Exogenous and Endogenous Money: Room for Reconciliation?

A common response made by economists to my previous post on the overwhelming evidence for endogenous money is: ‘so what?’ Economists rarely disagree about the mechanics, but assert that there are no major implications of endogenous money that differ from their theories.  This is a mistake. Reality is so complex that seemingly small errors in a model can have a big impact on its conclusions. As I will show, endorsement of the exogenous money theory causes economists to miss some key features of a capitalist economy.

It is worth noting that the names are perhaps misleading, as both theories contain endogenous and exogenous elements. In the case of exogenous money, the central bank expands the supply of base money, and the reaction of banks to this – how much they ‘lend out’ – is in large part endogenous. In the case of endogenous money, banks create loans as they please, except for an exogenous constraint (the interest rate), set by the monetary authority*. Clearly there is a large crossover between the two theories, but there are also subtle differences, which lead to important conclusions.

A point emphasised by endogenous money proponents is the robust correlation between private debt and other key variables such as growth, stocks and house prices:

Obviously correlation doesn’t equal causation, but it is based a theoretical link Keen often mentions – Minsky’s observation that, in order for aggregate demand to increase, planned spending must be greater than current income, and therefore credit must fill the gap. This is a pithy observation, but it seems to me that, contra Keen/Schumpeter/Minsky, the exogenous money model can account for this: the central bank fills the gap by increasing the money stock. This can cause both an increase in debt and an increase in aggregate demand, but, in contrast to the endogenous story, the increase in debt does not cause the increase in aggregate demand.

In other words, the exogenous story is that central bank expands the money supply, and this increases both debt and AD. The endogenous story is that banks expand credit, which expands aggregate demand and forces the central bank to expand the money stock. Thus both are compatible with the correlation between private debt and growth, although the exogenous story would not necessarily have the correlation so tight, or have private debt moving first every time.

In any case, given the other evidence – that credit money expansion precedes base money expansions, that central banks have failed to control base money in the past, and that anyone who actually works in a bank will tell you they make loans independently of the number of reserves they have – endogenous money appears to have the mechanics correct.

So why does this matter? Well, the exogenous story has the causality backwards: it assumes that banks receive reserves and then ‘lend them out,’ whereas what they actually do is make loans and then balance their reserve requirements afterwards. Obviously this means economics textbooks are wrong about the causal mechanics, but economists will likely plead that it doesn’t really matter. However, it matters for a couple of reasons.

The first is stability: if banks have adequate reserves before they make loans, a bad loan will cause problems for the bank that lent them out. But if the banks depend on each other for reserves, and look after the loans have been made, then bad loans can quickly destabilise the entire system as the availability of reserves dries up, triggering a positive feedback loop rather than a return to normality. Thus the system is highly interlinked, and far more vulnerable to systemic crises.

Even more crucially, endogenous theory means that money is effectively created and destroyed by the banking system. This is because debt-based assets and liabilities expand and contract simultaneously as debts are repaid; in other words, the loan-ee is both the saver and the borrower. When the loan is created it is deposited in the recipient’s bank account; as this is paid down both the asset and liability are discharged. Reserves are a secondary consideration and the availability of them does not affect lending decisions. It is true that, in name, the reserves ultimately come from the central bank. But really the expansion of spending power is an endogenous decision, though the central bank influences it via setting the price of reserves.

Simply put, debt does not cancel out at the macro level; it scales up. Just as it is true for a household that income can be scarce relative to debts, it is true for the economy**, which as a whole can find itself over-indebted.

Economists often realise that disequilibrium and finance are important, but their faulty view of the banking sector causes them to miss the mark. Take neoclassical models such as Krugman’s, which argue debt is merely a redistribution from savers to borrowers, and have to add ‘special case’ considerations to make debt matter. But this is misguided – debt always matters, because money enters the economy primarily as new debt, which the economy must expand to service. Hence, debt must go into productive investments, which create future income streams, rather than bidding up the price of assets. I doubt economists such as Krugman would object to the policy implications of this argument, but their models do not imply it is important.

Thus, the name for endogenous money strongly implies its conclusions: the system is easily destabilised endogenously, and the money stock endogenously expands and contracts to accommodate activity (thus rendering the ‘neutrality of money‘ an absurd proposition in any time frame). The differences in the fundamentals are perhaps more subtle than endogenous money proponents make out, but the conclusions are extremely different, and have strong implications for equilibrium analysis, crises and the relationship between finance and the real economy.

