Sequence and class divide: a reply to the critics of the theory of the monetary circuit

While the theory of the economic process as a set of simultaneous exchanges seems specifically made to outline a classless society, the idea of the economic process as a circuit immediately leads to identifying the class distinction within the economic process.

Graziani 1977, p. 116 (translated from the Italian)

The class divide must be the primal datum of the reasoning: it is only the capitalist entrepreneurs who can start the cycle by using money capital for purchasing labour power. This choice structurally differentiates them from the workers, who can only sell their labour force.

Graziani 1977, p. 117 (translated from the Italian)


Short abstract

The monetary circuit scheme is not a mere list of stylised facts, but the necessary sequence of the relations of production and exchange between different and opposed social classes within the capitalist space


1. Introduction

A recent, valuable, contribution by Sergio Cesaratto, Sei lezioni sulla moneta [Six lessons on money], gives me the opportunity to reflect on the theoretical legacy of Augusto Graziani’s monetary circuit approach, meaning both the inspiration that it keeps providing and the several misunderstandings it has been subjected to since its inception. On the one hand, Cesaratto praises the theory of the monetary circuit, for it contributed to unveiling the endogenous nature of money in a capitalist economy. On the other hand, he defines it “a bit conspiratorial” (Cesaratto 2021, p. 297), because banks and private firms are factored in as fully aggregate and homogeneous sectors, having their own wills that transcend those of the individual agents they are made up of. In addition, there would be no room for Keynes’ reflection on the role of aggregate demand in determining the levels of real output and employment.

Cesaratto’s are not the only criticisms that have rained down on the theory of the monetary circuit from its early formulation, dating back to the late 1970s, to today. In fact, there have been many attempts to refute, correct or update it ever since. The basic circuit scheme has been considered unsuitable, or insufficient, to account for recent developments in financially-sophisticated advanced economies. But is it really so?

The aim of this short essay is to help shed light on some of the most controversial aspects of Graziani’s approach. More precisely, four common misunderstandings are considered: a) Graziani’s idea that the initial bank loan must cover the costs of production would be inconsistent with the evidence that the change in the bank debt recorded by the firms at the end of each period matches the portion of investment not covered by other funds; b) once one admits that private firms do not act as a single consolidated sector, the circuit scheme would ignore that an additional financing is necessary to buy investment goods; c) the basic scheme of the monetary circuit would be just a stylized outline of “Fordist” manufacturing capitalism, hence unsuitable for accounting for transactions and other monetary flows that mark a financially-sophisticated economy; and d) the theory of the monetary circuit would resemble the neoclassical approach, because of the assumptions of given real supplies and market-clearing prices. In the next sections, I will argue that all these misconceptions are based on the misunderstanding of the both logical and class-related nature of the sequence of phases identified by the theory of the monetary circuit. This, in turn, arises from the underestimation of its deep connection with the Marxian analysis of the cycle of money capital.¹


2. Production financing or investment funding?

As is well known, the theory of the monetary circuit attributes to the commercial banks the key function of providing the initial finance that private firms need to purchase the labour force to be used in the production process. At the maximum level of abstraction and aggregation, firms can be considered a fully integrated and consolidated sector. The only external initial finance they need at the beginning of the circuit sequence is that necessary to make the only “external purchase” to their sector, namely, the purchase of labour force.² As a result, the initial finance will match the wage bill paid to the employees.

Once the production process has taken place, the wage-earners will spend a share of their money income for consumption. They will save the remaining share by either subscribing to new financial assets or increasing their idle liquid balances (that is, bank deposits, if there is no fiat money). Both the money spent for consumption and that spent for new financial assets eventually return to the firms. The latter must pay interests to the lenders and distribute profits to their owners (the capitalists). Firms then use the remaining amount of money, named the final finance, to pay back (a portion of) their debt to the banks. By contrast, any increase in households’ money holdings implies a corresponding increase in firms’ debt to the banking system.

