Endogeneous Theory of Money

In this video I explore the endogenous theory of money, by explaining what it is, how it differs from exogenous theory, its historical roots and the justifications/evidence for this theory. This video is created and presented by Komilla Chadha

Transcript

Endogenous Theory of Money

What is it?

• Idea that money grows from within, from within the economy  through money demand and economic activity.

• Money exists as needed by the real economy, because bank system reserves vary to accommodate money demand via interest rates. 

• Banks borrow from the fed reserve discount rate as much as needed to support consumer lending and endogenous money activity .

• This why the money is always backed by productive assets - as it is given on the basis of the real economy not depending on savings/reserves present. 

• loans are typically created ‘out of nothing’ then central bank accommodates this response to the real economy regardless of deposits

• Point to note; two key characteristics: (i) money backed up by productive assets and (ii) money is lent out of nothing, the loans rely on central banks lending. 

How is this different to Neoclassicism and the exogenous theory of money?

• ‘money multiplier’ - fractional reserve system - once reserves are created then they lend out and in this process create credit 
• Whereas, in the endogenous theory of money first loans are given out in response to money demand then does the banks accommodate the loans with borrowing from central banks.

History?

• Post Keynesian - so money has three functions - unit of account - measure of value, means of payment - transitionary and store of value most important which is that it is an asset in itself - an explanation for hoarding which keynes was very interested in 

• A lot of Keynes’ monetary idea was adopted from Marx especially where the need for fiscal policy is stated 

• Basil Moore - banks cannot control reserves in a discretionary manner - they do it on basis of the money demanded and central banks accommodate. This can be linked to the Radcliffe Report.

• In 1957, a report chaired by Lord Radcliffe essentially said  there are two reasons why central banks have a limited role/need when it comes to stability and that is that (i) central banks can never completely control money supply as there are many near-money substitutes such as savings deposits and (ii) velocity of money cannot be controlled and has the power to alter inflation significantly. The report was completely forgot about with the creation of the Quantity Theory of Money and the rise of the monetarist.

• The interesting thing is that now, after the Financial Crisis, questions regarding the exogeneity of money supply and therefore the role of central banks have appeared again. Moore for instance says that central banks can maybe control the supply price of money via interest rates but cannot control the quantity of credit and by implication the need for central banks extinguishes into something quite menial. 

• Keynes argued the demand to hoard - fetish for liquidity - causes unemployment because it keeps interest rates too high to permit sufficient investment to raise ad to the full employment level .

- Tobin stresses that banks have a profit motive and are thus responsive to the private sector, so although authorities control monetary policy instruments, money supply will always be dictated endogenously by the private sector. 

Evidence/Justifications 

1. Does reserves come first ?- evidence shows that reserves sometimes arrive many month after money supply as increase - links to banks being responsive to economic activity as opposed to the financial sector - in neoclassical model except for inflation central banks and neutral money doesn’t have a real process 

1. Monetarism in the 80s did reduce inflation through this monetary aggregate system - which is not possible in endogenous theory of money as it is not central banks but each agent that creates the money. In  80s banks undershot money target and interest rate - controlling money supply essentially failed. 

1. Evidence with private debt and consumption has been shown - link to prior to recession -- this correlation is strong in the endogenous model whereas the exogenous they are just intermediaries so just redistribution of credit so not emphasis with debt and growth 

1. For exogenous money altering the money base should have an impact on lending and other economic indictors whereas for endogenous this is ‘oiling the wheels’ minimal it is endogenous economic activity - latest qe bad results could essentially been seen as proof for endogenous theory of demand.

1. Also if central banks can only use overnight interest rate, which only has indirect impact on quantity of reserves - as main impact is deposits - then it is clear that this set by economic endogenous activity not reserves as it is indirect .

Links to recession

When demand is low the private sector will not create money endogenously 
therefore it is the role of government and fiscal policy to increase reserves to encourage central banks to do open market operations to prevent interest rates reaching to low 0. Open market operations is not a borrowing operation why would sovereign issuer need to borrow from public - it is an interest rate mechanism. There is an issue though because the government is right now in a lot of debt so how can it fulfill this role. 

Policy Implications 

The appropriate way to control the economy is to control money demand (all three types of demand especially hoarding) and it is impossible that monetary policy affects demand, since causation runs from demand to supply not the other way round. 

Dependency Theory

Dependency Theory

Dependency theory is in essence, an extension of structuralism and rose out of the failures of ISI. Dependency theory was categorised in two groups; the first was the disillusioned structuralist and the radical neo-marxists. The essential difference between these two groups if that for the neo-marxist, revolutionary is key for development.

