When I first started Perry Mehrling's Economics of Money and Banking course (2012), I had no clue about the money market. What does it mean for there to be a market for money?

The money market is where banks and other institutions temporarily borrow large amounts of money from each other to satisfy their survival constraints and make their promised payments. Deficit agents—those with more outgoing than incoming payments—cover their shortfalls by borrowing extra cash from surplus agents.

The money market is a wholesale market for low-risk, highly liquid, short-term IOUs.
(Stigum and Crescenzi 2007, 1)

The money market is a short-term funding-liquidity market.1 You can get money today2 by promising to pay more money tomorrow.3 The difference—the interest rate—is the price you pay.

Everyone has their own individual balance of payments: the time pattern of locked-in cash flows and cash commitments.4 When money is tighter in the market as a whole, those with payments deficits drive up the money rate of interest by bidding for funds.5

The state of the money markets … gives information about the coherence of the system as a whole. Are people in general able to meet their cash commitments with the cash flows that are coming in to them, or are they in general trying to put off the day of reckoning to another later day? The money market is a sensitive barometer, telling everyone the current state of the system to which they are trying to adapt their own behavior.
(Mehrling 2012a, 6)

Mehrling (2012) relies on Stigum's Money Market (Stigum and Crescenzi 2007) and the Financial Times for real-world descriptions of the money market.

Clip Length 5:12 (2012 Lec 1:1, 4:57–10:09)

Think of yourself as an anthropologist reading the sacred text of some tribe, maybe primitive tribe, and trying to figure them out—how they think about the world, and so forth. I'm not trying to teach you to trade the money markets—not at all. But we are trying to understand this world that's really rather arcane—rather special. And the people who live in that world are interviewed in here. So this is our sort of window into the operations of this strange tribe.
(Lec 1:1, 5:57)

The survival constraint6 naturally gives rise to the money market that eases it. That's why the money market features so heavily in practical banking.

We start not so much with the tools of economics but rather with the testimony of practical bankers themselves, whose business requires them to work out the implications of a changing world for their own practice. One thing that my historical studies have taught me is that the origins of monetary thought lie in concrete banking practice.
(Lec 1 Notes, 1)

This course7 is about building a theory of money that's grounded in the realities of the survival constraint and the money market. Stigum and the Financial Times help provide that grounding.

References

Howlett, Alex. 2025a. "Settle or Die: Payment, Liquidity, and Survival." The Survival Constraint (blog). February 9. https://survivalconstraint.substack.com/p/settle-or-die.

Howlett, Alex. 2025b. "Balancing Act: Lining Up Cash Flows in Time." The Survival Constraint (blog). February 10. https://www.survivalconstraint.com/p/balancing-act.

Howlett, Alex. 2025c. "Gap Liquidity: Money, Funding, and Markets." The Survival Constraint (blog). February 13. https://www.survivalconstraint.com/p/gap-liquidity.

Howlett, Alex. 2025d. "Market-Makers Make Markets: Rethinking Supply and Demand." The Survival Constraint (blog). February 17. https://www.survivalconstraint.com/p/market-makers-make-markets.

Howlett, Alex. 2025e. "The System is Fragile: Promises Breed Instability." The Survival Constraint (blog). April 8. https://www.survivalconstraint.com/p/the-system-is-fragile

Mehrling, Perry. 2011. The New Lombard Street: How the Fed Became the Dealer of Last Resort. Princeton, NJ: Princeton University Press.

Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Mehrling, Perry. 2012a. "A Money View of Credit and Debt." Institute for New Economic Thinking Working Paper. https://www.cigionline.org/sites/default/files/inet2012mehrling_amoneyviewofcreditanddebt.pdf.

Mehrling, Perry. 2012b. "Lecture 1: The Four Prices of Money — Part 1: The Big Picture." Economics of Money and Banking, Columbia University, recorded September 5, 2012. Video of lecture, 19:25. https://youtu.be/KNEouYM5wRE.

Mehrling, Perry. 2013 Lecture 1 Notes: The Four Prices of Money. https://sites.bu.edu/perry/files/2019/01/Lec-01-The-Four-Prices-of-Money.pdf

Stigum, Marcia, and Anthony Crescenzi. 2007. Stigum's Money Market. 4th ed. New York: McGraw-Hill.

Clip Length 4:51 (Lec 1:1, 0:06–4:57)

The big thing that we're trying to figure out—everyone's trying to figure out—is financial globalization. … What I've learned from reading the history of monetary thought—the history of financial thought—is that every generation has to figure out the world in front of them. The world is changing. This is a system that is not constant.
(Lec 1:1, 1:55)

Money is global. Payments do not stop at the border. Neither does funding. International payments are just payments that happen to cross arbitrarily drawn political boundaries. Capital flows are just financial transactions that happen to cross those boundaries.

Our task is to work out the implications of financial globalization for how we understand money, banking, and central banking.
(Lec 1 Notes, 1)

Mehrling starts with an emphasis on globality, but he doesn't really explore the global perspective until the second half of the course. For now, we can imagine that the whole world is like one country running on the US dollar as its currency. In terms of money, banking, and finance, that's not too far from reality. As we flesh out the details of this global system, we can start to differentiate between nations, currencies, and central banks.

