Philip Pilkington: Three Reasons Why Endogenous Money Matters

By Philip Pilkington, an Irish writer and journalist living in London. You can follow him on Twitter at @pilkingtonphil

There’s been a bit of confusion of late in blogland about whether endogenous money really matters all that much. Endogenous money is, of course, the theory that, contrary to what mainstream economics would have you believe, private banks in modern capitalist economies actually create money out of thin air. In my experience, theoretical economists grasp very quickly how much of an impact such a theory would have if it were accepted as true. Less theoretically inclined commentators who are generally more interested in policy and practical matters, however, often express confusion over what exactly all the fuss is about. “Does endogenous money really matter?” they ask.

In what follows I will lay out the three leading reasons why endogenous money does, in fact, matter. While I will try not to go too much into theory I will briefly mention the ISLM, but as we move from point three to point one our discussion will become less and less abstract. Hopefully such an endeavour will play a part in lifting the fog surrounding the relevancy of endogenous money. Then it will simply be up to commentators themselves to decide what approach they want to accept.

Reason One: Death of the ISLM

The ISLM model has been called “the workhorse of mainstream macroeconomics”. It is generally taught at both a graduate and undergraduate level and as such it generally becomes lodged in the minds of economics students, thus informing many aspects of contemporary policy debate. Because of this it also tends to haunt the discussions we have about macroeconomic policy more generally – even if you couldn’t care less what an IS-curve is all about, it is likely that you are familiar with many arguments and policy prescriptions based on the ISLM framework.

The ISLM model assumes that there is a mechanical relationship between the amount of money central banks release into the banking system and the level of economic activity. The model represents this as an upward-sloping LM-curve – representing, broadly, money – and this is set against a downward-sloping IS-curve – representing, broadly, investment and hence incomes. While I have dealt with the workings (and flaws) of this model in detail elsewhere, I will here only point to one aspect of the model.

The model assumes that if you increase the amount of money in the system, the rate of investment will change. This is envisaged in a wholly mechanical fashion. Thus, more money = more investment. The channel through which this increase in the amount of money affects the rate of investment is the interest rate. More money = lower interest rate = higher investment. However, in the circumstances of a so-called “liquidity trap” no matter how much money is pumped into the system the rate of investment does not respond. This is represented on the ISLM model as the tail-end of the LM-curve flattening off. The extra money pumped into the banks then just sits there as would be investors hoard it out of fear. This, according to many, is where we are today.

Endogenous money theorists would have a different view of all this. They would say that there is never any mechanical relationship between the amount of money in the system and the rate of investment. Yes, they would say, if the interest rate is lowered this may have effects on investment, but these effects are highly indeterminate and always reliant on other variables (like confidence and the outstanding level of effective demand). Thus, endogenous money adherents are far more sceptical about the effects monetary policy alone can have on the economy in general. For them a “liquidity trap” means very little in that the effects of interest rate changes are always highly contingent.

Related to this is the idea that having a negative real rate of interest might kick-start an economy operating in a so-called “liquidity trap”. If inflation outpaces the rate of interest by a sufficient amount, an ISLM adherent would argue, then because the LM-curve falls below the zero-bound level, the ISLM framework begins to work once more. Because the ISLM theorist assumes that there is a mechanical relationship between the amount of money, the interest rate and the level of investment then economic recovery from a liquidity trap can always be overcome by simply lowering the interest rate below the zero-bound level.

Endogenous money theorists would be far more sceptical of this presentation. Again, part of the reason for this is that they do not believe in a mechanical relationship between the amount of money in the system and the rate of investment. For them economic relationships are not like those between snooker balls. They are complex, interrelated and overdetermined – and certainly in no way mechanical. With regards to the ISLM framework an endogenous money theorist would accuse an exogenous money theorist of simplifying the workings of the macroeconomy to the point of intellectual and policy irrelevance.

Reason Two: Institutional Versus Distributional Instability

Adherents of the exogenous money view have recently begun to recognise the important role played by debt in modern capitalist economies. Some might say that the reason that these theorists ignored the impact of debt prior to the crisis and thus were unable to predict the crisis was because they adhered to the view that money is exogenous. While I believe there is a lot of truth to this, we will not engage here in what sorts of myopias result from adhering to incorrect theoretical assumptions.

The main issue for our present discussion is that they view debt in terms of distribution. The exogenous money view holds that for every borrower there is a saver. Thus, when too many people are saving at the top and too many borrowing at the bottom, major imbalances may occur that result in financial crises. This may appear an intuitively appealing way to view the crisis of 2008 – especially from a left-of-centre perspective. After all, didn’t wealth inequality grow enormously prior to 2008? And isn’t it likely that this was one of the root causes?

The answer to both those question is undoubtedly “Yes”. However, such observations do not excuse us for sloppy and unempirical thinking. The idea that for every saver in the economy there is a borrower is simply not true. Endogenous money theorists make the case that banks create loans out of nowhere – ex nihilo, if you will. If a bank wants to create a loan they need not wait for a saver to deposit cash that they then hold in reserves while they make their loans. Instead they simply enter the loan as an asset on their balance sheet and give the borrower cash. The reserves are sorted out later and are usually advanced by the central bank when the situation warrants.

