Lavoie - 1999 - The Credit Led Supply of Deposits and the Demand for Money, Kaldor's Reflux...

5/28/2018 Lavoie - 1999 - The Credit Led Supply of Deposits and the Demand for Money, Kaldor's Reflux Mechanism as Previously Endorsed by Joan Rob

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Cambridge Journal of Economics1999,23, 103113

The credit-led supply of deposits and thedemand for money: Kaldors refluxmechanism as previously endorsed byJoan Robinson

Marc Lavoie*

The purpose of this note is to reconsider the puzzle arising from a theory of endoge-nous credit-money: if the supply of bank credit is the source of bank deposits, whatwould occur when the supply of bank deposits exceeds the demand for deposits?It has recently been argued that changes in interest rate differentials would be theprimary mechanism through which such an inequality could be reduced back toequality. T he argument here is that such a mechanism is a secondary one, akin toKaldors reflux principle, which is itself the primary mechanism, when properly gen-eralised to increases in advances generated by the private, the public, and theexternal sectors, and when reflux is extended to all agents, including households and

banks.

1. Introduction

While all post-Keynesians seem to agree that the money supply is endogenous, a con-siderable amount of literature has arisen discussing the details and the implications of thisview. M y own inclination on this literature, including the issue to be discussed, is thatmost of the disagreements that have arisen are more apparentthan real, and that the dis-cussions reflect differences of opinion or emphasis over what factors should be consideredof primary rather than secondary importance. Whereas previous discussions focused onthe meaning of liquidity preference in a theory of endogenous money (Dow, 1996;Lavoie, 1996), a new issue has been brought to the fore in two recent papers by PeterHowells (Arestis and Howells, 1996; Howells, 1995).1The problem tackled by Howellsarises from the belief among post-Keynesian theorists that loans create deposits. In aneconomy where money deposits are created whenever banks grant advances to agentsrequiring bank loans, how can we be sure that the quantity of money deposits so created isequal to the demand for money of agents?

Howells (and Arestis) basically offer four solutions to this puzzle. Highly simplified,these answers are: (i) the income multiplier, which will increase required transaction bal-ances whenever loans and money deposits have been increased because of additional

Cambridge Political Economy Society 1999

Manuscript received 16 September 1996; final version received 18 August 1997.

*University of Ottowa, Canada. I benefited from comments by Peter Howells and two anonymous refereesof the journal. The usual disclaimers apply.

1 See also Howells (1997) response to Moores (1997) comment. Arestis and Howells (1996), Palley(1996) and also Dow (1996), discuss extensively the correct graphical representation of the supply ofendogenous credit-money, but this difficult issue will not be taken up here.


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104 M. Lavoie

expenditures;1 (ii) Moores convenience lending, which assumes that agents will acceptvoluntarily, although not deliberately, whatever money balances they happen to hold;2

(iii) K aldorTrevithicks reflux principle, through which excess money is extinguishedwhen outstanding overdrafts are paid back; (iv) Arestis and Howellss own mechanism,which relies on changes in interest rate differentials between deposits and bonds, and

between bonds and loans.While Arestis and Howells seem to be in agreement with all of the mechanisms outlinedabovean opinion shared by the present authorthey are inclined to focus on theimportance of relative interest rates (Arestis and Howells, 1996, p. 548), and sometimesput down the reflux mechanism, going so far as to call it a fallacy(Arestis and Howells,1996, p. 546, fn. 5). T he intent of the present note is twofold: first, I wish to show that theproblem tackled by Arestis and Howells can be found in some of the previous literature,and that the novel solution they propose is not in conflict with the reflux principle; second,I want to establish the reflux principle as the primary mechanism through which the

deposits arising from bank advances are equated to desired money balances. In doing so,we shall see that K aldors reflux mechanism had been put to the forefront by anothermajor member of the Cambridge SchoolJoan Robinson.

