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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  • alain­ton

    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

  • bar­ry­thomp­son

    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.

  • bar­ry­thomp­son

    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.

  • 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.

  • 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.

  • Steve,

    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.

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

  • Free Con­sti­tu­tion Project

    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?

  • 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.