Endogenous money

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Endogenous money creation or destruction is the concept that each participant in the economy has his or her own version of a 'printing press' for money. This concept was explained by Irving Fisher in his treatise on The Theory of Interest (1930) in terms of the value of currency being affected by two (potentially opposing) movements - expected growth in the money supply reducing the real purchasing power of money and expected increases in productivity increasing the real purchasing power of money.

This means that participants can affect the value of currency in a number of ways:

  • Choices to invest in 'non productive' money equivalents rather than to invest directly in productive assets effectively increase the money supply, reducing the real value of currency.
  • Demands for higher wages or supplier payments can increase the financing requirements of firms, creating a risk of 'supplier led inflation', effectively reducing the real value of currency.
  • Choices made about the level of contribution to productivity can increase the real value of currency, (in fact this is the only mechanism which provides any basis for the real value of currency.)

This all adds up to the conclusion that participants have the power to affect the value of currency, albeit via less direct and potentially less effective mechanisms than simple printing of money by the central bank (exogenous money creation.)


Theories of endogenous money date to the 19th century, by Knut Wicksell,[1] and later Joseph Schumpeter.[2]

Knut Wicksell's (1898, 1906) theory of the "cumulative process" of inflation remains the first decisive swing at the idea of money as a "veil". Wicksell's process has its roots in that of Henry Thornton . Recall that the start of the Quantity Theory's mechanism is a helicopter drop of cash: an exogenous increase in the supply of money. Wicksell's theory claims, indeed, that increases in the supply of money leads to rises in price levels, but the original increase is endogenous, created by the relative conditions of the financial and real sectors.

With the existence of credit money, Wicksell argued, two interest rates prevail: the "natural" rate and the "money" rate. The natural rate is the return on capital - or the real profit rate. It can be roughly considered to be equivalent to the marginal product of new capital. The money rate, in turn, is the loan rate, an entirely financial construction. Credit, then, is perceived quite appropriately as "money". Banks provide credit, after all, by creating deposits upon which borrowers can draw. Since deposits constitute part of real money balances, therefore the bank can, in essence, "create" money.

Wicksell's main thesis, the disequilibrium engendered by real changes leads endogenously to an increase in the demand for money - and, simultaneously, its supply as banks try to accommodate it perfectly. Given full employment, (a constant Y) and payments structure (constant V), then in terms of the equation of exchange, MV = PY, a rise in M leads only to a rise in P. Thus, the story of the quantity theory of money, the long-run relationship between money and inflation, is kept in Wicksell.

Primarily, Say's law is violated and abandoned by the wayside. However, real aggregate supply does constrain. Inflation results because capital goods industries cannot meet new, real demands for capital goods by entrepreneurs by increasing capacity. They may try but this would involve making higher bids in the factor market which itself is supply-constrained - thus raising factor prices and hence the price of goods in general. In short, inflation is a real phenomenon brought about by a rise in real aggregate demand over and above real aggregate supply.

Finally, for Wicksell the endogenous creation of money, and how it leads to changes in the real market (i.e. increase real aggregate demand) is fundamentally a breakdown of the neoclassical tradition of a dichotomy between monetary and real sectors. Money is not a "veil" - agents do react to it and this is not due to some irrational "money illusion". However, we should remind ourselves that, for Wicksell, in the long run, the quantity theory still holds: money is still neutral in the long run, although to do so, we have broken the cherished neoclassical principles of dichotomy, money supply exogeneity and Say's law.[3]

In March of 2014 the Bank of England wrote a widely distributed primer endorsing endogenous money and control of the money supply by private banks. [4]


Endogenous money is a heterodox economic theory with several strands, mostly associated with the post-Keynesian school. Multiple theory branches developed separately and are to some extent compatible (emphasizing different aspects of money), while remaining united in opposition to the New Keynesian theory of money creation.

  • Monetary circuit theory was developed in France and Italy, and emphasizes credit money creation by banks. A detailed explanation of monetary circuit theory was provided by Augusto Graziani in the book The Monetary Theory of Production.[5]
  • Horizontalism was developed in America by economist Basil Moore, who was also its main proponent in the 1970s and 1980s. It emphasizes credit money creation by banks.
  • Gunnar Heinsohn and Otto Steiger in their book "Eigentum, Zins und Geld" developed a theory called "Property Theory of Money", which also explains money by endogenous processes.

Exogenous theories of money[edit]

Mainstream (New Keynesian) economic theory states that the quantity of broad money is a function of the quantity of "high-powered money" or "government money" (notes, coins and bank reserves), and the money multiplier (the inverse of the reserve ratio). New Keynesian economists believe that when a bank has no excess reserves, new credits can only be granted if banks' deposits increase. Monetary authorities can use either interest rates or the quantity of money, generally having favored the former during the Great Moderation.

See also[edit]