Hyman Minsky’s Early Work on Banking and Endogenous Money

From Minsky’s earliest work, he adopted what became known as the “endogenous money” approach that was revived by Post Keynesians in the 1980s. It is useful to return to Krugman’s critique of Minsky to compare Minsky’s early view of banking with the current view held by many macroeconomists. Minsky’s views over half a century ago are far more advanced than those held today by Krugman.


By L. Randall Wray

Some quarter of a century ago I wrote a paper that presented Minsky’s approach to money, linking it to his Financial Instability Hypothesis. The paper was rejected by one of the heterodox journals, because a referee took particular issue with my use of the new word “securitize” adopted from Minsky to describe the packaging of assets (such as mortgages) into securities. The paper was published a couple of years later in a Minsky festschrift marking his retirement from Washington University. (Wray 1992)

In that piece, I argued that from Minsky’s earliest work, he had adopted what became known as the “endogenous money” approach that was revived by Post Keynesians in the 1980s. The most important contribution to that literature was Basil Moore’s 1988 book, in which he formulated the “horizontalist” approach to endogenous money. My own contribution (Wray 1990) was based on the dissertation I wrote under his supervision between 1986-8. It traced the early history of the approach from the Currency School-Banking School controversy, through Marx and on to Keynes and Schumpeter. I then focused on the post-war revival from Kaldor and the Radcliffe committee to Gurley and Shaw and on to Minsky, and then to Tobin, Moore and Lavoie.

Minsky and Horizontalists

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Unlike some other Post Keynesians (1), I have always included Keynes’s liquidity preference theory as well as Minsky’s financial instability within the endogenous money approach. For some time, the “horizontalists” argued that Keynes’s liquidity preference theory was equivalent to the “money demand meets fixed money supply” approach of ISLM textbook Keynesians. Hence, they wanted to drop a liquidity preference approach to interest rate determination in favor of an “exogenous interest rate” approach.(2) While I never thought that was either necessary or appealing, it seems that most Post Keynesians are now comfortable with the argument that endogenous money and liquidity preference are compatible. We take the overnight interest rate as “exogenously determined” by central bank policy, but we leave a role for liquidity preference to play in influencing other rates.

Some Post Keynesians also argued that Minsky’s financial instability hypothesis must be inconsistent with endogenous money.(3) Minsky’s basic model of investment posits that firms use a combination of internal and external funds; external funds are subject to lenders’ and borrowers’ risks, with the first of these reflected in the cost of external funding. As an expansion gets underway, firms and their bankers willingly accept riskier financial profiles (Minsky was famous for his distinctions among hedge, speculative and Ponzi positions). Minsky argued that over the course of an upswing, the supply of finance can become less than perfectly elastic as lending rates rise. Rising interest rates and/or disappointing revenues can cause the financial positions to deteriorate beyond what was desired—eventually to the point that investment is reduced and the expansion is transformed into a downturn; via the Kalecki profit equation, this only makes the financial difficulty worse because lower investment reduces profits, all else equal. Further, if the current account balances or if the government’s balance moves toward surplus, profits are reduced even if investment does not decline. For these reasons, financial positions generally worsen as the economy peaks.

Horizontalists did not like this exposition for two reasons. First, the extreme horizontalist position was that banks simply take the exogenously determined overnight rate set by the central bank, and then add a mark-up to determine the lending rate—with the supply of credit through bank loans infinitely elastic at that rate. Hence, Minsky’s approach seemed to imply some fixed quantity of finance (some even claim that he adopted a savings-driven loanable funds approach) that was at odds with the endogenous money approach. Further, some critics also adopted a sort of Say’s Law approach to investment: since investment creates equivalent profits (holding all else equal) then the revenue of firms could never be disappointing. Firms can always service all external funding because the investment creates the profits needed to pay the banks.