Thus, we can imagine that even in an economy with fairly equitable distribution of income a debt crisis might arise. In fact, we have an empirical example of just this: namely, the case of the Swedish housing bubble that deflated in 1991-92 and resulted in a series of bank bailouts. Sweden, of course, is a country recognised for its equitable income distribution and yet its banks lent out in a manner similar to those of the US prior to 2008 crisis. When viewed from the point-of-view of the exogenous, distribution theory of debt this may appear confusing; but when viewed from the endogenous, institutional theory of debt this does not appear remotely unusual. Such is simply the nature of the modern capitalist game.

What endogenous money theory tells us is that banking in a capitalist economy is inherently and structurally unstable. It is not distribution that matters so much as it is the institutional arrangements of banks themselves. If banks are able to issue credit whenever bubbles begin to inflate in the economy, thus accommodating their expansion, it simply does not matter whether savers are saving – the credits are simply entries on computer balance sheets. This has enormously important implications for how we envisage the functioning of a modern capitalist economy.

Reason Three: There is No Such Thing as “Crowding Out”

These days we hear a lot about the supposed phenomenon of “crowding out”. The story goes something like this: there is a fixed supply of funds available in any economy at any given time and if the government borrows those funds to pay for its deficits, the private sector will not be able to borrow them. Thus, any expansion of government spending will restrain private sector spending. And since most people assume that government spending is inefficient this is usually seen as a bad thing.

The manner in which this crowding out is supposed to effect the private sector is through interest rates. Since there is a fixed quantity of money in the system, the more of this money is demanded the higher its price (interest rate) will be. Even though we see no effects on interest rates as government borrow in large amounts today, adherents of the “crowding out” view claim that we eventually will and hence the government should be cutting down on its expenditure by engaging in austerity.

Neo-Keynesians and sympathetic media pundits who, implicitly or otherwise, believe in exogenous money largely agree with this view. They claim, however, that during times when the economy is in a “liquidity trap” – that is, when people are essentially hoarding money and not investing it (see Reason One above) – there will be no crowding out effects because this money would be sitting idle anyway. However, these same authors and commentators do recognise that eventually when the economy recovers and the liquidity trap comes to an end government borrowing will indeed lead to crowding out.

Endogenous money theorists, on the other hand, argue that this is not the case. They argue that central banks set a target interest rate and then inject reserves into the system to maintain this interest rate regardless of what the government is spending or taxing. Thus, even in a boom, if the government borrowed lots of money this money would, in a roundabout way, be replaced by the central bank. (This, the astute reader will note, is where endogenous money theory meets MMT).

Crowding out, then, can never ever be a problem in an economy where the central bank sets a target rate of interest. Interest rates will always be set by the central bank and private sector actors will get access to funds at this price regardless of how big the government deficit is. In this way the quantity of money in the system is never fixed, but fluctuating with regard to how much private sector demand for that money there is at any given point in time. And so, the endogenous money theorist would argue, crowding out will never be a problem – ever. Not even in a boom. The only restraint upon government spending is that it might lead to inflation or devaluation of the currency.

This is a powerful argument when it comes to considering policy. No longer can we justify policy decisions based on the idea of crowding out or a limited pool of loanable funds. Instead we must take a more nuanced look at inflation, unemployment and other economic variables when making policy choices. Needless to say, greater public awareness of these issues could change the framing of political debates significantly. Exogenous money theory, many endogenous theorists would argue, places a massive taboo on discussing economic policy in a reasonable manner.


There are a number of other important aspects of the endogenous money theory. Most notably, that it largely demolishes marginalist or neoclassical conceptions of how the economy functions and renders many textbooks used by undergraduates and graduates irrelevant. However, this is beyond the ambit of this article which merely seeks to lay out some of the more practical differences endogenous money theory makes to how we understand the economies in which we live and consider policy decisions that might improve them.

Between the endogenous and exogenous views of money there lies a gulf of difference. And while those that adhere to the latter may try to integrate elements of the former, they will, in the view of those that adhere to the former, always come up short. For they are, as the great French psychoanalyst Jacques Lacan said in a rather different context, “two countries towards which each of their souls strive on divergent wings, and between which a truce will be the more impossible since they are in truth the same country and neither can compromise on its own superiority without detracting from the glory of the other.” If we renege on their absolute difference we render both banal and meaningless.

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  1. Luis Enrique


    jesus f ing christ read a textbook!

    1. David Lentini

      If you’ve read Keen or other posts about this issue here, you’ll see that the textbooks are the problem.

      1. Joe Buck

        The point about “read a textbook” is that textbooks do explain that when a bank makes a loan, money is created. This is standard economic theory, and I learned about it in Economics 101 in college. This is not a revelation to economists.

        The Fed controls the money supply in part by setting rules on reserve requirements, which limits the ability of banks to make loans.

        1. Adam1

          The usage of the words “The Fed controls the money supply” is EXOGENOUS money creation.

          The FED has even publish research papers saying specifically that it cannot control the broader money supply and if you read Kydland & Prescott’s 1990 paper you will discover that their empirical findings confirm that broader money aggregates (the ones the grow because of credit creation/expansion) grow before base money (FED created money) – base money ENDOGENOUSLY grows in response to ENDOGENOUS bank lending. Banks are capital constrained not base money/reserve constrained. Any demand for reserves/base money that happens because a bank has lent additional/new money is automatically met by the FED in order to defend its target interest rate.

      2. Ralph Musgrave

        I quite agree that Philip Pilington’s point about private money creation is not a “revelation” as you put it. Moreover, his point about that money creation leads to instability is not original either. Advocates of full reserve banking (of which I am one) were objecting to this characteristic of private money creation in the 1930s (e.g. Irving Fisher).

