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Endogenous money is a core component of post-Keynesian economics, but it has not been fully integrated into its macroeconomics. To do so requires replacing the accounting truism that ex post expenditure equals ex post income with the endogenous money insight that ex post expenditure equals ex ante income plus the ex post turnover of new debt. This paper derives this result after exploring precedents to this concept in the work of Schumpeter,Minsky, Keynes and Pigou.
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Endogenous money and effective demand
Steve Keen
School of Economics, History and Politics, Kingston University, Kingston upon Thames, UK
Endogenous money is a core component of post-Keynesian economics, but it has not been fully
integrated into its macroeconomics. To do so requires replacing the accounting truism that
ex post expenditure equals ex post income with the endogenous money insight that ex post expen-
diture equals ex ante income plus the ex post turnover of new debt. This paper derives this result
after exploring precedents to this concept in the work of Schumpeter, Minsky, Keynes and Pigou.
Keywords: endogenous money, effective demand, loanable funds, macroeconomics,
monetary theory
JEL codes: E10, E12 E40, E44, E51
The ideas which are here expressed so laboriously are extremely simple and should be obvious.
The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those
brought up as most of us have been, into every corner of our minds. (Keynes 1936, p. xxiii)
The concept of endogenous money has been integral to post-Keynesian economics ever
since the pioneering empirical work of Basil Moore (Moore 1979; 1983; 1988a; 1988b;
1995; 1997; 2001; 2006), and it is fundamental to Minskys Financial Instability
Hypothesis (Minsky 1963; 1972; 1975; 1977; 1980; 1982). The concept can be traced
back to Schumpeter (Schumpeter 1934), and even further (though in not as explicit a
form see Newcomb 1886; Taussig 1911).
However, the ubiquity of the concept does not mean that its implications are fully
understood, even by those who accept it is true, for the reason encapsulated in my open-
ing quote from Keynes. Old ideas even old ones from Keynes himself can make it
difficult to fully appreciate the consequences of a new idea. In this paper, I prove that a
key concept in KeynessGeneral Theory (Keynes 1936) the equality of income and
expenditure and hence of savings and investment must be modified for a model of
capitalism with growth in which banks endogenously create money.
The starting point of the monetary macroeconomics of endogenous money is
instead that effective demand is equal to income plus the turnover of new debt.
This is entirely consistent with sectoral balances summing to zero, as I prove below.
The proposition that effective demand exceeds income is not a new one: it can be
found in both Schumpeter and Minsky (and arguably in Keyness writings after
The General Theory, though not in as definitive a form see Keynes 1937, p. 247).
Review of Keynesian Economics, Vol. 2 No. 3, Autumn 2014, pp. 271291
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A difference between income and expenditure, with the gap filled by the endogenous
creation of money, was a foundation of Schumpeters vision of the entrepreneurial role
in capitalism. Minskys attempt to reconcile endogenous money and sectoral balances
is the closest antecedent to the argument I make, but I will start in chronological order
with Schumpeters analysis.
To Schumpeter, an entrepreneur was fundamentally someone with a good idea, but no
money to put that idea into effect. Lacking money, he must either raise it or borrow it
from a bank, and Schumpeter focused upon the latter route.
The entrepreneur was
therefore the typical debtor in capitalist society(Schumpeter 1934, p. 102). When
the bank advanced the entrepreneur a loan, this was not the transfer of existing pur-
chasing powerbut the creation of new purchasing power out of nothing which is
added to the existing circulation(Schumpeter 1934, p. 106, my emphasis).
Total demand in the economy was therefore the sum of demand from incomes
earned by the sale of existing goods and services (which Schumpeter described as
fully covered creditin the circular flow) plus this debt-financed expenditure by
entrepreneurs. Consequently total demand which he describes as total credit
exceeds that from income alone:
From this it follows, therefore, that in real life total credit must be greater than it could be if there
were only fully covered credit. The credit structure projects not only beyond the existing gold
basis, but also beyond the existing commodity basis. (Schumpeter 1934, p. 101, emphasis added)
Minsky confronted the issue of reconciling sectoral balances with effective demand
exceeding income in his most famously named paper (Can ItHappen Again?,Minsky
1963), and his first book-length treatment of the Financial Instability Hypothesis (John
Maynard Keynes, Minsky 1975). In both cases he described his work as tentative
heading the former A Sketch of a Modeland describing the latter as the bare bones
of a model. Since this issue remains contentious, with many post-Keynesian economists
seeing an obvious double-counting error in the proposition that effective demand can
exceed income (Berry et al. 2007; Keister and McAndrews 2009; Benes and Kumhof
2012), I cite this passage from Minsky (1963) in its entirety, to show that the argument
that expenditure exceeds income has a long but neglected pedigree:
Within a closed economy, for any period
which can be written as:
ðSIÞþðTGÞ¼0 (2)
1. Schumpeter acknowledged that many entrepreneurs have money (Schumpeter 1934, p. 73),
and can also raise funds from share issues. But he focused on the extreme case of an entrepre-
neur with no money which is the more difficult one in order to clarify his argument.
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where (SI) is the gross surplus of the private sectors and (TG) is the gross surplus of the
federal government. The surplus of each sector ζ
(j= 1 ... n) is defined as the difference
between its gross cash receipts minus its spending on consumption and gross real investment,
including inventory accumulations. We therefore have:
ξj¼0 (3)
Equation 3 is an ex post accounting identity. However, each ζ
is the result of the observed
investing and saving behavior of the various sectors, and can be interpreted as the result of
market processes by which not necessarily consistent sectoral ex ante saving and investment
plans are reconciled. If income is to grow, the financial markets, where the various plans to
save and invest are reconciled, must generate an aggregate demand that, aside from brief
intervals, is ever rising. For real aggregate demand to be increasing, given that commodity
and factor prices do not fall readily in the absence of substantial excess supply, it is necessary
that current spending plans, summed over all sectors, be greater than current received
income and that some market technique exist by which aggregate spending in excess of
aggregate anticipated income can be financed. It follows that over a period during which
economic growth takes place, at least some sectors finance a part of their spending by emit-
ting debt or selling assets.
