(Tiểu luận) group assignmentcourse monetary and financial theories

Endogenous Money Exogenous Money Definition Endogenous money is an economy’s supply of money that is determined endogenously—that is, as a result of the interactions of other economic va

NATIONAL ECONOMICS UNIVERSITY

FINANCIAL ECONOMICS (FE)

GROUP ASSIGNMENT

COURSE: MONETARY AND FINANCIAL THEORIES

CLASS: FE63 GROUP 9

HA NOI, 2022

TOPIC: Money is created endogenously

1.Definition

1.1 Money

Money is a medium of exchange that is centralized, generally accepted, recognized, and facilitates transactions of goods and services

● Money is a medium of exchange for various goods and services in an economy

● The money system varies with the governments and countries

● Different countries have different currencies

● The central authority is responsible for monitoring the monetary system

Endogenous Money Exogenous Money Definition Endogenous money is an economy’s

supply of money that is determined

endogenously—that is, as a result of the

interactions of other economic variables,

rather than exogenously (autonomously)

by an external authority such as a

central bank

 The “money supply” is endogenous if

we believe that the central bank sets the

policy rate of interest; the level of money

is determined by factors within the

private sector (The root endo- implies

that it is an internal property; that is, the

level of the money supply is determined

within the model of the private sector.)

Exogeneity means the supply of

money is independent of demand

is an

Exogenous Money

economy’s supply of money that is determined exogenously—that is, if the existence and quantity of money are determined by forces outside the economy — most often by the state — money is considered exogenous

Exogenous money that part of the

money supply that is ‘put into’ the economic system from outside by the government

 The “money supply” is

exogenous if we believe that it is

set directly by the central bank; private agents within the economy will set interest rates on instruments

in response to the supply of money

(Exo- is the Greek root that indicates that something is external;

in this case, the money supply is set externally to the model of the private sector.)

Origins and

evolution of

money

- According to Knapp (1924) and his

followers, on the one hand, money was

introduced by the authorities Money is

thus an exogenous creation of law

and the state.

- According to Menger (1871), money

was not the top-down result of an act of

will, but the unplanned product of

market mechanisms Money evolved

spontaneously in the market through the

self-interested actions of individuals who

wanted to improve their position

- Mainstream economists believe that

money endogenously evolved from

commodity money to Fiat money, as

individuals economize on production and

transaction costs

Austrian economists argue that fiat

money did not endogenously

(read: spontaneously) emerged on

the free market, but resulted from

exogenous government intervention in the monetary sphere

(For example, Hoppe, 1994; Hülsmann, 2008).

the monetary

system

essence of endogenous money theory is

that the stock of money in a country is

determined by the demand for bank

credit, and the latter is causally

dependent upon the economic

variables that affect the level of output.”

- In practice, the central bank can decide

to respond more or less to commercial

banks’ demand for reserves, rendering it

dependent on the state of the economy

and thus endogenous

 “Inside Money”

that under the gold standard— understood here as a monetary system without a central bank and government intervention in the monetary sphere, with gold as the

outside money—the money supply

is exogenous, as the total stock

of gold cannot be increased at will.

- Commercial banks have no control over the money supply In a full reserve system, they cannot create money at all, while in a fractional-reserve system, they need gold reserves, the supply of which cannot be increased at will—that is,

the reserves constitute an exogenous constraint on credit creation

→ This is the core of the main

argument for and against the gold standard: neither the

government nor the banking system

is able to arbitrarily increase the money supply For supporters of this system, it protects people against inflation, while for opponents it makes the monetary system not elastic enough to stimulate the economy during recessions

- Under a fiat standard, the

supply of money is exogenous,

when the world is understood as being outside the market system, as

it is determined, at least partially, by the central bank, a non market institution

- In principle, under a fiat standard, the central bank, a monopolistic

producer, can choose the supply

of outside money to be whatever it

wants

 “Outside Money”

Bank money - The endogenous view claims that

loans create deposits.