    2. skippy

      “jesus f ing christ read a textbook!” – Luis Enrique

      Indubitably, that’s the hole point, its nothing more than religious dogma with a vainer of hagiographa. Hence your f ing christ intro being so apropos.

      Endogenous money theory coupled with MMT – if – conjoined with the right policy’s, could save this world, and with it… our species.

      skippy… whats not to like? Remember its the pigs that squeal the loudest at the trough… eh.

    3. joebhed

      As money itself can only be described as a legal, social construct, there comes a necessity that ‘somebody’ must create new money, ‘ex nihilo’ so to speak.
      In this country, all of that ex-nihilism is freely exercisedby by the private banking system.
      Please, from where did your textbbook say that money is created?

    4. Philip Pilkington


      Read the f-ing post!

      Discussing Taylor rules etc. is just layering bullshit upon bullshit.

          1. Jose Guilherme

            This textbook has endogenous money:

            Macroeconomics Principles and Policy, by Baumol, Blinder, Lavoie and Seccareccia (Canadian edition)

          2. UnlearningEcon

            I just looked and I’m pretty sure it doesn’t. They still use the traditional money multiplier, and though they do go to great lengths to stress it is oversimplified, they do not teach that loans create deposits, that M1+ moves first, and that the quantity of reserves does not factor into bank’s lending decisions at all.

        1. p

          I think you’re talking about the traditional ‘money multiplier’ – the idea that banks take a certain quantity of funds and lend them out over and over again, so that the banking system as a whole can be said to ‘create money’ by promising the funds to lots of different people. That story is a load of bullshit and bears no relation to how banks actually function.

      1. Calgacus

        Wray says somewhere that it is arguable that endogeneous money was the mainstream position around 1950 (?). Mr. Calgacus-who-isn’t-happy-unless-he-is-out-on-a-limb-somewhere would indeed so argue. Take a look at Schumpeter, p.1111 & thereabouts & the footnotes, an easy page number to memorize. Consistent with Schumpeter, take a look at Moore’s treatment in the first PostKeynesian Guide (haven’t read anything else by him really). Basically, for all of its good points, such finance detail disappeared from the General Theory, while it was well treated in the Treatise. So basically endogenous Keynes (& the success of his policies & the financial consequences of the war) was largely to blame for the eventual end of endogenous!

        I took a look myself a couple of years ago at the pieces of a few hundred old textbooks available at google books. Looked like somewhere around 1960+ “loans create deposits” stopped being taught. Before that, economists made fun of bankers for thinking deposits create loans a la money-multiplier, which had been reborn a bit earlier. Afterwards, the reverse. But economists always were sure they were the smart guys. Schumpeter says that by the 20s, the great majority of economists thought “loans create deposits”. So when there was the additional complication of (the remnants of) the gold standard, people got things basically right. When the real world complication/confusion disappeared, everyone lost their minds, by the Law of Conservation of Human Stupidity. Par for the course, until a new dawn of Moore & a few others. For a real study of The Adventures of Endogenous, which I’ve looked for but not found, I think one would have to decamp to a library annex where ancient (text)books moulder & mutter to each other. Such places were the haunts of my (& Mrs. C’s heh, heh, heh) youth.

    5. craazyman

      If money is the root of all evil, why does the money supply keep going up?

      The textbooks don’t explain that.

      Economics is the kind of thing you have to figure out for yurself. haha

    6. Jim

      jesus f ing christ read a textbook!

      Is this kind of gutter language really necessary, or for that matter tolerable? I presume you are not a slum dweller and that in addition you are over 14 years old?

      1. Aaron F2

        Please, what difference would it make if he (or I) were currently residing in a bank redlined “slum.” Enough of that language. His post may be mistaken and naive, but let’s be nice, or people will start calling your post elietist condescending and very probably racist krap.

  2. David Lentini


    This strikes me as the same Say’s Law, “supply creates demand”, nonsense that one still finds in neo-classical economics.

  3. ambrit

    Dear Brother Philip;
    Please excuse the ignorance herein shown but, since you talk about ‘Money’ and its effects, interest rates and supply factors etc., what about the idea of ‘Wealth,’ as embodied in things like houses and land, food and water, all the concrete things people need to live. Seeing all the families being pushed to the margins; losing jobs and houses due to the vagaries of the ‘Money’ supply, one thinks of social utility issues. Do the Neo-Keynsians et. al. really live in blissful ignorance of the ‘real’ world around them? (Or are they just exhibiting the follies of Careerism?)
    As the recent events in America clearly show; Money IS Politics. Conversely, Economics IS Policy. We’ve been toiling through a failing experiment where Politics is subservient to Finance. Time to right the balance.
    Thank you for your lucid exposition.

  4. Jose Guilherme

    There is a 4th reason why it matters, inside the eurozone.

    While commercials banks can create money out of thin air, elected governments under Troika programs can’t.

    And this means democracy has truly reached a higher level in the euro regime.

  5. joebhed

    The discussion of whether endogenous money really matters needs a broader perspective.
    It’s one thing to understand clearly that debt-money generation happens independently from multiplying reserves, and that the relations between interest rates, savings and investment are not causal, if understood.
    However, all of that fails to engage whether en-money is superior to ex-money creation – in the real world.

    There is a construct for exogenous money that is far more real than the ‘quasi-monetarism’ of modern times. It does not involve pushing on the interest-rate ‘mechanism’ to effect changes in the money supply so as to promote investment, etc.
    It involves issuing the money supply.
    By the government.
    Like MMT sometimes claims happens now.

