base/bank deposit multiplier provided a simple and concise way of explaining his- torical developments. Yet other Monetarists feel perfectly happy with the ivLv M vH model. So, while my belief is that more Monetarists accept, and teach, the H vM vi model, and that as you progress through Keynesian to various factions of post-Keynesians, an increasingly larger proportion reject H vM vi (with many accepting i vL vM vH), it is hard to argue that the issue is primarily ideological. So what has caused academic monetary theory to be out-of-step with reality for so long? One view of the failings of economics is that it is too abstruse and mathemat- ical. I believe that to be wrong. In financial economics (finance) complex maths, e.g. the Black/Scholes formula and the pricing of derivatives, goes most success- fully hand-in-hand with practical and empirical work. My own criticism, instead, is that large parts of macroeconomics are insufficiently empirical; assumptions are not tested against the facts. Otherwise how could economists have gone on believing that central banks set H, not i? 9 Insofar as the relevant empirical underpinnings of macroeconomics are ignored, undervalued or relatively costly to study, it leaves theory too much in the grasp of fashion, with mathematical elegance and intellectual cleverness being prized above practical relevance. In the particular branch of monetary theory described here, that had remained the case for decades, at least until recently when matters have been greatly improving. 5. Summary and conclusions 1 In their analysis most economists have assumed that central banks ‘exoge- nously’ set the high-powered monetary base, so that (short-term) interest rates are ‘endogenously’ set in the money market. 2 Victoria Chick is one of the few economists to emphasise that the above analy- sis is wrong. Central banks set short-term interest rates according to some ‘reaction function’ and the monetary base (H ) is an endogenous variable. 3 This latter has been better understood in practical policy discussions than in (pedagogical) analysis, so this common error has had less obvious adverse con- sequences for policy decisions (in the UK at least) than for analytical clarity. 4 At last, after decades in which practical policy makers in central banks and academics have often been talking at cross-purposes, more recently leading theorists, e.g. Svensson, Taylor, Woodford, have been narrowing the gap between academics and practitioners. Notes 1 Others would include one of the early papers on the monetary base multiplier, e.g. Phillips (1920), Keynes (1930) or Meade (1934), and Tobin’s (1963) paper on ‘Commerical Banks as Creators of “Money”’. C. GOODHART 22 2 See Sayers (1976, chapter 3, especially p. 28). Also see Sayers (1957, especially chapter 2, pp. 8–19) on ‘Central Banking after Bagehot’. 3 For a current example, see Handa (2000, chapter 10); but also Mankiw, 4th edn. (2000, chapter 18), Branson, 3rd edn. (1989, chapter 15), Burda and Wyplosz (1997, chapter 9.2), and many others. 4 See, for example, Chick (1973, chapter 5, section 5.7), on ‘The Exogeneity Issue’, pp. 83–90. 5 As noted earlier, this was a function of the differential between Fed Funds rate and the Discount rate. Given the Discount rate, there is a belief that the Fed chose a desired Fed Funds rate, and then just derived the implied associated borrowed reserves target (see Thornton 1988). 6 There are numerous reasons for this, several of which, including those usually put for- ward in the time inconsistency literature, are, however, neither convincing nor supported by much empirical evidence. Nevertheless better reasons can be found, see Bean (1998) and Goodhart (1998). 7 This is not the place to discuss over-funding, or the implications of trying to influence the slope of the yield curve. 8 Since what matters for economic policy are these predictable regular feedback relation- ships, it is, perhaps, not surprising that econometric techniques that focus on the erratic innovations (in i, or M) to identify monetary policy impulses, e.g. in VARs, have been coming under criticism from economists such as Rudesbusch and McCallum. 