Note that the endogenous money approach mostly concerns commercial bank activity—with banks creating demand deposits when they make short-term loans to firms or households. On the other hand, Minsky’s FIH was about investment finance—the proper purview of investment banks, not commercial banks. During the time that Minsky was formulating his FIH the USA maintained a strict separation between commercial banking and investment banking. For some reason, this distinction was not recognized by those criticizing Minsky. In much of the Post Keynesian literature the treatment of investment finance was rudimentary at best. (An exception is Paul Davidson.) It has largely been presumed that investment is internally financed out of retained earnings. In that case, commercial banks provide the short-term loans to investment goods producers; spending on the wage bill in that sector generates the profits that are then used to internally finance investment. While this is theoretically possible, it is not consistent with the empirical reality that firms take on long term debts to finance positions in real and financial assets. In particular, this view sheds little light on the 1980s explosion of mergers and acquisitions and leveraged buy-outs. These “innovations” intentionally leveraged corporate income flows with huge debt as financial profiles moved from hedge to speculative and Ponzi. Minsky’s “Wall Street view” developed from the 1950s was prescient and became increasingly useful for understanding these trends.

In this piece I will revisit only the main underlying issue: what was Minsky’s early approach to banking? Did Minsky adopt an endogenous money approach–at the time that he was first developing his financial instability approach? If he did, that, by itself, does not prove that his FIH is consistent with an endogenous money approach. Nor does it disprove the claim that there is a Says Law of finance. Both of those criticisms could still be made whether or not Minsky held and explicated an endogenous money approach. I have argued elsewhere, however, that these positions do not hold up to scrutiny. In fact, Minsky’s FIH relies critically on an endogenous approach to money, and the Say’s Law approach of some Post Keynesians is fundamentally flawed. In any case, we will not detail those critiques here. (4)

Further, it is useful to return to Krugman’s critique of Minsky to compare Minsky’s early view of banking with the current view held by many macroeconomists. I’ll argue that Minsky’s views over half a century ago are far more advanced than those held today by Krugman.

Krugman versus Minsky and Endogenous Money

In an earlier piece (Wray 1992) I closely examined Minsky’s published writings to support the argument that from his earliest articles in 1957 to his 1986 book (as well as a hand-out he wrote in 1987 on “securitization” (5)) he consistently held an endogenous money view. I’ll refer briefly to that published work. However, I will devote most of this paper to unpublished (and previously unknown) early manuscripts in the Minsky archive (Minsky 1960; see also Minsky 1959).

After Minsky died in 1996 I helped to organize his papers and discovered he had started several extended pieces that were meant to become books. One was a long piece on poverty that we supplemented with other related pieces and published as Minsky 2012. Another was a set of chapters written in the early 1990s on “reconstituting the financial system” that was clearly meant to become a monograph. (See Wray 2010.)

These manuscripts show that from his early career Minsky had already developed a deep understanding of the nature of banking. In some respects, these unpublished pieces are better than his published work from that period (or even later periods) because he had stripped away some institutional details to focus more directly on the fundamentals. It will be clear from what follows that Minsky’s approach deviated substantially from the postwar “Keynesian” and “Monetarist” approaches that started from a “deposit multiplier”. Further, Minsky’s understanding of banking at that time appears to me to be much deeper than that displayed three or four decades later by much of the Post Keynesian endogenous money literature.

Why is this important today? Many economists remain confused about the banking business. For example, Paul Krugman has recently revisited Minsky in several of his influential blogs for the NYTimes. Krugman is a “public intellectual”, the most visibly prominent public face of “Keynesianism”, and he adopts the old “bank as intermediary between savers and investors” and “deposit multiplier” views in his critique of Minsky.(6) He also connects this to both the loanable funds arguments and to the ISLM model. To piece together his views, I will need to draw on three of his blogs.

I had an insight: banking is where left and right meet. Both the Austrians — who believe     that whatever the market does is right, unless it’s fractional reserve banking, which is somehow terrible — and the self-proclaimed true Minskyites view banks as institutions that are somehow outside the rules that apply to the rest of the economy, as having unique powers for good and/or evil. I guess I don’t see it that way…. For in the end, banks don’t change the basic notion of interest rates as determined by liquidity preference and loanable funds — yes, both, because the message of IS-LM is that both views, properly understood, are correct. Banks don’t create demand out of thin air any more than anyone does by choosing to spend more; and banks are just one channel linking lenders to borrowers.  http://krugman.blogs.nytimes.com/2012/03/27/banking-mysticism/.

