Most Recent Stories

Did Keynes Understand Endogenous Money?

One of the core understandings of MR is the endogeneity of money. Endogenous money is based on the understanding that the money supply is high powered money + broad money and that these variables are determined by the private sector’s demand for money. That is, almost all of the money in our monetary system is created by banks almost entirely independent of the government.  It is created INSIDE the private sector.  The government has essentially outsourced the creation of money to a private oligopoly of banks who compete for business.  This fact is largely untouched in most of mainstream economics.  And there might be a fairly good reason why.

JM Keynes is clearly one of the most influential economists of all-time.  Perhaps THE most influential economist of all-time.  His General Theory is a veritable bible for many economists.  So it’s interesting to note that while many economists during the era of Keynes were aware of the endogeneity of money (Soddy and Fisher for instance), Keynes himself appeared extremely confused on the subject.  In the General Theory he wrote:

We can sum up the above in the proposition that in any given state of expectation there is in the minds of the public a certain potentiality towards holding cash beyond what is required by the transactions-motive or the precautionary-motive, which will realise itself in actual cash-holdings in a degree which depends on the terms on which the monetary authority is willing to create cash.

“In the case of money, however—postponing, for the moment, our consideration of the effects of reducing the wage-unit or of a deliberate increase in its supply by the monetary authority—the supply is fixed.”

Thus we can sometimes regard our ultimate independent variables as consisting of (i) the three fundamental psychological factors, namely, the psychological propensity to consume, the psychological attitude to liquidity and the psychological expectation of future yield from capital-assets, (2) the wage-unit as determined by the bargains reached between employers and employed, and (3) the quantity of money as determined by the action of the central bank

These are various forms of a money multiplier or government centric money system and they’re inapplicable to the way the system is actually designed.   It’s clear that JM Keynes did not have a solid grasp of endogenous money.  And perhaps that explains why so many modern day economists and economic models simply ignore the reality that banks rule the monetary roost.    Perhaps the confusion over so much of modern macro stems directly from the master himself?   Was the most influential economist of our times actually woefully misinformed?  It appears so….

Comments are closed.