9 This is not just apparent in monetary economics. The whole development of rational expectations theorising has appeared to proceed with minimal concern about what it actually is rational for people to expect in a world where learning is costly and time short; and about what people do expect, and how they learn and adjust their expecta- tions. Much the same could be said for models of perfectly flexible wage/price variation, or for models assuming some form of stickiness. There remains limited empirical knowledge of what determines the speed and extent of wage/price flexibility. References Bean, C. (1998). ‘The New UK Monetary Arrangements: A View from the Literature’, Economic Journal, 108, 1795–809. Branson, W. H. (1989). Macroeconomic Theory and Policy, 3rd edn. New York: Harper and Row. Burda, M. and Wyplosz, C. (1997). Macroeconomics: A European Text, 2nd edn. Oxford: Oxford University Press. Chick, V. (1973). The Theory of Monetary Policy, revised edn. Oxford: Basil Blackwell. Chick, V. (1992). ‘The Evolution of the Banking System and the Theory of Saving, Investment and Interest’, in P. Arestis and S. Dow (eds), Chapter 12 in On Money, Method and Keynes: Selected Essays. New York: St. Martins Press. Goodhart, C. (1989). ‘The Conduct of Monetary Policy’, Economic Journal, 99, 293–346. Goodhart, C. (1998). ‘Central Bankers and Uncertainty’, Keynes Lecture in Economics, Oct 29, reprinted in Proceedings of the British Academy, 101, 229–71 (1999) and in the Bank of England Quarterly Bulletin, 39(4), 102–20 (1999). Handa, J. (2000). Monetary Economics. London: Routledge. Keynes, J. M. (1930). A Treatise on Money. London: Macmillan. Laidler, D. E. W. (ed.) (1999). The Foundations of Monetary Economics. Cheltenham, UK: Edward Elgar. Mankiw, N. G. (2000). Macroeconomics, New York: Worth Publishers. THE ENDOGENEITY OF MONEY 23 Meade, J. E. (1934). ‘The Amount of Money and the Banking System’, Economic Journal, XLIV, 77–83. Phillips, C. A. (1920). Bank Credit. New York: Macmillan. Rasche, R. H. and Johannes, J. M. (1987). Controlling the Growth of Monetary Aggregates. Dordrecht, Netherlands, Kluwer Academic Publishers. Sargent, T. J. and Wallace, N. (1975). ‘“Rational” Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule’, Journal of Political Economy, 83(2), 241–54. Sayers, R. S. (1957). Central Banking after Bagehot. Oxford: Clarendon Press. Sayers, R. S. (1976). The Bank of England, 1891–1944. Cambridge: Cambridge University Press. Svensson, L. (1999). ‘How should Monetary Policy be Conducted in an Era of Price Stability’, Centre for Economic Policy Research, Discussion Paper No. 2342 (December). Thornton, D. L. (1988). ‘The Borrowed-Reserves Operating Procedure: Theory and Evidence’, Federal Reserve Bank of St Louis Review (January/February), 30–54. Tobin, J. (1963). ‘Commercial Banks as Creators of “Money” ’, in D. Carson (ed.), Banking and Monetary Studies. Homewood, Illinois: Richard D. Irwin Inc. Woodford, M. (2000). Interest and Prices, draft of forthcoming book (April). C. GOODHART 24 4 THE TRANSMISSION MECHANISM WITH ENDOGENOUS MONEY 1 David Laidler 1. Introduction It is a time-honoured monetarist proposition that no matter how money gets into the economic system, it has effects thereafter. But, if money is the liability of a banking system presided over by a central bank that sets the rate of interest, the quantity of money must surely be endogenous to the economy: how then can it play a causative role therein? Victoria Chick was probably the first person to nag me about this, when we first met at LSE in 1961–2, at a time when very few peo- ple thought that questions about the quantity of money were worth serious dis- cussion. Vicky and I did at least agree that ‘money mattered’, though not about much else. And so it has been ever since. But I have always learned from our dis- cussions, so what better topic for an essay in her honour than endogenous money, and its causative role in the transmission mechanism of monetary policy? 2. The role of monetary policy If one were to discuss monetary policy with a representative group of central bankers, they would probably agree with the following four propositions: (i) Monetary policy should be focused on the control of inflation. (ii) In the long run, the logarithmic growth rate of real income, dy/dt, is beyond their direct control – though many supporters of inflation targeting would suggest that this variable’s average value might be a bit higher were the inflation rate, dp/dt, low and stable, as opposed to high and variable. (iii) Velocity’s long-run logarithmic rate of change, dv/dt, is largely a matter of institutional change – and to that extent again beyond the direct control of policy. (iv) The critical variable determining the infla- tion rate, again in the long run, is the logarithmic rate of growth of some repre- sentative monetary aggregate, dm/dt. In short, they would probably assent to the following formulation of the income version of the quantity theory of money: . (1) dp dt ϭ dm dt Ϫ dy dt ϩ dv dt 25 They would also agree that, within this equation, the important action, as far as their task is concerned, involves the influence of dm/dt on dp/dt. Were the discussion then to turn to the actual conduct of policy, however, those same central bankers would probably agree that the framework that they actually deploy in setting the day-to-day course of monetary policy was some