We tend to like to think that we live in countries—that our monetary system is the monetary system of our country. … and that, somehow, it all gets added up into an aggregate. This is just not the way the world is. It's not a collection of nation-states; it's a global system, and each central bank is part of this hierarchy.
(2017 Lec 1, 44:45)

Individual countries want to believe that they can control their own monetary systems, but they don't have their own monetary systems. There is one system: a global system. It doesn't "belong" to a single nation.

No sovereign wants to be told that monetary sovereignty is a myth.
(Mehrling 2022, 166)

Mehrling's most recent book, Money and Empire: Charles P. Kindleberger and the Dollar System (Mehrling 2022), tells the story of how the US dollar found its way to the center of the global monetary system.

Our system is now a global dollar system. We might not want that to be true. But if we try to manage our monetary system as if it's the system we want rather than the system we have, we'll break the system we have.

What is liable to happen, if there is a failure of international credit, is that nations will turn in upon themselves, becoming more autarkic or more protectionist, impoverishing themselves and each other by refusing to trade with each other. (And this means, we can already see, refusing to aid each other.) That is the danger with which we are confronted; we can already see that it is no imaginary danger at this present time.
(Hicks 1967, 172)

References

Hicks, John. 1967. "Monetary Theory and History." In Critical Essays in Monetary Theory, 155–173. Oxford: Clarendon Press.

Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking.

Mehrling, Perry. 2012a. "Lecture 1: The Four Prices of Money — Part 1: The Big Picture." Economics of Money and Banking, Columbia University, recorded September 5, 2012. Video of lecture, 19:25. https://youtu.be/KNEouYM5wRE

Mehrling, Perry. 2013 Lecture 1 Notes: The Four Prices of Money. https://sites.bu.edu/perry/files/2019/01/Lec-01-The-Four-Prices-of-Money.pdf

Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI.

Mehrling, Perry. 2022. Money and Empire: Charles P. Kindleberger and the Dollar System. Cambridge: Cambridge University Press.

One person's cash inflow is another person's cash outflow.
(Mehrling 2011, 12)

The liquidity of one entity—its ability to meet cash commitments—depends on the liquidity of anyone who is promising to pay that entity. The more cash commitments there are in the system as a whole, the more entangled everybody's liquidity positions become.

It is in the daily operation of the money market that the coherence of the credit system, that vast web of promises to pay, is tested and resolved as cash flows meet cash commitments.
(Mehrling 2011, 3)

When the money market has trouble covering liquidity gaps2, the system as a whole is under stress. Money-market interest rates spike as everyone bids for the cash they need to satisfy their survival constraints.

As the web of interlocking payment obligations grows more tangled, the system grows more fragile. One missed payment can trigger another. If the metaphorical dominos get too close together, a cascading credit collapse becomes inevitable.

Clip Length: 3:43 (2017 Lec 1, 29:28–33:11)

This is difficult for well-trained economists to appreciate—the inherent instability of credit—because it suggests that the instability is coming from inside the system—from some feature of the system dynamics of the system. And we're used to thinking about equilibrium—thinking about a system in which prices are clearing markets. Supply equals demand. … Instability, if there is any, comes from outside. It comes from political interference with markets. Or it comes from a bad realization of a crop. Or power—you know some some riot somewhere. … Markets are a stabilizing force, and so we always prefer markets over politics. And what this is suggesting is that markets have their own inherent instability.
(2017 Lec 1, 31:28)

In the above clip, Mehrling highlights the expansion and contraction of credit at various timescales.3 The following diagram, adapted from Mehrling's slides, illustrates the entire hierarchy of money and credit4 expanding and contracting.

Not all credit expansion and contraction is unstable, however. Cycles of flux and reflux are normal and routine (Mehrling 2023). Banks release money (flux) when they lend. They reabsorb that money (reflux) when repaid. A financial crisis is a widespread failure to meet cash commitments and a widespread failure of reflux.

Hyman Minsky famously wrote that "stability is destabilizing" (1982, 26). As long as cash commitments are easy to meet, people will continue entering into new cash commitments. The web will grow more tangled. The dominos will get closer together. This continues right up to the point of financial crisis.

Maybe Minsky is wrong, and there's a way to keep the dominos a safe distance apart. But even if he's right, the money view can help us make the most of our unstable financial system.

References

Hawtrey, Ralph G. 1932. The Art of Central Banking. London: Longmans, Green and Co.

Howlett, Alex. 2025a. "Balancing Act: Lining Up Cash Flows in Time." The Survival Constraint (blog). February 10. https://www.survivalconstraint.com/p/balancing-act.

Howlett, Alex. 2025b. "Gap Liquidity: Money, Funding, and Markets." The Survival Constraint (blog). February 13. https://www.survivalconstraint.com/p/gap-liquidity.

Howlett, Alex. 2025c. "Banking Implies Hierarchy: A Natural Money Structure." The Survival Constraint (blog). March 18. https://www.survivalconstraint.com/p/banking-implies-hierarchy.

Mehrling, Perry. 2011. The New Lombard Street: How the Fed Became the Dealer of Last Resort. Princeton, NJ: Princeton University Press.

Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI.

