Behavioral Finance Lecture 07: Endogenous Money & Circuit Theory

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I’ve done a demolition derby on Neoclassical economics in the previous 6 lectures; for the next 6, I’ll build a realistic alternative. First stop is the importance of the endogeneity of money in utterly revising macroeconomic analysis. In the first half of this lecture, I outline the basic propositions in endogenous money, and some of the disputes that have arisen in the very early days of this theory. By way of analogy, the state of endogenous money theory today would be a bit like the early days of the Copernican model of the solar system: the fundamental idea is correct, but many of the arguments that people make about it reflect confusion about a new concept.

I then conclude with an outline of the brilliant insights from the Circuitist School, and in particular from Augusto Graziani, into why a monetary economy is fundamentally different to the neoclassical fiction of a barter economy. (PPT Slides: Debtwatch Subscribers [Membership needed–non-members click here]; CfESI Subscribers  [Membership needed–non-members click here])

Though Graziani’s fundamental insights were brilliant, when he attempted to develop a (verbal) model of this process, he made many errors which arose from confusing stocks with flows. I outline the accepted verbal model of the monetary circuit prior to my own research, and point out the flaws in this verbal argument as a prelude to developing my mathematical model of the Monetary Circuit in the next lecture. (PPT Slides: Debtwatch SubscribersCfESI Subscribers)

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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9 Responses to Behavioral Finance Lecture 07: Endogenous Money & Circuit Theory

  1. alainton says:

    Ok things are beginning to fall into place now

    conceiving of profits as a flow with dimensions of ‘dollar years’ – a very ‘swedish’ and correct view of capital as a flow of income.

    Rearranging your anti-walras law formula to give price on the LHS we have a formula for pricing of a surplus producing asset (still think it needs some tweaks on RHS to fullly account for risk and true value of debt overhang)

    That gives us a formula we can use to bridge several economic fields

  2. barrythompson says:

    Nice lecture. Nice to see Steve incorporate Graeber’s ideas too.

    One point. When Steve says he doesn’t believe that repayment of loans destroys money, I presume he is referring to repayment in cash, which then becomes bank reserves. Repayment of loans obviously does destroy credit – this is just the opposite of credit creation by taking out a loan from a bank.

  3. barrythompson says:

    One more point.

    Many Modern Monetary Theory adherents, such as Scott Fullwiler and Cullen Roche, are firmly on board with ‘horizontal’ credit creation.

    Stephanie Kelton has even described US government borrowing as involving credit creation in the same way as private borrowing: First, government bond issue creates credit in accounts at commercial banks mediating the bond sales. Second, the new credit is withdrawn and reserves are transferred from the private banking system into the government’s reserve account at the central bank. Third, government deficit spending adds those reserves back into the private banking system, which then creates deposits in the account of the recipient of government spending.

    So the net effect of government borrowing is the creation of both credit (deposits) and debt (bonds) – just like private borrowing. Reserves just serve to track transactions between commercial banks, the central bank and – because reserves can be converted to cash – people’s wallets.

    Often, the MMT crowd like to start with government spending first – to emphasise that deficit spending creates deposits and reserves.

  4. Steve Keen says:

    No it does not Barry–it takes money out of circulation but does not destroy it. This is a point on which I happily differ from most modern Post-Keynesian economists and instead concur with Keynes: credit money circulates, it is not destroyed by loan repayment. The argument that repayment destroys money made no logical sense to me when I first heard it, and was treated as absurd when I discussed it with bank accountants as well. I’ll elaborate more fully on this in future lectures.

  5. Steve Keen says:

    I agree that they are “on board” with horizontal money Barry–I just feel that they have made a logical error in how they have integrated it with vertical money. Again, that’s something I’ll elaborate in later lectures, though more likely later papers since it will take a comprehensive model of both horizontal and vertical money creation to establish the proper logical connection between the two.

  6. NeilW says:


    I’ve not seen anywhere recently where MMT people say money was ‘invented by the state for the payment of taxes’.

    Perhaps the idea has evolved based on the new data coming from the anthropologists, but if you look at Randy Wray’s modern money primer (which admittedly isn’t published work, but is recent) it says:

    “All you need to drive a currency is a more or less involuntary obligation to deliver the currency—and that can be a tax, fee, fine, or even religious tithe. Or a payment to obtain water or any other necessity. ”


    “That answers the question: yes it is not enough to impose the obligation (fee, fine, tax); the obligation must also be enforced. A tax liability that is never enforced will not drive a currency. A tax that is only loosely enforced can create some demand for the currency, but it will be somewhat less than the tax liability for the simple reason that many will expect they can evade the tax.”

    So the short version is ‘taxes drive currencies’ but its more nuanced than that.

    It’s back to your Saturn V vs. dinosaur flight example. Currency may not have been invented to pay taxes, but you can demonstrably drive a non-convertible currency if you have the power to enforce an obligation on somebody and require payment in your scrip.

    Looking forward to your more formal models of the horizontal and vertical systems.

  7. Pingback: Loan repayments destroy credit money. Right? Well no…. | Modern Monetary Theory: Real Economics

  8. Free Constitution Project says:

    Steve, I noticed that you made an eliquent argument against the idea that commercial banking money is destroyed when a loan is repayed. I also never believed that load of BS either. I have two questions for you if you do not mind:

    1. I noticed there are two separate money trails to follow here. One is the money that the vendor receives which you already commented on in the video, and that made sense to me. However, the second money trail to follow here is the money that the debtor repays to the lender. If the principle is not destroyed, where does it go?

    2. If the principle is not destroyed, doesn’t this present us with an ethical dilemma where the banks are receiving both principle and interest as profits from loaning money which they never had in the first place?

    I have never heard a sufficient explanation as to how either the money which the vendor receives nor the bank for the principle simply cease to exist. I have heard the claim that they owe it to the central bank for reserves that they already received from said central bank. If this is the case, then wouldn’t it logically follow that the central bank actually does create 100% of the money supply?

  9. Steve Keen says:

    I’ve actually realised that I was wrong on that point. With a double-entry viewpoint, if the asset is reduced by repaying debt, then the liability side falls by the same amount. Since we trade using banking sector liabilities (ie by transfers between deposit accounts), the money is destroyed by repayment.

    Cash complicates the issue: cash repayment transfers money from active to inactive circulation (bank deposit accounts to the bank vault). But it is still taken out of circulation and will only get back into it via another loan.

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