Monetary Policy and Central Banking
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Monetary Policy and Central Banking

New Directions in Post-Keynesian Theory

Edited by Louis-Philippe Rochon and Salewa ‘Yinka Olawoye

Divided into two parts, this book presents a detailed, multi-faceted analysis of banking and monetary policy. The first part examines the role of central banks within an endogenous money framework. These chapters address post-Keynesian interest rate policy, monetary mercantilism, financial market organization and developing economies. In the second part of the book, the focus switches to the analysis of the financial crisis that began in 2007. The chapters in this section discuss the role of central banks in times of crisis.
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Chapter 2: Stabilization Policy with an Endogenous Commercial Bank

Mark Setterfield and Kurt von Seekamm


* 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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