Mehrling, Perry. 2023. "Payment vs. Funding: The Law of Reflux for Today." In Monetary Economics, Banking and Policy: Expanding Economic Thought to Meet Contemporary Challenges, edited by Penelope Hawkins and Ioana Negru, 103–118. London: Routledge. https://doi.org/10.4324/9781003142317-8.

Minsky, Hyman P. 1982. "The Financial Instability Hypothesis: Capitalist Processes and the Behavior of the Economy." In Financial Crises: Theory, History, and Policy, edited by Charles P. Kindleberger and Jean-Pierre Laffargue, 13–39. Cambridge: Cambridge University Press.

Credit is a promise to pay money, and money is the highest form of credit.
(2017 Lec 1, 28:22)

This sounds a bit circular. Is money a promise to pay money?

Clip Length: 20 Seconds (2017 Lec 1, 28:20–28:40)

Henry Dunning Macleod (1866) provides a definition of credit that can help us unpack Mehrling's statement.

Credit is anything which is of no direct use, but which is taken in exchange for something else, in the belief or confidence that it can be exchanged away again.
(Macleod 1866, 18)

Here, credit does not have to be a promise to pay money—or a promise at all. Credit is anything whose value derives from what it can be exchanged for.

Money, then, is the standard form of credit that we use to settle debts.

Now, as money is always exchangeable throughout the commercial community, it is evident that it has a general and a permanent value; that is, it is exchangeable among all persons and at all times, and in all places of the same country. It is therefore the highest and most general form of credit.
(Macleod 1866, 18–19)

There is no such thing as non-credit money. Even gold, though it has some direct use, is a form of credit when we use it as money. Every layer of Mehrling's hierarchy (2017 Lec 1, 25:45) fits Macleod's definition of credit.

Instruments at different layers can all be fully money as long as they serve as the standard settlement instrument for their respective layer.

Henry Thornton (1802) emphasizes that money, irrespective of its form—whether gold, currency, or deposits—serves as a claim on goods and services.

Money of every kind is an order for goods. … It is merely the instrument by which the purchasable stock of the country is distributed with convenience and advantage among the several members of the community.
(Thornton 1802, 260)

This perspective underscores an intrinsic link between money and the real economy. Money is not a promise to pay money. Money is a claim on goods and services. And other money-denominated credit is a claim on money.

Credit is to money what money is to commodities.
(Daniel Webster, quoted in Macleod 1866, 20)

I find the preceding description of money compelling, but Mehrling might not. He likely intended his circularity.2

The most real thing is money, but money is nothing more than a form of debt, which is to say a commitment to pay money at some time in the future. The whole system is therefore fundamentally circular and self-referential. There is nothing underneath, as it were, holding it up.
(Mehrling 1999, 138)

Money is either a claim on goods or a circular claim on itself. Either way, money, in its ideal platonic form, is a credit claim. Commodity monies such as gold are merely an approximation of that ideal.

References

Howlett, Alex. 2025. "Banking Implies Hierarchy: A Natural Money Structure." The Survival Constraint (blog). March 18. https://www.survivalconstraint.com/p/banking-implies-hierarchy.

Macleod, Henry Dunning. 1866. The Theory and Practice of Banking. 2nd ed. Vol. 1. London: Longmans, Green, Reader, & Dyer.

Mehrling, Perry. 1999. "The Vision of Hyman P. Minsky." Journal of Economic Behavior & Organization 39 (2): 129–158. https://doi.org/10.1016/S0167-2681(99)00029-3.

Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI

Thornton, Henry. 1802. An Enquiry into the Nature and Effects of the Paper Credit of Great Britain. London: J. Hatchard and F. and C. Rivington.

Always and everywhere, monetary systems are hierarchical.
(Mehrling 2013, 394)

Credit issued higher up serves as money for the entities below.

We choose to hold a lower form of money—inserting banks above us—because banks make owning deposits more convenient than holding currency. The emergence of banking is the emergence of hierarchy (Howlett 2024).

Clip Length: 3:51 (2017 Lec 1, 25:37–29:28)

We're uncomfortable with hierarchy. And we're uncomfortable as economists. When we hear the word "hierarchy," we think of power; we think of monopoly—as opposed to markets. We're in favor of markets. Markets are flat. But I'm saying: Here at the very center of the market system, the monetary system is not flat. And, as we'll see, there are reasons it's not flat and probably cannot be flat. So we need to adapt to that and understand that phenomenon and how we can manage that system for the general good.
(2017 Lec 1, 28:43)

Monetary hierarchy can take many forms. There was a time in history when global money consisted of claims on gold. That's not today's world, but it is a world that's easier to think about. For pedagogical simplicity, Mehrling places gold at the top of the hierarchy and securities at the bottom. Gold represents money that's above everyone. Securities (e.g., bonds) represent credit instruments that nobody uses as money.

The following diagram, adapted from Mehrling, illustrates the four layers of Mehrling's hierarchy along with a pyramid showing that there's more stuff at the bottom than the top.

The Money and Banking lectures (Mehrling 2012) focus on the mechanics of money and credit without dwelling too much on the top of the hierarchy. These mechanics work largely the same regardless of how the monetary standard is ultimately anchored.

