Not all money is equal

As many will know I’m an ‘amateur economist’. And happy to be amateur as I think that if the economy is important, then anyone interested should be able to understand it.

Yet I’ve long been mystified by some of the terms used with regard to money. In particular ‘Exogenous’ and ‘Endogenous’ money…..

And these turn out to be the same as ‘Vertical’ and ‘Horizontal’ money.

Exogenous and Vertical money are the ones that can be helicoptered in. Simply they are created by the Central Bank, on behalf of the government, out of thin air. Thus they are presumed to be exogenous – or outside the actual economy. In Vertical money the economy is presumed to be on the Horizontal so this Vertical money is a completely new, unforeseen addition!

Endogenous and horizontal money is just that money created by the private commercial banks working in the everyday economy – the sort of stuff Barclays creates out of thin air.

Whereas the Bank of England works on an Exogenous or Vertical plane.

So at least now I know and (if you didn’t) I hope you do too!

I’ve no intention of adopting the terms but at least when I’m reading elsewhere I know what they are talking about.

Indeed those that speak of Exogenous and Vertical money, when you deconstruct the jargon, are actually being quite honest about money creation.

It is just a pity they cannot say so!

Comments

  1. Andrew -

    How much of each (exogenous versus endogenous, vertical versus horizontal) is there in the economy, roughly?

    1. Peter May -

      That is always a moot point. The BoE says https://www.bankofengland.co.uk/knowledgebank/how-is-money-created
      about 80% private bank money after the last (2008 financial) crisis taking account of QE. But if you consider that government spending creates money and taxation destroys it then (as gov’t taxes less than it spends) I consider that an overestimate for the private banks. With all the Covid-19 QE the proportion is, I suggest likely to be even lower.
      But I still think that certainly the majority of the money in the economy has been created by private banks – and as they are hardly lending of their own volition at the moment, it is important that gov’t money creation keeps up to make sure the economy recovers – something I’m not confident this government considers!

      1. Andrew -

        Thanks for that. It notes that 3% is notes, 18% is “reserves” (who creates them? how are they held?) and 71% is “bank deposits”, meaning virtual money created as matching debts and credits.

        That bears some resemblance to the numbers I have seen, that sterling notes and coin in circulation are about £87 billion, and “M3” is about £3,200 billion. Those are figures at 1 July and 30 June 2020. Central bank sterling reserves on 1 July was about £700 billion, which is about 20%.

      2. Schofield -

        Doesn’t matter in the sense we need a Double Currency (government and bank money) for a variety of reasons. The important thing is understanding those reasons. Most voters are too lazy and arrogant to make the effort to understand those reasons which is why the UK is in decline.

  2. Peter May -

    Reserves are held at the Central Bank and these are what commercial banks use to pay each other. There used to be a reserve requirement but as I understand it in the UK these are no longer.
    https://capital.com/reserve-requirement-definition
    But every time we repay a bank loan that goes to bank reserves, so I imagine they tend to increase naturally (even when of course every time we pay a tax bill that bank’s reserves decrease!)

    1. B. Gray -

      Of course not all loan repayments involve reserves, as reserves are only used to settle accounts between banks. If you have a loan at the same bank where you have your checking account (as many people do), loan repayments only shift numbers on the banks balance sheet, with no change in reserve balances.

      Normal transactions in the domestic economy have no effect on total reserves in the banking system, they only shift bank reserve balances around. Reserves only increase through government spending, central bank lending (to private banks), and central bank purchase of assets (QE), and decrease through taxation, loan repayment, and bond or other asset sales.

      While UK banks don’t necessarily have minimum reserve requirements as in the US, under the Basel (I,II,III) accords, they do have to maintain minimum capital reserves (all liquid assets including reserves) as a ratio of their risk weighted asset portfolios (i.e. loans). Also, the U.S. Federal Reserve recently reduced the minimum reserve ratio of U.S. banks to zero back in March in response to the COVID-19 pandemic, but this doesn’t change the overall capital reserve requirements, only the portion of bank assets required to be held as central bank reserves.

      Minimum reserve ratios were needed under the old gold standard, and later helped stabilize interest rates under the early fiat system. Today they don’t have much meaning as central banks directly support their target interest rates and will always accommodate the resultant demand for reserves from market driven lending.

      BTW, I also consider myself an amateur economist, and the usual response I get when I tell people that is a glazing over the eyes, along with a sudden realization they having something else important to do. Nice to find a group here of similarly minded people.

      1. Peter May -

        Thank you for that!
        When the world operates – rightly or, mostly, wrongly, on supposed ‘economics’ we need to know how it works and who it is operating for!
        I’m conflicted on the repayment scenario. It seems to me if you are repaying a loan it must go back to reserves – even if you bank at the same bank as the repayment recipient bank. I just cannot see where else it can go?

  3. Michael G -

    I can’t find a good current source for private and public debt, however I think public debt has risen to about 100% of GDP (partly due to the fall in GDP)
    https://www.theguardian.com/business/2020/jun/19/uk-debt-is-bigger-than-economy-for-first-time-since-1963-coronavirus
    Private debt is about 220% of GDP (probably now higher thanks to the fall in GDP)
    https://tradingeconomics.com/country-list/private-debt-to-gdp?continent=europe
    3 comments
    1) I suggest that private debt is far more dangerous and far less controlled than public debt.
    2) Who “printed” the 220% of GDP private debt £s?
    3) When private debt goes bad, who “prints” the £s to replace the missing money? Is defaulted private debt just relabelled excessive public debt?

  4. Peter May -

    Public debt is really private saving in the only place that is 100% safe – the people that actually create the money – and is not dangerous at all.

    I agree private debt is distinctly dangerous and if it goes bad on a wide scale banks will topple. The debt gets written off and the money disappears from the economy. It would only get to the public sector if government agreed to support the banks or the debtors themselves.

  5. Peter May -

    Public debt is really private saving in the only place that is 100% safe – the people that actually create the money – and is not dangerous at all.

    I agree private debt is distinctly dangerous and if it goes bad on a wide scale banks will topple. The debt gets written off and the money disappears from the economy. It would only get to the public sector if government agreed to support the banks or the debtors themselves.

    1. Michael G -

      As I understand it, private debt itself is money “printed” by the bank.
      The interest is government “printed” money
      However, part of that interest is insurance against the loan going bad.
      So that there is always a trickle (or occasional flood) of government “printed” money being poured into a black hole by the banks.
      For reasons that I do not follow, “printing” the money that banks destroy is regarded as reckless.

      1. Peter May -

        Quite – and when the banks create money there’s never any problem!

  6. Charles Adams -

    Like you Peter I am not keen on the jargon as this shuts most people out of the discussion.

    It’s a mess and that suits the finance sector just fine!

    I had a go at my overview in

    http://www.progressivepulse.org/economics/the-duopoly-of-money-creation

    The Central Bank is kind of like any other bank except that it effectively underwritten by the whole country. Too big to fail makes private banks even more like the Central Bank.

    The case for both is that private banks lend for private goods, whereas the Central Banks/governments should lend for the public good, where the latter is decided on collectively/democratically. The finance sector, which is mostly wealth management, do not really like public goods because they do not profit from them and they tend to be redistributive. Finance also has too much power as wealth buys power in our corrupted democractic system. To compound our problems, they make up stories like the field of neoclassical economics with its exogenous money to keep the public on the outside.

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