*They can also be constrained by regulation, but that is another story.

**This is the only time I will use a household analogy to communicate a point about the economy as a whole.


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  1. #1 by paul on September 27, 2012 - 4:13 pm

    “it is based a theoretical link Keen often mentions – Minsky’s observation that, in order for aggregate demand to increase, planned spending must be greater than current income, and therefore credit must fill the gap.

    Absolutely impossible unless one believes that there is no negative feedback loop undermining the ability to expand credit. One has to ignore natural leakages and the fact that when credit is issued the balances to pay the interest are not generated. The net difference between credit assets and credit liabilities is ever-expanding in the negative.

    Sure, in a vacuum credit can be expanded infinitely. Trouble is, the liabilities associated with credit expand at a greater rate than the ability to service the debt.

    Then, in steps fiscal spending (net money creation) to make the impossible look possible.

    In the long run planned spending is a function of either new fiscal spending (deficits) or re-distribution, ie tax the crap out of winners (the few) and give it to losers (everyone else) to spend. Re-prime the pump.

    Anything else requires belief in perpetual motion.

    Did Minsky say “therefore credit must fill the gap.” or is that someone else saying it or someone else’s conclusion?

    • #2 by Unlearningecon on September 29, 2012 - 2:10 pm

      If income is to grow, the financial markets, where the various plans to save and invest are reconciled, must generate an aggregate demand that, aside from brief intervals, is ever rising. For real aggregate demand to be increasing, . . . it is necessary that current spending plans, summed over all sectors, be greater than current received income and that some market technique exist by which aggregate spending in excess of aggregate anticipated income can be financed. It follows that over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets.

      If the debt goes towards expanding productivity then I don’t see why it would require belief in perpetual motion?

      • #3 by paul on October 1, 2012 - 3:00 pm

        “If the debt goes towards expanding productivity then I don’t see why it would require belief in perpetual motion?”

        Did you mean PRODUCTION rather than PRODUCTIVITY?

        This issue is complex because it involves a chain of logic (each link is simple however) that may not be obvious to those not familiar with system theory.

        The economic system, being tied to spending that must be present to maintain activity, is itself tied to the level of funds available for spending.

        Saving or hoarding of funds removes funds from the spending pool resulting in natural decay in economic activity. Profits are a component of saving if they are not fully re-invested back into the system. At any rate, since companies in the aggregate are historically profitable, investment removes funds from the system. Investment can’t create jobs on it’s own, it must be funded externally. Actually I don’t buy the argument that investment creates kobs but I don’t wish to get into that now.

        If the funds available for spending are not replenished through deficit spending, then the only alternative is private debt. Private debt does increase spending when used to purchase goods or services.

        When the debt is repaid, it subtracts from spending that would otherwise have followed from the income used for the payments.

        Debt cannot be expanded beyond the borrowers ability to service it, and the liabilities accrue faster than growth in incomes, so eventually the credit circuit becomes inactive. Growth in the non-government money supply stops or very nearly so.

        Economic growth in this case must decline as credit expansion approaches it’s ceiling . There are no longer new funds available to stimulate economic activity. The level of funds becomes essentially fixed, cannot grow.

        Attempting to maintain an economy with a fixed level of funds would require a frictionless system, hence perpetual motion.

        Frictions would include saving, a shift of funds (re-distribution) towards the top of the income spectrum, and imperfect allocation of funds within the system.

        A credit-only based monetary economy cannot function for very long (see Eurozone). It will last until a significant subset of participants can no longer expand their own debt.

      • #4 by john77 on October 1, 2012 - 3:33 pm

        According to your theory Apple could not exist in the form that it does today.

      • #5 by paul on October 1, 2012 - 7:18 pm

        “According to your theory Apple could not exist in the form that it does today.”

        Can you explain why?