Meanwhile, banks are more than just deposit-taking institutions. They also lend. Every layer of the hierarchy faces a survival constraint2 that can be relaxed by borrowing from banks above.3

The below diagram illustrates bank lending as a mutual obligation4 (swap of IOUs) in two different ways: payment arrows on the left and balance sheets on the right. The borrower receives deposits in exchange for promising to repay the loan. The bank issues deposit liabilities in exchange for a loan obligation from the borrower.

If there's no layer above us, the survival constraint will induce us to insert one by paying banks to lend. Banking emerges as a natural response to our need to meet our payment commitments. The survival constraint makes the hierarchy of money inescapable.

References

Howlett, Alex. 2024. "The Many Faces of Money and Hierarchy." Working paper, The Greshm Institute. https://www.greshm.org/files/2024-01-31-the-many-faces-of-money-and-hierarchy.pdf.

Howlett, Alex. 2025a. "Settle or Die: Payment, Liquidity, and Survival." The Survival Constraint (blog). February 9. https://survivalconstraint.substack.com/p/settle-or-die.

Howlett, Alex. 2025b. "Transactions: It Takes Two." The Survival Constraint (blog). February 24. https://survivalconstraint.substack.com/p/transactions.

Howlett, Alex. 2025c. "The Alchemy of Banking: Transmuting Promises into Money." The Survival Constraint (blog). March 1. https://survivalconstraint.substack.com/p/the-alchemy-of-banking.

Howlett, Alex. 2025d. "Public-Private Monetary Hybridity: Money as a Creature of the Market." The Survival Constraint (blog). March 9. https://survivalconstraint.substack.com/p/public-private-monetary-hybridity.

Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Mehrling, Perry. 2013. "The Inherent Hierarchy of Money." In Social Fairness and Economics: Economic Essays in the Spirit of Duncan Foley, edited by Lance Taylor, Armon Rezai, and Thomas Michl, 394–404. London: Routledge.

Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI

An issue that runs through the history of money is its intrinsic nature. Is money what the state says is money—legal tender in some formulations that must be accepted in payment of debts, if offered—or is it what people use as money?
(Kindleberger 1993, 38)

In the following clip, Mehrling describes "essential hybridity" (2017a, 7) as the second big hurdle to understanding money. I have recreated his balance sheets further down.

Clip Length: 5:05 (2017 Lec 1, 20:32–25:37)

The system is hybrid. It's public and private. Each one adds something, and they mutually support each other. It's a symbiotic system.
(2017 Lec 1, 24:06)

Like any bank, a central bank monetizes debt by issuing money liabilities.1

We can take currency (notes and coins) to a bank and get a deposit claim, or vice versa. Both currency and bank deposits are money. The central bank, a public entity, issues one form of money while private banks issue the other.

For banks, their reserve of money takes the form of deposit claims on the central bank.2

See the balance sheets.

Here it is as a network of money claims.3

A central bank monetizes both government and private debt. The Treasury—the arm of the government responsible for taxing, spending, and borrowing—keeps a deposit account at the central bank just like the private banks do.

[C]entral banks are part private bankers’ bank and part public government bank, with the proportions shifting over time with financial development and with the exigencies of the state (such as war).
(Mehrling 2017a, 7)

The following balance sheet labels Treasury-issued government IOUs as "Treasurys" and uses "Discounts" to refer to private-sector IOUs purchased at a discount.

The two rows show a government bank and a bankers' bank. However, specific liabilities need not pair with specific assets. Everything is entangled. The central bank is not a government bank coexisting with a bankers' bank. Instead, it is a hybrid of the two.

[B]ecause of the risks to which any bank is in principle subject, a banking system as such has a tendency to develop a centre, being a bank, or group of banks, on which other banks come to rely. This can come about without any action by government. The relation so established can indeed transcend the boundaries of nations.
(Hicks 1989, 98)

Central banks emerge to help the monetary system better manage the survival constraint. In doing so, they serve the public interest, as well as the interest of individual participants in the monetary system, including governments.

Centralization is natural. Money and banking connect everything. Labeling the economy as distinct public and private sectors doesn't change that. Beneath the labels, the monetary system is all one thing.

References

Hicks, John. 1989. A Market Theory of Money. Oxford: Clarendon Press.

Howlett, Alex. 2025a. "Four Ways to Pay: Representing Payment Types." The Survival Constraint (blog). March 1. https://survivalconstraint.substack.com/p/four-ways-to-pay.

Howlett, Alex. 2025b. "The Alchemy of Banking: Transmuting Promises into Money." The Survival Constraint (blog). March 1. https://survivalconstraint.substack.com/p/the-alchemy-of-banking.

Kindleberger, Charles P. 1993. A Financial History of Western Europe. 2nd ed. New York: Oxford University Press.

Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI

Mehrling, Perry. 2017a. "Financialization and Its Discontents." Finance and Society 3 (1): 1–10. https://doi.org/10.2218/finsoc.v3i1.1935.

“You cannot ride on a claim to a horse, but you can pay with a claim to money.”
(Schumpeter 1954, 305)

Perry Mehrling calls this "the alchemy of banking" (2017, 2017a, 2023).

