Thursday, 18 April 2013

Exogenous Theory of Money

What is it?

  • Idea that money is a neutral thing which is not determined by the real economy and thus can be controlled and manipulated by central banks. 

  • This idea was greatly ties to the Quantity Theory of Money which is believed and used in the 70/80s when there was an inflation crisis. 

  • It is based on the notion that banks will only lend what is in reserves that is the only factor that determines lending . Thus to grow deposits can be increased through open market operations which essentially gives the public money to deposit. 

- It is a market led understanding as they state that banks are the best allocator of capital and the government has minimal role in stabilization, mainly there for open market operations. 

How is this different to Neo-Keynesianism and the endogenous theory of money?

In endogenous theory of money, money supply is determined by money demand not some monetary aggregate set by the bank and this is essentially because neoclassicist do not believe money is demanded as an asset too.



  1. It is justified on the basis of a theory of bank behavior. The theory is generally known as the deposit multiplier or the bank credit multiplier. The theory does not necessarily yield the conclusion the money supply is exogenous, but it will do so if we assume that (i) bank reserves are exogenously determined and (ii) there is a rigid link between bank reserves and money supply. Obviously, these are far-retching assumptions but that is what the theory states. In this theory, idea is that government puts money into the hands of the public through open market operations and they reserve the excess money in deposits which the bank can lend out.
  2. Controlling money supply did tame inflation in 70s/80s so although the unemployment that was resulted provides evidence for endogenous growth money, it cannot be denied that some level of control can be made. 

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