Friday, November 15, 2013

Empirical Evidence for the Endogeneity of the Money Supply in the United States from 1971-2008

Dear Readers,

Let me start off by sincerely apologizing for my abrupt and now lengthy absence from the blogosphere. Although I have been absent from blogging, my interest in the endogenous money hypothesis and Modern Monetary Theory (MMT) continues to grow.

This semester I have been taking a directed readings course on those topics with another GMU PhD student, Paul Mueller. As part of the course, we are co-writing two papers that will hopefully be published in an academic journal. Our first paper, “Empirical Evidence for the Endogeneity of the Money Supply in the United States from 1971-2008,” is now sufficiently complete to make publicly available.

The unique aspects of our paper are the incorporation of Divisia monetary aggregates and a focus on broader measures of the money supply (i.e. M3 and M4). While the paper remains in draft status (so please do not cite this version), we would greatly appreciate comments and suggestions for improving the paper before a final draft is submitted for publication. The paper can be downloaded at SSRN ( Here is the abstract:

“This paper demonstrates that contrary to orthodox monetary theory, fluctuations in total commercial bank loans affect the quantity of various money aggregates, including the monetary base, but not vice versa. The Granger causality tests that we run on lagged quarterly data strongly suggest that changes in the money supply depend on private demand for commercial loans, not “exogenous” changes in the monetary base. Our findings strongly contradict the notion of a fixed “money multiplier.” The theory behind endogenous money is that banks issue new loans (credit) on demand and look for reserves later. The Federal Reserve must ultimately accommodate increases in demand for reserves from the banking sector to maintain an interest rate target and, more importantly, financial stability. These findings suggest that most economists need to revise their theories about monetary policy and credit expansion.”

Thank you in advance for taking the time to help and for continuing to follow my blog. 

(Note: In the past couple days it has come to my attention that using Granger-causality tests on the first differences of variables may lead to invalid results. Apparently a separate technique, created by Toda and Yamamato, generates more valid results using extra lags of the variables in levels as exogenous variables in the regression. The preliminary results using this method don’t materially alter the paper’s conclusion. Since each technique has been used in recently published articles, we would appreciate insight from other economists on which method (or both) to include our final version.)