Adam Smith's Theory of Money and Banking

41 Pages Posted: 26 Aug 2012 Last revised: 5 Sep 2012

See all articles by Nicholas Adam Curott

Nicholas Adam Curott

Ball State University - Department of Economics

Date Written: August 20, 2012

Abstract

This paper resolves a long-running debate in the economics literature – the debate over Smith’s theory of money and banking – and thereby revolutionizes current understanding about the history and evolution of monetary analysis. Smith did not present either the real-bills theory or a price-specie-flow theory of banknote regulation, as generally presumed, but rather a reflux theory based upon the premise that the demand for money is fixed at a particular nominal quantity. This theory denies that an excess supply of money can ordinarily make it into the domestic nominal income stream or influence prices or employment. The essence of Smith’s theory is not, as the real bills interpretation would suggest, that banknotes are elastic credit instruments that accommodate changes in demand; rather, it is that the supply of money, including banknotes, is forced to regulate itself to a fixed demand. And unlike Hume’s price-specie-flow mechanism, Smith’s specie-flow mechanism does not point to changes in domestic relative to world prices as the factor motivating the trades that restore monetary equilibrium.

Keywords: Adam Smith, Price-Specie-Flow Mechanism, Real Bills Doctrine, Free Banking, Law of Reflux, Monetary Approach to the Balance of Payments

JEL Classification: B12, B31

Suggested Citation

Curott, Nicholas Adam, Adam Smith's Theory of Money and Banking (August 20, 2012). Available at SSRN: https://ssrn.com/abstract=2136133 or http://dx.doi.org/10.2139/ssrn.2136133

Nicholas Adam Curott (Contact Author)

Ball State University - Department of Economics ( email )

Muncie, IN 47306-0340
United States

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