Changing United States financial structure and the theory of endogenous supply of money

The theory of Endogenous Supply of Money has a long history in economics, and plays an especially prominent part in modern Post Keynesian theory. Though it lends itself to various different interpretations its central proposition is a simple one: non-financial business sector's need for credit is seen as the driving force behind the process of money creation in the economy. Loans made by banks to firms return to them in the form of new deposits, which in turn lead to an increase in reserves in one way or another as well, causing the money supply to expand.; Despite this strong emphasis on commercial and industrial loans and traditional banking, the role commercial banks and depository institutions have changed significantly in the era of financial liberalization since the early 1980s, at least in the US. As competition from nondepository financial institutions increased with financial deregulation, depository institutions lost many of their advantages in attracting savings and supplying credit. Banks were thus forced to undergo dramatic changes and innovate, transforming the role banking played in money and credit creation mechanisms along the way. As a result, not only has the importance of traditional bank lending decreased in the overall credit creation process in the economy, but also the relative importance of commercial and industrial loans in banks' overall asset structure has experienced a steady decline.; Arguably, the core of endogenous money approach is still valid in that credit creation is still what lies behind money supply expansion. As commercial banks have historically been the major supplier of credit and non-financial business has been the biggest private borrower, Post Keynesian economists have traditionally focused on these two sectors. There is no intrinsic reason why the theory should be based on the assumption that non-financial businesses and banking sector are the sole determinants in the credit creation mechanism. The growing importance of the credit needs of households in financing transactions not related with Gross Domestic Product (non-GDP transactions), along with the emergence of new financial intermediaries and instruments that have transformed the process of credit creation can in principle be incorporated into the theory of endogenous money. The objective of this dissertation is to examine the way in which the theory might need to be recast if not revised in order to do so.