Abstract

The macro accounting identity of the equation of exchange (MV=PY) is analysed from a four-actor, threeperiod economy´s balance sheet. It is shown how money flows via actors, ending up both as financial assets and real assets. A distinction is made between financial money flows financing the purchase of financial assets and real money flows financing the purchase of real, GDP affecting expenditures. Elaborating on the equation of exchange in growth terms gives the qualitative finding that the vast majority of total growth of money flows consists of financial money flows. The finding ows to the strong trend towards financialization over the past decades (increasingly more financial flows/assets relative to real ones) and the fact that financial asset prices exhibit more volatility than nominal GDP. From this is concluded the need for a new and developed statistical database over money flows and real and financial assets. Such a basis would enhance the knowledge of how the global real and financial economy functions as well as benefit central banks in better knowing what parts of the economy it can and cannot influence. The analysis gives rise to recommending a shift in monetary policy focus from the real economy to the financial economy. Monetary policy has not been overly efficient in controlling nominal GDP in recent decades at the same time as financial money flows have become increasingly dominant in terms of total money flows. The current policy set up risks missing out on serious financial stability risks. A shift in focus would aim at stabilizing financial money flows to the effect that risks of future financial crises are reduced.

Keywords:The equation of exchange; Macro accounting identities; Financialization; Financial money flows