Philip Pilkington: Bank of England Endorses Post-Keynesian Endogenous Money Theory

Yves here. Not only is the Bank of England siding with Post-Keynesian ideas about money, but it has even taken to creating layperson-friendly videos about the nature of money.

By Philip Pilkington, a writer and research assistant at Kingston University in London. You can follow him on Twitter @pilkingtonphil. Originally published at Fixing the Economists

Well, the Bank of England has finally come out and said it: loans create deposits; banks create money and don’t simply lend out savings; and the money multiplier in the economics textbooks is false. Actually, we’ve known this for a long, long time. While the BoE report references much Post-Keynesian work — including early work by Nicholas Kaldor and Basil Moore’s path-breaking 1988 book Horizontalists and Verticalists — they would have done well to look up the findings of the Radcliffe Commission in the UK in 1957 (I have written about this extensively here).

It is fantastic that the BoE has finally decided to lay its cards on the table and be honest with the public about how money is created. Unfortunately though, the report is not willing to make certain concessions. For example, it largely paints the Quantitative Easing programs as being effective — which they were not — and it also claims that the BoE still sets the variable that has the most influence on money creation; that is, the interest rate. This latter point ties into the whole debate surrounding the so-called ‘natural rate of interest’ (which I have dealt with extensively here).

With regards to the central bank’s power to control lending the BoE authors insist that the “ultimate constraint on lending” is monetary policy. They explain how this functions as such,

The interest rate that commercial banks can obtain on money placed at the central bank influences the rate at which they are willing to lend on similar terms in sterling money markets — the markets in which the Bank and commercial banks lend to each other and other financial institutions… Changes in interbank interest rates then feed through to a wider range of interest rates in different markets and at different maturities, including the interest rates that banks charge borrowers for loans and offer savers for deposits. By influencing the price of credit in this way, monetary policy affects the creation of broad money. (p8)
Now, the functionality of the mechanism that the BoE authors describe is perfectly in keeping with Post-Keynesian endogenous money theory — it is also perfectly in keeping with recent innovations (if we can call them that) in the New Keynesian literature by the likes of David Romer who replace the vertical-sloping LM curve in the ISLM model with a Taylor interest rate rule. But to a Post-Keynesian the characterisation of the setting of interest rates as being the “ultimate constraint on lending” is complete nonsense. Just to get a sense of the BoE authors’ belief in the borderline omnipotence of the central bank let us once again quote them in the original,

The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. (p1)

Actually no. The amount of money created in the economy is ultimately dependent on the demand for credit! Yes, the supply price of this credit — that is, the interest rate — will influence the demand for credit; but if we have learned anything from the economic stagnation of the past few years it is that the demand for credit is what truly drives credit creation and the supply price of credit is of secondary importance. Messing around with the supply price of this credit has very different affects, say, post-2008 as it did, say, at the beginning of the housing boom.

So, what decides the demand for credit? There are any number of different things that drive credit demand. Speculative excesses in the property or stock market might lead to substantially increased demand for credit as investors borrow money to speculate. Inflationary wage-price spirals may also drive the demand for credit as firms borrow money to meet increasing wage bills. But if we were to give one single determinate that is likely the most important in considering the demand for credit I would say: income growth. Yes, that’s right: GDP growth.

At this point we encounter the classic Keynesian accelerator effect where increases in income cause increases in investment which in turn cause increases in income and so on in a circular fashion. What central banks do in such cyclical upswings or downswings of income and investment is of secondary importance.

Now, here’s a controversial thought: what if the BoE authors actually understand this? We know that they have read the endogenous money literature which states all of this quite explicitly. Also, any time I encounter central bank economists they seem very pessimistic about their ability to spur lending. But what if in their official documents they simply cannot bring themselves to say it out loud?