Clip Length: 3:11 (2017 Lec 1, 17:21–20:32)

You and I can't create money, but through the interaction with banks, money is created. This is the nature of the system, and we need to understand that this is how it works.
(2017 Lec 1, 20:11)

When a bank lends, it accepts the borrower's promise (the loan) in exchange for its own promise (deposits).

The essence of banking is a swap of IOUs.
(Mehrling 2017a, 7)

The above balance sheets show the creation of a loan.

1. The loan is the liability of the borrower and an asset to the bank.

2. The deposit is the liability of the bank and an asset to the borrower.

The bank and the borrower each promise future payment to the other. They are "paying" each other by issuance.1 It is a mutual obligation.2

Nothing could be simpler, and yet the mind rebels, especially the well-trained economist’s mind, because this simple operation increases my purchasing power without decreasing anyone else’s. It seems like alchemy, or anyway a violation of some deep conservation law. Real productive resources are the same as they were before, and the swap doesn’t change that, does it?
(Mehrling 2023, 103)

It might be easier to imagine a scenario where someone borrows money from a lender (1) and deposits it in his bank (2).

But what if the lender and the bank are the same entity? The borrower gets cash and immediately deposits it back in the bank. Why not skip the cash step? No cash needs to exist to make this loan possible. We're back to our swap of IOUs.

Now imagine a bank lending out (2) some deposited money (1).

If the borrower and depositor are the same person, we're again back to our IOU swap.

These scenarios are two different perspectives on the same transaction. The borrower deposited the money he borrowed. Meanwhile, the bank lent the deposited money.3

There is expansion, from [the bank's] point of view, on each side of its balance-sheet. But from the point of view of the rest of the economy, the bank has 'created' money.
(Hicks 1989, 58)

Borrowing from a bank means paying the bank—in the form of interest—to convert your promise of future payment into money you can spend today. Banks are in the business of "monetizing" debt.

Hyman Minsky famously wrote:

Everyone can create money; the problem is to get it accepted.
(Minsky 1986, 255)

What he meant was that everyone can write an IOU. Not everyone's IOUs are money. And not everyone's IOUs are exchangeable for money.

Bank IOUs are money. Banks turn other people's IOUs into money by replacing them with their own IOUs. That's the alchemy of banking.

References

Hicks, John. 1989. A Market Theory of Money. Oxford: Clarendon Press.

Howlett, Alex. 2025a. "Four Ways to Pay: Representing Payment Types." The Survival Constraint (blog). February 23. https://survivalconstraint.substack.com/p/four-ways-to-pay.

Howlett, Alex. 2025a. "Transactions: It Takes Two." The Survival Constraint (blog). February 24. https://survivalconstraint.substack.com/p/transactions.

Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI

Mehrling, Perry. 2017a. "Financialization and Its Discontents." Finance and Society 3 (1): 1–10. https://doi.org/10.2218/finsoc.v3i1.1935.

Mehrling, Perry. 2023. "Payment vs. Funding: The Law of Reflux for Today." In Monetary Economics, Banking and Policy: Expanding Economic Thought to Meet Contemporary Challenges, edited by Penelope Hawkins and Ioana Negru, 103–118. London: Routledge. https://doi.org/10.4324/9781003142317-8.

Minsky, Hyman P. 1986. Stabilizing an Unstable Economy. New Haven, CT: Yale University Press.

Schumpeter, Joseph A. 1954. History of Economic Analysis. Edited by Elizabeth Boody Schumpeter. New York: Oxford University Press.

Notes

The most straightforward transaction is one where someone buys a good or service in exchange for money.

These balance sheets show a buyer exchanging money for goods from a seller.2 There is an assignment of money from the buyer to the seller paired with an assignment of goods in the opposite direction. The buyer and seller swap assets. To help differentiate the two legs of the transaction, I have colored them in two different shades of yellow.

Balance sheets can show us each counterparty's asset and liability position. If we only need to see the transaction, we can use payment arrows.

In his A Market Theory of Money (1989), John Hicks encourages us to look beyond the asset swap.

It will no doubt have been taken for granted that in the markets we have been discussing, the typical transaction was an exchange of some article (good or service) for something that was recognized as being money; and it may also have been taken that the money was simply handed over, as one does when one buys a newspaper in a shop. A useful way of introducing the monetary theory, which will be the subject of the chapters which follow, is to begin by calling into question these two assumptions, asking how far they are justified.
(Hicks 1989, 41)

Following Neilson (2021), we can use our four payment types to construct a four-by-four grid classifying possible two-way transaction types.3

A generic financial transaction involves two simultaneous payments. For example, two counterparties might exchange two different forms of money. Each of the two payments will fall into one of the four categories above (assignment, set-off, issuance, novation), so there are sixteen possible ways that two payments between two entities can be completed.
(Neilson 2021)

Given that we can flip who's on which side of a two-way transaction, there are really only ten two-way transaction types. We will cover each of them in turn as they arise in the Money and Banking lectures (Mehrling 2012).

As an example, let's follow Hicks. What Hicks (1989, 42) calls "the representative transaction of sale or purchase" combines three two-way transactions: a mutual obligation and two asset disintermediations.