      • #6 by john77 on October 1, 2012 - 7:43 pm

        Because it does not depend on government deficit spending and yet is able to continue growing.and its liabilities do not grow faster than its ability to service them.
        In the real world UK economic growth was faster during the Victorian era when budgets were balanced than during the last 48 years when budget deficits wre the norm. The period of fastest real growth, over any reasonable period, since WWII was 1951-64 when the government attempted to, and often did, balance its budget. The slowest real growth periods were 1974-9 and 1997-2010 (real growth in the latter period has been overstated due to statistical error in RPI and CPI introduced in 1997 and only corrected in 2011 so that CPI was understated by 0.3% pa and RPI by something approaching 0.6% pa so calculations of real growth by subtracting inflation from money GDP growth overstate it).when the government ran huge deficits and, in the latter case household sector debt grew by over one trillion pounds.
        In practice, even if not in theory, it has proved possible to grow an economy without deficit financing

      • #7 by Unlearningecon on October 1, 2012 - 8:21 pm

        Seems to me that economic growth depends on either an increase in public debt, private debt or exports. In the Victorian era exports were very high.

      • #8 by john77 on October 1, 2012 - 9:26 pm

        In the world as a whole net exports/imports should (actually do) sum to zero [there used to be a standard joke about the world’s trade deficit with Mars since adding up all the different countries trade balances showed a net deficit].
        In the Victorian era the largest share of the capital generated by the UK Trade surplus was invested in the lost-Civil War USA which therefore had a trade deficit but also had fast economic growth without comparable budget deficits.
        The whole point of capitalism is that investing creates future income whose value to the investor is in excess of the amount invested. So that we can choose whether to be prudent and be able to retire instead of working until we drop dead because our bodies are no longer able to take the strain of our jobs.

      • #9 by paul on October 2, 2012 - 12:35 am

        John77 wrote:

        >”Because it does not depend on government deficit spending…”

        How do you know that? There certainly has been plenty of it (aboot $10 Trillion) since Apple’s near-death experience in 1995.

        “Civil War USA which therefore had a trade deficit but also had fast economic growth without comparable budget deficits.”

        …so you haven’t heard of Greenbacks?

        Unlearning econ wrote:

        “Seems to me that economic growth depends on either an increase in public debt, private debt or exports.”

        …and private debt is unsustainable, because as I pointed out , in a closed system economic activity cannot continue on a steady, stable path if there are frictions (saving, etc.)…and without question there are. The economy, without external input, must follow a path towards zero activity (not saying it will reach zero). This may first manifest itself as a deflationary spiral.

      • #10 by john77 on October 2, 2012 - 8:03 am

        Of course I have heard of greenbacks – have you heard of the Union government refusing to honour confederate currency? Both of which were issued *during* the Civil War, not after it. I am not as stupid as you seem to think.
        US Government debt was only 10% of GDP in 1900, which had risen to over 240% of 1865 GDP by then.
        Maybe you think that the rise in GDP was due to the much smaller increase in government debt less trade deficit – in that case, Osborne’s budget deficit should be creating explosive growth in UK GDP of hundreds per cent per annum: it doesn’t seem to be doing so.

      • #11 by john77 on October 2, 2012 - 8:06 am

        Oh, and try reading the whole of my sentence on Apple.

      • #12 by paul on October 2, 2012 - 12:43 pm


        Relax, I was merely pointing out that the Greenbacks event tends to undermine your argument about a lack of deficit spending. Not trying to be snarky.

        As far as your entire comment on Apple, yes, I read it. I don’t see anything there that undermines my premise.

        Basically you are taking YOUR VIEW of data and trying to show that my premise must be wrong because the data seems to contradict it. That can’t work if your opponent’s argument is based on arithmetic in a closed system.

        The problem here is the math relationships I am basing my argument on are, for lack of a better word, irrefutable. Don’t get excited, I’m not claiming that my argument IS perfectly framed around the math, but I THINK it is. You are welcome to show that it isn’t, that’s what discussion is all about.

        Math trumps data, if the data says something the math doesn’t support you may be interpreting the data incorrectly.

        For example, the NIPA and FoF data are not stock-flow consistent and contradict the sectoral balances identity in some areas, especially the gross saving and net saving accounts.

        Does that mean that the sectoral balances identity is not always balanced and thus flawed or does it mean the NIPA and FoF tables are not properly constructed?

        WRT Apple, nothing I wrote precludes them from accumulating wealth. In fact, the accumulation tends to support my argument. Since Apple’s near-death in 1995 when they held about $3 Billion in cash they have grown their cash hoard to about $130 Billion.

        Where did those funds come from if not from deficit spending and/or someone else’s pocket (or through private debt)?

        Without deficit spending (and trade leakages), the economy is zero-sum. One agent’s gain is another agents loss (in nominal terms). In a closed system it is impossible for it to be any other way.