2. Loans make deposits

The issue brought up by Arestis and Howells, and the various authors they mention, wasfirst formally stated by Richard Coghlan (1978). While agreeing with the idea that reservesand the supply of money are endogenousbecause banks grant advances and hencecreate deposits, worrying about high-powered money laterCoghlan denies that the

stock of money is demand-determined. For Coghlan (1978, p. 16), such a conclusion is toconfuse the demand for money with the demand for credit. Just as Arestis and Howells do,Coghlan claims that it is the demand for loans (or for bank advances) which drives thesupply of money. Simply put, Coghlan has the following model:

A DMd C DC bDMs (1 b)A

where Dare deposits, Cbank notes, ba parameter, Ms

the money supplied, and wherebank advances A are the exogenousterm.3 Note that the high-powered money of thissimplified model, the bank notes C, is an endogenous variable, as are the bank depositssuppliedD.

But then, Coghlan (1978, p. 17) continues, the possibility must exist that bank depositscan grow beyond the desires of money holders. There could be an excess supply ofmoney.4 While Coghlan recognises that such a situation could arise for some time withoutany other adjustmentbecause of convenience lending or buffer stockssome equilib-

1This mechanism is discussed in more detail in Cottrell (1994) and Dalziel (1996).2

An additional answer, Laidlers buffer stock theory, essentially says the same, at least for the short-run.3The model can be made more complicated at will, without changing its structure, as in Palley (1996,p. 5967).

4 As Coghlan (1978, p. 18) puts it: The money is accepted but not necessarily demanded. T he same pointwas made by Chick in the 1990s, as quoted by Howells (1995, p. 95), but she had put the question as early as1983: No one asked the holders of the new deposits whether they wanted a larger aggregate money supply.. . . No one refuses payment for a sale just because the source of the payment is an overdraft. . . . But inaggregate there is now a larger quantity of money than before which no one intendedto accumulate. In thatsense it could be said to be forced (Chick, 1983, p. 237).


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The credit-led supply of deposits and the demand for money 105

rium mechanism will eventually be set in motion. The process of adjustment can beaffected markedly by changes in the interest rate paid on deposits relative to the returnavailable on competing assets . . . The banks can induce an increase in the demand formoney which may at least partially eliminate any potential excess supply (ibid., p. 20). AsCoghlan points out, banks are adjusting their liabilities, not their assets.

A very similar problem, with a very similar solution, is offered by David L lewellyn(1982) in his flow-of-funds analysis. L lewellyn (1982, p. 65) derives a similar algebraicmodel of the supply of the money, where the latter depends on the amount of bankadvances: The money supply becomes a function of the volume of bank loans that thebanks find it profitable to meet. If a discrepancy arises between the demand for and thesupply of money, changes in interest differentials will do the trick. T he banks response toan excess demand for bank loans is to bid for funds by raising interest rates on deposits. Bywidening the differential between the interest rate on bank deposits and, say, governmentbonds, banks seek to induce an increase in the demand for money (bank deposits).1 As

Llewellyn points out, this is the so-called li abil ity management. The initiative belongs tothe banks. Interest rates on deposits are raised to induce agents to hold on to the bankingdeposits previously created as a result of new loans.

While tackling similar issues and giving similar answers, Arestis and Howells (1996)focus instead on the decisions of non-financial agents. T he attempts by firms and house-holds to reduce money balances cannot be successful in the aggregate, unless bank loansare repaid. However, the attempts by agents to dump their money balances will reduceyields on bonds, and induce households or firms to hold the additional deposits volun-tarily. Another way to look at it is the following: assuming that portfolio decisions are

related to relative amounts, as agents try to shift their financial wealth towards bonds, theprice of bonds rises, and hence the ratio of money balances to the value of bond holdingsdecreases.2

Arestis and Howells, however, provide an additional mechanism based on interest ratedifferentials. They argue that changes in these differentials will modify the behaviour ofborrowers, and hence change the (relative) amounts of funds acquired through directbank loans and through the emission of securities. When deposit holders desire lessmoney balances, their decisions to purchase bonds or similar financial assets lead to areduction of the yields on bonds compared to lending rates. As a result, Arestis and

Howells (1996, p. 548) say, firms will increase their use of bond finance, and reduce therecourse to bank lending, thus helping to wipe out the excess money supply in the process.In the next section I intend to show that the above process based on interest rate dif-ferentials, which Arestis and Howells call the novelty of their approach, is akin to theKaldorT revithick reflux process.