It goes without saying that the end-of-period change in the stock of bank loans obtained by the firms will equal the difference between the initial finance granted by the banks and the final finance raised by the firms during the period. In this regard, notice that: a) total profit can be defined as the value of national product minus the wage bill and interest payments on corporate debt; b) if, for the sake of simplicity, we consider a closed economy with no government sector, the value of national product is simply the sum of aggregate consumption and investment.

It follows that the change in the stock of bank loans to the firms, at the end of each period, will equal the amount of investment that has not been covered by internal funds and/or new security issues – please refer to the Accounting Appendix for a formal demonstration. The reason is exactly the explanation provided by Graziani: firms remain (further) indebted to the banking system for an amount that equals the new bank deposits. The latter ex post always match the investment that has not been covered by private saving.

Summing up, the initial finance granted by the banks to the firms equals the costs of production at the beginning of the circuit, although the net change in firms’ bank debt at the end of the period will match the investment that has not been funded by household and/or corporate saving. Not only is Graziani’s approach coherent with this evidence, but it provides a sound ex ante explanation of ex post net entries (on this point, see also Zezza 2012).


3. Firms as an aggregate sector or as individual agents?

First, Graziani himself suggests abandoning that level of aggregation when moving on to a less abstract analysis of the functioning of a capitalist economy (see, for example, Graziani 1994, 2003). At the level of the single industry or firm – Graziani repeatedly stresses – bank financing must also cover the expenditure for the purchase of investment goods, in addition to wages (although I will argue that this financing is inessential at the macroeconomic level). The cliché according to which Graziani’s theory of the monetary circuit would neglect this component of bank credit is literally unfounded. In fact, it seems to be based on a hasty and partial reading of his works.

Second, the reason the aggregation hypothesis is adopted in the first instance is due to the sequential nature of the monetary circuit analysis, not to mere simplification or, worse, to a conspiratorial view of economic relations. Notice that the first reflections on the theory of the monetary circuit arise from an analysis of inflation as a change in relative prices, hence in the distribution of income between wages and profits.3 Notice that what matters, for Graziani, is not the detailed description of the phases that mark the production and exchange process, and the related monetary flows, but the exact identification of their logical sequence. This, in turn, is not a mere list of stylised facts, but the necessary sequence of the relations of production and exchange between different and opposed social classes within the capitalist space.

The adjective “initial” (for the bank loans that allow the firms to finance their production plans) does not simply imply a time dimension. Rather, it means that only the firms have the power to purchase the “special commodity” labour force, thus starting the circuit. Those loans are qualitatively different from any other loan obtained by the households (and/or other economic sectors) for the purchase of consumer goods and financial assets. Not only bank loans to households (mortgages, consumer credit) express a different class relation compared with bank loans to firms, but the former can logically take place only after the productive process has ended. They entail an additional flow of credit that, by definition, cannot start the circuit.4 Rather, it makes it easier for the firms to recover the sums initially advanced in the labour market. Therefore, bank loans to households are final, not initial, finance – a definition that reflects class relations within a capitalist society, not a mere time posteriority. I will get back to this point later on.

Third, as it should now be clear, while each individual firm needs bank credit to purchase capital goods, this credit does not logically constitute initial finance – although Graziani himself may sometimes sound terminologically ambiguous on this point. In fact, it merely lubricates an exchange of goods within the firms sector. This internal exchange can logically take place only after capital goods have been produced and does not involve any transaction between different classes or sectors. On closer inspection, those transactions could have been regulated through private bilateral credit agreements. For this reason, investment-driven loans should be regarded as an intermediate or auxiliary financing, distinct from the initial production-oriented loans. The former have no impact on the final stock of firms’ bank debt (see equation 6 in the Accounting Appendix), as they are a mere clearing entry for the firms sector as a whole.5

The point is that money acts as capital – therefore, as narrowly-defined credit money – only if the firms use it to make the fundamental external exchange for a capitalist economy, that is, the purchase of labour power to be employed in the process of production. Outside this exchange, money acts as a lubricant – therefore, as a commodity money – even when it takes the form of credit. It is from the underlying class relations that the nature of money and the related cycle can be inferred, not from its content or collateral.6 This explains why, macroeconomically, investment-related loans should not be considered at the beginning of the circuit.