    It is the system proposed by Simons, Fisher and other noted economists, later even supported by Friedman, and it is remarkably akin to the thinking of MMT-fave Lerner.

    It is a ‘monetarist’ concept based on the original works of Fredrick Soddy early last century.
    What we need is the ‘forward-looking’ discussion of how money should be created, where a look back is only for reference that we are not getting outside of what history should teach us.

    The very recent work of IMF researchers Benes and Kumhof models the modern macro-economy based on the Chicago Plan proposal presented to FDR.

    It proves pretty convincingly that how a nation issues money DOES matter for things that count to real people in the real world.
    Having economic stability without inflation and a reduction in both public and debt make the discussion of who creates the money – and how – worth pondering.

  6. BlackBox

    Another description of bank debt creation might be more appealing to those who don’t like money to be created out of thin air.

    All banks are endowed with some capital at their creation and they can (usually) raise more later if needed. A bank can lend this capital out and when the loaned money is deposited, it automatically backs the loan. If the money is deposited at another bank, it is available for borrowing by the first bank to balance the books. But the bank still has money equal to its capital to lend and it can keep making more loans up to the leverage limit set by the Basel rules.

    This has the same effect as the simple endogenous money story, but banks always start with some money before they make loans.

    1. Rob

      The banks may have SOME money under deposit,before they make a loan.but, due to fractional reserve requirements,they can lend out ….what? Ten times that amount?…in 1803, the shareholders who supplied the financial backing to become a bank,were only allowed to lend out THREE times their investment.then wasn’t it up to fifteen?and now it’s back down to ten times?I’m fuzzy on the reserve requirement now….but that is a lot of room to “create”money.

      1. Adam1

        In a fiat monetary regime there is an infinite supply of reserves at the central banks target interest rate – hence banks are not reserve constrained in their lending. So long as they have sufficient CAPITAL to back stop their lending risk and have a ready supply of credit worth customers willing to borrow at a profitable interest rate a bank can and will lend regardless of their current reserve position – that can always be adjusted after the fact and there is a guaranteed supply created by the central bank at the target interest rate.

  7. Samuel Conner

    Granting that the endogenous money theory is correct (which I do), it doesn’t follow by necessity that “crowding out” is impossible, ie, that the state of the public fiscal deficit has no effect on commercially relevant (ie, longer term) interest rates. The Central Bank sets, via conventional OMO, the overnight interest rate, but it has less control the shape and steepness of the yield curve (unless it explicitly attempts to influence longer maturity yields through unconventional asset purchases, as at present).

    It is the longer maturity yields that are relevant to much economic activity (at least borrowing for investment, some of which occurs by borrowers issuing bonds rather than borrowing from banks; working capital loans will be shorter term and so more directly tied to the overnight rate).

    The question of the relationship between Central Bank overnight interest rate targets and longer term interest rates, and the relationship between the public deficit and those interest rates, is a question that presumably could be illuminated empirically.

    There has been a lot of talk recently of future expectations, particularly expectations of future inflation, as a significant channel by which central bank policy influences the economy. Partisans of the “crowding out” view might fall back to the position that deficits influence expectations of long term inflation and so raise interest rates on long-maturity debt, with an effect similar to the prior “shortable of loanable funds” explanation. Again, that could be evaluated empirically; there certainly is plenty of data and large cross-nation sample.

    Surely such studies exist?

    1. Philip Pilkington

      I went through this in the piece linked to above:

      “If you adhere to this view you could say that the standard ISLM model is theoretically valid. As the economy grows and the demand for money increases the long-term interest rate on 10-year treasury bills increases in expectation of future inflation or interest rate hikes. At the same time, the central bank is also reacting to economic expansion and the demand for money by tracking the inflation rate. These reactions on the part of both the markets and the central bank simulate a fixed stock of money because interest rates rise as the economy grows ‘too fast’. (As an aside it should be noted that these expected movements are not firmly grounded in reality because in floating exchange regimes empirical evidence indicates that interest rates can climb at the same time as the money supply increases, so there is no direct link here.)

      The dance that takes place between the variables is rather chaotic but there is a clear pattern. You can get a good idea of it by looking at the graph below. In red is the long-term interest rate, in blue the inflation rate and in green the short-term interest rate.”

  8. Bert_S

    Ya so, mainstream econ doesn’t have the fractional banking money multiplier, plus endogenous, bubble blowing, shadow banking levered/federal reserve unlimited base money,Minsky be calm until it blows, regulators agreeing, treasury backstopped and bubble blowing federal reserve backstopped model all worked out in charts and math and hot off the printing press yet.

    Can we live without the reading material?

  9. Greg Marquez

    Uhh… if banks create money their would never be a run on a bank. Runs happen because the to lend the bank has to take some of A’s money and give it to B. If a bank does too much of this then when A comes to get his money the bank has nothing to give him.

    1. EconCCX

      >Uhh… if banks create money their would never be a run on a bank.

      For others who may be confused, here’s a link to explain. Anna J. Schwartz, co-author, with Milton Friedman, of A Monetary History of the U.S., hardly an alternative theorist. Note the ratio between Reserves (Central Bank Money) and Deposits (Commercial Bank Money.) Commercial banks can create money in amounts that are not unlimited, but up to a high multiple of their reserves. Several commenters here support a %100 reserve requirement, whereby money would be created only by the Treasury and/or Central Bank.