The first is the contract between the parties, consisting of a promise to deliver and a promise to pay … ; the second and third consist of actual delivery, one way and the other.
(Hicks 1989, 42)

We call the payment and delivery4 "asset disintermediation" because the two parties each end up holding their respective asset directly rather than a promise for the asset.

Don't worry if you don't understand all the transaction types yet. We're building vocabulary that will help us make sense of things later.

References

Hicks, John. 1989. A Market Theory of Money. Oxford: Clarendon Press.

Howlett, Alex. 2025. "Four Ways to Pay: Representing Payment Types." The Survival Constraint (blog). February 23. https://survivalconstraint.substack.com/p/four-ways-to-pay.

Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Neilson, Daniel H. 2021. "Balance-sheet reasoning: Accounting for Soon Parted." Soon Parted (blog). October 19. https://www.soonparted.co/p/balance-sheets.

Borja Clavero (2021, 17:30) quotes Wadsley and Penn (2000):

It is not always clear from the way we talk which party is paying whom ... No doubt the confusion arises because concepts appropriate to the simple payment in cash [...] are stretched to make them apply to the more complex world of modern payment mechanisms.
(Wadsley and Penn 2000, 366)

In the Money and Banking course, Mehrling (2012) often represents payments by adding and subtracting balance-sheet assets and liabilities. A big part of the course is learning how to read balance-sheet operations. If you can read balance sheets, it will always be clear who's paying whom.

Consider the aforementioned simple case of paying someone by handing them money.

We can read the rows on this set of balance sheets chronologically from top to bottom.

1. The top row shows the initial state in which the payor holds money as an asset.

2. The middle row shows the payment operation in which money is subtracted from the payor's balance sheet and added to that of the payee.

3. The bottom row shows the final state in which the payee has the money.

Borja Clavero (2021, 2022) calls this payment by assignment. The owner of the money passes it to someone else. Assignment is only the first of four payment types.

Following Clavero (2021), I will highlight assignment in yellow.

The second type of payment is payment by issuance. This means paying someone now by promising to pay them later—that is, paying on credit. I pay you by issuing an IOU for money. That IOU is my liability and your asset.

I will highlight issuance in green.

In the above balance sheets, nobody starts with money or any other assets. Nevertheless, a payment has been made.

The third type of payment is payment by set-off. That means I pay you by canceling a debt that you owe me. The IOU—my asset and your liability—is extinguished. Set-off is the mirror image of issuance.

I will highlight set-off in red.

The final payment type is payment by novation. I pay you by taking on one of your debts.

I will highlight novation in blue.

Clip Length 1:20 (Clavero 2021, 23:39–24:59)

That there are four ways of making a payment is not subject to discussion, alright? Because that would be going against logic. Logic determines this. There is no way around it.
(Clavero 2021, 24:20)

Here are all four payment types together.

To emphasize the direction of payments, we can use a color-coded arrow notation that I've adapted from Chris Rimmer (2021).

The early lectures of the course (Mehrling 2012) cover the payments system. An intuition for the four payment types will help us get the most out of those lectures.

References

Clavero, Borja. 2021. "Money and Hierarchy: Four Ways to Discharge a Payment Obligation," Segment 16:31–35:05 of "Applying the Money View | Presentations IV." Money View Symposium, INET Young Scholars Initiative, recorded March 6, 2021. Video, 1:23:49. https://youtu.be/pMC4joNiiPo

Clavero, Borja. 2022. "Money and Hierarchy: Four Ways to Discharge a Payment Obligation." SSRN Scholarly Paper ID 4032398. Social Science Research Network. https://doi.org/10.2139/ssrn.4032398.

Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Rimmer, Chris. 2021. "A Pictorial Notation to Illustrate Balance Sheet Changes" https://www2.bluehydra.co.uk/misc/notation.pdf

Wadsley, Joan, and G.A. Penn. 2000. The Law and Practice of Domestic Banking. 2nd ed. London: Sweet & Maxwell.

"Supply and demand" by SilverStar, modified by Alex Howlett, is licensed under CC BY 2.5.

When the balance between buyers and sellers becomes mismatched, we might expect the price to adjust to clear the market. However, too much price volatility would interfere with the market. The good news is that if the mismatch between supply and demand is temporary, someone can profit by buying when everyone is selling and vice versa.

All that is needed to make it realistic is to introduce intermediary traders, neither final buyers nor sellers, who on occasion may either buy or sell.
(Hicks 1989, 9)

The intermediaries "make" the market by ensuring there will always be buyers and sellers and that the price will stay reasonably stable. They supply market liquidity by absorbing supply and demand mismatches into their own inventories.

In his Money and Banking lectures (2012) and elsewhere, Perry Mehrling describes market-makers using Jack Treynor's (1987) model of the securities dealer.

In the above diagram, dealers quote buy and sell prices (the inside spread), adjusting those prices as their inventories change; more inventory leads to lower prices.

