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Bank of England on Endogenous Money

This paper by McLeay, Radia and Thomas from the Bank of England has been making the rounds in heterodox circles. In particular because it admits that the conventional story about money creation is simply wrong. For them:
"rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks."
Yes, finally the monetary version of Say's law is seen as incorrect. And for a change they do cite heterodox authors contributions. In a footnote they say:
"There is a long literature that does recognise the ‘endogenous’ nature of money creation in practice. See, for example, Moore (1988), Howells (1995) and Palley (1996)."
Interestingly they do get the reflux principle of the old Banking School (of Thomas Tooke and others). They say:
"There are two main possibilities for what could happen to newly created deposits. First, as suggested by Tobin, the money may quickly be destroyed if the households or companies receiving the money after the loan is spent wish to use it to repay their own outstanding bank loans. This is sometimes referred to as the ‘reflux theory’."
In this context, they refer to the contributions of Nicholas Kaldor, one of the fiercest critics of Monetarism and exogenous money views. Finally, they also note that the central bank determines essentially the rate of interest, and that there is no money multiplier per se. In their words:
"While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality. Rather than controlling the quantity of reserves, central banks today typically implement monetary policy by setting the price of reserves — that is, interest rates."
Mind you, it is weird that they think it is useful for teaching, and also it's not just 'today', but since their inception that central banks controlled the rate of interest. When they did try to control money supply in the late 1970s, central banks were unable to do so, and Goodhart's law that suggests that as soon as the central bank tries to control a particular quantitative target the very measure becomes unreliable.

Note, however, that endogenous money, while relevant and part of the usual set of ideas used by heterodox economists can be perfectly accommodated in a mainstream neoclassical framework, like the New Keynesian three equation model or the old Wicksellian model. And that is the way in which this paper by the Bank of England should be interpreted. Still nice that they do cite Kaldor and Moore, the quintessential endogenous money authors, and Howells and Palley of the younger post-Keynesian school.

PS: On a different note, this paper by the European Central Bank (ECB) cites my work with Esteban Pérez on the European crisis as one of the few that suggests that capital flows (after the convergence of interest rates) that allowed for spending in peripheral countries in part explains the current account imbalances in the region.


  1. An article by David Graeber on the issue:


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