Money as the Pre-Condition for Production: Keynes’s Monetary Theory of Production and the Iranian Economy

Abstract
This research seeks to provide a quantitative reconstruction of the Monetary theory of production. In the conventional Iranian macroeconomic literature, references to Keynes are often limited to demand-side analysis and expenditure-stimulus policies, with the deeper foundation of his thought. The formulation of a capitalist economy as a money-production economy is rarely represented structurally. The central question of this research is whether money and credit are the pre-condition for production. This can be elevated from a conceptual explanation to a structural hypothesis within the framework of a Dynamic Stochastic General Equilibrium (DSGE) model and empirically tested for the Iranian economy. The present research achieves this innovation on three levels. At the theoretical level, it offers a coherent narrative of the monetary theory of production, drawing on the works of Marx, the Old Institutionalists, Keynes, Schumpeter, and Minsky. At the quantification level, a clear distinction is made and explained between the monetary theory of production and other approaches that assess the effect of money on production (such as money in the production function). At the methodological level, an advanced financial DSGE model is developed to integrate the financial accelerator mechanism, banks’ balance sheet constraints, and the working capital constraint into a single framework. This model is parameterized and estimated for the Iranian economy using a hybrid method of calibration and Bayesian estimation. The results show that, given the bank-based structure and the high dependence of production on short-term financing, an expansionary monetary impulse only leads to a sustainable increase in output if the expansion of current credit occurs simultaneously and proportionally to the growth of real activity. Furthermore, an increase in credit stability always exacerbates the amplitude of fluctuations. The active working capital constraint causes the reaction of macroeconomic variables to the expansionary monetary impulse to reach its maximum point sooner. Moreover, larger short-term jumps do not necessarily lead to a greater cumulative effect on production. Consequently, the interaction between the intensity of the credit constraint and the stability of credit supply determines the shape, magnitude, and ultimate efficiency of monetary policy in the Iranian economy. Additionally, in the presence of the pre-financing constraint, an expansionary fiscal impulse transforms from a demand stimulus into a more volatile disturbance in production and investment. The activation of the working capital channel not only increases the range of reactions but also intensifies the magnitude of intermediate adjustments, as any increase in economic activity immediately raises the need for operational financing. This exposes the economy to credit volatility. The existence of a credit constraint also makes the restrictive effects of a fiscal impulse more severe and volatile for the private sector.
 
Extended Abstract
Purpose: The primary Purpose of this research is to quantitatively reconstruct Keynes’s Monetary Theory of Production, fundamentally positing that “Money and credit are the conditions for the possibility of production”. The study seeks to elevate this concept from a mere conceptual explanation to a verifiable, structural hypothesis within a Dynamic Stochastic General Equilibrium (DSGE) framework specifically tailored for the Iranian economy. The work addresses the gap in the Iranian macroeconomic literature, which traditionally limits Keynesian analysis to demand-side stimulus, neglecting the deeper, structural role of money as a prerequisite for real activity. The innovation lies in three areas including a) developing a coherent theoretical narrative based on Marx, Keynes, Schumpeter, and Minsky, b) clearly distinguishing the monetary theory of production from models where money is merely an input in the production function, and c) integrating key financial frictions, namely financial accelerator, bank balance sheet constraints, and working capital constraint, into a unified financial DSGE model.
 
Methodology: The study procedure is centered on developing and estimating a Financial Stochastic Dynamic General Equilibrium (DSGE) model. This model is structurally innovative because it explicitly incorporates money as a pre-condition by simultaneously integrating certain mechanisms including the financial accelerator, bank balance sheet limitations, and the constraint on working capital. The model was parameterized and estimated for the Iranian economy using a hybrid approach combining calibration and Bayesian Estimation. This method was chosen to rigorously test the explanatory power of the model regarding the dynamics of output, investment, and credit flows within Iran’s specific economic structure, characterized by its high dependence on the banking system and short-term financing. The theoretical foundation was established through a systematic reconstruction of the monetary theory of production by synthesizing insights from finance-driven economics.
 
Findings and Discussion: The findings provide critical insights into the transmission mechanism of monetary policy under binding credit constraints as follows:

Monetary Impulse Effectiveness: An expansionary monetary impulse only leads to a sustained increase in output if the growth in current credit coincides and is proportional to the growth in real activity.
Role of Working Capital: The active working capital constraint amplifies and accelerates the impact of monetary shocks. Any increase in economic activity immediately raises the demand for operational financing, exposing the economy to greater credit volatility and intensifying the magnitude of intermediate adjustments.
Stability vs. Volatility: an increase in credit stability consistently increases the amplitude of fluctuations. Furthermore, larger short-term credit jumps do not necessarily translate into a greater cumulative effect on output.
Fiscal vs. Monetary Shocks: In the presence of the pre-financing constraint, an expansionary fiscal impulse transforms from a simple demand stimulus into a more volatile disturbance impacting production and investment, highlighting the non-neutrality of money as a prerequisite.
Policy Determination: The ultimate shape, intensity, and efficiency of monetary policy in Iran are determined by the interaction between the severity of the credit constraint and the stability of the credit supply.

 
Conclusions and Policy Implications: The study concludes that the Iranian economy can be modeled quantitatively as a money-production economy, provided that the prerequisite nature of money and credit is recognized structurally. The primary Policy Implications are as follows:

Monetary policymakers in Iran cannot focus solely on prices (interest rates) but must actively manage real credit provision synchronized with production.
Expansionary liquidity policies without adequate financing for working capital risk lead to severe volatility and inefficiency, as the economy is quickly exposed to credit constraints.

Effective stabilization and growth policies require shifting the focus from money merely as a financial intermediary to its role as a pre-condition that must align with the real needs of sectors. Policymakers must also ensure that credit expansion is contemporaneous with real output growth to maximize the effectiveness of the stimulus.