So what did the Neo-Marxist add to the structuralist theory?

• The one capitalist world we live in originates from the centre, and why the periphery never developed was because the centre never required them to develop. In fact, they used the periphery. 
• Development was blocked by the outflow of surplus from the centre to the periphery. 
• This enhanced by the class system and maintained by dominant classes such as landlord who even in the periphery countries benefit.
• The poor remain with the primary products because there is a dominant class in underdeveloped countries, who interests are aligned with centre interests.
• This is why the only way to break out of this cycle is with a revolution.
• This is not to say there hasn’t been any development at all, but what there has is self-sustaining and ISI just made it worse by increasing the dependency on the centre and dominant class for trade and capital. 
• So this is why a radical political change is needed to eradicate these class incentives. 

So in what ways in the periphery depend?

1. They are depend for foreign currency, as even for ISI you need imports. 
2. Foreign financing - as even when you exports are struggling to take off, imports still required, and BoP crisis is still present. 
3. Technology - even though the technology may not be in line with the periphery’s factors of production
4. TNCs and their growing role also shows the growing reliance on the centre’s culture.

Prescriptions - How do neo-marixists suggest we rectify this development problem?

• Except for political revolution there isn’t much they have to offer.
• Sutcliffe’s propose a criteria for Independent Industrialisation, e.g. ‘diversify industrial base’ or ‘production for domestic market’ . However, again there is a lack of prescription, is he advocating a more Soviet Autarkic Socialist Development even though that failed for the USSR?

Critiques:

1. Great analysis, but lack of an answer or solutions prescribed
2. There isn’t much evidence to make their theories valid
3. Their theory missing geographical and democratic factors which also play a key role in development
4. What about the positive affects of TNCs and global capital
5. Personally, I fail to see where this takes us in the development debate.

Criticisms of Structuralism

Criticisms of Structuralism 

• Structuralism fundamentally disagrees with Samuelson’s Price Factor Theory which says that free trade over the long-term equalises, it is a matter of time , thing improve not become more worse as structuralist suggest.
• For neo-classists the ultimate arbitrator is the market so government intervention as prescribed by structuralists creates imperfections and distorts markets. 
• The PSH is sometimes referred to as a “myth” as there isn’t strong clear empirical evidence to back this theory up. 
• Is terms of trade really the fundamentally reason behind underdevelopment?
• The ISI protectionist stages are problematic. For example, the lack of price mechanism leads to inefficiencies and rent seeking (corrupt) behaviour by the firms that are protected. 

The ISI crisis in the mid-60s was self-critiqued in by the structuralist themselves

• The results showed that ISI went no way in reducing inflation or the BoP crisis. 
• Periphery countries were unable to reach scale and quality to move from stage one to stage two.
• Inefficiency meant that centre countries had no incentive to import more from periphery countries. 

Structuralism

Development Economics:“Structuralism” by Komilla Chadha

Roots:

• Structuralism arose from the “Economic Commission for Latin America (ECLA)” which set out to find the major obstacles to development in Latin America (LA) and propose policy prescriptions.

• This was as a result of the balance of payments and exchange rate crisis suffered by Argentina in the 1920s. Economist questioned the orthodox trade theory [comparative advantage]. 

The Proposition:

Development and underdevelopment are not stages in a process but rather structural conditions which are reinforced time and time again by international trade. 

Following this proposition, countries are classified as “centre”and “periphery” countries. Centre countries are those who have the structural condition of being developed and exporting non-primary products. Conversely, periphery countries are those who are underdeveloped and whose economies revolve around primary product exportation. 

These conditions are not new, they are historical but have been unable to change because of the repeated reinforcement of these condition via international trade.

How did the “structure”(i.e. centre/periphery) form? - A historical perspective

1. Industrial Revolution in the centre - perhaps centre countries had this first because of their colonial pasts?

1. The industrial revolution lead to dramatic increase in the productivity of factors of production

1. Centre countries internalised the new technology new technical progress attained from industrial revolution and spread it all economic sectors.

1. This resulted in a homogeneous and integrated economy

1. Periphery countries not having attained the industrial revolution and more importantly same level of technology became import dependent for their modern sector.

1. The periphery’s reliance on imports meant that exports remained primary products

1. A dualist economy formed in the periphery: the traditional agrarian sector and the modern sector which exported these primary commodities using technology imported from the centre.