variation on a model whose basic structure can be set out in three equations: namely, an expec- tations augmented Phillips curve, an IS curve, and a Fisher equation linking the real rate of interest that appears on the right-hand side of the IS curve to a nomi- nal rate that is a policy instrument, and hence an exogenous variable. This rather sparse framework must, of course, be filled out with many details in order to become a practical vehicle for policy analysis. A serious monetary policy model will include a foreign sector, and it might well deal with the interaction of not just one real and one nominal interest rate, but of the term structure of each linked by a term structure of inflation expectations. It will also take account of complicated distributed lag relations among its variables. Setting these complications aside, however, the underlying structure looks roughly as follows: , (2) , (3) . (4) Here y* indicates the economy’s capacity level of output, the superscript e the expected value of the inflation rate, X is a vector of variables that might shift the IS curve, and i should be regarded as an exogenous variable whose value is set by the monetary authorities. There is a paradox here, for this framework seems to have no role for the quan- tity of money! To this observation, there is a standard answer: namely, that money is implicitly in the model after all. Equations (2)–(4) may be supplemented by a demand for money function, and linked to the supply of money by an equilibrium condition. Specifically, one may write . (5) But, since eqn (2) determines p (given some historical starting value), eqn (3) determines y (given that y* is determined outside of this inherently short-run framework), and i is an exogenously set policy variable, this extra equation adds nothing essential to the model. It tells us what the money supply will be, but it also tells us that this variable responds completely passively to the demand for money, and has no effects on any variable that might interest us. 2 3. Money and inflation: Channel(s) of influence To the extent that the quantity of money’s behaviour is related to that of output and inflation, however, it seems systematically to lead rather than lag these m s ϭ m d ϭ m(y, i)p r ϭ i Ϫ (dp/dt) e y Ϫ y* ϭ h(r, X ) dp dt Ϫ ΂ dp dt ΃ e ϭ g(y Ϫ y*) D. LAIDLER 26 variables, even when allowance is made for variations in interest rates. That ought not to happen if the quantity of money is a purely passive variable, though there are at least two stories that can reconcile this fact with the foregoing model. First, money might indeed be a lagging indicator of output and prices, but the procliv- ity of these variables to follow a cyclical time path might produce misleading appearances. Second, forward looking agents might adjust their cash holdings to expectations about future income and prices before they are realised. But there is a third, altogether more intriguing, possibility. The money supply might, after all, be one of the variables buried in the vector X of eqn (3), and play a causative role in the economy. 3 It is this line of argument that I wish to follow up in this essay. In particular, I shall address what I believe to be the main stick- ing point in getting its relevance accepted, namely, the widely held belief that though one might make a plausible case for it in a system in which some mone- tary aggregate, for example the monetary base, is an exogenous variable, this cannot be done when it is some rate of interest that the authorities set. Let us start from the fact, particularly stressed by Brunner and Meltzer, that the banking system and the general public interact with one another not in one mar- ket, as conventional textbook analysis of the LM curve assumes, but in two. 4 It is not just that the public demands and the banks supply money in a market for cash balances. It is also the case that, on the other side of their balance sheets, the banks also demand, and the public supplies indebtedness in a market for bank credit. Furthermore, activities in the credit market impinge upon the money mar- ket for two reasons. First, the banking system’s balance sheet has to balance, and second the public’s supply of indebtedness and demand for money are parts of an altogether broader set of interrelated portfolio decisions. These involve not only public and private sector bonds, but claims on, and direct ownership of, producer and consumer durable goods as well. The relevant arguments are most simply developed in the context of an econ- omy in which all banking system liabilities function as money, and that is how I shall now discuss them, but I shall also argue in due course that the essential features of the case carry over to a more complex system. Consider, then, an economy operating