Thomas I. Palley
This chapter presents the post-Keynesian theory of endogenous money supply and shows how it is fundamentally different from conventional money-supply theory. The conventional approach relies on the money multiplier and bank lending is invisible. Post-Keynesian theory discards the money multiplier and focuses on bank lending, which drives money creation. The chapter emphasizes the structuralist version of post-Keynesian theory, which retains Keynes’s liquidity-preference theory of long-term interest rates and also recognizes that banks are subject to financial constraints which limit their lending activities. The chapter then shows how to derive the LM schedule in an endogenous-money economy, which is a necessary prelude to reconstructing the IS–LM model.