1. Up till today periphery cannot develop because they are stuck in this negative circle of being reliant on imports for technical progress and international trade reinforces the structural conditions of development and underdevelopment time and time again. 

What point is the historical perspective trying to get at?

Essentially what it is trying to demonstrate is that actually  because of all these historical events, trade is not equally beneficial to both parties as suggested by neo-classists. This is why there is a structure in the first place. The implication is that to develop a new strategy must be sought to eradicate this trade asymmetry which would allow countries to equally trade and lead to that wonderful global Pareto efficiency of production.

Q: Explanation provided by structuralist: What mechanism explains the formation of trade asymmetries ?

A: By deteriorating “Terms of Trade”

The Prebisch-Singer Hypothesis (PSH) 

The PSH refers to the idea that there are deteriorating terms of trade and this is locks countries into the conditions of development and underdevelopment.

The PSH suggests that there are declining terms of trade because:

1. The income elasticity of demand (YED) of primary products is much less than that of manufactured products. I was going to give an example here but I think it is more confusing than helpful so I will just say it how it is. When incomes go up, there is only a defined/limited amount of extra, better quality food you can eat, whereas your non-essential spending (for example on clothes, shoes, going out etc) will never stop increasing - it is an unlimited want. So what happens is when the world becomes richer, the demand for primary products does not rise as fast as the rise for manufactured which means again the centre has an advantage, an opportunity to grow (technologically as well as GDP) faster than underdeveloped countries. This cycle perpetuates until the underdeveloped countries can compete on manufactured goods.

1. Political Reasons - For instance the existence of sophisticated trade unions in the centre meant that there were trade rigidities and in down times, the centre did not suffer as much as the periphery. Assuming the Lewis model, the excess supply in periphery countries also goes some way in suggesting the wage discrepancy and thus the crucial reason why trade is unequal. Furthermore, some economist such as Nurske argue that centre countries develop synthetic substitutes for primary products and this enhances the asymmetries in trade

So now that we established why there may exist trade asymmetries, we need to question why are they so important, particularly from a purely economic stance?

1. Balance of Payments Crisis - demand for primary goods is not rising as much as the demand for manufactured goods, this leads to a BoP deficit for primary goods exporting countries i.e. periphery countries

1. Domestic Inflation - inflation is structural issue and is caused in two ways for periphery countries. The first is the Dusenberry Effect, this is when incomes are low so when they rise, rises in consumption are disproportionate to the rises in savings thus spurring demand-pull inflation. The second is cost-push inflation caused by supply inelasticities of agricultural/primary goods.

Now that we know why there are declining terms of trade and economically why we should care, let us have a look at how this model develops. 

1. In order to stop this trade asymmetry, periphery countries have to industrialise just as centre countries did.
2. This industrialisation will not follow the same pattern as centre countries as periphery countries are already a trading actor, this is called structural sequencing. 
3. The industrialisation need then, is Import Substituting Industrialisation (ISI), which requires government intervention. 
4. A government is required to put in place key policies such as tariffs and quotas.
5. The centre can also help through trade benefits and financial benefits.

A key to this growth then is Import Substituting Industrialisation, but what does that mean...

• ISI is a type of growth which increases exports and in the long run leads to greater openness. It is a stage on the way to export led growth. 
• Periphery should start by focusing on manufacturing consumer goods (different to the Soviet approach) as a market for them already exists.
• Then with the surplus created from there you move to intermediate goods and then capital goods. “Structural Sequencing” becomes important here.
• ISI is different to autarky, because even though some protectionist measures are put in place by the state, you are internalising import production but still conducting some extent of trade.

So what are the stages of ISI that led to Export Led Growth

Stage one:

• At least, one prototype of the goods the country wishes to species in are imported. 
• Primary products are this stage continue to be exported.

Stage Two

• Technology is now imported so that periphery can learn to make them
• Primary goods are still exported except in addition to some of the consumer goods that were made to a high standard. 

Stage Three - Export Orientated Growth

• Technology continue to be imported but are limited now
• C + I + K can now be exported and the unequal terms of trade have gone some way in being rectified. 

What was the government policy that structuralist prescribed?

1. Continued wage and productivity in the agricultural sector.
2. Following monetarist, control of money through the money supply 
3. Reducing non-essential imports and reducing BoP deficit
4. Picking the right sectors based on elasticities of what to import and what to export 
5. The centre should be encouraged to reduce their protectionist measures and increase FDI

An interpretation of Marx: A critique of the division of labour: alienation & Commodity Fetishism

Marx provided a great critique into the capitalist system and in this post I want to explore his ideas relating to alienation and commodity fetishism. 