[T]he money view has two foundational elements: banking as a payments system, and banking as a market-making system. The constraint to settle payments daily, the so called “survival constraint”, provides essential discipline to encourage agents throughout the economy to line up cash inflows and outflows in time, and to make provision to fill gaps by borrowing or lending in short term money markets. In this frame, the money rate of interest appears as the price of relaxing the survival constraint by borrowing. Alternatively, one can meet a deficit by selling some financial asset, into more or less liquid markets. In the money view, the price in those asset markets is understood as arising from the economics of the dealer function, an “inside” bid-ask spread quoted by profit-seeking market-makers who offer to counterparties the facility to move from money (means of payment) to financial assets, and vice versa, for a price.
(Mehrling 2023, 3)

Prices come from markets made by market-makers providing liquidity. And liquidity lets people meet their payment commitments to satisfy their survival constraint.

The traditional view that market price is, at least in some way, determined by an equation of demand and supply had now to be given up. If demand and supply are interpreted, as had formerly seemed to be sufficient, as flow demands and supplies coming from outsiders, it is no longer true that there is any tendency, over any particular period, for them to be equalized; a difference between them, if it were not too large, could be matched by a change in stocks [inventories].
(Hicks 1989, 11)

Clip Length: 7:53 (2017 Lec 3, 57:01–1:04:54)

In the lectures, Mehrling adapts the Treynor model to funding markets, too. It turns out that interest rates and funding liquidity also come from market-makers making markets.

References

Hicks, John. 1989. A Market Theory of Money. Oxford: Clarendon Press.

Mehrling, Perry. 2012. "Economics of Money and Banking." Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Mehrling, Perry. 2017. "Lecture 3: Fundamentals of the Money View." Warsaw School of Economics, recorded October 13, 2017. Video of lecture, 1:27:49. https://youtu.be/XzMXkJDksrE

Mehrling, Perry. 2023. "Exorbitant Privilege? On the Rise (and Rise) of the Global Dollar System." Institute for New Economic Thinking Working Paper Series No. 198. https://doi.org/10.36687/inetwp198.

Treynor, Jack L. 1987. "The Economics of the Dealer Function." Financial Analysts Journal 43 (6): 27–34. https://doi.org/10.2469/faj.v43.n6.27.

On any given day, if your cash inflows are sufficient to cover your cash outflows, we might say your balance sheet is liquid. If your inflows fall short of your promised outflows, there are three possible types of liquidity you can tap to close your balance sheet's payments gap (Brunnermeier and Pederson 2009; Mehrling 2024, 14:36–18:06).

1. Monetary liquidity — the ability to spend money in your possession.

2. Funding liquidity — the ability to borrow money.

3. Market liquidity — the ability to sell assets for money.

Clip Length: 2:58 (2017 Lec 3, 13:18–16:16)

These three forms of liquidity and the interrelation between them are going to be part of the story. In fact, I'll come to the end to an argument that one of the most important things to understand about the evolution of the monetary system since World War II is that we've moved from a system which was largely focused on monetary liquidity so that people met their payments by using their money balances, and we developed all monetary theory around the idea that that's the only way to do it, and then the system changed, and people started meeting their liquidity needs with funding liquidity, and then people started meeting their needs with market liquidity. And now all three of them are available, but the theory hasn't caught up to this fact about the world.
(2017 Lec 3, 14:05)

Any combination of these three liquidity types may be available to you at any given time, but only monetary liquidity is completely safe. You can always spend your cash.

Consider the following balance sheet.

To address a payments gap, the bank has a few options. It could:

1. dishoard (spend) some of its money reserves (Monetary Liquidity),

2. borrow in the wholesale money market (Funding Liquidity), or

3. liquidate (sell) some of its securities (Market Liquidity).

Not all assets are easy to sell. A security, such as a bond, can often be sold on the market, in contrast to loans, which tend to stick around until repaid.

A bank in payments deficit today could be in surplus tomorrow. The money market is where banks and other big firms borrow large amounts of money from each other for short periods of time.

Funding liquidity and market liquidity depend on the general state of the market. To sell an asset or borrow money, you need someone else—a counterparty—to buy your asset or lend you the money. Furthermore, interest rates and prices can move around. And if the market dries up, the counterparties disappear.

Dishoarding is the simplest source of funds. It requires no counterparty. The bank takes money from its pile and uses it to make the payment.

Ultimately, money reserves, borrowing, and selling assets are all ways to relax the survival constraint. Even if you fail to line up your cash flows and cash commitments perfectly, you can tap these forms of liquidity as a source of funds, and you can live to see another day.

References

Brunnermeier, Markus K., and Lasse Heje Pedersen. 2009. "Market Liquidity and Funding Liquidity." The Review of Financial Studies 22 (6): 2201–2238. https://doi.org/10.1093/rfs/hhn098.

Mehrling, Perry. 2017. "Lecture 3: Fundamentals of the Money View." Warsaw School of Economics, recorded October 13, 2017. Video of lecture, 1:27:49. https://youtu.be/XzMXkJDksrE

Mehrling, Perry. 2024. "Emergency Liquidity Management — Bagehot versus Kindleberger," recorded February 6, 2024. Video, 1:22:44. https://youtu.be/l-Bz53nSAU4

Clip Length: 1:07 (2017 Lec 3, 19:42–20:49)

The survival constraint … emphasizes the time pattern of cash flows and cash commitments, and the necessity in each period to settle. If you're a deficit agent, you have to find a source of liquidity to meet that deficit. That's the [survival] constraint. And this is a constraint that binds deficit agents, not surplus agents.
(2017 Lec 3, 19:42)

How can we keep track of future cash inflows and outflows? Behold the mighty balance sheet.

