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Money, Finance and Capitalist Development

Edited by Philip Arestis and Malcolm Sawyer

In the past thirty years the financial sector has seen unparalleled growth and has exerted increased economic and political influence and significance. This growth has come hand-in-hand with several serious economic crises and greater monetary instability. Set against this background, this important book offers a wide ranging, critical analysis of the financial sector.
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Chapter 5: The endogeneity of money

Peter Howells


Peter Howells 5.1. INTRODUCTION1 The core of the endogeneity thesis consists of two propositions. The first is that the money supply is determined by the demand for bank lending (‘loans create deposits’ in the jargon). The second is that the demand for bank lending is causally dependent upon other variables in the economic system. The short version of this is that the demand for loans is driven by the ‘state of trade’, essentially the level of nominal output. Since this is normally rising, as the result of some combination of price and volume changes, the normal case is for the stock of bank loans to expand, that is to say that there is normally a demand for new lending in excess of repayments, so that the flow of new lending, and new money, is positive. Expansion is the norm. The role of the central bank is then to set the level of official short-term interest rates. Banks will charge this rate plus some mark-up on loans. Changing official rates thus changes the cost of borrowing, influencing in turn the demand for and the flow of new lending. Since the central bank has no alternative but to supply reserves to validate the lending, varying the level of interest rates is the sole instrument of monetary control available to the central bank. In these circumstances, it is reasonable to conclude that the supply of money is perfectly elastic at the going rate of interest and this, in turn, has...

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