        Real wealth or value is another story. There is no direct relationship between value and nominal wealth (net cash). The concept of value exists entirely within people’s minds. The value of an object can and often does collapse overnight. It’s not real until a transaction takes place and an agent takes the cash, but even then it’s only true for that particular transaction at the micro level. At the macro level it can’t be true. If enough people tried to “cash out” at the same time we would have the equivalent of a bank run. There isn’t enough cash in existence to monetize everyone’s investments. Not.Even.Close.

        On a balance sheet value doesn’t mean much unless one can actually sell the object in exchange for nominal wealth. I can “value” my residence on my balance sheet at twice the market value and drive my apparent net worth up. Is that real?

        Conversely, my residence before the GFC was X and now it’s 0.5 X. Did I “lose” 0.5X? Of course not.

      • #13 by john77 on October 2, 2012 - 2:26 pm

        Dealing with your comments in order
        The Greenback event *cannot* undermine my argument about the growth in US GDP vs government deficit *after* the Civil Watr because the Greenback event was*during* the Civil War (as I pointed out in my last post).
        Apple’s growth rate has not declined towards zero as your theory says it must.
        “That can’t work if …” on *correct* arithmetic. Sadly, if *you* are starting from false assumptions then even correct arithmetic is likely to lead you to false conclusions. Hence someone thinking that Euclidean plane geometry (instead of Riemannian geometry) applies to the surface of the Earth gets stumped when the lines of longitude meet at the poles.
        If you think that $3 billion in cash is “near-death” what do you think about the 99.99% of UK companies with less than 1% of that? I Should not argue about Boeing’s benefit from government spending (not just the US government but all those that overtly or covertly subsidise airlines – even the TfL deficit on tube fares to Heathrow and the government subsidy to the operators of the Victoria-Gatwick and Liverpool Street-Stanstead lines subsidise Boeing and Airbus), but Apple – pull the other one.
        You seem not to believe that investment can generate economic growth without borrowing. Every farmer in history who has chosen to spend time diggings ditches, clearing waste ground for planting, building sheepfolds, using elementary pumps to raise water from the Nile to irrigate land, planting trees to form a windbreak etc will disagree with you. If you do not want to accept my view (which you obviously do not) try asking Christian Aid or Practical Action whether Third world farmers can improve matters through their own labour.
        It is debatable whether economies are zero-sum; perhaps you meant monetary transactions are zero-sum; whatever! Real economic growth used to arise from better harvests or higher milk yields or better catches, none of which relied on credit or government deficits bit on weather and/or, selection of better seeds and/or improved breeding and/or the farmer’s back-breaking labour in fertilisation, clearing weeds, digging ditches for better drainage, irrigation etc. Now it results from innovation and investment. You may not have noticed that Japanese growth has plummeted in the last twenty years despite burgeoning government deficits and a trade surplus (the sources “unlearning economics” cites as the engines for economic growth).
        “Real growth” is a widely understood phrase (in the financial sector it is almost unheard-of for it to be misunderstood) to indicate growth net of the distortions caused by the debasement of the currency (or specific price changes) or fluctuations in foreign exchange rates of economies or revenues or profits. I am surprised that you do not understand this.
        The value of an object does not collapse overnight, but the price may do so. You have got it completely upside-down there. One problem with soviet economics was that the Slav languages have only one word to cover both concepts of “price” and “value”. The value of my house as a place to live stays the same, regardless of the market price of the house next door. It is not inevitable that there will be a “bank run” that destroys price (NOT the same as value) if too many people try to cash out at the same time – it depends whether or not there is a panic (read Jeremiah chapter 32 or the account of the second Punic War where some wealthy Romans bought and sold the land on which Hannibal’s army was standing)

      • #14 by paul on October 2, 2012 - 3:14 pm


        “Apple’s growth rate has not declined towards zero as your theory says it must.”

        My theory says nothing of the sort. I’m baffled by your interpretation, and am waiting to read your logical argument as to why you think it must.

        Apple’s growth rate is limited only by the availability of willing buyers able to purchase their products.

        The very existence of deficit spending and/or credit expansion makes those purchases possible.

        Credit growth is unsustainable, in that is has limits, the ability of borrowers to service debt. Deficit spending has no natural limit.

        In a closed system with no leakages or external input any growth by Apple would have to be at the expense of another agent or group of agents within the system.

        There is nothing controversial in that statement.