Perhaps we should think of the central bank as a corporate institution that, like any corporate institution, seeks both funding/revenue and influence. And then perhaps we should understand their bald assertions that they are almost omnipotent in their creation of credit money not simply as self-aggrandisement — although there is surely an element of that — but as a sort of public relations exercise deisgned to keep the public interested and the politicians listening.

After all, it would be a strange emperor that would reveal his own nudity in front of his subjects. But still, the BoE — which is surely the most honest of the central banks — should certainly be given credit for at least giving its loyal subjects a little grin and a wink as it parades in front of us in its birthday suit.

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  1. bruce wilder

    “the” interest rate is unsustainable, and with it, interest rate as a supply price.

    There are always multiple interest rates — by definition of intermediation. And, the goal of the banker is to avoid holding the bag for a toxic investment yielding a negative present value — socially and politically, we hope, by avoiding bad bets.

  2. ed royal

    Today we have microscopic interest rates coupled with high speculative demand for credit. If you understand why this is I wish you would explain it. I have been trying to dope this out for several years.

    It seems to me that the small banks have no lending opportunities worth pursuing, and the big banks get all the reserves they want offloading MBS onto the Fed. This eliminates the interbank lending which otherwise might boost rates. Is this about it?

    1. Ben Johannson

      It seems to me that the small banks have no lending opportunities worth pursuing, and the big banks get all the reserves they want offloading MBS onto the Fed.

      Small banks and big banks can obtain whatever reserves they require for their operations, which is why loading them with excess reserves has done nothing to stimulate lending. Markets would rather have the securities as they pay a higher rate of interest.

      This eliminates the interbank lending which otherwise might boost rates.

      Markets haven’t determined the short term rate in the U.S. for a hundred years.

      1. big ed

        You state “Small banks and big banks can obtain whatever reserves they require for their operations”. From where do they get them, apart from deposits, asset sales, and borrowing Fed funds?

        1. Yves Smith Post author

          They can borrow reserves from other banks. This is a routine operation for bank Treasuries. Only is the entire system is short of reserves does the Fed need to accommodate.

        2. Ben Johannson

          In addition to what Yves outlined, banks also gain reserves when the Treasury spends. It credits their reserve accounts when disbursing the funds authorized by Congress.

    2. Dan Kervick

      The interbank rate is a Fed policy target. The Fed uses the discount rate to set the ceiling on the Fed Funds rate.

    3. bh2

      The interest rate at (virtually) zero says money, limitless in supply relative to real demand, is crap. Inevitably crap money funds equally limitless crap “investments” providing only downside risks to the public and no enduring prosperity except for financial engineers and politicians. Academic economists — who bear exactly zero personal risk when they are wrong — continue to promise opposite results.

  3. BigRed

    Because language matters: I’ve recently read the argument that the buyers of an IPO (or subsequent stock offerings) are indeed investors since their money ends up in the business’ coffers, allowing to do productive investments. Everybody else, however, who buys stock options of other entities than the original business with the sole goal of getting a money increase (particularly from reselling), is simply a speculator.
    So if I read

    Speculative excesses in the property or stock market might lead to substantially increased demand for credit as investors borrow money to speculate.

    I can’t get around some headscratching: people are described as “speculating”, the markets are described as being in “speculative” excess, yet we refuse to name individuals speculators and let them cloak themselves in “investors”?

    1. digi_owl

      Pretty much.

      I think Steve Keen has suggested that shares should have a limited period of validity after that second sale. So if you buy to invest, and hold on to the shares, they will provide you dividends as long as the company stays in business. But if you sell them on, the buyer will only get X number of years of dividends out of them before they run out. This then favors true investment over ponzi speculation.

      Btw, this ponzi mechanism is what is driving house prices through the proverbial roof across the globe. This because the buyer taken on debt for the initial buy, then pass that debt on to the next buyer, who takes on additional debt to cover various profits for the seller and intermediaries. Do this song and dance enough times and the housing market gets wildly out of whack from the rest of the economy.