4. A stylised outline of Fordist capitalism?

It has often been argued that, although the theory of the monetary circuit would be an accurate depiction of Fordist manufacturing capitalism, it would ignore the sophistications that characterise today’s financialised capitalism, especially in Anglo-Saxon countries. An example of such theoretical obsolescence would be the failure to include consumer credit in the initial finance granted by the banks.

This criticism, even when it is phrased in terms of the need to update the basic scheme, is based on a misunderstanding. As mentioned, the adjective “initial” does not merely refer to a historical-time sequence. Bank loans to households (or to other sectors, such as financial intermediaries) are of a different class nature compared with loans granted to production firms to purchase the labour force. The initial finance to firms is capitalistically necessary, as it allows the capitalist class to command over the production process. Without it, the whole process could not even be started, hence no good could be produced and consumed, no income could be saved, no financial liabilities could be issued, and no additional loans could be granted. This is the reason of the priority position of initial finance to firms in the monetary circuit sequence.

By contrast, the role of consumer credit (and mortgages) is to support consumer spending. This makes it easier for the firms to realise the value produced and pay back their debt at the end of the period. While quantitatively relevant in most modern economies, consumer credit does not embody any necessary class relation. Macroeconomically, it is a monetary subsidy to the firms, which shifts the burden of the final bank debt from the industrial capitalists to the wage earners. As a result, it must be considered final (not initial) finance. The point is that the theory of the monetary circuit is an abstract analysis of the sequence of dominant (monetary) relations in a capitalist economy, not a stylised and approximate outline of non-financialised manufacturing economies!

Similar considerations apply to the other aspects connected with financialisation and shadow banking. None of these recent developments affect the logical priority of the initial finance granted to production firms, although they may well involve an extension of the final-finance chain (due to the proliferation of assets and financial intermediaries), which can entail significant indirect effects, especially for a single country or region.


5. No role for aggregate demand?

It has often been argued that Graziani’s theory of the monetary circuit would neglect aggregate demand, since the level and composition of output are exogenously fixed. As a result, wage earners’ spending decisions would only determine the price level of consumer goods. This claim is based on some textual evidence, which, however, needs clarification.

To shed light on this point, one must first consider the key purpose of the theory of the monetary circuit, namely, to identify the logical phases of the process of creation, destruction and circulation of money in a capitalist economy, inhabited by different and opposed social classes. For this purpose, some simplifying hypotheses are used. First, the government sector is initially ignored, in line with the analysis of money as capital already developed by the Classics and Marx. As there are no government spending and no taxes, there is neither creation of legal money nor issues of Treasury bonds. Therefore, the only form of money considered is bank money (but these assumptions can be relaxed once the basic scheme has been sketched).

Second, the study of the money circulation must logically be distinguished from the study of the crisis. The point is to explain the existence – and, indeed, the necessity – of money regardless of hoarding behaviours, that is, abstracting from any increase in the liquidity preference of the economic agents. It should be no surprise that Money without crisis is the title of one of Graziani’s first writings on the monetary circuit (Graziani 1983). The problem with the traditional Keynesian analysis is that it factors in money only when, due to uncertainty, firms and households prefer holding idle balances rather than spending, hence aggregate demand falls. This would seem to imply that, outside the crisis, money returns to be the irrelevant veil postulated by neoclassical theories.7 By contrast, Graziani aims to shed light on the process of creation, circulation and destruction of money during “normal times”, that is, abstracting from the psychology of the economic agents and minimising the behavioural assumptions of the model. The hypothesis that the real output is determined by the autonomous decisions of private firms must be understood in that light.

Third, the basic rendition of the monetary circuit proposed by Graziani is a single-period scheme. The assumption of a fixed supply, hence a market-clearing price, does not imply a neoclassical closure of the model – as has sometimes been suggested. If the economy only lasts one period, it makes no difference whether the firms are assumed to set the real output (thus implying an endogenous price adjustment) or the unit price (thus implying an endogenous quantity adjustment). In both cases, the quantity of product and its composition are fully determined by the autonomous decisions of the firms within the period. In fact, the assumption that the firms directly set the supplied quantity is simply the clearest choice.