      • #15 by john77 on October 2, 2012 - 3:41 pm

        That isn’t what you said before
        Secondly credit growth is *not* unsustainable IF returns from investment generate economic growth faster than the growth in debt. DUH!!
        Thirdly deficit spending has resulted in inflation far more often than economic growth.
        Maths does not trump data. Mathematics is a universal language than enables us to understand data and relationships therein. Mathematics explains how the world, and the universe, works – it does not create it:the apple landed on Newton’s head before he expounded the theory of gravity. Imaginary numbers help us to understand electromagnetic induction of alternating current but do not themselves generate electricity.
        Facts DO matter. In science facts trump theory: when facts disagree with the theory it is discarded and replaced by one that does explain the facts.

      • #16 by paul on October 2, 2012 - 5:36 pm


        “That isn’t what you said before”

        Dude, everything I wrote is still on the page. Go find it and point out the error in my thinking.

        “credit growth is *not* unsustainable IF returns from investment generate economic growth faster than the growth in debt. DUH!!”

        This is where your thinking goes off the rails. Of what form are the returns you speak of?

        “deficit spending has resulted in inflation far more often than economic growth.”

        That’s not part of the discussion, but since you brought it up, inflation has been almost entirely a function of rising oil prices, a scarce commodity, over the past 30 years or so.

        The buying power of ones wage dollar has been relatively stable over that period.

        “Maths does not trump data.”

        Another place where your argument goes off the rails.

        Within the context of the discussion, the level of dollars and bonds held by the public, plus bonds held by foreign entities, plus net cash in existence is currently about $18 Trillion.

        Your argument requires that, assuming balanced trade and a balanced federal budget, the remaining closed economy can grow without any further intervention.

        Segments of the economy can grow for a while if private debt can be expanded further. The economy as a whole cannot.

        Seems like you are defining growth as growth in values. That kind of growth is meaningless. It’s vapor if the balances necessary to maintain the price level are not increased accordingly.

        You can’t keep adding circuits to your electrical panel unless you increase the size of the main service.

        Your argument assumes unlimited leverage. Good luck with that.

        “the apple landed on Newton’s head before he expounded the theory of gravity. “

        Exactly right. The natural systems have always been there. It follows that the relationships underlying those systems can’t be proven wrong by ones interpretation of data.

        Are you claiming that your interpretation of empirical data is to be relied on rather than that which the system math deems possible?

        The domestic economy can be active as long as we provide the impetus…spending and by extension expansion of (state-backed) financial assets. Cut the supply of those financial assets while at the same time allowing saving in all of it’s forms to take place and we have a system winding down, as we would expect.

        No other outcome is possible.

      • #17 by john77 on October 2, 2012 - 7:18 pm

        Oh sure – growth in values is meaningless!! Only to you.
        Growth in values means that people have more to eat (no, I will not accept that obesity is a necessary consequence people have choices) and better houses and better education and better healthcare and better leisure.
        I have already pointed out the basic flaw in your thinking: read it!
        A false axiom results,if logic is applied, in a false conclusion. This was repeatedly demonstrated by Socrates, who was sentenced to death by the left-wing democracy.
        Shall we start with “Saving or hoarding of funds removes funds from the spending pool resulting in natural decay in economic activity” – saving is the transfer from current consumption to investment ONLY IF such investment is worthless or is worth less than the investment does this lead to a decay in economic activity.
        I should have started with the mind-blowing stupidity that ignores the impact of weather on harvests and hence the food supply and general economics. Are you an academic economist? You are obviously not a mathematician!
        “investment removes funds from the system” NO NO NO
        By definition, investment puts funds into the system
        Hoarded profits does take money out of the system (the only thing that Hitler got right) but capitalism is all about ploughing profits back in order to create future income and allow the capitalist to retire.
        ” Investment can’t create jobs on it’s own, it must be funded externally.” Do you have the brain of a rabbit? By definition external funding.IS investment but most investment in the private sector is internally funded from retained profits. My son is seriously disadvantaged because I have do not have a garage in which he could launch a competitor to Microsoft
        “If the funds available for spending are not replenished through deficit spending, then the only alternative is private debt. ” Can you really believe this?
        “liabilities accrue faster than growth in incomes” ONLY IF the interest rate exceeds the rate of growth in incomes AND if the borrowers o not repay some of their debt. SO NOT TRUE.
        When I had a mortgage I continually reduced it: what sort of guy doesn’t (rhetorical question).
        Your axiom that companies are in aggregate profitable does not deserve the status of an axiom but your error lies in the assumption that profits disappear from the economy: in reality (a few million miles from your fantasy) profits are used for investment, generating future economic growth, or distributed to shareholders to finance current consumption.
        Will this do for now? I feel that I have had enough

      • #18 by Unlearningecon on October 2, 2012 - 7:28 pm

        I hate to be so authoritarian, especially since I recently banned two people, but I don’t see this debate going anywhere and it’s off topic. Please can you guys wind it down (though I will not take any action if you want to have a final word).