      And the only way I can see this stopping is by some entity offering houses at zero interest “rent to own”, with enough houses in various locations for them to act as a price cap. This in that one would be crazy to take on debt, at interest, above what the zero interest “rent to own” price is.

    2. Yves Smith Post author

      I agree with your notion of IPOs or other primary offerings v. trading in the secondary market, that’s been a pet peeve of mine, that “investing in the stock market” helps companies. Yeah, right. It’s very hard to get past how well established the beliefs and nomenclature are here.

      1. F. Beard

        Otoh, if companies were forced by lack of a government-supported counterfeiting cartel and the resulting suppressed interest rates to use their own common stock to buy assets, including labor, then accepting common stock would often DIRECTLY help the issuing company.

        But who will share when their competitors can resort to legal theft of purchasing power?

      2. JohnnyGL


        Don’t forget, giving the benefit of the doubt to IPOs as drivers of investment is also too generous. Many of them are done so that existing owners can cash out and ‘diversify’. Among others, Doug Henwood pointed out in his first book “Wall Street: How it works and for whom” that most investment is internally financed and corporate bonds sales account for a large chunk of what’s left. Very little actual investment is financed through equity offerings. A lot of times it’s just a change of ownership.

    3. TimR

      But would they argue, that without a secondary market, the primary market could not function? i.e., who would invest initially if they could not sell their shares down the line to “speculators”?

      I think the stat though, is only 1% or so of the stock market represents direct share issuance by companies for funding, and the rest is the secondary market between speculators.

      1. Berial

        But if the purchasers of the initial stock are only buying it to sell to later speculators and are not interested in dividends or eventual stock buyback aren’t they essentially also just speculators hoping to sell to later ones?

        1. TimR

          Mebbe so… I don’t really understand the mechanism of stock buybacks though — would companies do that with speculative ends in mind, as well?
          To be honest, I have ALWAYS found the idea of stocks difficult to grok. Seems very ethereal/ abstract to say this piece of paper = fractional ownership of some company you have no relation to…

    4. pebird

      I’m still trying to figure out how Whatapp goes for $19 billion, whereas Safeway sells for $9.4, or about $7.5 million per grocery store. I wish I could buy a Safeway store for $7.5 MM, that’s like 4 houses in the Bay Area.

  4. dcb

    In regards to the effectiveness of QE. That lie will never change. they will keep saying it over and over. That’s what will get reported in the media. You will continue to see folks like krugman endorsing it. It suits their goals to have an endless bailout wealth transfer upwards as a formal policy mechanism. Sadly folks like krugman ignore the structural reforms that would help QE perhaps be effective. But once more the elites don’t want it to be effective. they want 95% of it going into their portfolio.
    adolf hitler had the technique for the working of QE

    The Big Lie (German: Große Lüge) is a propaganda technique. The expression was coined by Adolf Hitler, when he dictated his 1925 book Mein Kampf, about the use of a lie so “colossal” that no one would believe that someone “could have the impudence to distort the truth so infamously.”

    1. Alex Hanin

      I don’t think you’re right about Krugman. IMHO, he loves IS/LM too much to adopt an alternative view on QE and monetary policy in general.

  5. F. Beard

    Good to see a central bank admit that banks are legally supported counterfeiters. Things must be desperate when they resort to the truth. Is it too late already with the Ukraine situation? Not really since we SHALL have ethical money creation one day – if only after a Malachi 4 purge of the arrogant and evil.

  6. susan the other

    Central banks can’t do anything to stimulate demand. They can only try to keep it down once it takes off. That is a pretty ineffective way to deal with the ponzi structure of capitalism. We’ll just raise interest rates to keep it down – and that just makes it grow exponentially bigger and faster. So interest rates become part of the ponzi. And everybody buys to make a quick sale. So after the crash, when there is no demand and everyone is lying dead on the battlefield, doing zirp is just an affirmation of how ineffectual central bank methods are. Actually zirp should be the standard because all money is fiat, created by loans in the first place and supplied by the central bank. Money itself is a political construct from start to finish. The moment some nutty bankster wants to raise interest rates is the moment of truth and everybody should run like hell. This whole picture continues to question the basic economic DNA of mankind – that is, the drive for profit. It sets off a ponzi spiral every time. We need a non-profit world. One in which everyone gets a good livable wage. The less desperation the better in a world of greedy denial begging for stability.

