Sunday, May 19, 2013

Endogenous Money under the Gold Standard

Lavoie makes an important and perhaps not well understood point about money under certain gold standard regimes:
“What about [sc. endogenous money in] fixed exchange regimes (gold standard regime or dollar standard regime)? Mainstream economists argue that monetary policy is then impossible. Balance of payments deficits (surpluses) lead to foreign reserve losses (gains), and hence either lead or should lead to reductions (increases) in the monetary base and in the money supply, followed by endogenous hikes (cut-backs) in interest rates. In such a context, the money supply is endogenous, but it is supply-led, no longer demand-led. It is thus totally at odds with the post-Keynesian approach. It is also at odds with empirical facts.

Studies devoted to both gold standard periods have shown that the rules of the game did not apply whatsoever (Lavoie, 2001b). Increases or decreases in central bank foreign assets were compensated by fluctuations of central bank domestic assets in the opposite direction. This is the ‘compensation’ thesis, advocated in particular by French central bankers and Le Bourva (1992, pp. 462–3). Compensation is the rule rather than the exception. In standard terminology, fluctuations in foreign reserves were ‘sterilized’ or ‘neutralized’. Neutralization arose either automatically, at the initiative of the private sector, or naturally, as a result of the normal behaviour of the central bank to sustain the payment system. Thus, even in the gold standard period, fixed exchange rates did not prevent central banks from setting interest rates, while money creation was still demand-led.” (Lavoie 2006: 29).
But even with these activist measures by certain central banks in the gold standard era, did the endogenous broad monetary systems meet the demand for credit?

The deflationary period from 1876 to 1896 that most countries experienced in the 19th century suggests that it did not (even though part of the explanation for the deflation appears to be price declines in many commodities as production in the Americas and Australia expanded).

Lavoie, M. 1992. “Jacques Le Bourva’s Theory of Endogenous Credit-Money,” Review of Political Economy 4.4: 436–446.

Lavoie, M. 2001. “The Reflux Mechanism and the Open Economy,” in L. P. Rochon and M. Vernengo (eds.), Credit, Interest Rates and the Open Economy. Edward Elgar, Northampton, MA, USA and Cheltenham, UK. 215–242.

Lavoie, M. 2006. “Endogenous Money: Accommodationist,” in P. Arestis and M. Sawyer (eds.). A Handbook of Alternative Monetary Economics. Edward Elgar, Cheltenham, UK and Northampton, Mass. 17–34.

Le Bourva, J. 1992. “Money Creation and Credit Multipliers,” Review of Political Economy 4.4: 447–466.


  1. “did the endogenous broad monetary systems meet the demand for credit?”. No doubt the latter “systems” did meet demand for credit in the sense that any bank would have created credit for anyone approaching a bank with a viable lending proposition. But the problem is that where gold / monetary base flows out of a country, that depresses economic activity, so the “viable lending propositions” tend to dry up.

    I.e. the simple existence of an endo money system won’t enable an economy to escape a recession. In a sense, that’s the endo money system failing to meet the demand for credit, but I think the latter phrase is a poor description of the problem.

    1. Of course, business cycles are induced by both endogenous and exogenous forces. Amongst the arguably endogenous forces is the volatility of expectations and the instability of the propensity to invest.

      That is, no amount of endogenous money or elastic money supply will induce investment in situations of shocked expectations, as we see today in the failure of QE1, QE2, and QE3.

    2. Isn't a fixed currency effectively a foreign currency and therefore really exogenous in nature? I'm confused as to how the concept of endogenous money could be applied to such a regime.

  2. Charles Goodhart is very good on this in his book The Business of Banking. He argues the price-specie flow mechanism doesn't work, changes in money income and credit are closely correlated and that the demand for credit is accomodated (ie income rises/falls lead credit rises/falls).

  3. I've had the impression that under a gold standard, endogenous money is what sows the seeds of the GS' destruction. It sets up the condition of overindebtedness that prompts the monetary authority to ditch the GS, much like it prompts it to ramp up the scale of QE etc under a non GS system.