Capitalism at a glance...

Capitalism was founded upon classical economic thought such as those of Smith and Ricardo. 

One could argue that the building block was Smith’s theory of division of labour and specialisation which was later extended by Ricardo to his theory of Comparative Advantage. 

Smith argued that to develop the “division of labour” must take place because this increases productivity. By this he meant that as workers specialise in one particular part of the production process, they are able to produce more and if workers collaborate in specialising them the productivity of goods will increase and development will be in process. 

Do Note: Smith was aware of the negative social implications this could have in society as if he predicted the existence of Marxist “Alienation” theory. 

Marx

Before defining the notion of Alienation and Commodity Fetishism, we need to set out a few points. 

For Marx the whole organisation of society changed in capitalism. 

In the old Feudal system, the economy was run (as seen below):

C -> M -> C

But what does this mean? This means that workers would produce a commodity such as tomatoes (remember as this society didn’t have full division of labour employed), they would use some of their production for  subsistence and they rest would be sold for money (M). This money would be used in exchange for other goods such as apples which the worker may not be producing. The implication of this is that the price of commodities arises out of the time and value of labour used in the production. 

However, in the capitalist system this has changed to:

M -> C -> M’ 

What does this mean? In the capitalist system, we start with the premise that there are two classes of people which are continually diverging: the bourgeoisie and the proletariat's.  The bourgeoisie are the capitalist class they have money [M] (either through getting a loan or previous economic activity) and they use this money to employ labour (the proletariats) and means of production and produce commodities, C. These commodities are then put on the market and are sold separate from the labour and the production process that was used to make them. Given the distance of the production process and that now workers need to use their wages to buy everything (as they own nothing that they make) prices are determined exogenous to the production process and the outcome results in a larger some of money produced for the capitalist who instigated the production process in the first place.

So what do we learn from this? The first critique Marx has for the capitalist system is alienation.

Alienation

For Marx, the capitalist system led to the worker being alienated. Social relations become estranged in such a society because the worker works for subsistence (as he can no longer on his own compete with capitalist productivity) and this subsistence derives it existence from the exchange of labour for a wage. We can summarise that the worker becomes alienated for three reasons:

1. The workers do not own the means of production - so even if they wanted to make the product for themselves, they would have to buy it as they simply do not have the money required to own the means of production - even their own labour is now separate to them - it is a commodity (leads to second point). 
2. Workers do not own the product of their activity.
3. Workers do not control the organisation of productivity process - they merely carry out specific roles. 

Alienation is crucial for Marxian thought because you can see this one of the reasons that has the potential to leads to such high levels of tensions that would eventually cause a revolution and lead us into the new era of socialism (although what that is we do not know - we just know workers would not be alienated).

Commodity Fetishism 

What is commodity fetishism? and how does it link to all we are talking about?

So we have already established in a capitalist society all relations are economic not social such as employer-employee. Workers are compelled to sell their labour to have some kind of subsistence in this new society. 

Commodity Fetishism refers to economists obsession with commodity. The transformation social relations into objectified economic relations because of this obsession.Commodity fetishism is blinding because now products derive their value on what people perceive the product to be worth not their real economic worth which includes the labour that has gone into them.  This value is no longer equivalent to the price - price derives itself from contingent factors whereas value by fetishism of commodities.

The ultimate aim of the whole production and exchange process is to own exchanged values (and these values aren’t real because of commodity fetishism). Furthermore, the capitalist society is now characterised by social stratification - the workers and the capitalist and controlled by one class implying the exploitation of one class over the other. Here you can see exploitation could include alienation that capitalism causes. 

The obscures the notion of division of labour in a way, because there isn’t that collaboration between workers. Yes workers do specialise but for a wage which is used for subsistence - again showing the estrangement of social relation by some objective economic relations. 

Conclusion

The post boils down to Marx’s philosophical and economic ideas that the capitalist society which is characterised by the process of M -> C -> M’( money used to produce commodities which are sold to create a profit). This leads to the alienation of workers which is crucial for eventually spurring a revolution and moving into the Socialist realm of society. Furthermore, it is important to recognise that the capitalist system is essentially based on a lie - products derive their values from what people perceive to be their value not their real labour or exchange value. This turns what were social relations to objective economic relations and this transformation he terms commodity fetishism.

Lewis Dual Sector Model

This is quite a long and advanced video (not designed for Alevel like my other videos) on the Lewis two sector model and the criticisms of it. This video is created and presented by Komilla Chadha.