Monetary policy rules in the context of endogenous money and financial instability

The endogenous money approach supposes that commercial banks and the central bank are both “passive” players in the money creation process. The central bank can determine money supply indirectly through interest rates which affect economic and investment activity and money demand, to create money supply. Supposing that the causality leads not from the amount of money in the economy to investment and economic activity but the other way round, this leads to balancing demand and supply of money on the money market through multiplication effect of creation noncash money directly connected with providing loans.

Post-Keynesian theories regard developed capitalist economies as internally unstable. A very important indicator of instability and uncertainty are changes in velocity of money. If the changes in economic and investment activity reflect in demand for money to which the money supply adapts using creation of noncash money, the changing velocity of money is a mechanism balancing money market. This indicator bears important information for monetary policy rules estimation and implication.

The authors focus on the role of interest rate rules estimation and its stability during the crisis period. The empirical part of the paper applies conventional VECM with known cointegration vector and a linear trend in the cointegration relation, where the long-term connection of money and economic (investment) activity is developed in the quantity theory of money.