3. The reflux of money: a common-sense approach

The problem with Coghlans and Llewellyns algebraic models is that they do not take

into account the reflux mechanism. They are partial equilibrium analyses. The out-1 Most likely there is a misprint here: L lewellyn probably means that reducingthe (usually positive)

differential between the rate of return on bonds and the interest rate on deposits would induce an increase inbank deposits. As Godley and Cripps (1983, p. 160) point out, Rates on interest-bearing bank deposits mustbe lower than bond yields (otherwise neither the public nor banks would want to hold bonds). See Godley(1998) for a recent restatement.

2This is the crux of the mechanism used by Wray (1992, p. 71): in his obvious notations, the ratioM /pBBwill decrease, aspBrises.


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standing stock of bank advances and the demand for bank deposits cannot be consideredto be independent variables. Such a point of view is based on the analysis of the monetarycircuit (Graziani, 1990; Lavoie, 1992, pp. 15169).

The circuit of a monetary or entrepreneur economy starts out with the productiondecisions of firms. For these decisions to be realised, initialfinance (working capital) must

be provided by the banking sector. Bank loans or advances are usually this initial finance.When firms pay out wages and other costs, bank deposits are transferred to households,who may either consume or save their incomes. In the former case, the deposits of firmswill be replenished. In the latter case, households may either purchase bonds and otherfinancial assets, or they may decide to keep their savings in the form of money (bankdeposits). Looking at it from this angle, whenever households are remunerated as a resultof the producing activities of firms, they always wind up with some undesired moneybalances.1 But most households usually intend gradually to decrease these money bal-ances by purchasing goods and services. In the meantime, they offer (Moores 1988)

convenience lending. When the goods are purchased from firms, these firms use thereceipts to reduce the amounts which they have borrowed from the banks. T his is wherethe KaldorTrevithick reflux mechanism comes into play. Hencefinaladvances are not anindependent variable, as is assumed in the algebraic model of Coghlan and others. Ashouseholds get rid of undesired deposits, advances will be paid back, so that they decreasepari passuwith the decreased stock of money held by households. The gross flow of advancesand hence the flow of money depends on the demand for credit of firms, but the stock of advancesand of money deposits depends in additi on on the port folio behav iour of all agents.

When Arestis and Howells (1996, p. 546) allude to the KaldorT revithick mechanism

as a fallacy, they refer to Victoria Chick and Allin Cottrell. T heir objection to the refluxmechanism is that not every agent, notably households, has an overdraft. The aboveclearly shows that this objection is a rather weak one. M ost of us do not have auntsdropping money from a helicopter, as assumed by Charles Goodhart in an example takenup by Howells (1995, p. 99). Our money balances are acquired from our earnings, and wetend to spend most of them.2 Between the beginning and the end of the week, or betweenthe beginning and the middle of the month, we do not compare asset yields to decidewhether or not we should shift our cash balances out of banks (this is Moores con-venience lending). Even if households have saved none of their income by the end of the

month, spending their monthly earnings continuously during the month, monetary aggre-gates will show money stocks equal to half the value of monthly earnings. When house-holds disburse their money balances, the banking deposits revert to firms, all or most ofwhich owe money to banks. I f firms do not wish to hold money balances, they can usethem to extinguish part of their bank borrowing, and both the advances and the moneydeposits will vanish.3

But assuming that households hold no lines of credit is already granting too much to theopponents of the KaldorTrevithick mechanism. Several individuals, like myself, hold

1

For this reason, it is difficult to imagine a situation of deficient money balances, in contrast to excessmoney balances, within the monetary circuit.

2 Households save, but, as argued by Marglin (1984, ch. 7, pp. 17, 18), most household savings are com-pulsory or involuntary (compulsory pension schemes, residential mortgage payments).

3 It is interesting to note that while the financial savings of American households represent only 25% ofprivate financial savings, corporations owning the remaining part (Marglin, 1984, p. 427), these same house-holds hold 64% and 90% of M1 and M2 money balances (Mankiw and Summers, 1986, p. 417). This wouldindicate that there is some merit in the stylised hypothesis that firms use their income to pay back advances,holding little money balances either for the finance motive or for precautionary reasons.