at full employment equilibrium, with a stable price level (or more generally, a stable and fully anticipated inflation rate) in which the banking system is happy with the size of its balance sheet, and mem- bers of the non-bank public are also in portfolio equilibrium. In that case, the real rate of interest must be at its natural level at which the term (y Ϫy*) in eqn (3) above is zero. Now let the central bank lower the nominal and therefore, given the expected inflation rate, the real rate of interest at which it makes high-powered money available to the banks. These will then lower the nominal and real rates of interest at which they stand ready to make loans to the non-bank public, thus disturbing portfolio equilibria among this last group of agents. They will wish to increase their indebtedness to the banks, but not, as conventional analysis of the LM curve would seem to have it, simply to add to their money holdings. 5 THE TRANSMISSION MECHANISM 27 As Hawtrey (1919: 40) put it, ‘no-one borrows money in order to keep it idle’. The fall in the interest rate at which the banks offer loans will disturb not just the margin between money balances and other stores of value, but also, and crucially, that between indebtedness to the banking system and desired stocks of durable goods. The non-bank public will, then, be induced to borrow money, not in order to hold it, but in order to spend it. Now, of course, this initial response is captured in eqn (3) of the simple model with which this paper began which describes the link between aggregate demand and the (real) rate of interest. This effect is only the first round consequence of an interest rate cut for spending, however. The money which borrowers use to buy goods is newly created by the banks, and though it leaves their specific portfolios as they spend it, it nevertheless remains in circulation, because it is transferred to the portfolios of those from whom they buy goods. Credit expansion by the banks in response to the demands of borrow- ers, even though it involves transactions that are purely voluntary on both sides, nevertheless leads to the creation of money which no one wants to hold. At first sight this seems paradoxical, but money is, above all, a means of exchange, and what we call the agent’s demand for money does not represent a fixed sum to be kept on hand at each and every moment, but rather the average value of an inventory around which actual holdings for the individual will fluctu- ate in the course of everyday transactions. In a monetary economy, the typical sale of goods and services in exchange for money is not undertaken to add perma- nently to money holdings, but to obtain the wherewithal to make subsequent pur- chases of other goods and services. Only at the level of the economy as a whole will fluctuations in individual balances tend to cancel out. However if we start with a situation in which everyone’s money holdings are initially fluctuating around a desired average value, so that, in the aggregate, the supply of money equals the demand for it, the consequence of an injection of new money into cir- culation will be the creation of a discrepancy at the level of the economy as a whole between the amount of money that has to be held on average and the amount that agents on average want to hold, an economy wide disequilibrium between the aggregate supply and demand for money. The consequence of this disequilibrium must be that, again on average, agents will increase their cash outlays in order to reduce their holdings of money. For the individual agent the destination of a cash outlay undertaken for this purpose is irrel- evant to its accomplishment. That agent buys something, or makes a loan, or pays off a debt to another agent, or pays off a debt to a bank, and gets rid of surplus cash in each case. From the perspective of the economist looking at the economy as a whole, however, the agent’s choice of transaction, and hence the destination of the cash outlay, is crucial. Specifically, if that destination is a bank, as it would be, for example, if the agent decided that the most advantageous transaction available was to pay off a loan, excess cash is removed from circulation. If, on the other hand, the transaction is with another non-bank agent, portfolio disequilibrium is shifted to someone else. In the first case the economy’s money supply is reduced, and in the second case it remains constant, and hence has further consequences. D. LAIDLER 28 In principle, either type of response can dominate the second-round effects of a cut in the rate of interest, but with very different implications for the transmission mechanism of monetary policy. If, predominantly, money disappears from circu- lation at this stage, as bank debts are reduced, the overall consequences for aggre- gate demand of a cut in interest rates are dominated by the response of output to a discrepancy between the actual and natural rate of interest, the effect captured by the parameter h in eqn (3). If it mainly remains in circulation, however, portfolio disequilibria will persist, as will their effects on expenditure, until some argument of the demand for money function, the price level say, moves to adjust the demand for nominal money to its newly increased supply. Let us refer to the first-round effects of the interest rate cut as working through a credit channel and the second and subsequent round effects as working through a money channel. 