If you've seen balance sheets before, you might be used to thinking of assets and liabilities as what an entity owns and owes. Your instinct is to add up the total value of the assets and subtract the liabilities to find "net worth." That's fine, but it doesn't help us understand the entity's liquidity position: its ability to meet payment commitments as time rolls on.

Even worse than netting assets and liabilities within a balance sheet is netting across balance sheets. That's why the money view keeps individual entities' balance sheets separate rather than consolidating them into aggregate "sectors."

Net-money doctrine consolidates private domestic accounts so that private domestic debt cancels out against an equivalent amount of private domestic financial assets in both monetary and nonmonetary form. The only financial assets remaining in aggregative analysis are those held by the private sectors as net claims against the outside world—against, that is, government and the foreign sector.
(Gurley and Shaw 1960, 187)

In the words of Gurley and Shaw (1960), we prefer "gross-money doctrine" over "net-money doctrine." To get a handle on liquidity, the money view interprets a balance sheet’s asset and liability sides as timelines of cash flows and cash commitments, respectively.

If we begin at any date, we have that at each and every future date, in order to survive, the firm must satisfy the condition that the initial cash plus the receipts minus the costs payable to that date are greater than zero. That is, in order to survive a firm must be able to pay debts when due.
(Minsky 1954, 96)

A balance sheet is like a zipper moving through time, zipping the two timelines together. Whenever a payment fails, someone's zipper has broken.

[M]y suggestion can be expressed by saying that we ought to regard every individual in the community as being, on a small scale, a bank. Monetary theory becomes a sort of generalisation of banking theory.
(Hicks 1935, 12)

Banks and the rest of us all have to manage our balance sheets to ensure that we can meet our payment commitments. We all want our zippers to zip.

References

Gurley, John G., and Edward S. Shaw. 1960. Money in a Theory of Finance. Washington, D.C.: Brookings Institution.

Hicks, John R. 1935. "A Suggestion for Simplifying the Theory of Money." Economica 2 (5): 1–19.

Mehrling, Perry. 2017. "Lecture 3: Fundamentals of the Money View." Warsaw School of Economics, recorded October 13, 2017. Video of lecture, 1:27:49. https://youtu.be/XzMXkJDksrE

Minsky, Hyman P. 1954. "Induced Investment and Business Cycles." PhD diss., Harvard University.

We all have an intuition for what money is and how it works. And that intuition is basically right. Money is what we use to pay for stuff. It is the economy's standard means of payment—the generally accepted thing we pass around to settle debts.

However, money is deceptively simple. Understanding money any deeper than at the most superficial level is harder than it may seem. Perry Mehrling has made it his life's work to make sense of money for himself and the rest of us.

Clip Length: 1:24 (2017 Lec 1, 15:52–17:16)

Why is it so difficult for me to learn this and figure this out? Why did it take me so long? I don't think I'm stupid.
(2017 Lec 1, 16:36)

Mehrling (2017; 2017a) highlights four key features of money that present psychological hurdles to understanding:

1. Alchemy — Banks create new money seemingly out of thin air.

2. Hierarchy — Some forms of money are necessarily "better than" or "above" others.

3. Hybridity — The monetary system is a combination of public and private.

4. Instability — Credit structures are fragile and prone to collapse.

It might not be obvious why, but we'll eventually see that these four "problematic" features of money all derive from the constraint that every entity (person, household, firm, government, etc.) has to settle its debts as they come due. This constraint is the survival constraint. If you can't settle, you're done. If nobody can settle, the system grinds to a halt.

Mehrling adapts the term "survival constraint" from Hyman Minsky (1954), who uses it slightly differently.

Firm behavior can be considered as ruled not only by the desire for profits but also by the desire on the part of the firm’s management to avoid failure or bankruptcy: for in failure or bankruptcy the value of the organization disappears. These monetary or financial constraints upon the firm I have labeled the survival constraints.
(Minsky 1954, 96)

The ability to meet your cash commitments and satisfy your survival constraint is called liquidity. Being illiquid means you're dead in the eyes of the monetary system. Everyone being illiquid means the system is dead.

Liquidity kills you quick.
— Perry Mehrling

When liquidity is scarce, the survival constraint acts as an ever-present disciplining force that provides structure to the monetary system and causes it to cohere. It prevents people from promising to make whatever payments they want whenever they want.

However, too much discipline can cause problems. Banks are entities that specialize in relaxing the discipline of the survival constraint. They provide flexibility and elasticity. They provide liquidity. We pay them for it. They run the payment system. They make liquid markets between money and other financial assets.

We haven't answered any hard questions about money, banking, and finance. But we have chosen a starting point. Mehrling (2012) shows us that we can understand a surprising amount by building on liquidity.

References

Mehrling, Perry. 2012. "Economics of Money and Banking." Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI

Mehrling, Perry. 2017a. "Financialization and Its Discontents." Finance and Society 3 (1): 1–10. https://doi.org/10.2218/finsoc.v3i1.1935.

Minsky, Hyman P. 1954. "Induced Investment and Business Cycles." PhD diss., Harvard University.