    2. EmilianoZ

      Bank creates money out of thin air and lends it to A. A uses money to pay B. Plenty of Bs claiming the money can cause the bank run. No need for depositors.

    3. maude

      Banks have a very small percentage of total deposits on hand in hard currency, therefore a run on the bank wouldn’t mean they ran out of ‘money’, it means they ran out of cash. The run on the bank is pretty much a mental state rather than a physical one as people who think like you believe that means the bank is then broke. It’s not.

        1. J Sterling

          The borrower’s and the bank’s, in both cases.

          The best way to see it is to see four accounts, not two. The borrower’s money account (1) is credited with purchasing power, that he can now use to buy assets. But his “tab” (2) is debited with the same value, which he must pay back to the bank at some future date. Meanwhile the bank’s money account (3) is debited the amount the borrower borrowed, but its asset register (4) now includes a new asset, the debt contracted by the borrower.

          But (3) is just something the bank made up; it said “you know what? we’ve got some money here, and we promise to pay it to people we owe”. Is the bank good for it? Sure it is, just look at (4), which now has more value in it than it had before. The debts in (4) — which are the borrowers’ debts remember, they’re assets to the bank — may be sold like any other asset.

          And that’s how banks make money out of nothing. The trouble comes if everyone stops believing the bank’s assets (all those debts, remember?) are good, and if they all turn up at the bank’s window demanding hard cash, not promises. Then the bank can be unable to do for everyone at once what it said it could do for anyone: pay hard cash to everyone it owes.

          The bank can, in an emergency, sell its debts for cash and use the cash to pay its clamoring depositors. But if the panic is widespread enough, everyone the bank might borrow from is facing the same trouble as the bank is, so you get a global financial crisis.

          At this point, a government can step in and provide banks with the cash they need, by creating a debt “contracted” by its taxpayers. We call government debt cash because it’s so reliable: it’s hard to imagine a government will be unable to pay the debt, given its unique ability to tax. So government can make money, but the banks did it first.

        2. joebhed

          If any two entities, each with a balance sheet, are involved in a monetary transaction, then each of the parties to the transaction must have entries, and entries must balance.
          The bank, in this case, makes a loan and creates purchasing power. The borrower receives the loan proceeds and owes the bank repayment.
          It’s not either / or…. it’s both / and .
          In duplicate.

          Purchasing power via debt-issuance.
          Brought to you through the magic of simple double-entry bookkeeping.

      1. EconCCX

        >When banks loan money whose account gets credited and whose account gets debited?

        The bank hands the borrower an IOU for loan amount L, all available right now. The borrower hands the bank an IOU for amount L+X, payable over time. The bank’s IOU is in the form of a checkbook, physical or digital. The borrower writes checks to folks who deposit them in other banks. The bank must then clear the check by delivering an equivalent value in reserves to the other bank. Except that…

        Except that roughly the same amount of interbank transfer orders are going in the other direction.

        And so, only at end of business does the bank move a relatively small NET amount of reserves to and from other banks. The recipient has new money, which continues to circulate and is no longer associated with the original loan. Neither the Federal Reserve Bank nor the US Government created that money; reserves remain unchanged. But M1, a component of the money supply, has gone up. A small amount of reserves keeps a large amount of bank money rolling, and the bank collects interest and fees, per day, per transaction, on all of it. That’s the game.

        Out of time for beginners’ questions. Good luck to you in your continuing study of finance.

        1. JR

          I always thought the easier explanation of fractional reserve banking was to look at an account holder and borrower separately. An account holder deposits $100 into the bank. The bank then makes a $100 loan to a separate borrower. The bank has just created $100 out of thin air. The account holder still has the $100 in her bank account. The borrower now has an additional $100 in hers. Fractional reserve banking means that the bank can lend more than it has, keeping only a fraction of deposits on reserve.

  10. Schofield

    Better me thinks to say “money itself can only be described as a legal, social construct for “instruction”, there comes a necessity that ‘somebody’ must create new money, ‘ex nihilo’ so to speak.”

    I mean before we had “the money” how did we get “instructing” done? For survival’s sake we’ve always had to have “instructing” and optimally in consequence agreement on the specific content of the “instructing.”

    1. Susan the other

      No, that time never comes – when private banks create money out of nothing – it’s never ever legitimate. Except in our totally screwed system whereby the private banks suck the live out of taxpayers. Bad, very bad system. Our system should be sovereign, endogenous, and meticulously exclusionary of private banking. Private banking should come up with its own capital before it loans or invests or speculates. Never ever should it do business or speculate that the public will make up the difference.

    2. joebhed


      But to further the legal definition of money into its operational identity, we may best say that money is a legal, social construct for ‘distribution’ of the national economy’s wealth(goods and services).

      Once we recognize this essential characteristic of money as the “distributive” mechanism of the national economy – as always described in Soddy’s work – what actually comes to light is that endogenous(debt-based) money creation leads to the distribution of nation’s wealth to the highest return on investment.
      Thus, the crisis.

  11. reason

    there is another sort of crowding out – competition for resources. Crowding out doesn’t just refer to financial competition for funds.

