Model Answer
0 min readIntroduction
Endogenous money theory challenges the traditional Quantity Theory of Money, which posits a fixed relationship between the money supply and nominal income. Instead, it argues that the money supply is determined *within* the economic system, responding to demand for credit. Post-Keynesian economists further developed this idea, leading to distinct horizontalist and structuralist approaches. Both reject the central bank’s ability to directly control the money supply, but they differ in their explanations of the mechanisms through which money is created and the constraints faced by banks in the lending process. This answer will delineate these differences, highlighting their implications for monetary policy.
Horizontalist Approach
The horizontalist approach, pioneered by Nicholas Kaldor, views the banking system as passively accommodating demand for loans up to a certain point. Banks are seen as having a ‘horizontal’ supply curve of loans at the prevailing interest rate. The money supply expands as firms and households demand credit for investment and consumption. However, this expansion is constrained by the ‘liquidity preference’ of the public – the desire to hold money rather than lend it.
- Key Features: Banks are profit maximizers, lending freely until they reach their liquidity preference constraint. The central bank influences the money supply indirectly through interest rate policy.
- Money Creation: Money is created through the extension of bank credit, driven by the demand for loans.
- Constraints: The primary constraint is the willingness of the non-bank public to hold additional bank liabilities (deposits). If the public becomes unwilling to hold more deposits, banks cannot expand lending.
Structuralist Approach
The structuralist approach, developed by Basil Moore, offers a more complex and institutionally-focused explanation of endogenous money. It emphasizes the *structure* of the financial system and the specific roles played by different financial institutions. Moore argues that the money supply is determined by the demand for financing investment, but this demand is channeled through a complex network of financial intermediaries.
- Key Features: The financial system is segmented, with different institutions catering to different types of borrowers. Banks are not simply passive lenders; they actively manage their balance sheets and respond to regulatory constraints.
- Money Creation: Money is created through the financing of investment. The demand for finance originates in the corporate sector, and banks respond by creating credit.
- Constraints: Constraints are not simply liquidity preference, but also include capital adequacy requirements, reserve requirements, and the profitability of lending. The structure of the financial system itself imposes limits on the money supply.
Comparative Table
| Feature | Horizontalist | Structuralist |
|---|---|---|
| Bank Behavior | Passive lenders, profit maximizers | Active balance sheet managers, respond to regulations |
| Key Constraint | Liquidity preference of the public | Financial structure, capital adequacy, profitability |
| Focus | Aggregate demand for loans | Structure of the financial system and investment financing |
| Role of Central Bank | Indirect influence through interest rates | Limited direct control; influences structure through regulation |
| Key Thinker | Nicholas Kaldor | Basil Moore |
Furthermore, the structuralist approach highlights the importance of financial innovation and deregulation in altering the constraints on money supply. Changes in the financial landscape can significantly impact the effectiveness of monetary policy. For example, the rise of shadow banking has created new channels for credit creation outside the traditional banking system, making it more difficult for central banks to control the money supply.
Conclusion
Both horizontalist and structuralist post-Keynesian approaches offer valuable insights into the complexities of endogenous money. While the horizontalist model provides a simplified framework emphasizing liquidity preference, the structuralist approach offers a more realistic and nuanced understanding of the role of financial institutions and the constraints on money creation. Recognizing these differences is crucial for formulating effective monetary policy in a world where the money supply is not simply controlled by the central bank, but rather emerges from the interactions within the financial system. Future research should focus on integrating these perspectives to better understand the evolving dynamics of money and credit.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.