New Directions in Post-Keynesian Theory
Edited by Louis-Philippe Rochon and Salewa ‘Yinka Olawoye
Chapter 2: Stabilization Policy with an Endogenous Commercial Bank
* Mark Setterfield and Kurt von Seekamm INTRODUCTION 1 The three-equation New Keynesian or “new consensus” model is now a staple feature of monetary macroeconomics.1 One common criticism of this model is that it retains pre-Keynesian notions of the workings of the real economy, as encapsulated in “natural” rates of interest and unemployment (Setterfield, 2004; Smithin, 2004; Lavoie, 2006). A second criticism is that in its eagerness to embrace the modern “science” of monetary policy, according to which the central bank manipulates the interest rate rather than the quantity of money in circulation, the new consensus has become divorced from the monetary theory of the private financial sector – in particular, the orthodox monetary base multiplier explanation of commercial banking, with which it is incompatible (Friedman, 2003).2 The concern of this chapter is with the second of these criticisms. Various methods of integrating an account of private financial behavior into the new consensus have already been proposed. Some seek to “recover” traditional LM analysis (see, for example, Tamborini, 2009). Others, however, provide accounts of the financial sector that are consistent with the tenets of endogenous money theory, in which the behavior of commercial banks and the loan-creation process are seen as the nexus of the monetary sector (see, for example, Howells, 2009). Indeed, drawing on this second approach and motivated by the recent financial crisis, several authors have already begun to study the significance of exogenous shocks emanating from the private financial sector as a source of macroeconomic instability in new...
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