    1. Marley

      Exactly. Which is why all government spending is NOT created equal. It does matters “how” and “on what” the gov’t spends. Very tidily addressed in this NEP MMP installment (Wray): “the real resource” constraint.
      “For example, suppose government decides to newly hire 1000 rocket scientists for an expedition to Pluto. Our first consideration is whether there are 1000 rocket scientists available forhire with the necessary skills. Even if government can afford its desired spending plan that does not mean it can accomplish its mission if the resources are not available. In other words, the government always faces a “real resource” constraint: do the resources exist,and are they for sale or hire? Related to this consideration: are the existinginfrastructure, technology, and knowledge up to the task of achieving programgoals. That, of course, is an important question. Let us presume that theseconditions are met.
      “The second consideration, then, concerns competition with alternative uses of the resources, what is called the “opportunity cost”. If those 1000 rocket scientists would otherwise be unemployed, then the opportunity cost of hiring them for the Pluto mission is low or zero. (We might find, for example, that if they were not employed they would take care of their children at home so the non-zero opportunity cost of employing them is the value of the foregone childcare services. You get the picture—it is not likely that opportunity costsare zero, but for unemployed labor they are probably low relative to benefits of employment in appropriate jobs.)
      “More importantly, it is likely that many or most of them are already working, eitherin the private sector or on other government projects. Since sovereign government does not face an affordability constraint, it can win a bidding war against the private sector if it chooses to do so.”

  12. Schofield

    reason says:

    “Philip, there is another sort of crowding out – competition for resources. Crowding out doesn’t just refer to financial competition for funds.”

    Which is an argument for finding a new democratically accountable mechanism for agreeing the mix of exogenously and endogenously created money.

  13. mary

    I am no longer getting your blog in my email. Also, when I do a google or ATT search, the latest Naked Cap. entry that comes up is 9/27/12.

    By putting in the date at the end of the address I am able to get to your site. Just wanted you to know something is getting messed up.

  14. paul

    Excellent post with marvelous clarity. The MMT community could use you as their preeminent salesman.

  15. Cindy H.

    It’s time to refresh the readership that polishing a turd will never produce anything greater than a turd, ever.

    No amount of brainwashing and bullshit will change this fact.

    1. craazyman

      Oh, Cindy, such a limited way of seeing and thinking. Painful, painful, the tedium of a closed mind.

      You need to drink the Spanish wine and let your mind roam free. You will see the truth and the sun, radiant as a dream, and then you will know.

      Here is some polished elephant dung, formed into a quite maganificent work of art. The Renaissance masters used aborted dead chickens in their frescoes. Why quibble with the elements of nature, when imagination and form are the wine we drink and our inebriation is the highest form of sanity.

      As for money and economics, well, there’s not much there, but what’s there is certainly a bad sketch, mostly a polished turd that fails to transcend, but that happens to the best of them. Beauty is never easy.

  16. Enrique

    I am not familiar with the Endogenous Theory, but it seems to me a bit weird that according to the theory, the Banking system as a whole has no constrain to its capacity to create claims on the overall social production ( another definition for money) .
    If that was the case, what impedes the banking system to lend infinite amounts of money at minimal interest rates ( the marginal cost is zero.. Isn’t it ?) An if a lender fails to pay , why not to recycle her loan ad infinitum …. Since THE business , the main business is the interest rate, not the principal?

    Another point which I miss is the interaction between the money and prices. If Money is endogenous, what is the causation between M and P ? Is there any relation ? and

    1. Dan Kervick

      There are constraints. The money that a bank usually creates in the process of making a loan – an addition to the balance in a deposit account – is a liability of the bank that creates it. It is a claim against the bank’s assets, and so banks have no financial incentive to create these additional liabilities unless they are confident of their ability to acquire additional assets in the process. The deposit account balance, which is a liability of the bank and an asset of the borrower is exchanged for the borrower’s repayment obligation, which is an asset of the bank and liability of the borrower. If the bank cannot get a repayment obligation that has a positive value for the bank that exceeds the negative value represented by the deposit liability, it won’t make the loan.

      In addition, as the total volume of commercial bank deposit balances grows, so will the volume of interbank payments and the volume of reserve balances banks need to make these payments. If the central bank does not fully accommodate the demand for reserve balances, interest rates will rise which will create pressure on banks’ willingness or ability to make loans. So central bank policy creates a further global constraint on commercial bank money creation.

    2. Dan Kervick

      I don’t believe there is anything in MMT or the theory of endogenous money creation that is in conflict with the classic equation of exchange, MV = PT. All the same considerations about prices and money supply obtain. However, the relevance of endogeneity is that the central bank’s ability to control money supply and/or the price level is much more limited than is believed to be the case by those who think money is exogenously determined by central bank policy in conjunction with the money multiplier. The broad supply of money is determined primarily by commercial banks responding to market incentives and the demand for credit. Central bank policy influences and helps regulate this process, but can’t determine the outcome.

      In a stable, growing economy, M can continue to increase at a natural pace commensurate with the growth of the economy – the total number of transactions T – even if V and P remain constant. An increase in M only begins to cause a rise in P if it is not accompanied by an equivalent growth in real production and exchange.

      1. richard in norway

        But often the banks are not reacting to market demands but are actively creating those demands, this seems to be the case in most housing bubbles, where consumers believe that property prices are increasing because of a lack of supply but in reality are increasing because of an oversupply of credit

    3. J Sterling

      Banks do lend money at exponentially-increasing amounts over time, and they call it “economic growth”. Unfortunately, every so often depositors panic and then the banks are suddenly choked off until the real economy of people harvesting and mining has caught up.

