Endogenous money and the business cycle

Abstract

The theory of endogenous money has tended to reduce to a debate over the slope of the LM. This is because endogenous money is a dynamic phenomenon, and its implications are masked in static models such as ISLM. This paper examines the role of endogenous money in credit-driven business cycles. A key distinction concerns that between bank and direct credit. The former is more expansionary because it involves creation of new money balances, whereas the latter involves transfer of existing money balances. The paper provides a simulation revealing instability emerges at a lower debt-income ratio as the share of bank debt in total debt rises.