For such planned deficits to succeed in raising income it is necessary that the market pro-
cesses which enable these plans to be carried out do not result in offsetting reductions in the
spending plans of other units. Even though the ex post result will be that some sectors have
larger surpluses than anticipated, on the whole these larger surpluses must be a result of the
rise in sectoral income rather than a reduction of spending below the amount planned. For
this to take place, it is necessary for some of the spending to be financed either by portfolio
changes which draw money from idle balances into active circulation (that is, by an increase
in velocity) or by the creation of new money. (Minsky 1963; Minsky 1982, pp. 56,
my emphasis)
Minsky thus appreciated that there were biconditional logical links between growing
aggregate demand, demand exceeding income, and the endogenous creation of money,
which at the same time had to be consistent with sectoral balances summing to zero
as I prove later in this paper.
He returned to this theme in John Maynard Keynes (Minsky 1975, pp. 131134)
and attempted to construct a mathematical proof. In a section entitled The Economics
of Budget Constraints, Minsky defined the budget constraint for consumption (C)as
wages (W) plus a fraction αof income from the ownership of capital (Dwhich
included both distributed earning and interest payments on bonds) that was allocated
to consumption spending. Ignoring debt-financed consumption or savings by workers
for the sake of simplicity (this assumption is not necessary only convenient(ibid.,
p. 131)), his equation for the consumption budget was:
Investment (I) he defined as being equal to retained earnings (_
Q) times a leverage fac-
tor (λ):
Endogenous money and effective demand 273
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where λcould range from negative during a debt-deflation to very large during a
boom. The total budget constraint (Y) was thus:
Minsky reasoned that since ð1αÞDof household income was not used for consump-
tion, some fraction (u) of it would be available to finance investment. It therefore fol-
lowed that if the leveraged portion of investment exceeded this fraction of savings,
then part of the investment had to be debt-financed:
If λ_
Q>uð1αÞD,thensome of investment will have to be financed in a man-
ner other than by the intermediation of household savings. This excess
Quð1αÞDof investment financing demanded over the supply avail-
able from intermediation of savings can be satisfied by some combination of an
increase in the money supply and of a decrease in the money holdings in portfo-
lios, i.e., by an increase in velocity. (Minsky 1975, p. 132, emphasis added)
Minsky then attempted to formalize the distinction between ex ante and ex post
income, using a difference equation approach. He modelled planned or ex ante expen-
diture as depending on income levels in the previous period, so that
Ctexante ¼Wt1þαDt1
Itexante ¼ð1þλÞ_
Ytexante ¼Wt1þαDt1þ_
Ex post income in period t1 was
Yt1expost ¼Wt1þDt1þ_
For ex ante income in period tto exceed ex post in period t1, Minsky derived the
condition that:
He observed that, for income to grow, investment therefore had to exceed savings:
Thus for income to increase, the externally financed investment must exceed the savings of
households. (Minsky 1975, p. 133)
For this to be possible, another source of finance had to exist: an increase in the money
supply (ΔM)where ΔM
can be either money creation or a change in velocity(ibid.,
p. 133). Since a proportion uof household savings was presumed to be made avail-
able for financing investment, we have that(ibid., p. 133):
Substituting that λ_
Qt1>ð1αÞDt1from equation (1.6), Minsky concluded that
for ex ante income in period tto exceed ex post income in period t1in other
2. I want to thank Marc Lavoie for pointing out errors in the equations in my draft paper seen
by discussants. These emanated from the Kindle version I used for writing the draft paper, in
which ex ante and ex post,Yand I, and + and were confused at various points.
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words, for effective demand and income to grow over time the creation of new
money had to exceed the fraction of household income saved and not made available
for investment (see Figure 1):
Minskys principle thus transcends Keynes on both income equals expenditureand
savings equal investment,withKeyness identities applying in the abstraction of
equilibrium, but Minskys applying in the (normally) growing economy in which
we actually live. My analysis is thus consistent with Minsky, and formalizes the essen-
tial role of the endogenous creation of money by the banking sector in this analysis.
But it still appears, to many post-Keynesians, to be contradicting Keynes himself.
Minskys insight that the endogenous creation of money by the banking sector is
simultaneously an addition to demand that allows expenditure and income to grow
over time supports Grazianis assertion that the banking sector must be treated as sepa-
rate from the firm sector:
Since in a monetary economy money payments go necessarily through a third agent, the third
agent being one that specialises in the activity of producing means of payment (in modern
times a bank), banks and firms must be considered as two distinct kinds of agents. Firms
are present in the market as sellers or buyers of commodities and make recourse to banks
in order to perform their payments; banks on the other hand produce means of payment,
and act as clearing houses among firms. In any model of a monetary economy, banks and
firms cannot be aggregated into one single sector. (Graziani 1989, p. 4)
Keynes did not do this in The General Theory, arguing instead that technical mone-
tary detail falls into the background:
whilst it is found that money enters into the economic scheme in an essential and peculiar
manner, technical monetary detail falls into the background. A monetary economy, we shall
find, is essentially one in which changing views about the future are capable of influencing
the quantity of employment and not merely its direction. But our method of analysing the econ-
omic behaviour of the present under the influence of changing ideas about the future is one
which depends on the interaction of supply and demand, and is in this way linked up with
> (1 − α) Dt1 u (1 − α) Dt1
> (1 u) (1 − α) Dt1 for
Yt ex ante > Yt1 ex post
Figure 1 Minskys equations from John Maynard Keynes (1975, p. 133)
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our fundamental theory of value. We are thus led to a more general theory, which includes the
classical theory with which we are familiar, as a special case. (Keynes 1936, pp. xxiixxiii)
However, in Keyness debates with critics in 1937, he began to appreciate the need to
separate the banking sector from the firm sector when considering the finance demand
for money. In this next passage, Keynes also reached the conclusion derived by Min-
sky, above, that investment exceeds savings though when speaking in terms of an
individual entrepreneur:
I proceed to the third possible source of confusion, due to the fact (which may deserve more
emphasis than I have given it previously) that an investment decision (Prof. Ohlins invest-
ment ex-ante) may sometimes involve a temporary demand for money before it is carried out,
quite distinct from the demand for active balances which will arise as a result of the invest-
ment activity whilst it is going on. This demand may arise in the following way. Planned
investment i.e. investment ex-ante may have to secure its financial provisionbefore
the investment takes place; that is to say, before the corresponding saving has taken place.