      Given the inevitability of panics, a lender could only justify the risk of lending large amounts by the opportunity of collecting interest at a rate around the expected economic growth. So nobody, thankfully, is reckless enough to lend infinity at zero. But they do end up lending too much, risking too much, for what is eventually perceived to be too little return.

    4. tiebie66

      I am also troubled by the element of a lack of real resource constraint in endogenous money creation. Endogenous money creation makes sense, but creating money disproportionately to the ability of the real economy to respond is IMO the cause of crises. A ship cannot be built as quickly as money can be created, thus the creation of money can easily get way out of kilter relative to the productive capacity of the economy. Dan’s reply points out that there are certain constraints, but are these meaningful and/or adequate? I think they are woefully blunt. By the time policy makers respond to economic data, much of the key decisions have already been made and the money created. Thus, when the first ship is spotted, it is already too late to prevent the appearance of several (and now superfluous ones) more with the inevitable “lack of aggregate demand” and other adverse consequences.

      Should endogenous money creation not be limited to a (i) de facto monetization of existing assets of the borrower(s) (i.e. secured lending) and (ii) limited to a percentage (i.e. a percentage equal to the previous year’s GDP) of existing assets of the borrower(s) (unsecured lending)? Given further that interest would be required, interest must be limited to the rate of GDP growth and this would severely restrict unsecured lending to a residual percentage not consumed by interest. Consequently, interest, again IMO, is inappropriate because I do not see the issue of Keynes’ liquidity preferences and such at play here. Money should be created for a one time fee (seigniorage). Maybe this neatly falls under Yves’ ‘banks as utilities’ concept.

      A more fine-grained approach to money creation constraint is needed and one that is more effectively tied to the real economy.

    5. p fitzimon

      There is a limit on loans (money creation) and that is the capital ratio or percent. I believe the current limit is around 4% but will increase to 9% under Basel III. However, under Basel rules banks have some leeway in defining what is capital. For example a risky loan or bond can be transformed into capital by insuring the loan with a credit default swap (CDS). It’s now good as Gold.
      Resources are a problem. When resources run out prices go up as loans keep driving demand. This is what happened with housing. However, loans are a private sector phenomena and the resulting inflation is not a result of government spending. Of course government spending by itself can produce inflation. During the second world war massive governemnt spending consumed almost all the industrial resources as well as manpower. Inflation was controlled by taxation, appeals to patriotism that induced people to buy savings bonds and defer spending, and ultimately price controls.

  17. Scott Fullwiler

    Just an FYI since I see comments here that don’t appear to recognize this:

    Endogenous money has always been integrated into MMT. Wray’s first book from 1990 was “Money and Credit in Capitalist Economies–The Endogenous Money Approach.” In Wray’s 1998 book that set out much of the MMT paradigm, endogenous money is the core of chapter 4. Mosler’s origional piece from the early 1990s, “Soft Currency Economics,” had endogenous money. And the 1998 (?) Mosler/Forstater piece on horizontal and vertical money integrated state and endogenous money. There are more, but I’ll stop there, not yet out of the 1990s.

    1. joebhed

      “Endogenous money has always been integrated into MMT.”
      And, sorry, but wrongly done.

      From all of the writings mentioned, MMT’s theory of modern money is based on an unfounded theorem of sorts – that the nature of money is that it must be debt, a unit-of-accounting identity that, by this debt-based definition, must involve debits and credits in order to explain the MMT understanding of modern money.

      It is a debt-based foundation primarily due to the writings of A Mitchell Innes, in his attempt to explain “What is Money” – written just prior to the adoption of the Fed, while this country was seeking reform to its money system .

      Money is not debt.
      The issuance of money need not involve the issuance of debt.
      Greenbacks are the proof of that statement.
      When exercised through the issuing power of the government, public money administration provides a permanent, debt-free means of exchange, and resulting stability to the national economy.

      Once created through an account deposit representing the nation’s wealth, equity-money can readily be saved and, through a transaction, become debt and under the purview of the bankers.

      That would be true modern monetarist policy; money is directly and specifically being created by the government to meet the Congress-agreed needs of the national economy.
      It would be exogenously-created in econ-speak.
      Bankers would still have control over all of the money, once created.
      The only thing the bankers would not have is the power to create it in the first place.
      And with that loss of power – no more TBTF.

  18. Jesper

    If private banks can create money to lend out of thin air then why is the ‘deposit flight’ in Spain, Greece, Ireland etc seen as a problem?

    1. Ben Johannson

      Because the money banks create is only temporary. The money supply expands when the bank makes a loan, but as the loan is paid back the money returns to the aether and the money supply contracts. Banks cannot serve to permanently replace the financial assets lost to capital flight, only government spending money into the economy or a current account surplus can do that.

      1. GlassHammer

        Banks do get into a bind when the loans they make from nothing are not being paid back. Then it sits on their balance sheet and we all know what happens after that.

      2. joebhed


        That part is true.
        The part about the government creating the money is theory.

        This is how the former Atlanta Fed Credit Officer described this situation decades ago.

        This is a staggering thought. We are completely dependent on the
        commercial Banks. Someone has to borrow every dollar we have in
        the tragic absurdity of our hopeless position is almost incredible, but
        investigate and reflect upon.”

        Nothing has changed.
        Nixon’s abandonment of the gold-exchange standard for Current Account settlements had no effect on our need for permanence in our money system.
        Neither government spending nor a current account surplus can change the quantity of the national currency in existence.