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lines of credit, whereby ones banking account can go in the red up to a maximum agreedfigure.1 When the line of credit is being drawn, any deposit made into my bankingaccount, say by my employer, is automaticallyapplied to a reduction of my overdraft. Ineed not take any decision. My overdraft is routinely extinguished, and I presume thesame occurs in the case of many firms. Of course, the same mechanism occurs without

overdrafts strictly defined: nowadays, ordinary loans can also be reimbursed or partiallyreimbursed before they must be rolled over, even mortgages.2

Theorists of the monetary circuit believe that any excess supply of money would beautomatically extinguished through reflux. While not objecting to the KaldorT revithicks reflux mechanism per se, Howells (1995, pp. 934), and Cottrell (1986, p.17) before him, object to theautomaticityand thecompletenessof this mechanism. Althoughthe two positions appear to be impossible to reconcile, they can be harmonised. This canbe seen by realising that theorists of the monetary circuit often make the following implicitassumption: firms will issue new bonds whenever households wish to keep part of their

newly acquired money deposits in the form of bonds or other similar financial assets.Under these condi tions, it is clear that the sale of new securities provides funds to theinvesting firms that can be used to retire their original loans, and this reduces the stock ofcredit money by this amount (the Kaldor effect) (Dalziel, 1996, p. 316).3 Hence, in aclosed economy without government, the stock of deposits willingly detained by house-holds isnecessarilyequal to the consolidated amount of loans to the firms (Lavoie, 1992, p.156). In other words, finalfinance obtained by issuing securities will allow firms toreimburse temporary construction finance, i.e., bank loans (Davidson, 1992, p. 49).

The novel mechanism described by Arestis and Howells is thus almost identical to the

one described above. For the circuitists, the flow of funds being brought to the bondmarket or to the stock market will persuade firms to sell new bonds and new shares; whenhouseholds desire to hold more of their wealth in the form of bonds or shares, firms sellsecurities or shares, and are able to reduce their debt ratios. Arestis and Howells provide apricing mechanismchanges in relative asset yieldsthrough which this kind of refluxcould occur. When households desire to hold more of their wealth in the form of bonds,the induced fall in the cost of bond financing will coax some firms to sell new bonds. Thefunds flowing to firms should allow them to repay part of their outstanding loans.

The fact that we here have two compatible ways to describe the same phenomenon is

reinforced by the following statement from Arestis and Howells (1996, p. 549): Our viewof the change is that the demand for bank lending falls at the going (lending) rate ofinterest. This does not mean that deficit units repayloans, thus reducing the absolute sizeof deficits. We were dealing with a world in which flowsof funds are positive. Such astatement could equally have been made by a partisan of the reflux mechanism: if therequirements in working capital are gradually increasing, a change in portfolio preferencestowards bonds will not induce a net repaymentof bank loans; rather it will induce a slow -

1 Howells (1995, p. 96) himself discusses the case of households who borrow from banks to purchase

securities. T hose who sell their shares may also use the proceeds to reimburse loans previously taken to buyshares.

2 Smaller firms which do not have automatic access to credit lines may prefer to hold on to their liquidities,either in the form of deposits or in the form of bonds, fearing to be unable to obtain loans in the future.

3 T he final step of this elementary analysis of the monetary circuit is to consider the fact that households donot keep all of their savings under the form of money deposits. Households buy some financial assets, eitherbonds or shares, which are issued by the non-financial corporations. T he firms thus manage to directly gethold of a portion of the savings of households . . . The direct placements of households into firms will furtherallow the latter to reduce their borrowing from banks (Lavoie, 1992, p. 155).


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downin the amounts which need to be borrowed from banks.1 By contrast, when therequirements in working capital are constant, then the novel mechanism described byArestis and Howells indeed implies that deficit units repayloans. As Dalziel points out inthe quotation above, we are back to a variant of the Kaldor reflux mechanism!

4. The reflux of money: some perspective

On a number of occasions Arestis and Howells (1996) wonder whether Basil Moore orother horizontalists would object to their description of changes in interest rate differ-entials as the means to equate credit and deposit demand. Moore believes that thisanalysis, while correct, is of secondary rather than of primary importance.2 Thiscorresponds also to previously expressed views on portfolio preferences: I t is clear thatdifferentials in the level of remuneration between private bonds and bank deposits willaffect the distribution of household wealth between bonds and deposits, unless house-

holds require money solely for transaction purposes. T he effects are not essential, ingeneral, compared to the initial creation of credit money (Lavoie, 1992, p. 156). No onedenies that interest rate differentials and the behaviour of economic agents based on thesedifferentials has some relevance. In contrast to what Thomas Palley (1994, p. 76) hasclaimed, horizontalists recognise that the choice of the composition of assets and liabilitiesplays a relevant role; this role, however, is a subsidiary one. The role is secondary both intheory and in historical time, for production is made possible by the flow of credit-moneyprovided by the banking sector in the first place. Portfolio decisions about new flows ofsavings come at a later stage. In the case with which we are concerned, I believe that most

of the adjustment between the creation of deposits and the demand for deposits is donethrough the reflux mechanism.