It is, so to speak, as though a particular piece of saving had to be earmarked against a partic-
ular piece of investment before either has occurred, before it is known who is going to do the
particular piece of saving, and by someone who is not going to do the saving himself. There
has, therefore, to be a technique to bridge this gap between the time when the decision to
invest is taken and the time when the correlative investment and saving actually occur.
This service may be provided either by the new issue market or by the banks; which it
is, makes no difference. Even if the entrepreneur avails himself of the financial provision
which he has arranged beforehand pari passu with his actual expenditure on the investment,
either by calling up instalments in respect of his new market-issue exactly when he wants
them or by arranging overdraft facilities with his bank, it will still be true that the markets
commitments will be in excess of actual saving to date and there is a limit to the extent of the
commitments which the market will agree to enter into in advance. But if he accumulates a
cash balance beforehand (which is more likely to occur if he is financing himself by a new
market-issue than if he is depending on his bank), then an accumulation of unexecuted or
incompletely executed investment-decisions may occasion for the time being an extra special
demand for cash. To avoid confusion with Prof. Ohlins sense of the word, let us call this
advance provision of cash the financerequired by the current decisions to invest. Invest-
ment finance in this sense is, of course, only a special case of the finance required by any
productive process; but since it is subject to special fluctuations of its own, I should (I
now think) have done well to have emphasised it when I analysed the various sources of
the demand for money. (Keynes 1937, pp. 246247, italic and bold italic emphasis added)
Keyness comments here arguably reach the same conclusion that Minsky later estab-
lished, that investment exceeds savings in a growing economy, and the gap is filled by
a rise in debt which also causes a rise in the stock of money.
We now proceed to generalize Minskys closed economy results in a continuous time
framework, prior to proving that expenditure exceeding income (and investment
exceeding saving) at a point in time is consistent with recorded expenditure equalling
recorded income over an accounting period.
3. The results in this section were derived jointly with Professor Matheus Grasselli.
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I start by defining income (Y
) as wages (W) plus profits (Π), where profits are either
distributed to households (Π
) or retained by firms (Π
Expenditure (Y
) is the sum of money spent purchasing either consumer goods (C)or
investment goods (I):
If income is to grow, then aggregate demand must rise over time, and, as Minsky put it,
[f]or real aggregate demand to be increasing it is necessary that current spending
plans, summed over all sectors, be greater than current received income and that some
market technique exist by which aggregate spending in excess of aggregate anticipated
income can be financed(Minsky 1963; Minsky 1982, p. 5, emphasis added). This
generates a divergence between ex post expenditure and ex ante income, where that
gap is financed by a rise in debt.
) is therefore the sum of wages plus the turnover of new
workersdebt used for consumption (D
); and consumption by capitalists (C
sum of distributed profits plus the turnover of new capitalistsdebt used to finance con-
sumption (D
in all cases, the change in debt is debt to the banking sector). We
assume that borrowed money is immediately spent, after which time it continues to
circulate and therefore can be spent again at some rate δwhich I specify later:
dt DWC
dt DΠC:
Investment is the sum of retained earnings plus the turnover of new debt of the firm
sector (D
dt DFI:(1.12)
Expenditure ex post minus income ex ante is thus equal to the turnover of new debt to
the banking sector:
dt DWC þd
dt DΠCþd
dt DFI
As Minsky emphasized, for this to be possible there must either be an increase in the
stock of money equivalent to the increase in debt, or an increase in the rate of
circulation of money. The latter can emanate from changes in the behaviour of either
lenders or borrowers: an increased willingness to invest can accelerate the rate of
4. To simplify notation, from now on I drop the explicit acknowledgement that all terms are
functions of time.
5. This can also result from a change in the velocity of circulation of money, but I ignore this
second-order process here.
Endogenous money and effective demand 277
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turnover of the existing stock of money. But for the former to occur, there must be a
mechanism by which the physical stock of money is increased by a change in debt.
The creation of a loan by any entity to any other increases assets and liabilities iden-
tically and simultaneously, and this accounting truism misleads Neoclassical econo-
mists into believing that therefore the aggregate level of debt does not matter only
its distribution can have economic significance:
Ignoring the foreign component, or looking at the world as a whole, we see that the overall
level of debt makes no difference to aggregate net worth one persons liability is another
persons asset. It follows that the level of debt matters only if the distribution of net worth
matters, if highly indebted players face different constraints from players with low debt.
(Krugman 2012b, p. 146)
However, as the Circuit School emphasizes, money is fundamentally a liability of the
banking sector which other agents in the economy accept as complete payment in a
The only way to satisfy those three conditions is to have payments made by means of prom-
ises of a third agent, the typical third agent being nowadays a bank. When an agent makes a
payment by means of a cheque, he satisfies his partner by the promise of the bank to pay the
amount due. Once the payment is made, no debt and credit relationships are left between
the two agents. But one of them is now a creditor of the bank, while the second is a debtor
of the same bank. (Graziani 1989, p. 3)
Since the total stock of money in existence is the sum of the liabilities of the banking
sector to the nonbank sectors of the economy, it follows that an increase in the assets
and liabilities of the banking sector increases the money stock. In contrast, a loan from
one nonbank entity to another does not change the stock of money in existence. There-
fore changes in the aggregate liabilities of the banking sector do matter, because they
directly change the supply of money and, as I argue, they add to demand as well.
Table 1 illustrates the difference between banking sector loans and non-banking sector
loans by comparing the sale of a bond by the Firm Sector to the Household Sector
which does not create money with a loan by the Banking Sector to the Firm Sector,
which does create money by creating a bank liability.
Table 1 Parsimonious comparison of bond issue versus new loan
Bank accounts Accounting sums
Assets Liabilities Equity Row sum Money creation
Flows Loans Reserves Firms Households Bank equity
Bond Bond +Bond 0 0
Loan +Loan Loan 0 +Loan
6. In all these tables, I follow the accounting convention of showing a liability as negative, so
that a liability is reduced by adding a positive amount to it. A transfer of $Xfrom account A to
account B is thus shown as +$Xon account A and $Xon account B.