      • #19 by john77 on October 2, 2012 - 7:55 pm

        Yeah – you actually accept it on the (OK rare) occasions when I spot a typo. I just like to get facts right.

      • #20 by paul on October 2, 2012 - 8:36 pm


        Off-topic. Really? It’s this very fundamental misunderstanding of how and why money relates to an economy that has caused the entire world economy to collapse.

        Mainstream economists don’t even partially grasp the concepts.

        If I though it was off-topic I would have ended it long ago.

        I do agree that it isn’t getting anywhere though. Cheers.

      • #21 by john77 on October 2, 2012 - 9:21 pm

        Sorry host – I cannot accept that I am a mainstream economist. If I was I should have prevented the dotcom bubble and the sub-prime insanity )unlike those who support paul’s ideas). I got horribly slagged off for saying stocks were over-priced in the late-90s.which cost me – I can do without insults from those who have been proved wrong by the last decade (and the last two thousand years)

  2. #22 by john77 on September 27, 2012 - 5:07 pm

    Minsky may be pithy but for aggregate demand to increase planned spending must exceed current *spending* not current income. If credit exists current spending can already be greater than current income (we had a decade of it under Brown so aggregate demand can *decrease* even if planned spending exceeds current income..
    In the exceptional case of deleveraging when income exceeds spending, aggregate demand can rise when the gap between income and spending shrinks without changing sign.

    • #23 by Steve on September 29, 2012 - 2:31 am


      What you are describing and what Keynes plagiarizes C. H. Douglas in saying:
      “Thus the problem of providing that new capital-investment shall always outrun capital-disinvestment sufficiently to fill the gap between net income and consumption, presents a problem which is increasingly difficult as capital increases. New capital-investment can only take place in excess of current capital-disinvestment if future expenditure on consumption is expected to increase. Each time we secure to-day’s equilibrium by increased investment we are aggravating the difficulty of securing equilibrium to-morrow.”

      ….is just an unconscious expression of Douglas’s A + B theorem. Endogenous money and central bank compliance in the obscuration of A + B is the REAL problem. You can go on and on for 80 years with money infusions by Banks and Central Banks and not have a depression (but of course have regular recessions) but eventually the still underlying cause of instability, i.e. the BUILT IN enforcement of cost accounting’s conventions which is individual income scarcity in relation to prices. Price inflation is a part of the current system…..unless you supplement individual incomes with a costless dividend and balance the economy with a retail discount of prices. That this would also enable a resolution of the millenia long problem of elite versus individual control of the monetary/economic system is a nice little side benefit.

      C. H. Douglas and Social Credit SOOOOO needs to be revisted.

    • #24 by Unlearningecon on September 29, 2012 - 2:10 pm


      Yes you are right.


      Good quote – but are you sure Keynes plagiarised? Is it not possible they just came to similar conclusions?

      • #25 by paul on October 1, 2012 - 2:34 pm


        Maybe so, but what I am describing is a system mathematical relationship that is common among many similar systems in the known universe. It’s just applied math. See Thermodynamics, 2nd Law for starters.

        I’ve never read a word of Keynes, or any other economist for that matter other than what I see posted in blog comments.

        The underlying dynamics of monetary economics can be explained and understood in plain math/system terms without any appeal to economic theory whatsoever wuthout losing anything important in the translation.

        For example an understanding of the implications of a closed system (properly identified) debunks most of the conventional wisdom about public debt.

  3. #26 by paul on September 27, 2012 - 6:13 pm

    Credit moves future spending into the present. The piper is paid when future income doesn’t add to future spending because of debt service.

    Credit issued for consumption rather than investment may be the stupidest of many stupid ideas in the history of economics.

