Edward Harrison — Endogenous or exogenous money?

I think the real difference between what Nick Rowe is saying and what people like Scott Fullwiler and Steve Keen are saying is that Nick believes over the medium-term, central bank interest rate policy is endogenous. What I think Nick means is that Scott Fullwiler’s view is reasonably clear and straightforward in his view that central monetary policy is exogenous but that it only matters over a short-term time horizon because central bank interest rate policy adjusts endogenously over the medium-term to commercial bank and other economic variables such that it is really endogenous rather than exogenous. 

Further, I think Nick Rowe is saying that it creates an expectation of central bank interest rate policy merely by announcing its target rate and the market moves to accommodate that target, knowing the central bank is the monopoly supplier of reserves. In that sense the central bank has control. But what he seems to suggest is that the central bank policy rate cannot be determined independent of macroeconomic variables (like inflation specifically) and that central bank may be forced to change policy based on these, making it possible to treat the central bank policy rate as medium-term endogenous.

Read it at Credit Writedowns
Endogenous or exogenous money?

By Edward Harrison

I think that Ed has this essentially right, and I said something similar to that effect yesterday. It is clear that the Fed sets the FFR and discount rates exogenously, but obviously, it doesn't do this arbitrarily, as Fed minutes show. Economics conditions figure into Fed decision-making and to that extent the process is "endogenous." I don't see this as a controversial point. It's essentially about semantics. 

When PKE and MMT economists say that money creation is endogenous and the Fed setting of the interest rate is exogenous, they mean that credit extension is determined in the market place through demand, while the Fed operates independently in setting rates. In the US, the overnight rate is not set in the overnight market by banks competing for available reserves. When the Fed does not manage the rate by paying IOR, it carefully manages quantity to target price using OMO, the issuance of tsys having already served as the major drain of excess reserves.

Is this all the kerfuffle is about? I don't think so.

Paul Krugman takes the position that the cb can use either price (interest rate) or the quantity (base money) as policy tools. PKE and MMT economists object that under the existing monetary and financial arrangements, this is merely theoretical and would be impractical to implement as a tactic. Policy tools need to be consistent with operational realities, not just modeling. Interest rate setting is what the Fed has actually been relying as a policy tool for some time, once this was discovered.

PKE and MMT economists would say further that the model-based approach of orthodoxy is misleading about causation, whereas the operations-based approach shows causation clearly. Once this is understood, orthodoxy is often discovered to have the causation reversed. 

For example, the "money multiplier" based on required reserves and "lending reserves" is seen as an accounting residual rather than as a cause, since operationally banks don't extend credit by lending either reserves or deposits — loans create deposits and obtaining reserves to settle and to meet the RR are a cost rather than a constraint. The spread between what a bank charges to make a loan and what the cost of the loans will be to the bank is determined by several factors including the cost of obtaining reserves.

So far a lot of what has gone down is people talking past each other. It was probably necessary to lay down the groundwork first, however. Hopefully, this discussion will now move forward to zero in on key issues.

One area that needs exploration is the interest rate. Monetarists make certain assumptions about the interest rate and inflation that PKE and and MMT economists challenge. Warren Mosler has observed, for example, that higher interest payments are actually economically stimulative, and that lower interest have the opposite effect. Therefore, he recommends setting the overnight rate to zero and using fiscal policy based on the sectoral balance approach and functional finance to address price stability.