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The theory of endogenous money and the LM schedule: prelude to a reconstruction of ISLM

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  • Thomas I. Palley

Abstract

Money is at the center of macroeconomics, which makes understanding the money supply central for macroeconomic theory. This paper presents the Post Keynesian theory of endogenous money supply and shows how it is fundamentally different from the conventional money supply theory. The conventional approach relies on the money multiplier and bank lending is invisible. Post Keynesian theory discards the money multiplier and focuses on bank lending which drives money creation. The paper emphasizes the structuralist version of Post Keynesian theory which retains Keynes’ liquidity preference theory of long term interest rates and also recognizes banks are subject to financial constraints that limit their lending activities. The paper then shows how to derive the LM schedule in an endogenous money economy, which is a necessary prelude to reconstructing the ISLM model. JEL Classification: E51; E52; E58.

Suggested Citation

  • Thomas I. Palley, 2017. "The theory of endogenous money and the LM schedule: prelude to a reconstruction of ISLM," Brazilian Journal of Political Economy, Center of Political Economy, vol. 37(1), pages 3-22.
    • Handle: RePEc:ekm:repojs:v:37:y:2017:i:1:p:3-22:id:101
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    File URL: https://centrodeeconomiapolitica.org.br/repojs/index.php/journal/article/view/101/94
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    Citations

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    Cited by:

    1. Missaglia, Marco & Botta, Alberto, 2022. "Households’ liquidity preference, banks’ capitalization and the macroeconomy: a theoretical investigation," Greenwich Papers in Political Economy 36807, University of Greenwich, Greenwich Political Economy Research Centre.
    2. Bibi, Samuele & Canelli, Rosa, 2023. "The interpretation of CBDC within an endogenous money framework," Research in International Business and Finance, Elsevier, vol. 65(C).
    3. Peter Skott & Júlio Fernando Costa Santos & José Luís da Costa Oreiro, 2022. "Supermultipliers, ‘endogenous autonomous demand’ and functional finance," Metroeconomica, Wiley Blackwell, vol. 73(1), pages 220-244, February.
    4. Andrea Cipollini & Francesco Frangiamore, 2023. "Government spending and credit market: Evidence from Italian (NUTS 3) provinces," Papers in Regional Science, Wiley Blackwell, vol. 102(1), pages 3-30, February.

    More about this item

    Keywords

    Endogenous money; structuralism; horizontalism; LM schedule; ISLM model;
    All these keywords.

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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