  4. #27 by pilkingtonphil on September 28, 2012 - 11:23 am

    “A common response made by economists…”

    I’m not sure that Yglesias would be the best person to comment on theoretical issues regarding economics — he’s a policy wonk and, from what I’ve seen, doesn’t know much about theory. When I discussed this with Dean Baker he instantly got why it would be important. Same deal when Paul Krugman came upon Steve Keen’s stuff. In fact, every neo-Keynesian economist I’ve talked to has understood why this would be a very big deal. I really don’t think that Yglesias is the best barometer on this.

    • #28 by Unlearningecon on September 29, 2012 - 2:14 pm

      He was just an example but that is a common response. I had it in my comments and I’ve seen it elsewhere.

      IS/LM is incoherent for any number of reasons, obviously endogenous money is one of them.

  5. #29 by pilkingtonphil on September 28, 2012 - 11:27 am

    The main critique is much more simple: if money is endogneous ISLM falls apart:


    If ISLM falls apart much else goes with it. Negative real interest rates, for example, no longer look like a solution to the present crisis, for example. In fact, if you want to engage Yglesias you might make that point.

  6. #30 by bond guy on September 29, 2012 - 1:00 pm

    To follow up a previous comment I made in the last post – I don’t think there is a huge difference in views if you look at “modern” neoclassical (DSGE-style) models. In those models, money is the monetary base. And as long as the amount of money is greater than required reserves, the central bank has almost complete control over the monetary base (money) – the other agents will allocate between bonds and money based on the interest rate. In the models, there are no banks, so required reserves are zero, so this is always true. In the actual economy under QE, we see this also holds true.

    The models use a formalism in which banks are not required: agents can take short positions in bonds as a way to obtain financing. From the point of view of “real economy” (consumers, firms) agents, this is not a big difference. But this means that model debt aggregates will not operate in the same way as debt aggregates in actual economy. (The only debt aggregate is government debt; private debt is netted out to zero.) As long as people understand that, this is not necessarily a problem. And since there are no bank loans within the models, it is impossible for them to predict any relation between bank loans versus any other quantity, by definition.

    That said, it appears many neoclassical economists do not understand this, and fall back to obsolete textbook “money multiplier” mumbo-jumbo when writing blogs or editorials. This only verifies the proposition that the vast majority of people have little capacity to understand the implications and uses of mathematical models.

    In a DSGE-style model formalism which somehow incorporates banks (good luck on solving that) the size of bank loan books may end up being under the control of the central bank, given the outsized importance of monetary policy expectations within those models. This is just like the central banks’ control of inflation within those models. According to Nick Rowe (as far as I could understand Nick Rowe’s meandering logic), that was Krugman’s underlying point, even though Krugman expressed it incorrectly. Since this power is expectations driven, looking at the operational details of when reserves are supplied does not prove anything.

  7. #31 by Ramanan on September 29, 2012 - 2:04 pm

    There is this nice footnote in Godley & Lavoie’s book Monetary Economics in Chapter 10 showing how inconsistent mainstream economists can be:

    “As pointed out in earlier chapters, some mainstream authors, for example Romer (2000), now argue that this model of exogenous money supply with endogenous interest rates should be forsaken and replaced by another model where money is endogenous and where the central bank sets real interest rates as a function of the discrepancy between the actual and the targeted rates of inflation. This is actually what John B. Taylor (2004) does in his chapter on monetary policy. However, in the chapter on money creation, Taylor reverts to the traditional story based on money multipliers and reserve-constrained creation – seemingly not realizing that this is inconsistent with his previous institutional description of the central bank.”

    • #32 by Unlearningecon on September 29, 2012 - 2:25 pm

      That’s a great quote – it’s something I’ve noticed. Economists can’t decide whether they already use endogenous money, whether it’s wrong, whether it’s right but doesn’t matter.

  8. #33 by Nathanael on October 1, 2012 - 4:11 pm

    I’d focus, very tightly, on the fact that *getting causality backwards causes economists to make major, subtle errors of reasoning*.

    You put it most simply back on August 1 when you noted that the ‘mainstream’ thinks that M0 changes first, and then M1/M2/M3 change — but in reality, *first* M1/M2/M3 change and then M0 (maybe) changes to match.

    This has very deep policy implications, and the “mainstream” just ignores them.

  9. #34 by Nathanael on October 1, 2012 - 4:32 pm

    I think it’s important to note that exogenous and endogenous money are descriptions of different systems which could exist in the real world.