As is well known, the reflux mechanism has a long intellectual history, which can easilybe brought back to T ooke and the Banking School. Besides Kaldor and T revithick (1981),the reflux mechanism has been invoked by a number of modern authors, includingrepresentatives of the free banking school, such as Fisher Black (1970, p. 18), as well asnon-orthodox authors such as Arestis himself:

The endogeneity character of the money supply implies that there can never be an excess supply ofmoney. T he recipients of such an excess would use it to diminish their liabilities so that theexcess is extinguished as a result of the repayment of bank debts. This argument explains the post-Keynesian contention that government deficits and favourable balance of payments have no directeffects on the creation of money. For any money thus created is completely compensated by anequivalent reduction in credit money. (Arestis, 1988, p. 65)3

Thus it does not matter whether advances have been granted to the private sector, togovernment or to foreign borrowers. In all cases the law of reflux applies. Among thosewho have given their support to the reflux principle, Jacques Le Bourva has emphasised anumber of times that there cannot be any excess supply of money, putting aside for now

changes in desired household portfolios. In 1959, L e Bourva wrote: Given that banks1 Or as Moore puts it to me in personal communication (December 1994): Gross loan repayment pro-

ceeds continuously. I t is quite consistent with net loans outstanding increasing, if net new loans are positivewhen income and transactions rise.

2 In a personal communication, December 1994. L ately, Moore (1997, p. 427) seems to take a harder line,arguing that the correct answer is thatno reconcili ation i s necessary, because there is no independent demandfor deposits to be reconciled.

3 An almost identical statement can be found in Arestis and Eichner (1988, p. 1018).


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exist only in so far as entrepreneurs are indebted to them, the quantity of money canalways be reduced by repaying loans without borrowing anew; in other words, only desiredmoney can exist (Le Bourva, 1992, p. 452). This point is further extended in a later paper,published in 1962, although, strictly speaking, it only deals with bank notes: Could thecentral bank, then, set the circulation of notes at a level that is higher than the needs of the

economy? If it issued excess notes, these would revert back to it through deposits to banksand repayments of loans fallen due. However, this very idea is ludicrous since the centralbank lends only upon demand (Le Bourva, 1992, p. 457).1

But, as pointed out above by Arestis, the compensation principle applies to other cir-cumstances. With respect to a favourable balance of payments, Le Bourvas argument in1962, now known in France as the compensation principle, was the following:

Is it not more correct and simpler to say that when regular banks receive foreign currencies, theycreate a corresponding amount of bank money, and that they then bring these foreign currencies tothe central bank, thereby obtaining a portion of the notes they need, which obviates the need for

using the other processes up to this amount? . . . I t is well known that compensations operate amongthe various means which the banks can resort to in order to obtain notes. Moreover, notice that aninitial compensation occurs in the accounts of productive businesses before doing so in those offinancial establishments. I f the businesses obtain the funds needed for the payments of their meansof production by foreign and not domestic sales, they present foreign currencies instead of regularbills of exchange to their bankers. (Le Bourva, 1992, pp. 4623)

Similarly, with respect to government deficits, Le Bourva made the following point in1962:

Likewise, when theTreasuryhas to obtain advances from the Bank of France in order to settle Statedebts, this money then flows into the accounts which regular banks have at the Bank of France . . .This phenomenon has no other effect on money-creation as a whole. When they receive the money spentby the State, its creditors will be able to reduce their recourse to other processes of financing, andpossibly repay their debts to the banking system or even underwrite T reasury bills in the context of asmoothly operating circuit of public finances. Be that as it may, since the banks already have thepossibility of obtaining notes, in so far as they are developing their loans, by applying directly to theBank of France, since these loans are limited not by the possibilities of converting bank money intofiduciary money, but only by the demands of borrowers with sufficient collaterals, since, in short, thequantity of money can already adapt to the demand, the introduction of a source of money to thebenefit of the State does not alter the total money supply, but only the way it is distributed among its

counterpart entries. (L e Bourva, 1992, pp. 4634)

The above statements show the importance and the extent of the reflux mechanismunderlined by Kaldor and Trevithick (1981).2The reflux mechanism does not only applyto the bank overdrafts of firms: it applies to the advances made to households, govern-ments and foreigners, and to banks alike. The reflux mechanism and the compensationprinciple, which are based on income effects rather than marginal substitution effects,extend to all levels in an entrepreneurial economy or in a monetary production economy.