 If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend…http://krugman.blogs.nytimes.com/2012/03/27/minksy-and-methodology-wonkish/.

Hence, according to Krugman, banks can raise demand by lending the savings of those with a low propensity to spend to those with a higher propensity to spend. They don’t really create higher purchasing power but simply move the power to those willing to use it.

As I read various stuff on banking… I often see the view that banks can create credit out of thin air. There are vehement denials of the proposition that banks’ lending is limited by their deposits, or that the monetary base plays any important role; banks, we’re told, hold hardly any reserves (which is true), so the Fed’s creation or destruction of reserves has no effect. This is all wrong, and if you think about how the people in your story are assumed to behave — as opposed to getting bogged down in abstract algebra — it should be obvious that it’s all wrong.

 First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand. I hope this isn’t controversial, although given what usually happens when we discuss banks, I assume that even this proposition will spur outrage.

 But the usual claim runs like this: sure, this is true of any individual bank, but the money banks lend just ends up being deposited in other banks, so there is no actual balance-sheet constraint on bank lending, and no reserve constraint worth mentioning either.

             That sounds more like it — but it’s also all wrong.

 Yes, a loan normally gets deposited in another bank — but the recipient of the loan can and sometimes does quickly withdraw the funds, not as a check, but in currency. And       currency is in limited supply — with the limit set by Fed decisions. So there is in fact no automatic process by which an increase in bank loans produces a sufficient rise in deposits to back those loans, and a key limiting factor in the size of bank balance sheets is the amount of monetary base the Fed creates — even if banks hold no reserves.         http://krugman.blogs.nytimes.com/2012/03/30/banking-mysticism-continued/.

As we’ll see, Minsky does not view “banks as institutions that are somehow outside the rules that apply to the rest of the economy, as having unique powers for good and/or evil” as Krugman claims. Yet, according to Minsky, banks do not “lend out” “stashes” of savings, nor is their lending limited by deposits or reserves. Loan officers do not lend out funds on hand; and, yes they do create credit out of “thin air”. The central bank does not limit the currency, so this is not the liquidity constraint faced by banks. Indeed, we’ll see that every statement made by Krugman about Minsky and about the way banks operate is wrong.

For example, Minsky (1960) explains the bank creation of money “out of thin air” in the handout he wrote for his Berkeley students in 1960:

A commercial bank lends by crediting the borrower with a demand deposit and it invests either by crediting the seller of the security with a demand deposit or by writing a check  on itself in favor of the seller of the security. The bank expects that the borrower or the seller of the security credited with a deposit will use their deposit very soon after it is created. This will result in checks being drawn on the initiating bank.

In a banking system with many banks, such as the American Banking System, the expectation is that the checks drawn on any particular bank will be deposited in another bank. The bank upon which the check is drawn must pay the bank in which the check is          deposited the face amount of the check. This payment takes place by transferring reserves   or banker’s money. In an active trading community offsetting claims for payments arise among the banks. Bankers are sophisticated enough to set up a clearing arrangement so    that only the difference between payments from a bank and payments to a bank are made in the form of reserve money. (if a check drawn upon a bank is deposited in the same bank, the entire transaction is internal to the bank: the writer’s account is decreased and the depositor’s account is increased.)

Minsky (1960) goes on to argue that if all banks expand at a rate such that none experiences net losses of reserves through clearing (each gains reserves from deposit of checks drawn on other banks but loses reserves when its own checks are presented at other banks), then there is no limit to their ability to expand loans and deposits—precisely counter to what Krugman believes:

Within a banking system with a stable amount of deposits and distribution of customers, and assuming that no striking changes are taking place in the economy, a particular bank will expect that in the long run the value of the checks written on it and the value of the checks deposited in it will be equal. On the average a bank in such an environment will not have any clearing losses. However there will be random, seasonal and cyclical shifts of deposits among the banks. In order to be able to meet the clearing losses which result from such shifts, a prudent banker will always try to keep some minimum ratio of reserve money to its deposits and will always try to have its portfolio of earning assets so arranged that it can acquire additional reserve money when needed without paying too great a penalty.