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While the actual process of lending can be very complicated, at a parsimonious level
the mechanism of endogenous money creation is extremely simple: the simultaneous
creation of an asset and a liability by the banking sector. I illustrate this with an exam-
ple that also shows the link between money creation and an increase in demand as
well as the actual role of reserves as the means by which banks transfer liabilities.
There are five entities in the model: three banks Buyer Bank, Seller Bank and the
Central Bank; and two nonbank agents Buyer and Seller. The account interactions
between the three banks are shown in Table 2 to Table 4, along with the impact on
the amount of bank liabilities (and hence the amount of money in circulation) at
each step in the process.
Two sources of demand are modelled: a purchase from existing deposits (Cash);
and a purchase financed by accessing debt (such as a line of credit or a credit card
Card). The Cash purchase uses funds generated from income; the Card purchase is
obviously funded by an increase in debt.
The cash purchase reduces the Buyers deposit by the amount Cash(shown as a
decrease in the Buyer Banks liabilities in Table 2), thus reducing the Buyer Banks
assets and liabilities by the same amount. At this step in the process, the amount of
money in circulation has fallen by Cash. However, the purchase increases the Sellers
Deposit at the Seller Bank, and also increases the Seller Banks Reserves by the same
amount (shown on the first row of Table 3). The net effect, of course, is no change in
the money supply.
The credit-financed purchase is shown in two stages: firstly the Buyer accesses his
line of credit, increasing his Deposit and his Loans from the Buyer Bank by the same
amount Card. This creates new money by increasing the Buyer Banks liabilities.
Then the purchase is executed, which reduces the Buyers Deposit by the same
amount, and also reduces Buyer Banks Reserves. The fall in Buyer Banks liabilities
reverses the money creation of the previous operation, so there is no net money crea-
tion at this point.
However, the transfer of the funds to the Sellers Deposit at Seller Bank increases
the assets and liabilities of Seller Bank by the amount Card. There is therefore an
Table 2 Account operations at Buyer Bank
Buyer Bank
Assets Liabilities Row sum Money change
Loans Reserves Buyer deposit
Buy with cash Cash +Cash 0 Cash
Access credit +Card Card 0 +Card
Buy with credit Card Card Card
Table 3 Account operations at Seller Bank
Seller Bank
Assets Liabilities Row sum Money creation
Reserves Seller deposit
Deposit cash revenue +Cash Cash 0 +Cash
Deposit card revenue +Card Card 0 +Card
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increase of the money supply by the amount Card. Since this was used to fund a pur-
chase, the increase in the money supply is identical to the increase in transactions
funded by the loan: the creation of new money is also an increase in demand.
The impacts of these transactions on the accounts of the Central Bank are shown in
Table 4. Since both Cash and Card operations involve transfers between liability
accounts at the Central Bank, no new Reserves are created by either operation;
reserves are simply transferred from Buyer Bank to Seller Bank in both cases.
Of course, if reserve requirement rules are in operation, then the Buyer Bank might
need to acquire additional reserves to fulfil the requirements. Does this then limit pri-
vate credit creation, as Neoclassical economists claim (Krugman 2012a)?
Two aspects of reality answer in the negative. First, as the European Central Bank
stressed as recently as May 2012, reserve requirements are backward-looking: reserve
requirements today are based on levels of loans and deposits typically one month earl-
ier. Second, the Central Bank in practice must meet demands for Reserves from private
banks, since if they did not, the system of interbank transfers would break down. My
credit example illustrates this.
A Buyer with unused credit (in a negotiated line of credit, overdraft or credit card)
has the right to access that unused credit at any time. If, at that time, the Buyer Bank
was already on its Reserve limit (so that the transfer of Card would take it below its
Reserve limit) and the Central Bank therefore refused to transfer reserves of Card from
Buyer Bank to Seller Bank, then the Buyers purchase would be voided even though
the Buyer had the necessary unused credit on his own contract with Buyer Bank. The
impact of the Central Bank behaving this way would be catastrophic for Buyer Bank,
and the interbank payments system in general.
This example puts flesh on New York Federal Reserve Vice-President Alan
Holmess discussion of the relationship between reserves and lending, when he
attempted to block the push for the Fed to adopt Monetarist money growth targeting:
The idea of a regular injection of reserves in some approaches at least also suffers from a
naive assumption that the banking system only expands loans after the System (or market
Table 4 Account operations at Central Bank
Central Bank
Assets Liabilities Row sum Reserve creation
Loans Buyer Bank
Seller Bank
Buy with cash Cash Cash 0 0
Buy with card Card Card 0 0
7. The same observation applies even for the Cash transfer, where it is conceivable that Buyer
Bank might not have the Reserves needed to support the transfer of Cash from its Reserve
account to Seller Banks. In this situation, the Central Bank faces the non-choice of honouring
the transfer anyway and allowing commerce to proceed smoothly, or of not allowing the transfer
and causing the interbank payment system to collapse.
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factors) have put reserves in the banking system. In the real world, banks extend credit, creat-
ing deposits in the process, and look for the reserves later. The question then becomes one of
whether and how the Federal Reserve will accommodate the demand for reserves. In the very
short run, the Federal Reserve has little or no choice about accommodating that demand;
over time, its influence can obviously be felt.
In any given statement week, the reserves required to be maintained by the banking
system are predetermined by the level of deposits existing two weeks earlier(Holmes
1969, p. 73, emphasis added)
Given the widespread ignorance of these issues within the economics profession itself,
the ECBs very similar recent statement is worth quoting at length to show that the
considerations which applied in Holmess time continue to apply today:
The occurrence of significant excess central bank liquidity does not, in itself, necessarily
imply an accelerated expansion of MFI credit to the private sector. If credit institutions
were constrained in their capacity to lend by their holdings of central bank reserves, then
the easing of this constraint would result mechanically in an increase in the supply of credit.
