Money Supply And Demand Theory
Economist and policy makers have been always concerned with the nature of the causation between money and real economic activities. The proponents of Quantity Theory of Money claim that money supply is exogenous. This is in contrast with Mundell`s proposition that money supply accommodates changes in output and income, being endogenous. Cagan (1965) also argues that money supply conveys both endogenous and exogenous properties. For short-run and cyclical fluctuation, he proposed a relation in which the money supply is endogenously determined by changes in real sector. However, he asserts that in the long-run, money supply is independent of real economic activities and is determined exogenously.
Different schools of economic thought have postulated
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As the economy grows, banks increase their loans to meet the growing needs of the economy, such as paying wages or remunerating other factors of production. The creation of money is thus parallel to the creation of income. As is argued by Joan Robinson (1956) and by post- Keynesians in general, the supply of money increases with the needs of production, in response to expectations of aggregate demand, through the banking system (see Arestis and Eichner, 1988). There are three distinct theories of money supply endogeniety: those presented by Accommodationists‟, Structuralists‟ and the Liquidity Preference School (see Kaldor, 1970; Basil Moore,1988; Palley, 1996; Arestis and Howells, …show more content…
In the first stage, money is entirely exogenous; saving determines investment. The causality runs from bank deposits to reserves, and finally to loans, money being exogenous. In the next stage, the banks are able to expand lending beyond their reserve capacity through deposit multiplier. Endogenous money is thus viewed as the result of institutional changes, defined as the ability of the banking system to increase the supply of loans with no prior expansion of bank reserves. Yet, Louis-Philippe Rochon (2004), Lavoie (1992) and Lavoie (1996) argue that money has always been endogenous, irrespective of the historical
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