    Arguably building societies in the UK operated under an exogenous money regime. Banks in the US under the gold standard may have operated under an exogenous money regime. The fact is that *now* we are under an endogenous money regime.

    It’s not so much that exogenous money is “per se wrong”, as that it does not describe the current structure of money in any major economy.

    Economics is legal-regime specific, and always will be, because the nature of money and the nature of contracts and the nature of ownership are defined by law! The Lucas Critique is therefore utter, utter bullshit — any economic theory is only as good as the legal regime which it describes. (There are some rare subsections of economics which are not dependent on ownership, money, or contracts, such as the microeconomics of subsistence agriculture, but those are not studied by hardly anyone.)

    Now, that’s fine! A *useful* economic theory will show us the consequences of the legal regime we have chosen, so that perhaps we may wish to choose a different one (if the consequences suck). The Lucas Critique is purest bullshit.

    If you want to have a theory which transcends legal regime, you need to go into political science, or sociology, or even anthropology — note that all of these are still enmeshed in studying cultural variation, and have found few cross-cultural universals — so perhaps if you really believe in the “Lucas Critique”, you need to go all the way down to mass & individual psychology. We don’t understand psych well enough to really do that yet, though.

    • #35 by Nathanael on October 1, 2012 - 4:54 pm

      I want to amend my comment. 🙂

      While exogenous money could theoretically exist, history has shown that when the government tries to tighten the money supply too much, people start generating their own forms of scrip and using them, regardless of law and regulation.

      Even military intervention cannot, as history shows, prevent the generation and use of endogenous money. Thus, the ability of a government to create an exogenous money regime appears to be extremely limited — exogenous money probably has never applied to an *entire* economy, only to individual sectors (such as building societies / mortgages / borrowing against land in the UK).

    • #36 by Nathanael on October 1, 2012 - 5:13 pm

      While I’m savaging Lucas :-), I might point out that I have read one version of his “critique” which claimed that the effects of past policies couldn’t be used to predict the effects fo future policies because we lived in a world with forward-looking optimizing agents.

      Of course, experimental psychology tells us that we live in a world with few, if any, forward-looking optimizing agents. 😛

  10. #37 by Nathanael on October 1, 2012 - 4:50 pm

    I am again going to recommend that you attempt to assemble this blog into a book. Most of the “heterodox” books are too heavily focused on demolishing “mainstream” economic fallacies, and most of the rest are hard to read and overly technical. You, on the other hand, are assembling the basics of an actual economics textbook here. I suppose you might need some collaboration and assistance to fill out the references to empirical studies which would be needed to make a proper academic work….

  11. #38 by Unlearningecon on October 1, 2012 - 8:16 pm


    Thanks for your substantive comments and the kind words, but can I just urge you, as I do with all my commenters, to try and keep the number of comments down so as not to flood the thread. Obviously if you are having a conversation with someone that’s different, just not when it’s with yourself! 🙂

    Anyway, thanks for the recommendation of writing a book. I am only an undergraduate so I don’t think I’m ready, but I do love writing and it would be something to think about over the long term. You are correct that many heterodox books – including, perhaps Steve Keen’s – are dedicated to ‘demolishing’ the mainstream from every possible angle, which is in my opinion a bad approach. Economists are not stupid – they’ve been doing this for 150 years. Some of it is bound to be right, and a lot of it will be logically consistent within its own assumptions, at the very least.

    You have touched on something quite fundamental: economists (and the libertarians who rest on them) seem to think they can deduce a theory that shows fundamental economic principles and laws across space and time. Of course, this is not possible as culture will have an impact (the word ‘profit,’ I believe, is actually derived from a meaning of ‘rip off’ or ‘defraud.’ Try profiting in a country where the word means that). Furthermore, as you say, legalisation will also have an impact.

    The Lucas Critique identifies the fundamental difference between the social sciences and ‘real’ sciences: reflexivity. Of course, economists knew this before Lucas, and social scientists have known it for ages. Lucas just stated it, and let it be interpreted, in such a way as to protect the core neoclassical framework.

    • #39 by john77 on October 2, 2012 - 9:53 pm

      @ 38 but frustrated by your website provider
      Your whole raison d’etre is that economists are stupid enough to be conned by the establishment … 🙂 I must get # 1 son to show me how to get a fancy smiley next time he comes home

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