The Eurosystem, however, as the monopoly supplier of central bank reserves in the euro area,
always provides the banking system with the liquidity required to meet the aggregate reserve
requirement. In fact, the ECBs reserve requirements are backward-looking, i.e. they depend
on the stock of deposits (and other liabilities of credit institutions) subject to reserve require-
ments as it stood in the previous period, and thus after banks have extended the credit
demanded by their customers
In the case of normally functioning interbank markets, the Eurosystem always pro-
vides the central bank reserves needed on aggregate, which are then traded among banks
and therefore redistributed within the banking system as necessary. The Eurosystem thus
effectively accommodates the aggregate demand for central bank reserves at all times and
seeks to influence financing conditions in the economy by steering short-term interest
rates. (ECB 2012, pp. 2122, emphases added)
If transfers between banks leave one bank in need of reserves, there are two sources:
loans from another bank, or direct borrowing from the Central Bank. The Central Bank
has an obvious motivation to want to provide such loans the desire to keep the pay-
ments system functioning. In practice, private banks prefer to borrow reserves from
each other when needed, and private banks with excess reserves banks face the moti-
vation to lend of a higher return than from holding excess reserves themselves.
In my example, if Seller Bank began with no excess reserves before the transactions,
it had excess reserves after them, because the transfer of funds from Buyer Bank
increased Seller Banks Reserves by precisely as much as Sellers Deposit account
rose. Since the Reserve Requirement is a fraction of deposits (10 per cent of household
deposits only in the USA there is no reserve requirement for corporate deposits see
OBrien 2007, p. 53), it now has more Reserves than it needs. Better to lend them at
the interbank rate to Buyer Bank than to get no return (or a very low return) on the
Reserves themselves. I model these two sources of required reserves in Tables 57.
On the Buyer Banks accounts, both operations increase its assets, and give it
matching liabilities, not to the nonbank public, but to the banking sector itself there-
fore no new money is created.
8. The lag is now 30 days see OBrien (2007, p. 53).
9. Money would be created if Buyer Bank then lent to the public (or government) from its
liabilities to the banking sector. The fact that banks are currently unwilling to take this risk is
Endogenous money and effective demand 281
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Seller Banks liabilities are unchanged, but its Reserve assets fall and its income-
earning asset of loans to Buyer Bank increases.
The Central Bank records the loan by Seller Bank as a fall in Seller Banks liabil-
ities to it and a rise in Buyer Banks, with no change in the level of reserves. Only the
direct loan to Buyer Bank creates new reserves.
Reserves therefore do not constrain lending, and causation runs not from Reserves
to private lending, but in the opposite direction: although the Central Bank can inject
excess reserves, the level of required reserves is determined by the lending practices of
the banking sector.
Table 5 Reserve operations from Buyer Banks perspective
Buyer Bank
Assets Liabilities Row
Banking sector Nonbank
Loans Reserves Loan by
Loan by Seller
Loan from Seller
Loan Loan 0 0
Loan from Central
New New 0 0
Table 6 Reserve operations from Seller Banks perspective
Seller Bank
Assets Liabilities Row sum Money creation
Reserves Loan by
Seller Bank
Seller deposit
Loan from
Seller Bank
Loan Loan 0 0
Table 7 Reserve operations from the Central Banks perspective
Central Bank
Assets Liabilities Row sum Reserve creation
Loans Buyer Bank
Seller Bank
Loan from Seller Bank Loan Loan
Create new reserves New New 0 New
evident in the unprecedented level of excess reserves (currently of the order of US$1.5 trillion
versus the pre-crisis level of below US$2 billion. See
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We now return to the topic of effective demand and the change in debt, firstly by
deriving a value for δin a manner that links the instantaneous formulae used in this
paper with period analysis more customarily used in post-Keynesian economics.
The starting point of endogenous money theory is that the rate of change of the money
supply is identically equal to the rate of change of debt:
dt MðtÞ¼ d
dt DðtÞ:(1.14)
Consequently, in a pure credit economy, the amount of money in an economy is the
initial amount (generated by fiat) plus the current level of debt:
dt DðtÞ¼Mð0ÞþDðtÞ:(1.15)
The level of economic activity can be related to the level of money via the velocity of
money Vtreated here not as a constant, as in Friedmans Monetarism, but merely as
the ratio of expenditure to the money stock:
VðtÞ YðtÞ
dt DðtÞ:(1.17)
Our unspecified constant δin equations to is therefore the velocity of money.
If we consider some defined time period t
, where t
and t
are both calendar dates
and t
is a fraction of a year, then aggregate demand and income in a given period is
the sum of aggregate demand and income at the beginning of that period, plus the
change in debt over that fraction of a year, multiplied by the velocity of money:
dt DðtÞ
If we consider a time period of one year, so that ðt2t1Þ¼1andt1¼0, and specify
the change in debt over a year as ΔD(1), we have:
This enables us to operationalize Keyness distinction between ex ante and ex post,
while proving the consistency of this dynamic formula with the standard accounting
Endogenous money and effective demand 283
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identity that ex post expenditure equals ex post income. In words, these equations
assert that ex post expenditure equals ex ante income, plus the velocity of money mul-
tiplied by the ex post change in debt.
Since the velocity of money comfortably exceeds unity (though it is highly variable
and pro-cyclical), the numerical impact of the change in debt on aggregate demand is
therefore larger than we have claimed in research.
As I detail in subsequent papers,
by far the major use of credit creation today is to
fund speculation in the FIRE sector, rather than purchases of goods and services.
A truly monetary macroeconomics therefore must incorporate the FIRE sector in its
analysis. The first step in doing this is to acknowledge that monetary expenditure is
on both goods and services and assets (A):
Making a similarly convenient assumptiontothatmadebyMinskywithregardto
workersconsumption, I focus solely on speculation by capitalists. Distributed earn-
ings are now used for both consumption and speculation Π
Asset purchases are funded both by distributed profits and new debt for speculation
dt DΠS:(1.22)
The gap between expenditure and income now includes the change in debt used to
finance speculation:
dt DWC þd
dt DΠCþd
dt DFI
dt DΠS:(1.23)
When the government sector is explicitly included, expenditure includes net govern-
ment spending (GT), where the difference between Gand Tcauses a change in gov-
ernment debt D
. There are many additional nuances that complicate the analysis
10. This formula is derived in a rigorous manner in a related paper comparing loanable funds
and endogenous money (Keen 2014).
