Abstract
The Post-Keynesian theory of endogenous money is typically used to explain the operations in advanced economies like the US. While the core ideas are relevant for all market economies, developing economies have additional features which complicate the process. These may include: the local currency is not accepted as a means of payment for international transactions, so the banking system (including the central bank) requires foreign currency reserves (balance-of-payments constraint); hard currency reserves are needed to provide ‘credibility’ for circulation of domestic currency; stock and bond markets are not well developed, so other financial instruments are necessary to complete the finance-funding process; and institutional differences regarding monetary control.We use the case of Mexico to show how these features of developing economies can complicate the endogenous-money process. For Mexico the process is constrained by the use of the US dollar as both a store of value and a reserve for the banking system. As a consequence, the interest rate is determined by the demand for the alternative sources of liquidity creation, and therefore a credit-financed expansion will necessitate an increase in the interest rate which can lead to a recession or other crisis scenarios.
Highlights
Post-Keynesian theories of the finance-funding process and endogenous money are oriented toward explaining the money-creation/destruction process and its effect on economic performance
Given the balance-of-payments (BoP) constraint, we argue that the interest rate is influenced by the dominant source of liquidity alternatives; and, as opposed to the singlecurrency case of advanced countries, an expansion of domestic currency will be followed by an increase in the interest rate which can foster crisis scenarios
We argue that the need for US$ reserves by the banking system since the 1995 crisis creates another restriction on growth for the Mexican economy
Summary
Post-Keynesian theories of the finance-funding process and endogenous money are oriented toward explaining the money-creation/destruction process and its effect on economic performance. Given the balance-of-payments (BoP) constraint, we argue that the interest rate is influenced by the dominant source of liquidity alternatives (domestic versus international); and, as opposed to the singlecurrency case of advanced countries, an expansion of domestic currency will be followed by an increase in the interest rate (to meet US$ needs) which can foster crisis scenarios. The endogenous liquidity process that we describe refers to the mechanisms used to inject liquidity from alternative sources of local and foreign credit and to withdraw liquidity through amortizations and savings deposits in the banking system, as opposed to private capital market instruments While these mechanisms operate to constrain or expand aggregate spending, changes in aggregate demand are expressed in domestic markets through changes in total peso liquidity, which can arise from either domestic or foreign sources.
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