1The same argument is made by Le Bourva in his 1952 dissertation: Ce retour la structure ancienne de

la masse montaire se ralisera au fur et mesure que les particuliers effectueront des dpenses de consom-mation. Les billets excdentaires rentreront alors dans les caisses des commerants, qui les dposeront dansles banques dont ils sont clients. Or les banques nont aucune raison de conserver les billets, puisque ceux-cine portent pas intrt, elles les dposeront par consquent la Banque de France, amenant ainsi unerduct ionde la circulation fiduciai re (1953, p. 239).

2The part of Le Bourvas quote about bank loans being limited only by the demands of borrowerswithsuff icient collaterals reminds us that horizontalists have long been aware of the existence of credit rationing andthe importance of credit worthiness, as recently emphasised by, for instance, Dow (1996) and Wolfson(1996).


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Needless to say, this does notimply that portfolio and interest rate effects are irrelevant;they are simply subsidiary.

5. Joan Robinsons reflux principle

It was pointed out in the introduction that Joan Robinson gave extensive support toKaldors reflux mechanism.1This might be a surprise to some, although Robinson is wellknown for having endorsed a theory of endogenous credit-money in various writings(Robinson 1952, pp. 29, 807; 1970). Robinsons analysis of the reflux mechanism is tobe found in The Accumulat ion of Capital. In her chapter 23 on money and finance,Robinson sets up a model of the monetary circuit where the notes now circulating cameinto existence as the results of loans from the banks to entrepreneurs, who pay out wagesin advance of selling the goods which the workers produce (Robinson, 1956, p. 226). Inthis set-up, which resembles that of the monetary circuit, the advances to firms are dis-

counted bills, and bank notes play the role of the deposits of Howells or of those ofCoghlan. For Robinson, just like Le Bourva and Kaldor, there can never be an excesssupply of money. When reading the following quote, recall that in Robinsons scheme theM1 money stock consists of bank notes only, since both transactions by cheques andhoarding of notes are excluded ( ibid., p. 234).

When an entrepreneur requires, for making payments in the near future, more notes than have cometo hand from recent receipts, he can discount a bill; and when he finds himself with more than heneeds, he reduces his outstanding bills (in order to save interest) by paying off, with notes, those that

are falling due and not renewing them. T he notes then return to the banks. T hus the quantity ofnotes outstanding is continuously being adjusted to the requirements of the circulation. (Robinson1956, p. 227)

One could object, as Cottrell, Chick and others do, that all agents in the economy donot have outstanding debts. T his case is taken into account by Robinsonin two stages.First, workers are considered. They are assumed to hold on to their money balances,without attempting to get rid of them, thus behaving in accordance with the conveniencelending assumption which so many of us, too poor to save beyond our mortgage paymentsor our compulsory pension scheme, entertain in real life: On an average day workers arein possession of notes equal to about half of a weeks wages bill (somewhat less or some-what more according to whether they spend more or less on the earlier than the later daysof the week) (Robinson, 1956, p. 228). Once all money balances have been spent, entre-preneurs are in a position to reimburse their loans. But what if some entrepreneurs haveno advances to pay back any more (for instance, because they are accumulating amor-tisation funds to be expended in the future on a new factory)? This case is also consideredby Robinson. She regards banks as being engaged in two sorts of business: the lendingbusiness, by discounting bills and offering notes; and a financial intermediary business, byborrowing funds and accepting deposits, or eventually by purchasing bonds.

