The theory of endogenous money is that funds will be available in whatever quantity is needed to meet demand for credit. It is essentially the belief that bank reserves, such as supported by the central bank, will be replenished in one area when money supplies are depleted in another. For example, a loan may reduce the reserves of a bank, but when the customer makes payments on the loan, the levels rise again. Endogenous money theory is expressed in several different branches, each of which describes different characteristics of money flow. While the different branches of endogenous money theory support the same overall belief, they are not necessarily compatible with each other.
Some of the different types of endogenous money theory include central bank endogeneity, fiscal endogeneity, and money multiplier and portfolio endogeneity. Central bank endogeneity is the theory that the money authority will provide the funds to help banks meet demand for credit. Fiscal endogeneity is the theory that the economy, and thus the banks, will be its own source of funds through the natural cycle of deficit and the debits and credits that drive it. Money multiplier and portfolio endogeneity is built on the belief that the proper balance of investments in the overall market will ensure adequate supply of credit.
According to the endogenous money theory, the supply of funds is determined by demand for bank credit. For example, if there is low demand, then reserves are typically high and the money authority will withhold funds. When demand for credit increases, portions of the reserves will be distributed to banks so that the increase in activity can boost the economy.
In some cases, the central bank will not tap reserves in order to accommodate a demand for credit, but often banks will have resources of their own to manage this kind of situation. For this reason, the theory of endogenous money also depends upon the asset and liability practices of the banks. Poor management of these elements can affect the ability of the bank to meet demand, whether or not the central bank provides funds.
At the core of the endogenous money theory is the belief that money is primarily a tool and that the economy is in essence a system of bartering. The government money authority supposedly increases or decreases the flow of funds from the central bank in order to ensure that this system can thrive. This is primarily accomplished by controlling the flow of cash so that prices are neither too high nor too low for the exchange of goods and services to be at a sufficient level of activity.
