Endogenous money represents a mainstay of Post Keynesian (PK) macroeconomics. Analytically, it provides a critical linkage between the financial and real sectors, with the link running predominantly from credit to money to economic activity. The important feature is credit is placed at the beginning of this sequence, which contrasts with conventional representations that place money first.

The origins of PK endogenous money lie in opposition to monetarism. Whereas neo-Keynesian economics challenged monetarism by focusing on the optimality of money supply versus interest rate targets, PK theory challenged monetarism’s description of the money supply process.

PK theory is itself divided between “horizontalist” and “structuralist” approaches to the money supply. Horizontalists believe the behavior of financial institutions is unconstrained by the availability of liquidity (reserves) provided by the central bank and the supply-price of finance to banks is fixed at a price set by the central bank. Structuralists believe liquidity pressures matter and the supply price of finance to banks can increase endogenously.

Horizontalists can be further sub-divided into “strong” and “weak” positions. The strong position holds the bank loan supply schedule is horizontal and interest rates are unaffected by lending. The weak position holds that interest rates may rise with lending if borrower quality deteriorates.

The PK debate has been useful in articulating the mechanics of the money supply process, but inadequate attention has been paid to the implications of endogenous money for interest rate determination, the business cycle, and economic growth.

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Paper provided by Political Economy Research Institute, University of Massachusetts at Amherst in its series Working Papers with number wp178.

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1. Thomas Palley, 2003. "Asset Price Bubbles and the Case for Asset-Based Reserve Requirements," Challenge, M.E. Sharpe, Inc., vol. 46(3), pages 53-72, May. [Downloadable!] (restricted)
2. Giuseppe Fontana, 2003. "Post Keynesian Approaches to Endogenous Money: a time framework explanation," Review of Political Economy, Taylor and Francis Journals, vol. 15(3), pages 291-314, January. [Downloadable!] (restricted)
3. William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers 244, Cowles Foundation, Yale University. [Downloadable!]
4. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier. [Downloadable!] (restricted)
5. Menger, Carl, 1892. "On the Origins of Money," History of Economic Thought Articles, McMaster University Archive for the History of Economic Thought, vol. 2, pages 239-255. [Downloadable!]

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