What is 'Circuitism'

Circuitism helps explain how banks create money for production activities, how firms direct production, how workers contribute to production and consumption and how money from those activities then returns to banks. It is a macroeconomic theory.

BREAKING DOWN 'Circuitism'

Circuitism, which is also known as monetary circuit theory or the circulation approach, is a post-Keynesian theory of monetary economics based on Karl Marx's ideas about the M-C-M, or money-commodities-money, capital cycle.

Circuitism was developed after the Second World War and was primarily advocated by French and Italian economists such as Bernard Schmitt and Augusto Graziani.

Circuitism holds that money is created endogenously, or through economic variables, as opposed to through a central bank.The theory holds that money supply is based on money demand. Money is demanded to finance production, to trade goods and services, to save and to invest.  

In contrast to neoclassical economic theory, which emphasizes the role of the individual in the economy, circuitism emphasizes the roles of banks and firms. Further, according to this theory, employment and income levels are also determined by conditions determined by banks and firms.

Money Supply and Monetary Policy

Circuitism is one of many different macroeconomic monetary theories, which are theories about the creation and role of money supply in the economy. A country’s money supply is the entire stock of its currency and liquid instruments which are circulating at any given moment in time.

Unlike circuitism, many other economic theories hold that money is created through central banks, which can then control the size and growth of money supply as an economic tool to influence interest rates and, in turn, employment rates and economic growth. In the United States, the Federal Reserve is in charge of the country’s monetary policy.  

Generally, central banks use two different types of monetary policy. The first is expansionary monetary policy, in which case the bank increases the money supply to lower employment, boost private-sector borrowing and stimulate growth in the economy. The other is contractionary monetary policy, where the government slows down the growth of money supply to control inflation. This, however, can also increase unemployment and slow growth.

In fact, there is a school of economic thought, called monetarism, that hold that the total supply of money in an economy is the primary determinant of economic growth. This economic theory is associated with economist Milton Friedman who argued that the government should keep the money supply steady and expand it a little every year to allow for natural economic growth.

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