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Lavoie on Endogenous Money and Effective Demand

Marc Lavoie has a nice paper in the Review of Keynesian Economics discussing Steve Keen’s views on endogenous money.  Marc is typically balanced and fair in his views.  And he highlights some important points:

  • Endogenous money matters and should be included in any macro model of the economy.
  • Many neoclassical economists overlook this fact completely and have been exposed in recent years as having flawed models.
  • Despite the importance of understanding endogenous money most of this stuff is not new at all and so those using the understanding of endogenous money should be careful not to overstep here.

Here’s the full Lavoie conclusion, but you can read the entire paper here:

“We are grateful to Steve Keen for having induced Krugman to engage in a public discussion over the role of bank credit and money creation. We are also grateful to Keen for designing a program that helps us to understand the dynamics of an integrated real and financial system. However, reading Keen’s paper, one gets the impression that he has discovered something fundamental about bank credit, something that previous and current post-Keynesian economists were not really aware of. I would argue instead that contemporary post-Keynesian authors, along with monetary circuit authors, have long been cognizant of the importance of bank credit and its impact, notably through their discussions about the relevance of Keynes’s finance motive, from the mid 1960s until now, as well as their insistence that saving does not finance production while credit does. I don’t think that the way forward is to go back and get trapped in the Swedish or Robertsonian time-lag analysis.

All post-Keynesians certainly concur with the idea that banks have the capacity to alter the level of aggregate demand, and hence that it would be desirable for banks, debt, and money to be included in models of macroeconomics. Indeed, one could argue that it was this realization that led Eichner (1987) to write down the equivalent of equation (1a) or (1b). There are several examples of post-Keynesian macroeconomic models that incorporate banks, debt, and money – for instance, Godley and Cripps (1983) and Godley and Lavoie (2007), just to mention those that I am most familiar with. For practical and pedagogical reasons, not all post-Keynesian models respond to such strictures: several models do not attempt to integrate the real and the financial sides of the economy, or they leave aside the role of non-bank financial intermediaries. But this does not imply, as Keen claims, that we need a redefinition of aggregate demand such that the starting point of macroeconomics is that ‘effective demand is equal to income plus the turnover of new debt’ (Keen 2014a, p. 286). Nor does it mean that aggregate supply needs to be redefined ‘to incorporate the financial markets’ (ibid., p. 290). 8 To provide new definitions of existing terms will only lead to a maze of confusions.”

Keen makes the grandiose claim that his approach leads to a ‘new, monetary macroeconomics’ (Keen 2014a, p. 286). While statements of this kind may appeal to an internet audience, I doubt they will convince readers of this journal.

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