Tuesday, 2 October 2012

Endogenous money matters - a summary.

I think it is worth summing up Philip Pilkington's excellent post on why endogenous money matters

Mainstream believes:
  • that there is a mechanical relationship between the amount of money, the interest rate and the level of investment
  • that for every borrower there is a saver
  • 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

The endogenous view is different
  • there is never any mechanical relationship between the amount of money in the system and the rate of investment. Yes, 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)
  • 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.
  • Crowding out, 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

The endogenous nature of money has to be worked with in any policy design. Trying to pretend a Cheetah is a vegetarian and treating it as such is bound to cause problems. You have to work with the nature of the beast. Cheetahs like chasing Gazelles and eating them. You might not like that, but that's the way it is.