Where Does the Money Come From? Exogenous vs Endogenous Money Growth

Economics Bsc at the University of Leeds. Global & Macro Analyst for Leeds Finsights & Writer for Cambridge Market Insights. Linkedin

Whether or not money growth is exogenous or endogenous has been hotly contested within the study of Economics. First came Milton Friedman’s revolution of Monetarism which attributed money supply growth to purely exogenous factors. (Godley, 1999) At the time, this development had swamped the dominant Keynesian economists as their models were simply unsuitable when trying to integrate Friedman’s logic and proposal. (Godley, 1999) Nowadays, the literature has developed to favour the notion that money growth is endogenous since Nicholas Kaldor’s (Sieroń, 2019) critique of money being largely created by private banks. (Mcleay, Radia and Thomas, 2014) This doctrine has been well received, yet, with the recent inflationary crises, the credibility of Central Bankers has been questioned. Intellectuals such as Tim Congdon have challenged the Keynesian focus on the natural rate of interest by suggesting that policies such as QE (which in this view exogenously influence money growth) have a much larger weighting on inflation than current models suggest. (IIMR, 2022) As such, to answer whether or not money growth is exogenous or endogenous, the following column will take two approaches. First, we examine and look at Dr. Joeri Schasfoort’s Agent-Based Model for Monetary policy transmission to look at endogenous factors. Then, we examine Wynne Godley’s sectoral balance equations to review how measures such as Quantitative Easing apply to these theories.

Schasforrt et al’s (2017) Agent-Based Model for the various transmissions of Monetary Policy can be best described as having a large focus on changes within interest rates. This is because the model begins its transmission by looking at both the lending and deposit facilities, which directly influence commercial bank deposit and loan rates. (Schasfoort et al., 2017) For our analysis, we have taken Schasfoort’s model and adapted it to show a reduction in the base interest rate set by the central bank as in the original analysis, he and collaborators chose to model an increase in the interest rate. (Schasfoort et al., 2017)

Another adaptation that we have made is a change in the transmission of the Bank Deposit Rate to the Wealth & Income flow. In the original model, a higher Bank Deposit Rate led to an increase in Wealth & Income as consumers saw an increase in the interest earned on cash held in deposit accounts. (Schasfoort et al., 2017) Instead, we have opted to increase Wealth & Income as we assume consumers and households hold wealth which according to the results of the model, will appreciate with an increase in Firm Net Worth as asset prices rise.

Schasfoort et al., (2017) shows endogenous money creation by deriving Loan Supply (newly created money) from Loan Demand due to higher Investment or higher Firm Net Worth. This is significant for a few reasons. First, it shows that the willingness of banks to provide loans is derived from real factors in the economy. This is because a firm's willingness to invest is ultimately a case of whether or not there is potential for future profits to be earned on said Investment. Second, banks only supply loans when there is money to be made, in other words, when there is demand. Although overlending can make a commercial bank unprofitable, overall, commercial banks create money in the economy almost freely and a common misconception is that they require deposits to do so. (Mcleay, Radia and Thomas, 2014) Building upon the model, banks receive payment on assets such as loans but also have to pay out interest on liabilities such as saving accounts. (Mcleay, Radia and Thomas, 2014) Therefore, a bank's business model is reliant on receiving higher rates of interest on loans than the rate paid on deposits. (Mcleay, Radia and Thomas, 2014) As such, in this analysis, a reduction in the rate of interest due to policy changes made by the Central Bank makes this spread wider, allowing for commercial banks to supply larger quantities of Loan Demand in a more profitable & sustainable manner. This builds a strong argument for endogenous money creation as, without Demand, which is derived from real (endogenous) factors, supply would not exist.

Although Schasfoort et al’s Agent-Based Model enables a deeper understanding of how money is created endogenously, unfortunately, the model is limited. The model does not account for the asset price channel as the paper claims firm investment decisions are based on desired growth of output which is influenced by real factors. (Schasfoort et al., 2017) This means that the model does not consider the implications of Quantitative Easing in increasing the value of assets such as assets and corporate bonds to boost Firm Net Worth. However, we believe that this assumption is severely misplaced, and it is not only Schasfoort et al that has ignored the implications of Quantitative Easing. The Stock-Flow Monetary Framework is a method of tracking national income outflows and inflows through double-entry bookkeeping. (Lavoie and Godley, 2000) To show this, we recall an equation proposed by Wynne Godley below. (Kelton, 2021)

We adapt Godley’s equation to show Real Non Government Surplus with ‘Real’ being the economy that concerns itself with the production of tangible goods.