1 One of the referees pointed out to me that Kalecki, who had such an influence on Robinson, alsoendorsed some version of the reflux principle. T he clearest passage I found was the following: Imaginons parexemple que, au cours dune anne, certains capitalistes . . . empruntent la banque dmission, et quilsaffectent les sommes mises leur disposition la construction de capitaux fixes additionnels. Au cours decette mme anne, ce montant sera vers dautres capitalistes sous forme de bnfices . . . et affect auremboursement de dettes envers la banque dmission. Le circuit se trouve ainsi ferm (K alecki, 1935,p. 298).


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As well as issuing notes, the banks borrow from savers by accepting deposits. T hey are repayable atshort notice . . . Under these arrangements a saver who is unwilling to take up bonds, and does nothave outstanding bills of his own to retire, can make a deposit, losing the difference of interestbetween the deposit rate and the bond rate . . . The banks enlarge the scope of their lending bybuying bonds, receiving the difference between the bond rate and the deposit rate as earnings on thebusiness. (Robinson, 1956, p. 234)

From the definition of deposits here given by Robinson, it is evident that certificates ofdeposits (CDs) would be the modern equivalent of Robinsons deposits. If Robinsonssavers want to hold certificates of deposits, rather than M1 money balances, this shouldhave no effect on the reflux mechanism: notes will be extinguished anyway. Now considerthe case where savers desire bonds in exchange for their excessive bank notes. As pointedout in great detail by Arestis and Howells, some marginal change in yield differentials isrequired to induce some other party to agree to hold certificates of deposits instead ofbonds, and in exchange of cash. T his change in interest differential need not occur, how-

ever, if banks decide to sell to these savers some of the bonds they hold as assets. In thislatter case, the excess notes (or money balances) will be wiped out as well.1

Thus Moores argument, endorsed by Arestis and Howells (1996, p. 546), i.e., indi-viduals moving out of money does not destroy deposits in the aggregate except in the caseof debt repayment, isnotentirely correct. If households get rid of their money balances bypurchasing bonds from banks, money deposits will be destroyed in the aggregate. T his waspointed out by Kaldor himself in his defence of the reflux principle: The excess supplywould automatically be extinguished through the repaymentof bank loans, or what comesto the same thing, through the purchase of income yielding financial assets from the

banks (Kaldor, 1983, p. 21). Hence the purchase of bonds from banks is almost astraightforward variant of Kaldors reflux principle.2

6. Conclusion

The purpose of this note was to reconsider the puzzle arising from a theory of endogenouscredit-money: assuming that the supply of bank credit is the source of bank deposits, whatwould occur if the supply of bank deposits were to exceed the demand for deposits?Howells (1995) and Arestis and Howells (1996) have argued that changes in interest ratedifferentials are an important mechanism through which such an inequality could bereduced back to equality. My argument has been that such a mechanism, althoughperfectly reasonable and technically correct, is more likely to be a second-order effect, afterconvenience lending and the reflux mechanism have played their role. I t has been furthershown that the novel mechanism described by Arestis and Howells may be considered as avariant of the reflux mechanism, where asset yields play a role. Hence, whatever the stanceone wishes to take, the primary mechanism through which the supply and the demand fordeposits become equal is the generalised reflux principlea mechanism defended by bothKaldor and Robinson. T his reflux mechanism applies when agents reimburse their debt,

1The above analysis thus allows Robinson (1956, p. 234) to conclude in the following: The banks have nodirect control over the amount of note circulation [money balances]. I f they issue more notes than arerequired for use as a medium of exchange, the excess returns to them as deposits [certificates of deposits] or incancellation of bills. But they can influence the amount of deposits [CDs].

2 Almosta straightforward variant, since, as was pointed out to me by one of the referees, it could be arguedthat a change in bond prices would be required to induce the banks to sell some of the bonds they hold asassets.


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when they purchase bonds from firms and induce them to issue new securities, and whenagents purchase bonds from banks.

It turns out after all that there is no real disagreement on the relative importance of thereflux mechanism among post-Keynesians. Moore maintains that monetary expansionnecessarily provokes changes in relative market interest rates, which impact back on both

the demand for bank loans and bank deposits, but that this process, while correct andwhile it undoubtedly occurs, is of only secondaryimportance.22 Howellss latest view isthat the reflux mechanism takes care of much of the case and that the bulk of newlending is willingly held. He agrees with the claim that the reflux mechanism is theprimary mechanism, insofar as there is some role left for interest rate differentialsarestriction which is certainly cogent.23

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