    1. allcoppedout

      I really agree this Susan. What we lack is a theory of motivation after the fall of profit, though I’d add immediately we don’t have a theory of profit or motivation to get the work we need to do done.

      1. participant-observer-observed

        Well, Aryasanga the 4th century Indian Buddhist pandit published the Bodhisattvabhumi treatise, laying out the most satisfying primary motivation as an altruistic wish for infinite others to have happiness and freedom from suffering.

        Most people know this to be true, empirically: the sweet taste of chocolate cake will be gone in a mere half an hour, while the sense of satisfaction of doing something meaningful for others will endure throughout life, and thus is a form of enlightened self-interest.

        Gandhi understood this when he got local Indians to spin their own cotton, and get the East Indian Trade Company monkey off of their backs.

        I once inherited a shawl of Gandhi Mills kadi cotton by a Buddhist teacher over 20 years ago, and he had it probably 5 or more years before that. That shawl is still in service, with no deterioration in quality less an accidental puncture hole. It is warm in the cool weather, cool in the warm weather, and completely durable.

        As a trading note, it would have a long shelf life. In fact, in Nepal, legal documents including land ownership titles are required to be produced on the fiber paper. These will last 2-3 generations kept wrapped in cloth and tucked into a ceiling beam in a villager’s house!

    2. ron taylor

      Noncriminal profit-making activities motivate and benefit mankind ; knowing the difference between that and deleterious criminal profiteering is the first problem to resolve .

  7. Vatch

    A few years ago, I found the Crash Course at the web site to be useful in learning about money and some related topics. Specifically, Chapter 7 about money creation is very good. One of the paradoxes of our monetary system is that it is mathematically impossible for everyone to pay back all of their debts. In theory, money is created when it is loaned, and it is destroyed when the loan is repaid. Since the principal of the loan plus interest must be repaid, there isn’t enough money in the economy to repay all of the loans.

    It’s hard to convince people of this, and since it is extremely unlikely that everyone will be able to repay all loans at the same time, I try not to belabor the point. Instead, I think it is vastly more important to emphasize other problems, such as corruption in the financial industry (Bill Black’s forte), and the increasing spectre of severe inequality. Still, it is good to be aware of the strangely paradoxical nature of our monetary system.

    1. ron taylor

      “” One of the paradoxes of our monetary system is that it is mathematically impossible for everyone to pay back all of their debts.””

      No it is not mathly impossible . It is politicly impossible . As commentator F. Beard has mentioned many times — the fedgov could theoreticly simply issue debt-free money to taxpayers to solve the impossible math part of debt retirement . Unfortunately , every time a U.S. President issues debt-free money there arises lethal objections to them ( Kennedy , Lincoln , Jackson ).

  8. MyLessThanPrimeBeef


    GDP growth ———> (leads to, drives) Demand for credit
    Demand for credit ——-> (leads to, is the most important determinant) Amount of money created.

    And not the other way around.

    We can ask, what leads to GDP growth. Money creation?

    But money creation is led by GDP growth.

    It seems to be, then, a case, of which one is going to go first to get it going, unless we can get GDP growth by something other than more money creation.

    In any case, we should think about going to a different system where we don’t have loans creating deposits, among other things.

    1. Ben Johannson

      Money just acts as a method for signaling demand to producers. Producers then respond to that demand by forming their expectations and rolling out the supply necessary to meet them. In the end all you really need is to reform the existing monetary system with stronger automatic stabilizers to reduce the need for credit.