Besides, in neoclassical simultaneous general equilibrium models, the exogenously-defined supply is also the reflection of the consumer sovereignty, as individual preferences are one of the factors that determine the natural levels of employment and production (together with the available technology and the initial endowments). By contrast, in the monetary circuit scheme, it is up to private firms to decide how much and what to produce. In making their decisions, firms are certainly influenced by expected sales. However, there is no consumer sovereignty. Firms will normally adjust their supply to expected demand,8 but this happens because (and only if) it is the most profitable strategy. A noteworthy implication is that, while fiscal policy is fully effective in redistributing income within each sector or social class, the redistribution between different classes is always mediated by the production plans of private firms.

If it is developed within a comprehensive dynamic macroeconomic model, the circuit approach shows that economic growth can be temporarily ex post funded by a compression of real wages (forced saving), rather than by an increase in capitalists’ voluntary saving – a result that resembles the “inflationary barrier” described by Joan Robinson (Veronese Passarella 2022). The point is that the purchasing power of wages is always defined at the end of the monetary circuit, when firms set the price of their products. Notice that, while in a homogeneous-product model the destination of output can be assumed to be decided at the end of the production process, in a multiple-production model output composition must necessarily be defined at the beginning of the process. Macroeconomically, ex post pricing decisions only validate ex ante production decisions. The real income for the wage earners, considered as a class, is measured by their actual consumption, which is ultimately defined by corporate production plans. By contrast, workers’ net wealth (including corporate liabilities they have subscribed to) is purely notional. Once production decisions have been made, some workers can consume more if and only if other workers correspondingly increase their saving.9

Summing up, the key implications that the circuit analysis highlights are the following. First, although aggregate supply tends to adjust to demand, any automatism must be rejected, because production decisions are eventually made by private firms. Second, the reason that the wage earners are not sovereign in the sphere of consumption (circulation) is that they are exploited in the sphere of production. Progressive fiscal policies can certainly improve real income distribution, but the most effective tool is a direct intervention of the government sector aimed at modifying the level and composition of output.


Final remarks

In this short essay, I have argued that the criticisms commonly addressed to Graziani’s theory of the monetary circuit are based on misunderstandings. Far from being a simple Italian translation of the theory of endogenous money developed by French circuitistes and (post) Keynesian economists, Graziani’s approach has its own specificities (Bellofiore and Veronese Passarella 2016). The point is that the link between Graziani’s theory and Marx’s is much deeper than is commonly believed, although it is not always apparent (Veronese Passarella 2015). It could be argued that the theory of the monetary circuit represents a Marxian rendition of the methodology of aggregates developed by Keynes.

This leads us to a second important point. The monetary circuit is not the stylized depiction of a specific historical or geographical configuration of capitalism – for example, the British manufacturing economy of the early-nineteenth century or the Italian factory system of the 1950-60s. Rather, it is a method that allows identifying the logical sequence of necessary monetary relations between opposed social classes in a capitalist economy. In a sense, the circuit scheme can be regarded as a theoretical meta-model, like the Marxian reproduction schemes or François Quesnay’s Tableau économique (see again Veronese Passarella 2015).

As Graziani himself noted, the analytical power of the basic single-period circuit scheme comes precisely from the possibility of identifying the sequence of simple (but fundamental) monetary relations between the key economic sectors of a capitalist economy, regardless of individual behavioural assumptions. Therefore, the monetary circuit is not a complete macroeconomic model, but a way to analyse capitalist economic relations, starting from the central role played by money.

The conclusions reached are sometimes in contrast with those dear to Keynesian economists. For example, while the limitations of monetary policy are confirmed, the effectiveness of the fiscal policy is also partially questioned. This is not due to a hidden fascination for the neoclassical theory, but, on the contrary, to the acknowledgment that monetary relations in a capitalist economy reflect class relations. It is Marx, not Lucas. As Graziani ironically observed, “we can ask an analytical model to be logically coherent, or confirmed by the empirical experience; not to be depicting la vie en rose” (Graziani 1995, p. 188).