11. This paper is part of a group of planned papers on endogenous money by Dirk Bezemer,
Matheus Grasselli, Michael Hudson, and myself. Vicki Chick and Richard Werner make similar
arguments in their joint paper.
12. Here, V
represents the velocity of money in the given asset market.
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(government generation of wages and profits; what the Central Bank does in response
to a deficit), but the parsimonious outcome is as shown in equation (1.24):
dt DWC þd
dt DΠCþd
dt DFI þd
dt DG
dt DΠS:(1.24)
International trade and capital flows add substantial complications to both income and
expenditure, but they do not alter the conclusion that effective demand is income plus
the turnover of new debt. I will now address the apparent paradox that this is consistent
with recorded income being identical to recorded expenditure.
Absent new debt, expenditure is financed by incomes generated by the turnover of
the existing stock of money, and the flow of expenditure can expand and contract
as behaviour changes, while the volume of money in existence remains constant,
if the rate of turnover of money changes. However, when an agent finances some
expenditure by debt, there is a simultaneous injection of additional money via
debt-financed expenditure into the turnover of the pre-existing stock of money and
the expenditure it finances. After the debt is expended, that expenditure has become
another agents income (and part of the money stock which continues to circulate and
finance expenditure), but at the point of the creation of new money, there is a
Figure 2 illustrates this with a hypothetical creation of $100 million debt, which is
then spent at time din a single day, when the level of income and expenditure prior
to the debt-financed expenditure was $10 billion per day (which itself reflected a rate
of turnover of the existing stock of money). Prior to time d, the flow of expenditure
was equivalent to the flow of income at the rate of $10 billion per day. After time d,
if the rate of turnover of the existing stock of money does not change, the flow of income
and of expenditure will equal $10.1 billion per day. The injection of the newly-created
10.1 bn p.d.
10 bn p.d.
0d24 t
Y, E
Y(t), E(t)
D(d)=100 mn
Figure 2 Debt-financed expenditure and a discontinuity in income
Endogenous money and effective demand 285
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money will cause a discontinuity at and only at time d. It will be greater or less than
$100 million if the rate of turnover of money does change, but there will still be a
The discontinuity means that there is a difference between income at time t(Y
income ex ante, prior to the debt injection and income as it will be recorded by an
accountant after the event for time t(Y
)) income ex post, after the debt injection.
Expenditure at time t(Y
(t)) is therefore equal to income at time t, before the debt
injection (Y
(t)), plus the debt injection (ΔD(t)).
EðdÞ¼$10:1bn=day ¼YðdÞþΔDðdÞ
The measurement of income and expenditure between any two points in time (t
and t
corresponds to integration of the flows of income and expenditure over time. Since
income and expenditure are identical to each other at all times except where there is
a debt-financed addition to expenditure, and since debt is a discontinuous injection
into the circular flow of existing income and expenditure, measurement will find
that these two quantities are identical because of a property of integration
that functions differing only at finitely many discontinuities must have identical
YEðtÞdt ðt2
There is thus no conflict between the statements Recorded income equals recorded
expenditureand Expenditure equals income plus the change in debt.Butthereis
a very big difference between a macroeconomic theory which begins from the propo-
sition that Aggregate demand equals aggregate incomeand one that commences from
Aggregate demand equals income plus the change in debt. The former is only true in
a Loanable Funds model of lending; the latter is true in the endogenous money world
in which we actually live as Schumpeter, Minsky, and (arguably) Keynes have
asserted before us.
Nonetheless, since the expression Aggregate Demandhasbeensolinkedto
Aggregate Supply via the habitual modes of thought and expression(Keynes
1936, p. xxiii) of the last 75 years, I propose resurrecting another of Keyness terms
that has fallen into disuse, Effective Demand,
to state my starting point for macro-
economics that Effective Demand equals income plus the change in debt.
In subsequent papers I explore the implications of this approach for a new, mone-
tary macroeconomics. In this paper I will conclude with two brief empirical examples
of the importance of this approach for macroeconomics and finance. More empirical
analysis will be provided in subsequent papers.
13. I thank Nathan Tankus for this suggestion.
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Equation (1.23), which focused upon the role of change in the level of private debt in
financing investment and consumption expenditure, can be summarized as asserting
that private sector aggregate expenditure on goods and services will equal GDP plus
the change in private sector debt. This in turn implies a relationship between change
in debt and employment amongst many other macroeconomic variables. The pure
Neoclassical case, well captured in Bernankes explanation of why Neoclassical
economists ignored Fishers debt-deflation theory of great depressions (Fisher
1933), is that any relationship between changes in the aggregate levelofdebtand
macroeconomic variables will be slight:
Fishers idea was less influential in academic circles, though, because of the counterargument
that debt-deflation represented no more than a redistribution from one group (debtors) to
another (creditors). Absent implausibly large differences in marginal spending propensities
among the groups, it was suggested, pure redistributions should have no significant
macro-economic effects(Bernanke 2000, p. 24, emphasis added)
This position is somewhat attenuated by the Financial Acceleratorargument
(Bernanke et al. 1996), but this asymmetric information argument relies upon credit
rationing and a credit price channel, rather than the direct impact of changes in the
aggregate level of debt. The Neoclassical aprioriwould therefore still be that
changes in the total level of private debt should have no macroeconomic signifi-
cance. This null hypothesisis clearly rejected by the data: the correlation of the
annual change in private debt (measured as a percentage of GDP) times velocity
with the current unemployment rate over the 25 years from 1988 till 2013 is
0.92 (see Figure 3).
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
v * Debt change
Percentage of GDP p.a.
e of workforce
Figure 3 Correlation between change in US private debt and unemployment
Endogenous money and effective demand 287
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As an important aside, we have recently discovered that this empirical correlation,
and the endogenous money causal mechanism behind it, was first proposed by Pigou
in his Industrial Fluctuations (Pigou 1927). Pigous analysis, in contrast to Keyness
in The General Theory, emphasized the importance of bank lending to the level of
But their borrowings from banks are different. Business men are able to achieve extra borrowings
of this type because the banks are ready, in response to offers of higher interest, to allow the ratio
of their reserves to their liabilities to decrease. The ability to make these extra borrowings enables
business men to enlarge the stream of floating capital available to them in good times more than
they would have been able to do so in the absence of such ability In other words, modern
practice in banking renders the supply of floating capital more elastic in response to
given variations (whether warranted or not) in their outlook. (Pigou 1927, p. 121)
He asserted the correlation between changes in credit and the level of employment in his
Table of Contents (see Figure 4).