    2. ron taylor

      The only diferent system needed is to nationalize all banks that do fractional reserve lending and otherwise keep banking as usual . That way , all profits would go into a public account to offset government spending ( retire gov debts ) instead of private accounts for unethical ( nonkosher ) personal enrichments ; after all , it is government money — U.S. Dollars in big letters printed on your money .

      1. Ben Johannson

        Ending fractional reserve will not restrict lending. Nationalization might, but the banks are already effectively public institutions and that hasn’t slowed them down.

    3. Laurențiu Victor Vișan

      You’ve got that ass-backwards.

      Monetary expansion must always preceed economic activity. Note, mere economic activity, not economic growth.

      This is due to capitalism’s inherent insufficiency of purchasing power.

  9. Paul Tioxon

    How many homeless people constitutes demand? How many without health care access constitutes demand? How many hungry people constitutes demand? At some point, the engines of wealth, profitable corporations, just do not have to invest more money in more physical plant or distribution, the current investments have capacity to produce all we need, or want, with waste to spare and profits galore. Build more cars? Build more nuclear power plants? The profits keep mounting but the productivity level increases and fewer people are needed. Less square foot of office space is needed. Factories and plants can last for 50 or more years, without building brand new from the ground up. So, with demand for money itself due to lack of jobs and plenty of stuff available, just not purchasable, due to lack of money, and lack of money can come with a job that has depressed, low wages or without a job with useless $20/mo food stamp allotments, SNAP. The money needs to be created and distributed and by means of other than wages for useless and pointless work.

    1. allcoppedout

      It’s hard to argue this stuff Paul, but it’s surely where we should start. Tony Benn died today (perhaps a bit like Henry Wallace) and he often started by looking at what real demand might be. The object of technology for him was to get more out of less. Why we keep thinking profit is key in this is beyond me.

      1. skippy

        Subjective numerology is a poor substitute for social psychology.

        skippy… consumers vs citizens thingy…

      2. ron taylor

        Since time immemorial mankind has rejected nonprofitable — nonbeneficial — activities . It is the ” fair ” distribution of profits ( wealth ) that is a major key .
        They say robots are going to replace the middle class . Good . Then tax each and every robot as a legal person , just like corporations , with extra high taxes to offset unemployment / re-employment expenses . Of course , the wealthy owners of the gov — the 1% — may not go along with that .

  10. David Merrill

    Philip, In the first interview the point was made that the bank of England is the monopoly supplier of currency, private banks when they loan create money out of nothing and that something like 97 % of money held privately is in private banks. The interview does not say, what happens when the government spends by crediting accounts electronically. This seems such an oversight. I wonder how much care when into dodging this point. However, simply saying that money is an IOU to me seems by itself to open the door to MMT. The first interview also did not mention that what the Government owes when it issues its IOUs, that is, its sovereign currency, is the cancellation of the individual’s tax obligation when that individual presents these IOUs. You are right, the second interview gave too much weight to the bank rate and perhaps your are right as to the explanation why.

  11. s

    This is still pushing the idea that money is essentially debt (ie. an IOU). This false assumption about the inherent nature of money benefits banks (because if money is essentially an IOU anyway, then it naturally follows that it should be created as loans with interest). But there no need for money to be a loan carrying interest, as thousands of years of use of coin currency illustrates.

    Money can also be (and has been historically) and act of law, which signifies a network of understanding and trust between members of a society. As such, it need not be interest bearing debt, although it still can be, depending on circumstances.

    For more detail on this, visit and read the extremely well-documented LOST SCIENCE OF MONEY by Stephen Zarlenga

    As long as one thinks, erroneously, that money is essentially an IOU (i.e., debt) one cannot see the issue clearly, and will see private banks as an essential service, when they are not.

    It is may still be beneficial to have private banks. But only govt (not private bankers, as currently) should have money creation power, and money creation should be done in an accountable and transparent way.

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