1 Among the few exceptions, see Bellofiore (2019), who argues that Graziani reinterprets Keynes’ theory of demand and financing within a Schumpeterian view of the capitalist process, thus reaching Marxian conclusions about value and distribution.

2 There are only two “things” that the firms cannot produce by themselves: money and workers (as living carriers of labour power, hence of living labour). Of course, at a lower level of abstraction, it can be assumed that the firms will pay wages at the end of the production process. However, this would not change the logical sequence of the monetary circuit, because it would not change the nature of the underlying class relations. Without the initial contractual promise to pay a money wage to the workers, the firms could not hire them and the production process would not take place. Therefore, the logical priority of the wage payment, as a condition for starting the monetary circuit, remains confirmed.

3 The point – according to Graziani – is that inflation has differentiated impacts on the purchasing power of profits and wages. Although they are recorded in the same historical period, they belong to different logical phases of the monetary circuit, due to their different class nature (Graziani 1977).

4 Although the expectation of higher sales – due, for instance, to an abundance of consumer credit – may induce the firms to enlarge the scale of production. However, this is an indirect effect, which ultimately depends on the autonomous decisions of the firms.

5 It is easy to see that, if one includes  in equations (1) and (2) in the appendix, the difference between the initial finance and the final finance remains unchanged. This conclusion does not hold if firms are modelled as a disaggregated and heterogeneous sector, in which some of them hold bank deposits (while other firms run into debt) or other financial assets issued by other sectors. This scenario is not considered in the basic scheme of the monetary circuit as well as in most macroeconomic models. Notice, however, this would not change the nature of investment funding, but only the balance-sheet composition of each individual firm.

6 Likewise, money acts as credit money even when it takes the form of commodity money if it is used to start the production process. This is the meaning of Keynes’ famous statement that the Indian rupee was “virtually a note printed on silver” (Keynes 1913: 26).

7 Thus reducing Keynes’s view to a crisis theory – as per Neoclassical Synthesis.

8 Notice that supply is exogenous with respect to the formal single-period scheme, not to the theory.

9 Clearly, a higher/lower than expected demand for consumer goods in the current period is likely to affect firms’ production decisions in the next periods. However, this is not automatic effect, but an indirect one.


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Accounting appendix

For the sake of simplicity, let us assume that prices remain constant over the period considered. At the beginning of it, the initial finance (FINi) that the firms need is:

FINi = w · N                                                                               (1)

where w is the money wage rate and N is the number of labour units.

By contrast, the final finance (FINf) is:       

FINf = C + ΔΒ – r · B – r · L – Θ · ∏                                         (2)

where C is total consumption from the wage earners, B is the stock of financial liabilities issued by the firms and held by the wage earners, L is the stock of bank loans to the firms,  is corporate profit, Θ is the share of profit distributed to the capitalists, and r is the (uniform) interest rate.

At the end of the period, the change in the stock of loans to the firms is:

ΔL = FINi  – FINf   

from which one obtains:

ΔL = w · N –  [C + ΔΒ – r · (B + L) – Θ · ∏ ]                           (3)

Corporate profits are:

∏ = Y – w · N – r · (B + L)                                                        (4)

Assuming away both the government and the foreign sector, the value of the national product is:

Y = C + I                                                                                     (5)

where I is aggregate investment.

Using (4) and (5) into (3), one obtains:

ΔL = I – ΔΒ – (1 – Θ) · ∏.                                                        (6)

At the end of each period, the change in the stock of loans to the firms equals the portion of investment (I) that is not funded by new issues (ΔΒ) and/or retained profits ((1 – Θ) · ∏).

Marco Veronese Passarella

Marco Veronese Passarella

Professore Associato di Economia Politica presso l'Università Link Campus di Roma e coordinatore per l'Università di Leeds del progetto JUST2CE

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