Money Supply Endogeneity: What are the Questions and Why do They Matter?

Abstract

The defining characteristic of the monetary and financial systems of advanced capitalist economies over the past thirty years has been one of persistent and fundamental change. Focusing on the US system, financial markets were highly regulated in the early 1960s. and the regulations created sharply segmented markets among various intermediaries. By the early 1990s, the regulatory system had been almost entirely abandoned, either through formal repeal of laws or the cir-cumvention of remaining rules through innovation. The distinctions between banks. thrifts, insurance companies and brokerage houses have greatly diminished and promise to become even weaker, perhaps non-existent, in the near future. Interest rates were relatively stable and low in real terms in the early 1960s, partially because of regulations establishing ceiling rates, but also because of the general stability and constraints on competition in the market. By the 1990s, interest rates had long been freed from regulation. Rates became much more volatile from the 1970s onward, and, over the 1980s, rose to and maintained a level that was unprecedented at least since the 1920s. 1 The dollar was still the official reserve currency for international transactions through the 1960s, and its exchange rate was fixed relative to other major currencies through Bretton Woods. At the same time, US credit markets were largely self-sufficient in the 1960s, as, on average, only 1 per cent of credit market funds came from foreign sources. Currency markets became highly volatile after the demise of Bretton Woods, and exchange rate fluctuations became a major factor in setting US monetary policy, especially since the contribution of foreign sources to US credit markets rose to an average of 6.5 per cent over the 1980s. No serious financial crisis had occurred from the Depression years to the mid-1960s, and indeed, in the 1960s high noon of macroeconomic fine-tuning, such 490 G. Deleplace et al. (eds.), Money in Motion