Wynne Godley’s hypothesis was that when the government chooses to overspend its budget then the wider economy would benefit. For instance, a government project that places strain on spending will ultimately transfer resources to the private sector as workers spend wages at stores. (Kelton, 2021) This expanded flow of resources can be illustrated by a matrix below. (Goldey and Lavoie, 2007)

As shown, Godley’s methodology comes to the conclusion that government deficits are ultimately good for the private sector as it diverts resources away from the government at least in the short run. Conversely, should the government run a surplus, this would be a cause for concern as resources are being drained away from the rest of the economy. However, this has its own inaccuracies.

However, by only focusing on firms and households, Godley does not consider the impact of Government deficits on the financial sector. Yes, a deficit would yield a surplus to the ‘real’ economy but the lack of tax revenue is apparent as overspending must be funded through debt. Therefore, we suggest that Godley’s equation should be changed to accommodate for this as a Government Deficit is also a Liquidity Deficit for the Financial Sector. Moreover, with the economy now seeing a Liquidity Deficit, the central bank must intervene to provide liquidity through Quantitative Easing to keep the financial market stable by preventing Crowding Out. Furthermore, central bank intervention also makes sense during this scenario as Government Deficits are a sign of recession, which can be attributed to large losses in the levels of aggregate demand. Once all of this is accounted for, Godley’s equation changes as shown below.

In the original hypothesis, the Government Deficit cancels with the Real Non Government surplus as both must balance to abide by a Stock-Flow Monetary Framework. However, when Central Bank intervention is introduced through Quantitative Easing Programmes, the equation breaks as the Liquidity Deficit from the Financial Sector is rectified as the Central Bank purchases bonds through Open Market Operations. As such, this converts existing productive assets (government bonds) into new unproductive assets (cash) for financial institutions such as pension funds. Now we must consider the inflation channel of expectations. Should the government engage in expansionary fiscal policy, the real non-government sector expects a surplus. Firms will expect increases in private expenditures with households expecting increases in income. This then leads to overall increases in Firm Net Worth due to improvements in real factors as stated by Schasfoort et al s model. However, this asset price channel is not only influenced by real factors, as shown below.

As previously stated, through QE, financial institutions that previously owned productive assets (assets that earn returns) such as government bonds now have had said bonds exchanged for cash. This creates a problem as financial institutions must rebalance their portfolios by purchasing higher-yielding assets. (Mcleay, Radia and Thomas, 2014) Fortunately, due to the government deficit leading to a non-government surplus, financial institutions such as pension funds now have a greater incentive to invest in riskier assets such as corporate bonds due to improved speculation. (Expectations channel) As such, this leads to increased asset prices both as a result of exogenous money creation by the Central Bank through QE (F+) and improved performance of the real economy (R). Therefore, this leads to a government deficit and non-government surplus yielding a value greater than zero as Quantitative Easing programmes inject extra liquidity which stimulates asset prices and therefore raises nongovernment wealth levels. Furthermore, this asset price channel also increases money growth as private firms see higher Net Worth which creates a synthesis between the real factors that are endogenously motivated and exogenous factors, QE, within Schasfoort’s model.

With the view that the money supply is ultimately determined by the demand for money, we have shown that the demand for money within an economy is not limited to purely real factors. Through Quantitative Easing, extra liquidity is made available to the non-government sector that enables extra money demand to manifest as speculation from improved real performance drives the price and purchase of riskier assets. In conclusion, this means that money creation itself is not a purely endogenous variable as external variables such as Central Bank QE measures can heavily influence the demand (and therefore supply) for new money in the economy.


Godley, W. (1999). Money and credit in a Keynesian model of income determination. Cambridge Journal of Economics, 23(4), pp.393–411. doi:10.1093/cje/23.4.393.

Goldey, W. and Lavoie, M. (2007). Fiscal Policy in a stock-flow Consistent (SFC) Model. Journal of Post Keynesian Economics, 30(1), pp.79–100. doi:10.2753/pke0160-3477300104.

IIMR (2022). IIMR July 2022: 'Do Interest Rates or the Quantity of Money Determine Demand growth?'. Tim Congdon. [online] Available at: [Accessed 15 Nov. 2022].

Kelton, S. (2021). DEFICIT MYTH : Modern Monetary Theory and How to Build a Better economy..

Lavoie, M. and Godley, W. (2000). Kaleckian Models of Growth in a Stock-Flow Monetary Framework: a Neo-Kaldorian Model. SSRN Electronic Journal. doi:10.2139/ssrn.240282.

Mcleay, M., Radia, A. and Thomas, R. (2014). Money Creation in the Modern Economy. Bank of England.

Schasfoort, J., Godin, A., Bezemer, D., Caiani, A. and Kinsella, S. (2017). Monetary Policy Transmission in a Macroeconomic Agent-Based Model. Advances in Complex Systems, 20(08), p.1850003. doi:10.1142/s0219525918500030.

Sieroń, A. (2019). Endogenous versus Exogenous money: Does the Debate Really matter? Research in Economics, 73(4), pp.329–338. doi:10.1016/j.rie.2019.10.003.


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