He also provided a very similar graph of the relationship between changes in credit
and the level of unemployment to my Figure 3 see Figure 5.
As noted in equation (1.20), the generalization of effective demand to include the
change in debt also necessitates the generalization of supply to include net expenditure
on asset markets. Debt-financed expenditure on assets will thus affect the asset price
level, the turnover of assets, and the quantity (via new share issues and new dwelling
construction). This leads to a relationship between the acceleration of debt and the rate
of change of asset prices. Biggs, Mayer and Pick, who first developed this analysis,
Figure 4 Pigous (1927) chapter 13 outline: There is a close relationship between
fluctuations in the amount of credit creations and fluctuations in employment
14. I thank Nathan Tankus for alerting us to this precedent.
288 Review of Keynesian Economics, Vol. 2 No. 3
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defined the Credit Impulse(Biggs and Mayer 2010; Biggs et al. 2010) as the accel-
eration of debt normalized by the level of GDP:
I prefer to describe this as the Credit Accelerator(since Impulseimplies a transient
and exogenous phenomenon whereas acceleration is a permanent endogenous feature
of a flow). I approximate this by the change in the change in debt over a year, divided
by the level of GDP at the midpoint, to reduce the noisiness of the data. The correlation
of the acceleration of mortgage debt with the change in the level of house prices since
1988 is 0.79 (see Figure 6).
Figure 5 Change in bank debt and the unemployment rate from 1800 till 1920 (plate
between pp. 132 and 133 of Pigou (1927))
Endogenous money and effective demand 289
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The development of the theory of endogenous money was a major contribution by post-
Keynesian economists from Basil Moore onwards. To fully integrate it into macroecon-
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Theory a work in which the role of banks in macroeconomics was conspicuously
absent to include the direct impact of changes in debt on effective demand, and
beyond the definition of aggregate supply to incorporate the financial markets and
the FIRE sector into macroeconomics. This will require overturning long-established
conventions in post-Keynesian economics, but this is necessary if the full promise of
the endogenous money revolution in macroeconomics is to be realized.
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... 27 The Fed nullified this requirement on 26 March 2020 (The Fed, 2020) 28 which means any bank can lend out money with zero reserves (Nichols, 1992: p. 3). 29 Werner (2014,2016), Keen (2014), and Moore (1983), and a growing number of central banks, for example, the Fed (Carpenter and Demiralp, 2012) and the Bank of England (McLeay et al., 2014), have mathematically, empirically, and practically proven that both FIB and FRB theories are untenable, factually incorrect and not reflecting reality hence are indefensible. Some literatures classified FIB and FRB as LF. ...
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Al Quran describes the prohibition of Riba rā bā wāw (ر ب و) (often translated as usury) and permission of commercial transaction or trade (bā yā ʿayn ب ي ع). We conducted a desk-study reviewing and analysing the historical connection between these two and their current implications through empirically proven and attested central bankers' modern banking theories and practices. We anchored our study on the etymological and ontological approaches. We specifically applied the spectrum of Al Quran (AQ) Chapter Al-Baqarah (2), verse 275 (AQ, 2:275) as the benchmarks. We discovered the root of the propagation of legalized riba through banks operating licenses issued by the government (temple biyaʿ (بِيَع) as a derivative of trade (bā yā ʿayn ب ي ع)). This makes the current permissible legal, commercial transaction or trade no longer isolated from prohibited riba. We argue that under the current banking practices and infrastructure, no transaction is riba-free, including those under Islamic banking and finance. Mitigating this requires immunized national banking practices that are detached from international banking systems and infrastructure. -----------------------Full paper can be found here
... What actually happens in a modern banking system is quite different, as pointed out by academic critics (Huber, 2014;Keen, 2014;Benes & Kumhof, 2012;Werner, 2005Werner, , 2014aBjerg, 2014), central bank governors (King, 2012, p. 3;Jensen, in Danmarks Nationalbank, 2014, p. 1), one top government regulator (Turner, 2013, p. 3), central bank economists (McLeay, Radia & Thomas, 2014a, b;Keister & McAndrews, 2009, pp. 7-8;Deutsche Bundesbank, 2012, p. 76;Bang-Andersen, Risbjerg & Spange, 2014;Sveriges Riksbank, 2013, pp. ...
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Educators and economists concerned with monetary reform face the extraordinary challenge of explaining to the public and its elected representatives not only what a reformed system would look like, but also how the current system works.
... This paper uses these two terms in the analysis. Werner (2014Werner ( , 2016, Keen (2014) and Moore (1983), and a growing number of central banks, for example, the Fed (Carpenter and Demiralp, 2010) and the Bank of England (McLeay, et al., 2014), have mathematically, empirically, and practically proven that both LF and FRB theories are untenable, factually incorrect and do not reflect reality, hence they are indefensible. ...
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The ADB takes more than five years to disburse the agreed-upon loan funds after the borrower signs the loan agreements, because of the conditionalities attached to such loans, compared with it only taking one day for commercial banks to release any agreed loans. During this five-year period, the funds stay in the bank and gain compounded interest, disfavoring Indonesia. Development studies have mostly overlooked these gains and their impacts. Knowing that ADB loans cause about 3% of Indonesia’s unemployment, we reviewed the delay’s impacts during a project’s implementation on unemployment involving 325 ADB loan projects, valued at over $33 billion, from 1969 to 2017. We used a non-econometric methodology by adopting the management principles of the project and portfolio. The results show that the ADB’s loans at 1% GDP initially helped Indonesia reduce its unemployment by 30%. However, because of the ADB’s standard implementation of five years, along with an extra two-year delay (seven years in total) we observed shorter unemployment reductions by half, but then reversed, increased and tripled joblessness. This is also causing Indonesia to suffer capital losses of $0.6 to $12 per $1 of loan money, which is equivalent to 4.98% of its GDP because of the delays in the disbursement of the funds. ADB loans have severe negative effects, with over 200% volatility because of the delays. Fixing this is simple but requires a paradigm shift.