6 Let us also agree that, in general, monetary policy can work through both channels, and that in particular times and places one or the other might dominate. Milton Friedman (e.g. 1992, chapter 2) has frequently asserted that no matter how money gets into circulation, its effects are essentially the same, that the method of its introduction makes, at the most, a small difference and only at the first round. In terms of the foregoing discussion, he should be interpreted as asserting that, as an empirical matter, the money channel dominates the transmission mechanism. On the other hand, in the model which Knut Wicksell (1898, chapter 9) used as the formal basis for expounding his pure credit economy, the bank deposits created at the beginning of the period of production, which is also the period for which bank loans are granted, all find their way into the hands of agents for whom the best course of action is to extinguish bank debt at the end of the period. In Wicksell’s model, therefore, the credit channel is the only one at work. It should now be clear why the existence of a complex modern banking system whose liabilities include many instruments that one would be hard put to classify as ‘money’, particularly if one takes the means of exchange role as being one of its important defining characteristics, makes no qualitative difference to the argu- ments that have been presented so far. If the money channel of the transmission mechanism is weak in a particular economy, that must be because individual agents who find themselves with excess cash typically transact with the banking system in order to rid themselves of it, and thereby reduce the money supply. In the simplest form of system in which all bank liabilities are means of exchange, this possibility already exists because agents have the option of paying off bank loans. A more complicated system provides them with more options whereby, in reducing their own cash balances, they also reduce the economy’s money supply. It permits them to purchase and hold a variety of non-monetary bank liabilities. The richness of the menu of liabilities that a modern banking system offers to the public thus makes it more plausible to argue that the credit channel is likely to dominate monetary policy’s transmission mechanism, but it does not make such an outcome empirically certain by any means. Indeed, the availability of such lia- bilities may only prolong, rather than eliminate, the working out of the money THE TRANSMISSION MECHANISM 29 channel, because non-monetary bank liabilities are, among other things, convenient parking places for excess liquidity, pending the formulation of plans to spend it. 7 Now the foregoing discussion has been carried on in terms of an experiment in which equilibrium is disturbed by a policy action, by the central bank lowering the nominal and therefore, given inflation expectations, the real interest rate too. But equilibrium can also be disturbed by shocks to the natural rate of interest. Productivity shocks, or fluctuations in what Keynes called the ‘animal spirits’ of the business community, to cite two examples, can create a gap between the mar- ket and natural rates of interest and lead on to credit creation and money supply expansion just as surely as can policy engineered cuts in the market rate. Factors such as these are buried in the vector X of eqn (3) above. This consideration sug- gests that the workings of the money channel of the transmission mechanism can amplify, even dominate, not only the consequences of monetary-policy-induced disequilibria for private sector expenditure, but also the consequences of disequi- libria whose origins lie elsewhere. Closely related, it also helps to explain the tendency of money to lead real income and inflation even in a world in which expenditure decisions are clearly subject to real disturbances originating outside of the monetary system. 