the state endorsement of these
debts as the ultimate guarantor of their liquidity, it would be wrong to
conceive holders of bank liability as bank creditors. In a sense, given its
endorsement by the state, one can legitimately argue that money is always fiat
money, even when the state is not issuing it and the role of the state is
marginal” (ibid., 105–106).
The French MCT is thus primarily concerned with
the institutional nature of money and with monetary and fiscal policy. It
overlaps conceptually with Neo-Chartalism or Modern Monetary Theory (MMT).
By contrast, the Italian MCT excludes the state
from the basic circuit model (Veronese Passarella 2023, 281). It focuses on the
sovereignty of firms over the working class. Like the French school, it maintains
that money is just a token and not a commodity, and that it must be issued as bank
debt through lending to firms, forming a triangular transaction: firms, banks
and workers (Graziani 1990, 11). However, the Italian school denies the privilege of
money issuance through government expenditure (ibid.). According to this view,
ordinary fiscal policy can only redistribute income within each class;
redistribution between classes requires direct political intervention (Veronese
Passarella 2023, 281–282). For this reason, the state is left out of the core
theoretical structure.
The Price Level
The French MCT generally assumes that prices
are fixed. This assumption is based on factors such as mark-up pricing over
costs, the aim of long-term profit targets, and the influence of Sraffian price
theory (Parguez 2023, 280; Lavoie 2023, 9; Godley and Lavoie 2007, 264). In
this framework, unsold goods are held as inventories, representing the credit
balance between banks and firms before securities are issued. The idea that
prices are determined by market demand and supply belongs to neoclassical
theory.
In contrast, Graziani—the central figure of the Italian MCT—allows for flexible pricing, where firms adjust prices in response
to expenditure of workers and to investment decisions made by firms. He
proposes the following formula:
- P = market price of output
- s = saving propensity of wage
earners
- b = proportion of total output that
firms decide to purchase
- w = money wage rate
- N = total employment
- π =
average productivity of labor
- B = total value of bonds issued by
firms
- i = interest rate on bonds
Y = C + I
Y, C and I can be expressed respectively as:
Y = πNp, C = c (wN+iB), I = bπNp
Therefore,
πNp = c (wN+iB) + bπNp
This leads to the
following expression for the price level:
The term in square brackets represents the
money cost of output (Graziani 1990, 23), composed of wage costs (wN)
and interest costs (iB) paid to workers who hold the firms' securities.
This equation shows firms’ sovereignty in
the pricing process, which allows them to adjust prices to reduce the real
wage.
When firms decide to purchase more output
(i.e., b increases), the price P rises. The workers, who received
a predetermined nominal wage, can buy fewer goods, as firms later set prices in
a way that reduces the real value of wages and allows them to obtain more goods
for investment. This case is one of involuntary forced investment. However, if
workers voluntarily decide to save so that the saving rate s equals b,
the price increase is contained, and workers’ saving covers firms’ investment
(Graziani 2003, 151–152). Although this price level does not imply full market
clearing as assumed in neoclassical theory, it does suggest that prices are
responsive to demand and supply conditions—unlike the fixed-price assumption in
the French school.
Purchase of Production Goods
In the French MCT, current output is bought based
on the consumption and investment decisions made in the previous period (Parguez
2023, 280). As a result, the French literature often uses overlapping circuits of
different periods to resolve theoretical issues, such as the "profit
paradox."
By contrast, the Italian MCT often completes
the process within a single circuit. The purchase of capital goods—that is,
investment—is always covered ex post through current workers’ saving (Veronese
Passarella 2023, 281). Since firms cannot repay the value of unsold goods, that
amount remains as outstanding money in the banking system, or is covered by
workers' purchases of firms’ securities. Thus, this approach stays within a
single circuit without requiring overlapping circuits.
Another School: The Dijon–Fribourg Group
The term "French school" can be
somewhat misleading, as there is another monetary circuit school within the
French-speaking world: the Dijon–Fribourg Group.
“A Handbook of Alternative Monetary
Economics” (2006) includes a chapter titled "French Circuit Theory,"
written by Claude Gnos, a member of this group. The Dijon–Fribourg Group
includes Bernard Schmitt, Claude Gnos, Alvaro Cencini, and Sergio Rossi.
This school places a strong emphasis on
double-entry bookkeeping and frequently uses balance sheets in its theoretical
framework. For example, in the aforementioned article, Gnos criticizes the
argument made by Parguez and Seccareccia (2000), stating that, from the
perspective of double-entry accounting, “Depositors are creditors of banks and
ultimately the creditors of bank borrowers” (Gnos 2006, p. 94). The
Dijon–Fribourg Group is often regarded as being closer to the Italian MCT than to
the French MCT associated with Parguez.
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