- The supply of money is considered

Exogenous approach to money creation

- The Exogenous approach to

determined by firms’ need to pay for the

costs of production

+ The production decisions of

companies generate the demand

for loans (Moore, 1988).

+ Commercial banks set the

interest rate on loans (the policy

rate plus a markup) and

accommodate the demand for

loans

 Money supply is endogenous since

demand for finance by private firms is

always matched by increasing money

supply by the central bank

- As Rochon and Rossi (2013, 224) put

it, “Money is and has always been an

endogenous phenomenon, owing to its

being essentially tied to the nature of

debt and the need for a means of final

payment that has to be provided by a

third party on the agents’ demand.”

base money, will move first,followed

by broader, credit based measures

of the money supply as this was

‘lent out”

- Exogenous money creation is based on the money multiplier however it is not a process of money creation Instead, through bank loans and rise in foreign assets made by banks which at the same

time creates new bank deposits

The importance of The Central Bank (RBA) in the exogenous theory is very high, as The Central

bank offers serious judgments and decisions on money supply and creation

- Exogenous money has predicted that the RBA has the right to control the quantitative aspects in money

supply and creation The RBA

controls the amount of base money when required.

- The Central Bank expands reserves, while private banks then convert them into loans, while keeping a percentage of the reserves, for the accommodation of money demand from customers

(Godley and Lavoie, 2016)

- Further, when deposits of loans are made a fraction of the loan is kept and this procedure is continued until nothing is left to lend out Thus,the procedure of creation completed by the money multiplier

is consistent over time and will

offer the Central Bank the capability to have control over money supply

- Additionally, RBA can effectively

manage the monetary base, i.e.,

the requirement of the total amount

of currency in reserves and circulation by open market operations and the need for reserve ratio

The quantity of loans is the

retain portions as reserves, in the situation of exogenous money, the central banks makes the expansion

in the base money supply, and the response of banks to this, i.e., the amount left to lend out (Greenwood,Hanson and Stein, 2015)

Exogenous/

Endogenous

in the

statistical

and policy

senses

The money supply may be endogenous

and either controllable, through the

central bank’s reaction function, or not,

because of money supply disturbances

generated from within the economy and

outside the central bank’s control (Palley,

2002)

- For example, in the quantity

theory of money, the money supply is supposed to be exogenous It is similarly

uncontroversial that the money-multiplier model assumes the monetary base is exogenous

- When economists model the private sector, including its response to some policy changes, it makes sense to assume that money

is exogenous in the policy sense— that is, that policy parameters are exogenous

In the control

sense

- The fact that the central bank supplies

reserves on demand implies that the

monetary base is not exogenous (in the

sense of being the source of change in

the economy) but rather a function of

investments and demand for loans, or

the needs of trade

 It responds endogenously to

changes in the demand for money and

other developments in the economy

(Chick, 1973)

In that sense, the exogeneity of the money supply implies that “its nominal size is or can be controlled

by the monetary authorities and does not automatically change as people make payments or try to build up or run down their money

holdings” (Yeager, 1997, 131).

-The monetary authorities control the monetary base and that there is

a strong link between it and the broader monetary aggregates;

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The central bank’s policy-response

function:

+ The central bank reacts to

economic developments; hence

the monetary base cannot be exogenous.

+ But central banks alter their

policy targets in response to

developments in the economic

endogeneity of money (Moore,

1998)

hence the money supply as a

whole can be taken as exogenous.