This paper aims to outline the stability conditions and the determinants of the public debt-to-GDP ratio within a theoretical framework representing the main features of a monetary economy of production. To this end, we first derive such conditions within a Stock-Flow Consistent model of a dynamic version of the traditional income-expenditure scheme with endogenous public debt service and only fiat money. Secondly, we extend the model to include investments and bank loans, thus considering both fiat and private money creation. Thereby, we develop an analytically solvable SFC model based on the Supermultiplier approach. Our main findings outline that: i) The steady-state value of the public debt-to-GDP ratio is determined by the saving rate, the growth rate of primary public spending, the tax rate, the capital intensity of the production process and the interest rate. Given these values, there exists a “natural” level of the public debt-to-GDP ratio towards which the system converges in the long-run. This result calls into question the idea of imposing exogenously given thresholds for targeting budgetary rules independently from the very specific features of each economic system; ii) The necessary condition for the stability of the public debt-to-GDP ratio is the absence of fiscal rules jointly to no full-hoarding of income from interests accrued on public bonds. It becomes sufficient when one of the following is fulfilled: the growth rate of primary public expenditure or the interest rate or the propensity to consume out-of-wealth is higher than zero. Finally, we highlight that the only fiscal manoeuvres that Government has at its disposal to lower the ratio consists of a permanent expansion in the growth rate of public spending or an increase in the tax rate.
We develop a New Keynesian model where all payments between agents require bank deposits, bank deposits are created through disbursement of bank loans, and banks face convex lending costs. At the zero lower bound on deposit rates (ZLBD), changes in policy rates affect activity through both real interest rates and banks’ net interest margins (NIMs). At empirically plausible credit supply elasticities, the Phillips curve is very flat at the ZLBD. This is because inflation increases NIMs, credit, deposits, and thereby output, while higher NIMs also dampen inflation by relaxing price setters’ credit rationing constraint. At the ZLBD, monetary policy has far larger effects on output relative to inflation, and inflation feedback rules stabilize output less effectively than rules that also respond to credit. For post-COVID-19 policy, this suggests urgency in returning inflation to targets, caution with negative policy rates, and a strong influence of credit conditions on rate setting.
Purpose This study aims to examine a potential case of interdependence in loan and deposit interest rate setting. Design/methodology/approach The authors set up a theoretical microsimulation model with endogenous loan interest rate determination via a learning algorithm. Findings The authors show that in certain environments, it may be beneficial for large banks to incorporate information on retail funding costs into the lending rate setting decision. Originality/value The author’s model is based on the realistic money creation mechanism.
Based on the experimental calculations carried out with the help of the shifting mode reproduction model, as well as on the theoretical studies of Marx, Schumpeter, Keynes and his followers - representatives of the post-Keynesian direction, two conclusions were made in the article. First, that non-neutrality of money takes place in both short- and long-term periods, and second, that each of these periods has its own basic preconditions for non-neutrality. For the short term, it is a "phenomenon of nominal rigidity", and for the long term, it is a "phenomenon of capitalization of money". The thesis is justified that the "phenomenon of nominal rigidity" manifests itself mainly within the framework of the existing production, when the economic growth caused by the increase in money supply is achieved by increasing capacity utilization and engagement of idle labor. Accordingly, the "phenomenon of capitalization of money" manifests itself through the conversion of issued money into investments in fixed capital and, through the growth of this capital (and capacities), affects the GDP growth. It is shown that behind the two considered basic prerequisites there are fundamentally different theoretical approaches. Behind the short-term "phenomenon of nominal rigidity" there is an orthodox vision of economy focused on the equilibrium pricing mechanism. Behind the long-term "phenomenon of capitalization of money" there is a heterodox vision related to the mechanism of money circulation, emission and economic growth caused by it. It has been concluded that in case of probable increase of competition between these theoretical approaches it is unacceptable if short-term basic preconditions of non-neutrality of money are used in the analysis of long-term processes and long-term preconditions are used in the analysis of short-term growth cases.
This paper compares the reserve requirements of OECD countries. Reserve requirements are the minimum percentages or amounts of liabilities that depository institutions are required to keep in cash or as deposits with their central banks. To facilitate monetary policy implementation, twenty-four of the thirty OECD countries impose reserve requirements to influence their banking systemsâ demand for liquidity. These include twelve OECD countries that are also members of the European Economic and Monetary Union (EMU) and twelve non-EMU OECD countries. All EMU countries employ a single reserve requirement system, which is treated as one entity.The reserve requirement system for each of the twelve non-EMU countries is discussed separately. The similarities and differences among the thirteen reserve requirement systems are highlighted. The features of reserve requirements covered include: reservable liabilities, required reserve ratios, reserve computation periods, reserve maintenance periods, types of reserve requirements, calculations of required reserves, eligible assets for satisfying reserve requirements, remuneration on reserve balances, non-compliance penalties, carry-over of reserve balances, and required clearing balances.
This book makes the case that economies are complex systems and in response to this, develops a unique dynamic nonequilibrium process analysis of macroeconomics. It provides a brief introduction to complex systems, chaos theory and unit roots. The importance and implications of contingency for economic behaviour are developed.
David Hume’s essays were “the cradle of economics,” suggested John Hill Burton, in his important biography of Hume. Although this may be a biographer’s exaggeration, there can be no doubt that Hume’s work provided an important contribution to political economy as a discipline, together with a significant critique of the “mercantile” system that was later attacked by his friend Adam Smith. ECONOMICS: THE BACKGROUND Mercantilism is difficult to define. As the historian P.J. Thomas put it: “Mercantilism has often been described as a definite and unified policy or doctrine, but that it has never been. In reality it was a shifting combination of tendencies which, although directed to a common aim - the increase of national power - seldom possessed a unified system of policy, or even a harmonious set of doctrines. It was a very complicated web of which the threads mingled inextricably.” In the seventeenth and eighteenth centuries the object of policy was the enhancement of the power of the nation state, a strategy that was to be attained in a number of ways, at least one of which was economic. The power of this state was to be enhanced by the accumulation of treasure through trade, the maximization of employment, and the encouragement of population growth.