4. Empirical evidence Now it is appropriate to ask whether there is any reason to believe that the money channel as I have described it has any empirical significance. Here, I believe, the answer can be a guarded ‘yes’. Lastapes and Selgin (1994), for example, have noted that, were nominal money a passively endogenous variable, always adjust- ing to changes in the demand for it, one would expect shocks to the time path of real balances overwhelmingly to originate in shocks to the price level. Fluctuations in the nominal quantity of money would usually appear as equili- brating responses to changes in variables determining the demand for nominal money, rather than as factors creating disequilibria in their own right. But, analysing United States data for M2 over the period 1962–90, when many would argue that money was indeed a passively endogenous variable, they found that shocks to the nominal quantity of money were an important source of fluctuations in its real quantity. In a slightly later study, Scott Hendry (1995) has analysed the nature of the error correction mechanisms underlying fluctuations of Canadian M1 around a co-integrating relationship that he interprets (quite conventionally and uncontro- versially) as a long-run demand-for-money function. Were nominal money a purely passive variable in the system, one would expect to see these mechanisms dominated by movements in its quantity, as agents attempt to move back to equi- librium after a disturbance by transacting with the banking system. If, on the other hand, they transact with one another to a significant extent, and hence fail to remove excess nominal money balances from circulation, one would expect to see the return to a long-run equilibrium level of real money holdings also reflected in D. LAIDLER 30 changes in the price level. In fact, as Hendry shows, both mechanisms seem to be at work. These results, however, do not help us to understand just what maximising choices they are that determine how much excess money falls into whose hands when, and what their best response is actually going to be. There is a gap in the analysis here, which, I suspect, it has only recently become technically feasible to fill. 8 Specifically, I conjecture that recent developments in dynamic general equi- librium modelling provide a technical means of introducing some much-needed clarity here. The models in question, as they currently exist, are capable of deal- ing with interactions among the monetary authorities, a banking system, firms and households, in a framework that pays explicit attention to the timing of spe- cific transactions between pairs of agents and the information available when decisions are made and acted upon, and also permits the imposition of a wide variety of restrictions on these activities which can significantly affect the econ- omy’s behaviour. Thus when participation in credit markets is limited to banks and firms, monetary policy has consequences by way of liquidity effects; when money wage stickiness is introduced, policy (and other) shocks can have real as well as purely nominal consequences; and so on. 9 It ought to be possible to introduce some simple analysis of the demand for money by households into such a setup, by making utility a function of real bal- ance holdings as well as consumption and leisure, and to supplement this with some adjustment cost mechanisms that are capable of producing ‘buffer-stock’ effects too. Firms too, might be given a demand for money function, perhaps by putting real balances into the productions function. And if the banking system were permitted to emit more than one type of liability, a further extension of the analysis to encompass simple portfolio decisions might be accomplished. To get at the tendency of injections of money to remain in circulation, it would also be necessary to introduce some variety among firms and households with regard to their starting level of indebtedness to the banking system too. I am sure it would not be easy to do all this, for if it were, someone would already have done it, but work along these lines does seem to me to be what is needed to fill the analytic gap to which I have pointed. 10 The question naturally arises, however, as to whether such work would be worth the effort. I can think of at least three reasons why policy makers might find these matters of interest. First, it is well known that monetary policy works with long lags. Perhaps eighteen months seem to elapse before a policy-induced interest rate change undertaken today will have noticeable effects upon the inflation rate. Some indi- cator variable, affected by the interest rate change, and in turn affecting aggregate demand, whose behaviour changes during the interval would surely be very useful. Potentially, the behaviour of some monetary aggregate can be the source of valuable intermediate stage information about the progress of policy, and the better understood are the theoretical mechanisms underlying that behaviour, the easier will it be to extract such information. THE TRANSMISSION MECHANISM 31 [...]