originated by central bank interventions, and proportional to them. It misses
completely the idea that money is created and destroyed endogenously, through
the interactions of the many actors (mainly banks, households and firms) par-
ticipating in the monetary and credit markets.
An important drawback of the traditional theory, as represented by the static
multiplier,1 is that it does not allow for a proper theory of endogenous money
creation that many economists think would be necessary.2 Presenting the whole
process of money creation as a pure deterministic response of the monetary
stock to an exogenous change in the monetary base is deeply misleading. In the
words of Goodhart (1984), the standard multiplier theory of money creation is
“. .. such an incomplete way of describing the process of the determination of
the stock of money that it amounts to misinstruction” .
In modern economies, where the central bank wants to control the interest
rate, money is necessarily endogenous to the system as the policymaker must
provide enough monetary base so that the equilibrium interest rate on the mar-
ket is the desired one. Though this fact is often recognized even in standard
macroeconomic textbooks, then an exogenous and fixed multiplier is still con-
sidered to be the link between the monetary base and the amount of money
available in the economy. It is completely neglected the fact that the ratio be-
tween these two aggregates can vary according to the behaviour of the system
and must not be assumed fixed a priori?
In this work we take a narrow perspective regarding the creation of money
in a credit economy and focus our attention only on its process. In particular,
our analysis should help explain the short term variability in the amount of
money, for the part that can be imputed to the volatility in the multiplier.4
Our work does not try to analyze the determinants of the behaviour of banks
and households but puts emphasis on the heterogeneity of the actors involved in
the monetary and credit market and tries to provide a better understanding of
the dynamics of the process of money creation, stripped down to its mechanics
and deprived of any behavioural content. Still, we believe that this approach can
provide useful insights and help build a more comprehensive theory of money
in a credit economy.
1We dub the traditional multiplier as static, to emphasize its lack of attention to the
dynamics involved in the process of money creation.
2Post-Keynesian economists, in particular, have long argued about the need of an endoge-
nous theory of money, one that recognizes the fact that the financial system is able to generate
monetary liabilities in response to real sector’s needs. But also on the other side of the macro-
conomics spectrum (see, e.g., Kydland and Prescott, 1990) there is support for the view of
endogenous money.
3These issues are somewhat related to the debate between verticalists and horizontalists
that was popular in the 1970s. For a detailed exposition and analysis of the two positions, see
Moore (1988).
4Moore (1988) shows that variations in the monetary base can explain only about 40% of
the variability in the M1 aggregate on a monthly base, while this proportion raises to about
65% with quarterly data and to 90% over horizons of one year. Over short time horizons,
therefore, a lot of variability in M1 is left unexplained by the standard theory.