Endogeneity/

Exogeneity

in the

horizontalist

and

structuralist

senses

- For structuralists:

+ Money is endogenous, because

techniques of management of assets and liabilities—

commercial banks can lend largely free of any central bank constraint (Howells, 2005)

+ The endogeneity of money

depends on both the central bank’s behavior and the actions

of commercial banks, which are

not fully dependent on the central bank

- For horizontalists: the endogeneity of

money depends exclusively on the

monetary authority and its willingness to

meet the demand for reserves

According to this view, the central bank exogenously sets the interest rates at which it fully accommodates demand for reserves that results from banks’ decisions to meet all creditworthy borrowers’ demand for loans Thus, under this approach, the money supply curve is horizontal—that is, perfectly interest elastic, as, although the central bank sets the short-term interest rate, it has to always accommodate bank demand for reserves in order to preserve the stability of the financial system

(Moore, 1998)

 Following the horizontalist

and structuralist money are being considered to be endogenous not exogenous

1.3 Examples for endogenous money and exogenous money in the real world.

Most of the money we use is actually endogenous

- Endogenous money is created when banks make loans When you get a

mortgage loan for $100,000, the lending bank simply marks up your account

by $100,000 (a bank liability), and you execute a promissory note for

$100,000 + interest; the promissory note is a bank asset As you repay the

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Monetary and Financial… None

6

books, but in the meantime, those dollars are free to be spent, over and over This type of money is the stuff that fills our bank accounts, and makes up most of the supply of money that we actually use for transactions, M1 money

- The key attribute of bank-created money is that for every dollar in existence,

there is also a dollar of debt; bank-created assets and liabilities net out

to zero It is impossible for a bank to simply create dollars without a

balancing debt on the other side of the ledger Another key attribute of bank-created money is that it cannot exist outside of bank ledgers (When you hold cash, you are holding a government liability that is serving as a substitute for

a bank liability.)

- Exogenous money comes from outside of the domestic private banking

system The main source of exogenous money in the U.S is the government Treasury sells bonds (which are government liabilities) to the private sector to fund government spending The Fed, our central bank, buys those bonds in exchange for reserves, which are simply settlement funds of private banks held in Federal Reserve banks Since the Fed is not part of the private banking system, these reserves are exogenous money; reserves (and cash,

which is exchangeable for reserves) are held by the private sector without

corresponding debt So the private sector holds government-created

liabilities (reserves, cash, and bonds) as net financial assets The government, specifically the Treasury, holds trillions in net liabilities, which are only extinguished by net taxation (running a budget surplus) But there is

no pressure on the government to extinguish these liabilities; they can exist

in perpetuity, unlike the liabilities of private banks.Another form of

exogenous money is foreign currency Countries that run trade surpluses

have a net inflow of foreign currencies, which are exogenous to the domestic system Banks hold foreign currency as an asset; foreign currency can be used in trade, or it can be used to exchange for your own currency, but it cannot be directly converted into domestic currency

bank-created money, and partially exogenous, government-created money

- Today, if we want money in order to be able to create or satisfy a need, we need to exchange something – our labor or something of value Thus, as far

as we are concerned, current money is exogenous, i.e it is provided externally and is independent of our activity However, for banks, who create money, it is endogenous – money is created as part of their banking activity; i.e banking and money creation are integral Similarly, Bitcoin, other than when it is “mined”, is exogenous to users We have to exchange something of value (labor or goods) to acquire Bitcoins However, to those who “mine” Bitcoins, they are endogenous, i.e Bitcoins are generated as part of the miners’ activity Building on the ideas generated from the taxonomy of money described previously, we can create endogenous tokens (aka money) for all, i.e token creation becomes integral to the human activity of satisfying needs through creation (of goods and services) and exchange

2 Theory of endogenous money

Based on 3 main claim:

2.1 Loans create deposits:

For the banking system as a whole, drawing down a bank loan by a non-bank borrower creates new deposits (and the repayment of a bank loan destroys deposits) So while the quantity of bank loans may not equal deposits in an economy, a deposit is the logical result of a loan – banks do not need to increase deposits prior to extending a loan The supply of money is considered endogenous in this view as it is determined by firms’ need to pay for the costs of production The production decisions of companies generate the demand for loans Commercial banks set the interest rate on loans and accommodate the demand for loans

2.2 While banks can be capital-constrained, in most countries a solvent bank is never reserve-constrained or funding-constrained:

It can always obtain reserves or funding either from the interbank market or from the central bank