... (corresponding to Ml) and money as a store of wealth (corresponding to M2 or broader monetary aggregate other than Ml) The transactions demand for money is a demand for narrow money, and the portfolio demand for money is a demand for broad money It is M1 which currently serves as the medium of exchange but not M2 or M3 (other than the M1 part) M2 and M3 should be viewed as financial assets whose nominal prices... Political Economics, 26 (3), 56–65 Arestis, P and Howells, P (1999) ‘The Supply of Credit Money and the Demand for Deposits: A Reply’, Cambridge Journal of Economics, 23 , 115–19 Bank of England (1999) Economic Models at the Bank of England London: Bank of England Chick, V (1973) The Theory of Monetary Policy, revised edn Oxford: Blackwell Chick, V (19 92) ‘The Evolution of the Banking System and the Theory... Journal of Money, Credit and Banking, 26 , 34–54 Meltzer, A H (1999) The Transmission Process, Working Paper, Carnegie Mellon University Nelson, E (20 00) ‘Direct Effects of Base Money on Aggregate Demand: Theory and Evidence’, Working Paper, Bank of England Parkin, J M (1998) ‘Presidential Address: Unemployment, Inflation and Monetary Policy’, Canadian Journal of Economics (November) Stiglitz, J and Weiss,... borrowers and lenders (cf Arestis and Howells 1994) Interest rate changes are likely to have implications for the composition of demand (e.g between consumer expenditure and investment, between tradable and non-tradable goods) Regions may be differentially affected, and also interest rate increases are likely 42 ECONOMIC POLICY WITH ENDOGENOUS MONEY to be geared to inflationary pressures in the high demand... K and Meltzer, A H (1993) Money and the Economy: Issues in Monetary Analysis Cambridge: Cambridge University Press, for the Raffaele Mattioli Foundation 33 D LAIDLER Cottrell, A (1989) ‘Price Expectations and Equilibrium when the Rate of Interest is Pegged’, Scottish Journal of Political Economy, 36, 125 –40 Davidson, J and Ireland, J (1990) ‘Buffer Stocks, Credit, and Aggregation Effects in the Demand... of affecting financial conditions and eventually, through them, the level of demand’ and 35 M SAWYER ‘we attribute to operations on the structure of interest rates a widespread influence on liquidity and a slower, more partial influence on the demand for capital …’ (p 337; see particularly pp 1 32 5) This type of approach was soon forgotten as the monetarist analysis (and the associated notion of potentially... so through aggregate demand channels, one has to ask whether there are hysteresis effects and whether monetary policy is the most effective way of influencing aggregate demand Second, interest rates are seen as influencing the level of and structure of aggregate demand, and as such its effects should be compared with those of the alternative, namely the use of fiscal policy Keynesian fiscal policy... System and the Theory of Saving, Investment and Interest’, in P Arestis and S Dow (eds), On Money, Method and Keynes: Essays of Victoria Chick London: Macmillan Church, K B., Mitchel, P R., Sault, J E and Wallis, K F (1997) ‘Comparative Performance of Models of the UK Economy’, National Institute Economic Review, No 161, 91–100 Cottrell, A (1994) ‘Post-Keynesian Monetary Economics’, Cambridge Journal... increase in nominal expenditure, including those increases which emanate from cost and price increases When the loans come into effect and are spent, deposits are created and thereby the stock of money expands Second, the stock of money depends on the willingness of the non-bank public to hold (demand) money Loans can be repaid, and the ability of the public to do so is a major mechanism through which the... Theory and an Application to the UK Personal Sector’, Journal of Policy Modelling, 12, 349–76 Friedman, M (19 92) Money Mischief – Episodes in Monetary History New York: Harcourt Brace Jovanovich Goodhart, C (this volume) The Endogeneity of Money Goodhart, C and Hofman, B (20 00) ‘Do Asset Prices Help to Predict Consumer Price Inflation’ LSE Financial Markets Group, mimeo Hawtrey, R H (1919) Currency and . Blackwell. Chick, V. (19 92) . ‘The Evolution of the Banking System and the Theory of Saving, Investment and Interest’, in P. Arestis and S. Dow (eds), Chapter 12 in On Money, Method and Keynes: Selected. e.g. Phillips (1 920 ), Keynes (1930) or Meade (1934), and Tobin’s (1963) paper on ‘Commerical Banks as Creators of “Money”’. C. GOODHART 22 2 See Sayers (1976, chapter 3, especially p. 28 ). Also see. Journal, 99, 29 3–346. Goodhart, C. (1998). ‘Central Bankers and Uncertainty’, Keynes Lecture in Economics, Oct 29 , reprinted in Proceedings of the British Academy, 101, 22 9–71 (1999) and in the Bank