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 a professional economist 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 debts accumulated in Australia, and our very low rate of inflation.
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6 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.

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