Later in the piece he correctly links this need for reserves for clearing with the attempt by banks to maintain a fairly constant reserve to deposit ratio:

From a banker’s perspective, the purpose of the reserve is to enable a banker to meet the clearing drains due to the behavior of secondary depositors. Each banker, to protect his  ability to meet his obligations when due, will set a minimum value to this ratio below   which he does not want to see it fall.

This is NOT because banks lend either reserves or deposits to their loan customers. Indeed, he explicitly looks at the case of the individual bank that receives a deposit, and argues (against the typical textbook exposition) that the single bank does increase the money supply as it increases loans and reserves. For Minsky, reserves are not a “raw material” from which loans are made but rather are held against adverse clearing. Exactly how much needs to be held depends on institutional arrangements. (He goes on to address the US case, which has legal ratios which varied at the time for Central Reserve City Banks, Reserve City Banks and Country Banks, and he deals with the case of nonmember banks holding deposits at the larger Reserve City Banks that were members of the Federal Reserve System.)

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Minsky’s 1960 views hold up quite well. He was writing in a time during which the Fed targeted interest rates, but did not announce the targets. It forced markets to “find” the target, supplying reserves at the discount window and in open market purchases to keep market rates within discretionary bounds unknown to markets. Banks were innovating to get around constraints—for example, by expanding the fed funds market (as discussed in his earlier 1957 article, this economized on reserves), by using “liability management” (encouraging depositors to shift to time deposits with lower reserve ratios), and by shifting deposits and reserves among different classes of banks (which had different reserve ratios).(8) However, Minsky fully recognized the reasons for these actions—to allow banks to meet required reserve ratios and to assure they could clear with other banks and with the Fed. He did not accept a simple deposit multiplier story—indeed, he argued that in the absence of legal requirements banks could if they wanted to expand loans and deposits together without limit.

Minsky understood all these matters in the late 1950s and early 1960s much better than most economists—including Krugman—understand them today.


1.  Particularly Moore (1988) and Lavoie (1985)

2.  The ISLM model uses Keynes’s exposition of “money demand” in Chapters 13 and 15 of the General Theory; most “fundamental Keynesians” adopt instead Keynes’s exposition of liquidity preference theory in Chapter 17. See Wray 2006.

3.  For those arguing that Minsky’s FIH depends on a loanable funds approach, see Lavoie (1983, 1986, 1995, 1996, 1997), Lavoie and Seccareccia (2001), and Parguez (2003); for an argument that Minsky adopts the orthodox deposit multiplier story, see Rochon (2003).

4.  See Minsky 2008(1975) for his classic treatment of the investment finance position. It is clear that he did not suppose that firms rely on commercial banks to finance investment. For example, he argues: “Loans, mortgages, bonds, and shares are the currency business firms use, either directly or indirectly after first exchanging them for money, to buy capital assets from the market, or from new production (i.e., investment).” (p. 104-5) He goes on: “Typically, additional capital assets are acquired partially by own funds and partially by borrowed or outside funds, new-share capital being one class of outside funds.” (105) He invokes “lender’s risk” as the reason that the costs of issuing debt tend to rise as the ratio of debt to assets increases: “Lender’s risk shows up in financial contracts in various forms: higher interest rates, shorter terms to maturity, a requirement to pledge specific assets as collateral, and restrictions on dividend payouts and further borrowing are some of them.” (107) “Lender’s risks do lead to observable patterns of borrowing rates, such as those that appear in the ‘ratings’ put on municipal and corporate debt by various services or the premiums over the prime rate that firms have to pay at banks.” (108) “As lenders and borrowers seek new ways to finance investment, borrowers increasingly, on the margin, will tap sources of funds that value liquidity ever more highly—that is, contract terms on debts will rise. This implies that short-run cash needs due to debts can outrun the cash being generated by the Q’s. This is due mainly to the short-term nature of many boom debts, which require the repayment of principal at a faster pace than the cash generated by the underlying operation permits.” (112) While Minsky probably did not accept the horizontalist approach to commercial bank lending rates, it is clear that none of these explanations of rising lender’s risk violates either the horizontalist approach or the Kalecki equation.

5.  This was later published as Hyman P. Minsky, “Securitization”, Levy Policy Note 2008/2, http://www.levyinstitute.org/publications/?docid=1073.

