Discussion Paper

No. 2012-61 | December 04, 2012
Money Creation and Financial Instability: An Agent-Based Credit Network Approach


The authors pick up the standard textbook approach of money creation and develop a simple agent-based alternative. They show that their model is well suited to explain the endogenous creation of money. Although more general, their model still contains the standard results as a limiting case. The authors also uncover a potential instability that is hidden in the standard approach but easily recognized within a strict individual-based and stock-flow consistent version. They show in detail how individual interactions build up systemic risk and how banking crises are triggered by the maturity mismatch of different cash-flows and spread by the depreciation of non-performing loans (e.g. interbank or government debt).

Paper submitted to the special issue
Economic Perspectives Challenging Financialization, Inequality and Crises

JEL Classification:

C63, E42, E51, G01


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Cite As

Matthias Lengnick, Sebastian Krug, and Hans-Werner Wohltmann (2012). Money Creation and Financial Instability: An Agent-Based Credit Network Approach. Economics Discussion Papers, No 2012-61, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2012-61

Comments and Questions

Anonymous - Referee Report 1
January 07, 2013 - 11:48

see attached file

Matthias Lengnick, Sebastian Krug, and Hans-Werner Wohltmann - Reply to referee report
January 29, 2013 - 10:39

see attached file

Michael Roos - Referee Report 2
January 29, 2013 - 15:26

Please see attached file.

Matthias Lengnick, Sebastian Krug, and Hans-Werner Wohltmann - Reply to referee report 2
March 05, 2013 - 09:16

see attached file

Anonymous - Referee Report 3
February 07, 2013 - 09:28

The paper presents an interesting agent based model in which households and firms are connected in a network endogenously generated by their behavioural rules. The model is extremely simple but nevertheless is able to capture the role of interbank lending in creating a financially fragile macroeconomic environment. The paper is ...[more]

... skilfully written. The introduction well frames the present contribution within the agent based literature and the model is effectively presented. It is also effective in stressing the relevance of microfoundation in the SFC approach. The simplicity of the model is at the same time its beauty and its limit. Some assumptions are clearly unrealistic and limit the ability of the model of identifying policy measures to stabilise the financial system (as for example the absence of an interest rate). One way to overcome this limit would be transform one of the (many) stochastic variables into parameters that can be influenced by the policy maker (for example the duration of loans). Other assumptions may leave the impression that the results necessarily come from the ad-hoc setting (as for example the neutrality to risk implicit in the borrowing behaviour of households and banks). I completely agree with the authors that also in mainstream models the foundational assumptions are ad-hoc. But, as proposers of non-orthodox approaches, we are somehow condemned to show that we can do better. In this respect the author may want to confront their approach with the one in Ussher ( A Speculative Futures Market with Zero-Intelligence, Eastern Economic Journal, 2008) with which it shares some features. A final remark about the use of the term “endogenous money”. The post-Keynesian literature, within which the SFC approach has been developed, refers to endogenous money (and credit) as the generation of deposits that is driven by the demand for credit. In other words, in that approach the supply of credit is infinitely elastic at the current interest rate and it is the demand by the borrowers that actually defines the credit market (see for example: Lavoie, Endogenous Money in a Coherent Stock-Flow Framework, Levy Institute working paper 325). In the paper at hand the mechanism is still supply driven (textbook approach in the authors’ words). In this sense the reference to Minsky and Godley and Lavoie is not appropriate in my opinion.

Matthias Lengnick, Sebastian Krug, and Hans-Werner Wohltmann - Reply to referee report 3
March 05, 2013 - 09:17

see attached file

Marco Raberto, University of Genova - Co-Editor´s remarks
April 03, 2013 - 09:39

I think that the major contribution of the paper is twofold:

1. an agent-based micro-foundation of the money multiplier 2. an example of endogenous instability arising through the interbank market

I think that both contributions are interesting and deserve publication, provided that the authors provide a better details ...[more]

... along the lines suggested by the reviewers.

In particular, concerning contribution #1, I think that micro-founding the money-multiplier, although often criticized and unrealistic, is not necessarily a bad research goal and it may be an interesting result, indeed.
Again using very simple behavioural rules is not necessarily a weak point but may emphasize the importance of structural assumptions, that indeed play a very important role in a SFC framework,. In this respect, however, the authors should clarify how (and indeed if) their "Endogenous Creation of Money" (as stated by the title of section 4) differentiates from the endogenous money theory of the post-Keynesian tradition.
To gain some insights about the post-Keynesian endogenous money approach in an AB macro-model, the authors may refer to Teglio et al. (2012).
Furthermore, a recent discussion about the fractional reserve banking system (the cause of the money multiplier) and about the mechanisms of banking can be founded in Mallet (2012).

Concerning contribution #2, I think that the research agenda proposed by the authors in their replies to the three referees, and in particular the introduction of a safe asset for banks and of repo operations, could strongly enrich the paper and motivate publication.

Finally, the English is fluent but there my typos in the text that need be addressed by the authors.

Teglio A., Raberto M., Cincotti S. (2012)."The impact of banks' capital adequacy regulation on the economic system: an agent-based approach", Advances in Complex Systems, vol 15 (supp2).
Mallet J. (2012). "What are the limits on comemrcial bank lending?", Advances in Complex Systems, vol 15 (supp2).