          1. joebhed

            If I understand the question, they DO do it a second time. and third, etc.
            When the loan is made, the money supply increases.
            When that loan is repaid, THAT loan money ceases to exist.
            The money supply has been decreased through the loan repayments down to zero.
            So the bank makes another (second?) loan in order to maintain the money supply, and/or a third to increase the money supply.
            It is this ‘temporal’ nature of money that Fed Credit Officer Robert Hemphill was addressing.
            If money ONLY comes into existence via debt by making a loan, then it is pretty simple to see that there is always more debt (principal plus interest) owed than there is money – leaving us not only with the reality that “if all loans were repaid, we would have no money”, but the more painful and accurate reality – “all loans can NOT be repaid.”

    2. p

      Banks don’t create cash, they create credit. Two different forms of money. Cash is a bank asset, credit is a bank liability.

  19. Jesper

    What is the cost of funds for the funds that the private banks create out of nothing?
    If the cost is always zero, why would it matter what interest rate the central banks sets?
    If the cost is not zero, who gets paid the cost if the funds just appear from nowhere?

    1. Ben Johannson

      The prime interest rate is a coast on bank loans. Banks do have to acquire reserves to make loans, it’s just that those reserves are always available via the central bank. That’s why post-keynesians and MMTers say that banks are never reserve constrained. The interest rates set by the central bank are the portion of a bank’s cost controlled by the central bank. Other costs are infrastructure, payroll and capital.

  20. The Dork of Cork

    Meanwhile the banks will continue to create and destroy credit at a whim.
    Leaving a trail of destruction in their wake.

    They will continue to do this forever – these Internet chap rooms will not stop them.
    Look lads the physical act of extraction is very simple.

  21. internationalmonetary

    Its not one thing or the other. Sometimes money is endogenous and sometimes it isnt. The system monetary system at times operates mostly endogenously and at other times mostly exeogenously.

  22. fromthefuture

    You know what this is like? It’s like if you put a guy in a video game world, a crazy video game world of constantly changing rules and laws of physics. Phil is in this video game world, right, and he’s measuring the distance from A to B. He’s figuring out how long it takes for an apple to drop and figures out the rate of acceleration due to gravity. He meticulously notes the visible color spectrum and maybe predicts some of the behavior of the local flora and fauna which are, after all, controlled by computer algorithms. There are other people in this game, of course, forced to be there by the guns of the state, and he thinks he can predict how they will react to the ever-shifting rules. And sometimes he is even correct.

    This is because Phil is a smart guy, and he takes his work Very Seriously. He is determined to map out all the rules and try his best to predict the outcome of different events. He thinks that understanding this game and how it works is the most important use of his time. He continuously records his findings on this blog so that his Very Serious Work can benefit all mankind.

    One day the game will end; the machine will shut down and will be carted away, and in retrospect everyone will marvel at its absurdity . And when Phil is there, on his deathbed, wondering how he could’ve wasted his life studying the intricacies of a grand game that was never anything more than a bunch of thugs pointing guns at the rest of us and telling us what “money” we could use and how much it would cost and all the other rules of the game were going to work, whether we liked it or not, and he’ll realize what a colossal waste of a perfectly functioning human mind it has all been.

    I have only pity for Phil.

    1. OTAY

      I believe you have answered the question the author first supposed “whether endogenous money really matters all that much”? It doesent matter at all.

    2. darthfader

      Carp all you want, but people in finance pay dearly to set economic policy in this country. Capitalism is built on the edifice of a perpetually unsatisfied, momentarily satisfied consumer, if transactions are considered de facto non-coerced. The power to manage that and reap the rewards requires no economic knowledge and it rejects any economic reasoning that gets in its way. It commands enough power to hold economies hostage over urban legends or its own party affiliation.

      In other words, capitalism doesn’t go drinking with economists. It pays more for drinks at a nice bar in midtown than economists make in a year. An economist is accepted as such by finance when he has been a top dog at a lender, investment house or commercial bank. Everyone else can go hang.

  23. PhilJoMar

    Dear Philip,
    I am really enjoying your economic musings and learning a lot from what you write but I have to call you out on quoting Jacques Lacan (if anyone else has commented on this I apologize, I’m too busy to read through quickly what others are saying).
    I don’t know why but it seems economic commentators seem to be the last group of intellectuals that routinely quote people outside their main competence to confirm what they say/impress people with their learning/ or show that a liberal education can be genuinely life-enhancing. Das of Extreme Money does this all the time. It’s like a tic he can’t control.
    I actually think this detracts from your economic writing because you complain about the spuriousness of much economic writing but then use Lacan (a man whose reputation is only alive in literature depts and whose eccentric and fraudulent
    behaviour has been well-documented even by one of his own supporters, Elizabeth Roudinesco), to round off your interesting pieces. I can only assume you’ve been reading Zizek, possibly another charlatan (whether deliberately so or not is THE question), and yes, he is considered a philosopher, but really I think we need less Lacan and more Burns, Shelley, Neruda, whoever…not a rather silly, over-hyped product of the ruins of 68.
    I am not trying to control what you write…keep quoting Lacan if you want, but I think you should seriously consider how this might affect how the broad generality of readers might approach what you say.
    “Great French psychoanalyst” sets up a cognitive dissonance that is really not worth the shoe-horning into your work of this kind of quote. The analogy wasn’t enlightening in any way.
    But I like your stuff, so don’t feel I’m criticizing you. I think you’re in danger of getting your rhetorical approach wrong, or at least it’s just plain unhelpful.
    All the best
    Another Phil

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