6.  See here for a discussion and links to Krugman’s pieces: http://www.economonitor.com/lrwray/2013/11/02/what-do-banks-do-what-should-they-do/. See also Scott Fullwiler’s critique of Krugman: http://neweconomicperspectives.org/2012/04/krugmans-flashing-neon-sign.html.

7. See Wray 1992 and also 1990 beginning at page 135 for a discussion of the arguments made by Minsky.

8.  While Minsky did not directly address Krugman’s claim that the central bank still controls deposit creation even in the absence of reserve holdings because it controls the quantity of cash, this is a red herring in any case. Banks hold some cash in vaults and when that runs out, they order more from the Fed. The Fed would be even less likely to refuse to supply cash to meet withdrawals than it would refuse to clear checks among banks. Ensuring par clearing and preventing runs on banks is among the most important functions of a central bank. The Fed’s extensive preparations in advance of 2000’s Y2K demonstrates the Fed’s unquestionable commitment.


Lavoie, M. (1983) “Loi de Minsky et loi d’entropie,” Economie Appliquée, 36 (2–3): 287–331.

—– (1985) “Credit and Money: the dynamic circuit, overdraft economics, and Post Keynesian economics” in Marc Jarsulic, “Money and Macro Policy”, Kluwer-Nijhoff.

—— (1986) “Minsky’s law or the theorem of systemic financial fragility,” Studi Economici, 41 (29): 3–28.

—— (1995) “Interest rates in Post-Keynesian models of growth and distribution,”Metroeconomica, 46 (2): 146–177.

—— (1996) “Horizontalism, Structuralism, liquidity preference and the principle of increasing risk,” Scottish Journal of Political Economy, 43 (3): 275–300.

—— (1997) “Loanable funds, endogenous money, and Minsky’s financial fragility hypothesis,” in A. J. Cohen, H. Hagemann and J. Smithin (eds) Money, Financial Institutions, and Macroeconomics, 67–82, Boston: Kluwer Nijhoff.

Lavoie, M. and Seccareccia, M. (2001) “Minsky’s financial fragility hypothesis: A missing macroeconomic link?,” in R. Bellofiore and P. Ferri (eds) Financial Fragility and Investment in the Capitalist Economy: The Economic Legacy of Hyman Minsky, vol. 2, 76–96, Cheltenham: Edward Elgar.

Hyman P. Minsky. (1959) “Bank Portfolio Determination”, from Hyman P. Minsky Archive, Levy Economics Institute of Bard College 1-1-1959

—–. (1960) “The Pure Theory of Banking”, University of California Department of Economics, Fall Semester, 1960.

—–. (2008) “Securitization”, Levy Policy Note 2008/2,http://www.levyinstitute.org/publications/?docid=1073

Moore, Basil J. (1988) Horizontalists and Verticalists

Parguez, A.  (2003) “The pervasive saving constraint in Minsky’s theory of crisis and the dual profits hypothesis: Minsky as a Post Keynesian Hayekian,” in L.-P. Rochon and S. Rossi (eds) Modern Theories of Money, 475–505, Cheltenham: Edward Elgar.

Rochon, L.P. (2003) “On money and endogenous money: Post Keynesian and Circulation approaches,” in L.-P. Rochon and S. Rossi (eds) Modern Theories of Money, 115–141, Cheltenham: Edward Elgar.

L. Randall Wray. 1990. Money and Credit in Capitalist Economies, Edward Elgar.

—–. (1992) “Minsky’s Financial Instability Hypothesis and the Endogeneity of Money”, inFinancial Conditions and Macroeconomic Performance: Essays in Honor of Hyman P. Minsky, Steve Fazzari and Dimitri Papadimitriou (eds), Armonk, NY: M.E. Sharpe, pp. 161-180.

—–. (2006) “Keynes’s Approach to Money: An assessment after 70 years”, invited paper for symposium in Atlantic Economic Journal, vol 34, no 2, June, pp. 183-193.

—–. (2010) “What Should Banks Do?: A Minskian Analysis”, Levy Public Policy Brief 115, September, http://www.levyinstitute.org/publications/?docid=1301.

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